One Year Anniversary of Hong Kong’s Cryptocurrency New Policy How to Trade Cryptocurrency Legally in Hong Kong?

1st Anniversary of Hong Kong's New Cryptocurrency Policies Guidelines for Legally Trading Cryptocurrency in Hong Kong

Introduction

On the occasion of the first anniversary of the Hong Kong Financial Services and the Treasury Bureau’s Policy Statement on the Development of Virtual Assets in Hong Kong, Hong Kong has been committed to creating a safe and efficient development environment for Web3 individuals to conduct virtual currency-related businesses, through innovative policies, comprehensive regulatory structures, and robust risk strategies. Several pilot projects have been launched to promote the application of relevant technologies. In this article, the Liu Law Firm team will analyze the relevant policies and highlight the key considerations for engaging in virtual currency-related businesses under the new policies in Hong Kong. This is intended to provide advice to Web3 individuals interested in expanding their businesses in Hong Kong, especially those interested in operating licensed platforms.

1. Accepting Compliance Regulation under the New Policies in Hong Kong

On February 20, 2023, the Securities and Futures Commission of Hong Kong issued the “Consultation Paper on Proposed Regulation of Virtual Asset Trading Platforms” with the aim of further expanding the user base of cryptocurrency trading platforms in Hong Kong. In other words, countries and regions that are either friendly towards cryptocurrencies or lack relevant legal regulations can essentially engage in virtual currency-related businesses in Hong Kong. However, the consultation paper not only proposes various procedural restrictions for platforms offering virtual asset-related services but also sets higher regulatory requirements. So, what are the specific differences between accepting compliance regulation under the new policies and operating privately as before?

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【Advantages】: First, under the new policies, engaging in virtual asset trading while accepting compliance regulation is considered a legally compliant act recognized by the Hong Kong government. After obtaining a virtual asset license (referred to as a “Type 9 license”) through the application process, one can also legally manage other people’s assets. Second, operating under the official regulatory framework of the Securities and Futures Commission of Hong Kong provides a more reliable source of funding for related businesses, reducing the risk of unintentionally receiving illicit funds and getting involved in criminal activities. Third, due to Hong Kong’s natural geographical advantage and the extent of its openness under the new policies, Hong Kong can attract more high-quality resources from mainland China and even globally, stimulating the new vitality of Hong Kong’s economic development.

【Challenges】: First, under the new policies, operating costs will be significantly higher compared to operating privately before. For example, obtaining a virtual asset Type 9 license requires payment of a substantial legal fee, which could be readily avoided previously. Second, given the increased number of applicants for licenses under the new policies, and the limited manpower of the Securities and Futures Commission, the time required to obtain a license in Hong Kong may be longer than in countries or regions such as Canada or the United States. Furthermore, the new policies in Hong Kong also impose new requirements on risk management. Not only is it necessary for practitioners to stay highly informed about changes in regulatory rules, but they might also need to hire professional teams to promptly update and understand potential legal and other risk points related to their business, in order to comply with new regulatory requirements.

[Transitional Arrangements]: According to the “Revised Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022” passed by the Hong Kong Legislative Council, trading platforms that have been operating in Hong Kong before June 1, 2023, are eligible for transitional arrangements. In other words, as long as the trading platform submits a virtual asset-related license application to the Securities and Futures Commission before February 29, 2024, they can continue operating their existing business until the Securities and Futures Commission makes a decision to issue or refuse a license. In the “Consultation Paper,” the Securities and Futures Commission has further limited the applicability of these transitional arrangements. Only platforms that have conducted “meaningful and substantial business” in Hong Kong before June 1, 2023, qualify for the transitional arrangements. When determining whether a platform has conducted “meaningful and substantial business” in Hong Kong, the Securities and Futures Commission will consider factors such as whether the platform has the necessary qualifications, actual office premises, and reasonable personnel structure.

II. Necessary Conditions for Virtual Currency Asset Trading in Hong Kong

(A) License Application

1. In the licensing system in Hong Kong, the main licenses related to virtual currency asset trading include:

License 1 (Securities Trading): Companies with this license are allowed to provide buying and selling services for stocks, stock options, bonds, mutual funds, as well as underwriting services for unit trusts and securities.

License 4 (Securities Investment Advisory Service): This license mainly involves issuing research reports and analysis opinions on relevant securities and providing investment advice to clients.

License 7 (Automated Trading Service): Companies with this license can provide electronic trading platform services for matching buy and sell orders.

License 9 (Asset Management): These companies can provide fund management, securities, and futures investment management services under discretionary authority. This includes both regular License 9 and the subsidiary license that allows management of virtual assets.

VASP License (Non-Securitized Virtual Assets Exchange): The nature of a VASP License is similar to a lightweight License 7. It can also handle OTC and token listing business. It is a relatively new type of license in Hong Kong with the most versatile application scenarios.

Different types of virtual asset trading exchanges require different licenses. For example, stablecoins like USDT and USDC fall under the securities category and require License 1 and License 7. BTC, ETH, Dogecoin, etc., as well as OTC business, fall under the non-securities category and require the VASP License plus a trust license. Derivative contracts require License 1, License 7, and the VASP License. In contrast to the aforementioned virtual asset trading, if one wants to provide virtual asset investment management services, regardless of the type of virtual assets being managed, they must apply for License 9. Additionally, institutions holding a regular License 9 can only manage investment portfolios with a virtual asset proportion of less than 10%. Only after upgrading to a subsidiary license that allows management of virtual assets can they manage investment portfolios with a virtual asset proportion of 10% to 100%.

2. Application Process for Virtual Asset License No. 9:

Currently, applicants can choose to first apply for a regular No. 9 license and then upgrade it to a license that allows for virtual assets. Alternatively, they can directly apply for a No. 9 license that allows for virtual assets. However, the latter option has higher requirements. First, there needs to be a licensed Responsible Officer (RO) who has previous experience in managing virtual currency assets. Theoretically, two licensed Responsible Officers are required, but since virtual currency assets operate 24/7, the Securities and Futures Commission (SFC) of Hong Kong actually requires at least three licensed Responsible Officers (working in shifts). A licensed Responsible Officer in Hong Kong must have at least 2 years of experience in managing virtual currency assets. To meet the requirements of a No. 9 license asset manager, they need at least 6 years of asset management experience. Additionally, if they were found to have engaged in virtual currency asset business within China after September 2021, they would not be considered qualified licensed Responsible Officers.

It is these requirements that make the RO in Hong Kong highly regarded and in short supply, which also increases the cost and difficulty of obtaining a No. 9 license for virtual assets.

3. Timeline for Applying for a Virtual Asset License No. 9:

Currently, the application process for a regular No. 9 license from initial entity registration to successful license application generally takes about 9 months. However, if the company has a large number of shareholders or a complex structure, it may take even longer. In addition, upgrading a regular No. 9 license to a virtual asset license requires completing a questionnaire from the SFC to clarify the hired service providers (such as exchanges, custodians, potential future funds, and types of virtual assets for investment). After the investigation is completed, the application process usually takes another year or so. Therefore, in the current industry situation, it generally takes at least 2 years of preparation time to obtain a No. 9 license for virtual assets in Hong Kong.

II. Financial, Taxation, and Human Resource Issues

1. Taxation: Engaging in virtual asset trading in Hong Kong requires financial auditing. An accounting firm specializing in virtual currency investments can be hired to calculate the enterprise profit after deducting operating costs (such as employee salaries and office expenses). Generally, a tax rate of 8.25% is charged for amounts less than HKD 2 million, and a tax rate of 16.5% is charged for amounts exceeding HKD 2 million. Additionally, due to the volatility of virtual currencies, it is necessary to assume the valuation of relevant virtual currency assets for the corresponding financial year and submit an audit report from an auditing firm specializing in virtual asset auditing to complete the financial reporting and taxation process. The financial year in Hong Kong generally ends in December or March, and applicants can choose either based on their operational status and timeframe.

2. Personnel: Registration of a legal entity is required (meaning there must be an actual office address, register an office in Hong Kong, and obtain consent from the owner). As mentioned above, theoretically, at least 2 licensed individuals familiar with virtual currencies (RO) are required, but it’s best to have 3 or more.

(3) Other obligations to fulfill:

1. Anti-money laundering review:

If engaged in virtual asset currency business in Hong Kong, and if third-party funds are received, such as establishing a virtual currency fund, the future company registered in Hong Kong must have a third-party fund administrator responsible for conducting anti-money laundering reviews of these third-party funds. If the anti-money laundering review is not passed, the related funds will be returned directly to the account, and suspicious activity reporting will be conducted.

2. Expert evaluation and committee establishment:

To provide virtual currency investment and trading services, the trading platform applicant must hire external evaluation experts to conduct comprehensive evaluations of the related business and provide evaluation reports. In addition, the virtual currency trading platform must establish a token inclusion and review committee, which is mainly responsible for matters related to the inclusion, suspension, temporary halt, and cancellation of token transactions.

3. Difficulties that may be encountered during the application process:

(1) Preliminary stage:

During the preliminary stage of the application, the Hong Kong Securities and Futures Commission is most concerned about the custody issue, as it is the most important aspect related to fund security. The Commission needs to investigate whether the applicant can truly hold and protect these assets, so it will ask many questions, such as whether subordinate employees have received qualified training and whether they can complete transactions. If any doubts are found in certain aspects, the approval may be denied, so the applicant needs to be fully prepared in advance.

(2) Intermediate stage:

In the intermediate stage of the application, the applicant must upload high-quality application documents to the Securities and Futures Commission. Taking the review report as an example, if different documents have different contents and consistency is not ensured, it will confuse the Commission and may result in rejection or a request for detailed explanations regarding the inconsistencies.

(3) Final stage:

In the final stage of the application, the applicant needs to demonstrate to independent audit evaluators that their system is fully built and fully complies with the policies and procedural documents of the Securities and Futures Commission. In simple terms, the applicant needs to prove that they have indeed fulfilled their commitments. For example, selecting a suitable custodial institution, ensuring that employees have received proper training, and providing evidence of team building models, all require the applicant to provide supporting materials and documents with sufficient evidential value.

3. Procedures for Mainland Employees Engaged in Virtual Currency Asset Business in Hong Kong

After Mainland employees apply for and obtain a Hong Kong work visa, they can freely enter and work legally in Hong Kong. For a newly established company involved in virtual currency business, the conditions for their employees to obtain a Hong Kong work visa include:

① Having a fixed office (relevant institutions will periodically check the lease agreement)

② Having a stable source of income and fixed expenses

③ The employees must have local individuals (i.e. Hong Kong residents)

Only when all three conditions are met can an application be made to regulatory agencies for the employment of non-local individuals (i.e. non-Hong Kong residents). Additionally, it is important to note that: Hong Kong has a protectionist policy, prioritizing the employment of local individuals. If a company can hire qualified local individuals in Hong Kong, it will be encouraged to do so.

4. Issues with the flow of funds from Hong Kong to Mainland China

(I) Transfer of funds from Hong Kong company accounts to Mainland company accounts

1. Method: According to current policies in Hong Kong, funds from Hong Kong can be transferred to Mainland China company accounts through the establishment of both Hong Kong and Mainland companies, and abiding by the bank’s transfer limit regulations.

2. Limit: Different Hong Kong corporate accounts have different daily transfer limits, generally ranging from 2 million to 20 million Hong Kong dollars per day. For specific limits, it is advisable to consult the customer service manager at the Hong Kong bank based on your own situation.

3. Requirements: In order for Mainland company bank accounts to successfully receive funds from Hong Kong bank accounts, the following requirements must be met:

① The Mainland company must have the right to import/export;

② The Mainland company can apply for a U.S. dollar account;

③ The Mainland company can provide corresponding export documents for the received funds.

4. Special Attention: The Mainland State Administration of Foreign Exchange has strict foreign exchange controls. Banks will only conduct foreign exchange settlement if legitimate export-related documents are provided (i.e. sales contracts, packing lists, bill of lading, invoices, etc.) signed by the payer. Otherwise, funds received from Hong Kong corporate accounts cannot be settled. However, since the Mainland State Administration of Foreign Exchange has not yet approved the category of virtual currency settlement, it is difficult for companies engaged in virtual currency quantitative trading exclusively in Hong Kong to directly transfer profits from virtual currency trading to Mainland company accounts under the current foreign exchange management system in Mainland China.

(II) Transfer of funds from Hong Kong company accounts to Mainland personal accounts

Due to the restrictions mentioned in the [Special Attention] section above regarding corporate account transfers, some people may wonder: can funds be transferred directly from Hong Kong company accounts to Mainland personal accounts? It is clear that funds from Hong Kong company accounts can be transferred to Mainland personal accounts, but we advise against doing this on a long-term or frequent basis. With the current trend of anti-tax evasion and CRS (Common Reporting Standard) agreements, Hong Kong banks have increased scrutiny of bank accounts. Even if a bank account has been successfully opened and is being used, if there is any suspicion of money laundering or other illegal activities, the bank will close the account.

Lawyers have something to say

Although Hong Kong is gradually opening up its policies on virtual currency asset trading, there are still certain restrictions in many aspects. If individuals or entities want to conduct related business in Hong Kong, they must handle matters such as licenses, manpower, finance and taxation, and anti-money laundering regulations in advance, otherwise they may encounter difficulties and even face accountability from the Hong Kong Securities and Futures Commission. Therefore, before engaging in virtual currency asset-related business, it is advisable to consult lawyers in the relevant field to understand the procedures and obligations that need to be fulfilled, ensuring smooth operations in Hong Kong.

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