Background and Overview
The Securities and Futures Commission (SFC) of Hong Kong released a consultation conclusion on May 23, 2023, titled "Consultation Conclusion on Proposed Regulatory Requirements for Licensed Virtual Asset Trading Platform Operators." This document outlines the regulatory framework for Virtual Asset Trading Platform Operators (VATPs), taking into account feedback from the public and industry stakeholders on the initial consultation paper published on February 20, 2023.
Key accompanying documents, including the revised "Guidelines for Virtual Asset Trading Platform Operators" and the "Anti-Money Laundering and Counter-Terrorist Financing Guideline," were gazetted on May 25, 2023, and came into effect on June 1, 2023. The SFC largely adopted the proposed regulatory requirements from the consultation paper, with several important updates aimed at enhancing investor protection and operational clarity.
Key Regulatory Updates for Virtual Asset Trading Platform Operators
Services to Retail Investors
The SFC has confirmed that licensed platform operators may offer services to retail investors for trading non-security tokens, provided they implement a robust set of investor protection measures. These include stringent requirements for client onboarding, token inclusion, due diligence, and disclosure.
Client Onboarding and Knowledge Assessment
Platform operators must conduct a comprehensive assessment of each investor's knowledge and understanding of virtual assets' nature and risks. Factors considered include past training, work experience, and trading history in virtual assets. Notably, the previous presumption that investors with five or more virtual asset transactions in the past three years were sufficiently knowledgeable has been removed. Additionally, platform operators must perform risk tolerance assessments for all retail clients, regardless of their perceived knowledge level.
General Token Inclusion Criteria
Each token must undergo thorough due diligence before being listed for trading. A significant update is that platform operators now only need to consider the regulatory status of the virtual asset in Hong Kong (e.g., whether it is a security token) rather than in every jurisdiction where services are offered. However, operators must still ensure compliance with all relevant laws in other jurisdictions where they or their affiliates operate, as violations abroad could impact their fitness to operate in Hong Kong.
Legal Opinions on Tokens
The requirement to obtain a legal opinion for each token confirming it is not a security token has been removed due to high costs. Instead, platform operators must ensure that only non-security tokens are offered, though the SFC may request legal opinions for specific tokens during the approval process.
Eligible Large Virtual Assets and Accepted Indexes
For a token to be considered an "eligible large virtual asset," it must be included in at least two accepted indexes provided by independent index providers. These providers must be independent of the virtual asset and the platform operator, with experience in publishing traditional securities indexes compliant with the International Organization of Securities Commissions (IOSCO) principles. Inclusion in indexes is a minimum criterion; platform operators must also ensure tokens meet general inclusion criteria and exhibit high liquidity. The SFC has not published a list of eligible tokens, accepted indexes, or index providers, placing the responsibility on platform operators to conduct ongoing due diligence.
Stablecoin Trading
Stablecoin trading for retail investors is prohibited until a regulatory framework for stablecoins is implemented in Hong Kong. The Hong Kong Monetary Authority (HKMA) published its consultation conclusions on stablecoin regulation in January 2023, with a framework expected in 2023/2024.
Insurance and Compensation Arrangements
Cold Storage Coverage Requirement
The requirement for coverage of client virtual assets held in cold storage has been reduced from 95% to 50%. Platform operators must still hold at least 98% of client virtual assets in cold storage, with the remaining 2% (held online or in other storage methods) fully covered by compensation arrangements.
Acceptable Assets for Compensation Arrangements
In addition to third-party insurance, platform operators may use the following assets as part of their compensation arrangements:
- Bank guarantees from recognized financial institutions in Hong Kong.
- Funds held as demand deposits or fixed deposits maturing within six months.
- Reserve virtual assets of the same type held in cold storage by an affiliated entity.
Custody of Client Virtual Assets
Client virtual assets must be held by a wholly-owned subsidiary of the platform operator licensed as a Trust or Company Service Provider (TCSP) by the Hong Kong Companies Registry. The SFC currently does not allow third-party custodians, though it may consider other custody solutions in the future if industry consensus on security and certification is achieved.
Transfer Rules
Transfer rules requiring the obtaining, recording, and submission of transaction information have come into effect as of June 1, 2023. However, until January 1, 2024, platform operators may submit necessary information "as soon as practicable" after a transfer if immediate submission is not feasible.
Dual Licensing Requirements
Platform operators must apply for both a Type 1 (dealing in securities) and Type 7 (automated trading services) license under the Securities and Futures Ordinance for security tokens, and a Virtual Asset Service Provider (VASP) license under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance for non-security tokens. This dual requirement accounts for the potential evolution of a token's classification over time.
Frequently Asked Questions
What are the main changes for retail investors trading virtual assets?
Retail investors can now trade non-security tokens on licensed platforms, but must undergo knowledge and risk assessments. Stablecoins and security tokens are not available to retail investors currently.
Do platform operators need legal opinions for each token?
No, the requirement for a legal opinion for each token has been removed to reduce costs. However, the SFC may still request opinions during the approval process.
What compensation arrangements are acceptable?
Platform operators can use bank guarantees, specific deposits, or reserve virtual assets held by affiliated entities, in addition to third-party insurance.
Can third-party custodians hold client virtual assets?
Currently, client virtual assets must be held by a platform operator's affiliated entity with a TCSP license. Third-party custodians are not permitted, though this may change in the future.
How do transfer rules affect virtual asset transactions?
Transfer rules require platform operators to obtain and submit transaction information. Until January 2024, information can be submitted "as soon as practicable" if not immediately feasible.
What licenses are required for platform operators?
Platform operators need dual licenses: Type 1 and Type 7 for security tokens, and a VASP license for non-security tokens, due to the potential for tokens to change classification.
Conclusion
The recent regulatory updates aim to balance investor protection with operational feasibility for virtual asset trading platforms in Hong Kong. While the changes reduce some burdens, such as the cold storage coverage requirement and the need for legal opinions, challenges remain, particularly regarding the limited tokens available for retail trading and the custody requirements. 👉 Explore more strategies for navigating virtual asset regulations. Platform operators should stay informed on further guidance from the SFC, especially concerning transition arrangements for existing platforms.