Regulation
Hong Kong’s Winning Approach to Cryptocurrency Regulation
Numerous measures demonstrate that Hong Kong is determined to promote a “dynamic ecosystem” for virtual assets and other related products.
Jill Wong, partner at the law firm Blacksmith Reedtells how Hong Kong is tackling cryptocurrency regulation, a task that involves assessing how to balance innovation and risk.
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As in many other jurisdictions, Hong Kong’s initial response to the advent of bitcoin and other cryptocurrencies was to ask, “What is this?” This response has since evolved, although in the early stages of regulatory thinking, virtual assets (VAs) were regulated only to the extent that they fit within existing laws governing financial services. For example, VAs that resembled traditional securities were treated as “securities” or “futures contracts” under existing securities laws and were subject to licensing, marketing and other requirements under Hong Kong law.
However, because these laws were not designed with VAs in mind, there were VAs that did not fit neatly into traditional definitions and were therefore excluded from the regulatory net. The securities regulator, the Hong Kong Securities and Futures Commission (SFC), took steps to address this issue in the form of public statements, advising the public that VAs, like cryptocurrencies, needed to be licensed. For example, Initial Coin Offerings could be considered “collective investment schemes” and therefore required a license under the Securities and Futures Ordinance (SFO), while bitcoin futures also required a license under the SFO as “futures contracts.”
Things picked up pace in 2018 when the SFC expanded its regulatory oversight to cover existing SFC licensees who were portfolio managers and distributors of VA funds. This was a significant step in bringing more oversight and stability to the VA ecosystem.
The SFC published a position paper in 2019, outlining a new framework for the regulation of centralized VA trading platforms (VATPs). VATPs that provide trading services in both non-securities VA and securities VA would fall under the SFC’s regulatory net. However, there was a loophole: VATPs that only dealt in non-securities VA remained unregulated.
This was soon resolved. In June 2023, after extensive consultation, Hong Kong enacted a comprehensive licensing regime for VATPs. Under this regime, VATPs conducting non-security VA activities are required to obtain a VATP license under the Anti-Money Laundering and Counter-Terrorism Ordinance (AMLO).
Current position and prospects
Hong Kong has ambitions to become a VA hub. It is already moving in the right direction, with the 2023 UN Trade & Development report ranking Hong Kong ninth in the world in terms of readiness for frontier technologies. Hong Kong’s commitment to innovation (while offering due protection to investors) and a crypto-friendly legal framework have also positioned the territory as a global leader in the VA space.
Hong Kong regulators continue to supplement the existing regulatory framework for VAs. This includes introducing licensing regimes for stablecoin issuers with reference to fiat and over-the-counter trading in VAs. Regulators have already completed public consultations on these regulatory proposals and plan to introduce relevant legislation soon.
Hong Kong also became the first jurisdiction in Asia to offer retail investors the ability to trade spot bitcoin and Ether ETFs, paving the way for an in-kind redemption mechanism. This gave investors additional flexibility to buy and sell crypto token shares with a portfolio of securities, financial derivatives or VAs instead of cash.
This is a major move to integrate VAs into Hong Kong’s mainstream financial products. The inclusion of Ether also opens the door to new ETFs that track other major cryptocurrencies. This will further diversify Hong Kong’s exchange-traded product offerings, which now include a Metaverse ETF, a Blockchain ETF, and a number of VA futures ETFs.
Hong Kong is also investing heavily in financial technology, a key driver of the city’s competitive advantage. For example, the Hong Kong government has instructed the Hong Kong Monetary Authority (HKMA) to subsidize training costs for eligible financial sector professionals under the Fintech Subsidy Scheme.
The latest “Fintech Promotion Roadmap” of 2023 outlined five key pillars for development, emphasizing the adoption of fintech solutions in Hong Kong’s banking sector, expanding the fintech workforce, and improving data infrastructure. At the same time, the HKMA’s exploration of a retail central bank digital currency, e-HKD, reflects the regulator’s commitment to remain at the forefront of digital currency innovation.
Earlier this year, the HKMA launched a “sandbox” for stablecoins. This allows potential issuers to conduct experiments in relaxed regulatory environments and will facilitate dialogue between issuers and regulators. One high-profile example is a fintech company, founded by a former senior regulator, actively working on a Hong Kong dollar-backed stablecoin, collaborating with major players in the digital payments and VA sectors to explore the use of its stablecoin in retail and cross-border payments.
Legal advantages?
Hong Kong’s legal system also provides a favorable environment for the VA sector. Cryptocurrencies have been recognized by Hong Kong courts as “property” that can be held in trust in a liquidation context. Courts have also granted cryptocurrency freezing injunctions as asset preservation measures. These rulings provide welcome certainty for traders and investors.
That said, while Hong Kong may be considered a crypto-friendly jurisdiction, it is not an “easy” jurisdiction for regulatory arbitrage. The current VATP licensing regime is rigorous and robust (some argue it is too rigorous). The current licensing regime sets detailed criteria for applicants’ financial resources, management and governance structure, VA token admission requirements, custody of client assets, and anti-money laundering and counter-terrorism policies.
The SFC also reiterated that VATPs cannot serve mainland Chinese residents. These demanding requirements and lack of access to mainland Chinese customers may have prompted several major exchange operators to withdraw their VATP license applications.
However, a robust regulatory regime is arguably a necessary basis for sustainable growth. It lends credibility to companies that are committed to compliance and increases investor confidence. This would explain the continued interest in Hong Kong among the 17 potential VATPs waiting to be licensed.
Is Hong Kong outpacing the competition?
Traditional financial institutions interested in distributing VAs or managing funds should be encouraged by the recent moves by the HKMA and SFC. In December 2023, the HKMA and SFC issued the third joint circular on intermediaries dealing with VAs, expanding the scope for brokers, advisers and fund managers to provide VA-related services.
There are additional safeguards for investor protection: most VA-related products are likely to be considered complex products and, except in limited circumstances, distributors will therefore need to comply with existing requirements for sales of complex products. This includes an assessment of the suitability of the VA-related product for investors.
Only professional investors would have access to these products. However, there are some options for retail investors as they can trade VA-related products that are traded on the Hong Kong Stock Exchange and some other specified exchanges and VA funds that are authorised by the SFC for public offering. This should be a major boost for VA markets in Hong Kong.
In addition, the SFC has already given the green light to 25 funds, allowing them to have portfolios that invest more than 10 percent in VA.
Traditional banks and securities brokers can also offer VA trading services through partnerships with SFC-authorized VATPs. Several securities brokers have already received the green light from the SFC, and while there are currently only two authorized VATPs, it is likely that more will become available in the future.
These measures demonstrate Hong Kong’s determination to foster a vibrant ecosystem for VAs, innovative products and those who distribute, manage and invest in them. The global market is competitive, but Hong Kong has positioned itself at the forefront of this global market and is well positioned to reap the rewards in the coming years.
Disclaimer: This article is provided for informational purposes only and does not constitute legal advice.