FSTB Consultation paper on new licensing regime for virtual assets services providers

FSTB Consultation paper on new licensing regime for virtual assets services providers

FSTB Consultation paper on new licensing regime for virtual assets services providers 1400 787 Charing

The Financial Services and the Treasury Bureau (“FSTB”) published a consultation paper (the “Consultation”) on 3 November 2020 seeking views on legislative reforms to enhance anti-money laundering and counter-terrorist financing (“AML/CTF”) regulation in Hong Kong.  Amongst the areas covered, the FSTB proposed to introduce a licensing regime for virtual assets services providers (“VASPs”).  The consultation period ended on 31 January 2021.

In recent years, trading in cryptocurrencies and other virtual assets (“VAs”) has significantly increased.  For all their potential, they pose significant money-laundering and terrorist financing risks because they are in general anonymous and decentralised.  VAs also pose challenges for investor protection as they are highly speculative in nature and are frequently associated with fraud, security breaches and price manipulation.

Under the licensing regime for VASPs, any person seeking to conduct the regulated business of VA trading platforms in Hong Kong will be required to apply for a licence from the Securities and Futures Commission (“SFC”) and be subject to the full range of AML/CTF obligations currently applicable to other financial institutions in Hong Kong.

The licensing regime is mandatory for any person who, as a business, engages in specified activities involving VAs, namely, (i) exchange between VAs and fiat currencies; (ii) exchange between one or more forms of VAs; (iii) transfer of VAs; (iv) safekeeping and/or administration of VAs or instruments enabling control over VAs; and (v) participation in and provision of financial services related to an issuer’s offer and/or sale of a VA.  As the operation of a VA exchange (“VA Exchange”) will typically involve the aforesaid types of activities, it will fall within the ambit of the proposed licensing regime.

Currently, peer-to-peer trading platforms (to the extent that the actual transaction is conducted outside of the platform and the platform is not involved in the underlying transaction), VA payment systems and VA custodian services operating as a stand-alone business, over-the-counter trade and crypto-ATMs are not within the scope of the proposed licensing regime.

The proposed licensing requirements are summarised as follows:-

Eligibility
  • Locally incorporated companies with a permanent place of business in Hong Kong
  • Natural persons or business establishments without a legal personality (e.g. sole proprietors or partnerships) will not be eligible
Fit-and-Proper Test
  • An applicant has to satisfy a fit-and-proper test, applicable also to other financial institutions regulated under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap 615, Laws of Hong Kong) (“AMLO”)
  • The fit-and-proper test will cover all responsible officers and ultimate owners of the corporate entity
  • Any change in responsible officers and ultimate owners would require prior approval by the SFC
  • An applicant will have to appoint at least two responsible officers to assume the general responsibility of ensuring compliance with AML/CTF requirements and other regulatory requirements, and be held personally accountable in case of contravention or non-compliance of the requirements
  • All executive directors of a licensed VASP must be responsible officers
Regulatory Requirements
  • A licensed VASP will be required to observe the AML/CTF requirements stipulated in Schedule 2 to the AMLO

The FSTB proposes to empower the SFC to impose licensing conditions and regulatory requirements covering, amongst other things, the following:-

    •  Professional investors only: At the initial stage, the licensed VASP should only offer services to professional investors
    • Financial resources: The licensed VASP should have adequate financial resources, for operating its VA business, including a paid-up share capital of a specified amount and liquid assets, depending on the nature of its business
    • Knowledge and experience: The licensed VASP and its associated entities should have a proper corporate governance structure staffed by personnel with the necessary knowledge and experience to enable the effective discharge of responsibility
    • Soundness of the business: The licensed VASP and its associated entities (i.e., a separate corporate entity with which the licensed VASP has a controlling relationship) should operate its VA business in a prudent and sound manner, and ensure that client and public interests will not be adversely affected
    • Risk management: The licensed VASP should have in place appropriate risk management policies and procedures for managing ML/TF, cybersecurity and other risks arising from a regulated VA activity that are commensurate with the scale and complexity of the business;
    • Segregation and management of client assets: The licensed VASP should implement proper segregation of client assets by placing them in an associated entity. Adequate policies and governance procedures should also be implemented to ensure the proper management and custody of client assets including VAs;
    • VA listing and trading policies: the licensed VASP should implement and enforce robust rules for the listing and trading of VAs on its platform(s). The VA exchange should also perform all reasonable due diligence on VAs before listing them for trading;
    • Financial reporting and disclosure: The licensed VASP and its associated entities should observe prescribed auditing and disclosure requirements and publish audited accounts
    • Prevention of market manipulative and abusive activities: The licensed VASP should establish and implement written policies and controls for the proper surveillance of activities on its platform(s) in order to identify, prevent and report any market manipulative or abusive trading activities
    • Prevention of conflicts of interest: To avoid any conflicts of interest, the licensed VASP and its associated entities should not engage in proprietary trading or market-making activities on a proprietary basis. Suitable firewalls should also be instituted between the different functions of the corporate structure to avoid conflict of interests. The licensed VASPs and its associated entities should also have a policy to eliminate, avoid, manage, or disclose actual or potential conflicts of interests for their employees who deal with VAs
Open-ended Licence It is proposed that a licensed VASP will be granted an open-ended licence, i.e. it will remain valid until the licensed VASP is revoked by the SFC, for example, due to misconduct or if the licensed VASP ceases its operation
Supervisory Powers The SFC will be empowered to supervise the AML/CTF conduct of licensed VASPs and enforce other regulatory requirements in accordance with the AMLO’s stipulations. Such will include the power to enter business premises of the licensed VASP and its associated entities for conducting routine inspections; to request the production of documents and other records; to investigate non-compliance and to impose administrative sanctions (including reprimand, order for remedial actions, civil penalty and suspension or revocation of licence) against non-compliance.

We expect the consultation conclusion paper will be issued soon.

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

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