FSTB Concludes Landmark Consultation on New Licensing Regime for Virtual Assets Services Providers

FSTB Concludes Landmark Consultation on New Licensing Regime for Virtual Assets Services Providers

FSTB Concludes Landmark Consultation on New Licensing Regime for Virtual Assets Services Providers 1400 788 Basil Hwang

After a three-month consultation (see our previous news update here) on the legislative proposal to introduce a new licensing regime for virtual asset services providers (“VASPs”) with an objective of enhancing anti-money laundering and counter-terrorist financing (“AML/CTF”) regulation in Hong Kong, the Financial Services and the Treasury Bureau (“FSTB”) published its consultation conclusion on 21 May 2021.

In general, the proposal has received broad support from respondents, who expressed understanding of the importance of regulating VASPs in fulfilment of the obligations outlined by the Financial Action Task Force (“FATF”). Other than the supplementary clarifications and minor adjustments made to the initial proposal, there are no significant changes to the proposed licensing framework. The Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”) amendment bill will be introduced into the Legislative Council in the 2021-22 legislative session.

A. Scope and Coverage of the Regulated Activity

Any person seeking to operate a virtual assets exchange (“VA Exchange”) in Hong Kong will be required to apply for a licence from the Securities and Futures Commission (“SFC”) as a licensed VASP under the AMLO. The licence granted will be one of an open-ended nature (i.e. licence will remain valid until revoked by the SFC). The definitions of the scope are provided as follows:

VA Exchange

Any trading platform operated for the purpose of allowing an offer or invitation to be made to buy or sell any money or virtual asset (“VA”), and which comes into custody, control, power or possession of, or over, any money or any VA at any point in time during its course of business.

This definition excludes peer-to-peer trading platforms (i.e. platforms merely providing a forum for buyers and sellers of VAs to post their bids and offers) in which

(i) the actual transaction is conducted outside the platform; and

(ii) the platform is not involved in the underlying transaction by coming into possession of any money or any VA at any point in time.

Virtual assets (“VAs”)

A digital representation of value that

(i) is expressed as a unit of account or a store of economic value;

(ii) functions as a medium of exchange accepted by the public as payment for goods or services, discharge of debts or investment purposes; and

(iii) can be transferred, stored or traded electronically.

The definition of VAs applies equally to stablecoins, and is irrespective of the purported form of underlying assets.

Exemptions include:

(i) digital representations of fiat currencies (i.e. central banks digital currencies, such as digital yuan);

(ii) financial assets already regulated under the Securities and Futures Ordinance (Cap. 571);

(iii) stored value facilities already regulated under the Payments Systems and Stored Value Facilities Ordinance (Cap. 584); and

(iv) closed-loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible in nature (e.g. air miles, credit card rewards, gift cards, customer loyalty programmes, gaming coins and etc.).

FSTB noted the evolving landscape of VA activities, and recommended that flexibility be built into the licensing regime such that it may be expanded to cover forms of VA activities other than VA Exchanges, shall they arise in the future.

B. Licensing Requirements

Eligibility

To be eligible for a VASP licence, an applicant must either be:

(i) a Hong Kong-incorporated company with a permanent place of business in Hong Kong; or

(ii) a non-Hong Kong-incorporated company registered in Hong Kong under Section 776 of Part 16 of the Companies Ordinance (Cap. 622).

Natural persons or business establishments without a legal personality will not be eligible for a licence.

Fit-and-Proper Test

An applicant must pass a fit-and-proper test, which involves considerations of the following factors:

(i) whether the person has been convicted anywhere of a money laundering and terrorist financing (“ML/TF”) offence or other offence in which the person is found to have acted fraudulently, corruptly, or dishonestly;

(ii) whether the person has failed or may fail to observe the AML/CTF, or other regulatory requirements applicable to licensed VASPs;

(iii) the experience and relevant qualifications of the person; and

(iv) whether the person is of good standing and financial integrity.

At least two responsible officers must be appointed by the applicant to assume the general responsibility of ensuring compliance with AML/CTF requirements under the AMLO.

C. Regulatory Requirements

A licensed VASP can only offer services to professional investors (i.e. individuals with investment portfolios worth over HKD 8 million or companies with total assets of no less than HKD 40 million) due to the highly speculative nature of VA activities. Retail investors are prohibited from trading cryptocurrencies at the initial stage of the licensing regime.

Other prescribed regulatory requirements are concerned with (i) financial resources; (ii) knowledge and experience; (iii) soundness of the business; (iv) risk management; (v) segregation and management of client assets; (vi) financial reporting and disclosure; (vii) prevention of market manipulative and abusive activities; and (viii) prevention of conflicts of interest.

Detailed regulatory requirements will be published by the SFC before the commencement of the licensing regime to provide more guidance on the regulatory expectations.

D. Exemption and Prohibition

A VA Exchange already regulated and supervised by the SFC as a licensed corporation under the voluntary opt-in regime will be exempted from the VASP licensing requirements.

The licensing regime offers a 180-day transitional period (starting from the commencement of the regime) to facilitate application by interested parties.

In the interest of investor protection, persons who are not licensed VASPs are prohibited from actively marketing (whether in Hong Kong or elsewhere) a regulated VA activity to the public.

E. Scope of Powers of the SFC under the Licensing Regime

The SFC is empowered to supervise the AML/CTF conduct of the licensed VASPs, as well as to enforce other regulatory requirements in accordance with the AMLO stipulations. This will include the power to:

  1. enter business premises of the licensed VASP and its associated entities for conducting routine inspections;
  2. request the production of documents and other records;
  3. investigate non-compliances and impose administrative sanctions (including reprimand, order for remedial actions, civil penalty and suspension or revocation of licence) against non-compliances; and
  4. impose restrictions and prohibitions against the operation of a licensed VASP and its associated entities where the circumstances so warrant (e.g. to prohibit further transactions or restrict the disposal of property in case a VA Exchange defaults).

F. Sanctions and Appeal

In addition to administrative sanctions (e.g. suspension or revocation of licenses, reprimand, remedial order and a pecuniary penalty), persons who carry out unlicensed activities or fail to comply with the regulatory requirements will be subject to criminal sanctions as follows:

Offence

Criminal liability

Conducting a regulated VA activity without a licence

  • A fine of $5,000,000; and
  • Imprisonment for 7 years

A further fine of $100,000 every day in the case of a continuing offence

Provision of a false, deceptive or misleading statement in a material particular in connection with a licence application

  • A fine of $1,000,000; and
  • Imprisonment for 2 years
Non-compliance with the statutory AML/CTF requirements
  • A fine of $1,000,000; and
  • Imprisonment for 2 years
Fraudulent or reckless misrepresentation for the purpose of inducing another person to acquire or dispose of a VA
  • A fine of $1,000,000; and
  • Imprisonment for 2 years

Appeals against future decisions made by the SFC in the implementation of the licensing and supervisory regime for licensed VASPs will be within the jurisdiction of the Anti-Money Laundering and Counter-Terrorist Financing Review Tribunal.

The consultation conclusions paper is available here.

To find out more about the VASP licensing regime, contact us today.

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