Interpretation of Hong Kong’s “Virtual Asset Consultation Conclusion”: Can mainland retail investors enter the market?

Hong Kong's "Virtual Asset Consultation Conclusion": Can mainland retail investors participate?

On the afternoon of May 23, 2023 Beijing time, the Securities and Futures Commission of the Hong Kong Special Administrative Region (SFC) published the “Consultation Summary on the Application of the Proposed Regulatory Requirements to Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission” (hereinafter referred to as the Virtual Asset Consultation Summary), demonstrating Hong Kong’s open attitude and regulatory approach to virtual asset trading. The document provides a comprehensive response to the suggestions raised by the public, and the process of modification is transparent and clear, leaving a deep impression.

1. Impressive Document Structure

The Virtual Asset Consultation Summary of the SFC in Hong Kong is divided into four parts: Summary, Feedback Received and SFC’s Responses, Implementation Timetable, and Appendices (with draft revisions marked in the appendices).

The Summary, which looks like an “abstract” in an academic paper at first glance, is intended to help readers who are unfamiliar with the field or in a hurry to quickly grasp the problems and ideas that the document seeks to address. Unlike a concise summary in an academic paper, the summary written by the SFC in Hong Kong marked 7 key points. The first point is the legal background; the second point is to clarify the consultation deadline and the number of opinions received; the third point responds to the opinions raised; the fourth point leads to Appendices A, B, and C; the fifth point thanks the public; the sixth point directly informs the effective date; and the seventh point provides the website for consulting the document and response letter. The logic is clear and easy to understand.

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Regarding the feedback received, the SFC in Hong Kong adopts a Q&A format, directly responding to the public’s opinions and classifying and abstracting them according to the document structure. The biggest impression is that the logical hierarchy is very clear. The first part is the revision of the proposed regulatory requirements for licensed virtual asset trading platform operators: A. Allowing licensed platform operators to provide services to retail investors subject to proposed investor protection measures (public opinion + SFC response); B. Requirements on establishing a business relationship with clients (public opinion + SFC response); C. Regulation (public opinion + SFC response); D. Disclosure obligations (public opinion + SFC response).

In summary, before soliciting public suggestions, the Hong Kong Securities and Futures Commission listed the core issues that need the public to provide opinions and suggestions to avoid missing the point. Then, when the deadline arrives, everyone’s opinions will be listed. What are the differences and basic reasons? Finally, the Securities and Futures Commission will give its own explanations and balanced results.

The implementation schedule is clear and precise: it will take effect on June 1, 2023, but a transition period arrangement is provided to allow existing companies to have time and opportunity to transform or obtain a license.

The appendix is ​​the full text of the guide, and the valuable part is that the original annotations are retained. Just like we usually use the review function of a Word document, the red font prompts where has been modified, how to modify it, what the original text is, and even includes footnotes and format modifications. From these modification traces, scholars can infer the thinking and value orientation of regulatory agencies, and market entities can also clearly know that some behaviors have been marked with red lines, and some behaviors are outside the red lines.

The Sa team organized a summary of virtual asset consultations, and made a brief summary of the most important issues for virtual asset trading platform operators and mainland investors, which is a feast for readers.

2. Allow licensed virtual asset platforms to provide services to retail investors

Under the current system in Hong Kong, according to the requirements of the Securities and Futures Ordinance, licensed virtual asset trading platforms can only provide services to professional investors. In recent years, there have been voices inside and outside Hong Kong that have been committed to breaking this restriction. The Hong Kong SFC also specifically solicited public opinions on this issue in the previous “Consultation Paper”, that is, “Under the premise of taking appropriate investor protection measures, should licensed platform operators be allowed to provide corresponding services to investors?”

In this “Virtual Asset Consultation Summary”, the SFC sorted out the responses to the opinions. Most respondents believe that if licensed virtual asset trading platforms provide investors with related knowledge training, risk investment, data disclosure, and a series of protection measures, it is permissible for retail investors (that is, so-called “scatterers”) to use licensed virtual asset trading platforms.

Accordingly, the SFC responded that it would implement the proposal to allow licensed virtual asset trading platforms to provide services to retail investors. However, licensed virtual asset trading platforms should comply with a series of safeguard measures to protect the interests of retail investors. The key points of these safeguard measures include:

• Conducting risk tolerance assessments and other KYC work

Before providing services to retail investors, relevant knowledge and risk assessments and investor training should be carried out, and risk tolerance limits should be set. The SFC stated that it had considered proposals to relax the relationship with retailers under certain circumstances, but ultimately determined that retail investors are generally unlikely to understand the terms, characteristics and risks of virtual assets, and that virtual asset trading platforms are automated, even if a transaction is unsuitable, the virtual asset trading platform is unable to intervene. Therefore, ensuring suitability when virtual asset trading platforms establish business relationships with retail customers becomes extremely important. Only by fully implementing the above KYC regulations can the purpose of protecting the interests of retail investors be achieved. Therefore, even if retail customers have an understanding of virtual assets, virtual asset trading platforms cannot be exempted from risk tolerance assessments. Similarly, the SFC considers that since the provisions for establishing business relationships with customers are designed to follow the suitability principle, individual professional investors should enjoy the same protection as retail investors.

• Fulfilling information disclosure responsibilities

In the “Consultation Paper,” most respondents believe that it is crucial to impose disclosure responsibilities on various virtual assets included in virtual asset trading platforms to protect the interests of investors. The SFC also responded to this issue. In this “Virtual Asset Consultation Summary,” the SFC acknowledges that due to the unique nature of virtual assets, which are different from traditional securities, regulatory measures for virtual assets are not carried out at the product level and are traded on multiple platforms. Therefore, it may be difficult to obtain and verify information from virtual asset issuers. Despite this, virtual asset trading platforms must conduct due diligence on each virtual asset before including it for trading. Platform operators should obtain information about each virtual asset (whether directly or indirectly), and require that platform operators take all reasonable steps to ensure that information disclosed about specific products is not false, misleading, or deceptive.

4. Combating Money Laundering/Terrorist Financing

Most respondents supported the inclusion of provisions on combating money laundering and terrorist financing in the Guideline on Anti-Money Laundering and Counter-Terrorist Financing applicable to Licensed Corporations engaged in virtual asset-related activities and recognized that it would reduce the risk of money laundering and terrorist financing associated with virtual assets. To address concerns about the transfer, refund and cross-border agency of virtual assets, the SFC provided further clarification in the Consultation Paper.

1. Implementation of the Transfer Principle

In accordance with the transfer principle provided in the Guideline on Anti-Money Laundering and Counter-Terrorist Financing, a licensed virtual asset trading platform (i) acting as a remittance institution shall obtain, hold and immediately and securely submit to the payee institution the required information on the remitter and payee; and (ii) acting as a payee institution shall obtain and hold the required information from the payor institution. This will provide information for the SFC to conduct sanction screening and transaction monitoring and assist in preventing and detecting the transfer of virtual assets to criminals and designated persons.

For concerns raised by respondents that existing technology may not enable them to strictly comply with the transfer rules, the SFC, after considering the implementation in other major jurisdictions, considers that licensed virtual asset trading platforms should adopt temporary measures to submit the required information to the payee institution within a practicable scope, if such information cannot be immediately submitted, by 1 January 2024. Specific regulatory requirements will be set out in subsequent FAQs.

2. Transfers to and from Non-Custodial Wallets

The SFC has stricter controls over transfers to and from non-custodial wallets, requiring licensed virtual asset trading platforms to take reasonable measures based on risk, such as obtaining the required information from customers and conducting sanction screening. In addition, licensed virtual asset trading platforms should only accept virtual asset transfers to and from non-custodial wallets that have been assessed as reliable, taking into account the results of screening on virtual asset transactions and related wallet addresses, and evaluation of the ownership or control of non-custodial wallets.

3. Refund of Virtual Assets

In order to reduce the risk of money laundering/terrorism financing associated with virtual asset transfers requiring the import of necessary information, SFC has decided that licensed virtual asset trading platforms should only return virtual assets under appropriate circumstances and in the absence of suspicion of money laundering/terrorism financing activities, and after considering the results of due diligence on the counterparties of virtual asset transfers as well as screening of virtual asset transactions and related wallet addresses . In addition, virtual assets should be returned to the account of the remitting institution, not the remitter’s account.

4. Cross-Border Agency

When a licensed virtual asset trading platform provides virtual asset services defined under section 53ZR of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance to virtual asset service providers or financial institutions located outside Hong Kong and acting for relevant clients, the provisions on cross-border agency relationships apply to the platform. This includes licensed virtual asset trading platforms executing buying and selling of virtual asset transactions for these institutions, but does not include virtual asset transfers with these institutions. In addition, SFC requires licensed virtual asset trading platforms to continuously monitor virtual asset transactions and related wallet addresses to more timely and accurately identify the sources and destinations of relevant virtual assets and any wallet addresses involving or subsequently involving illegal or suspicious activities/sources or designated persons.

5. Disciplinary Action Fines

According to the “Guidelines for Securities and Futures Commission Disciplinary Action Fines”, SFC may impose a fine of no more than HKD 10 million, or three times the amount of profit obtained or loss avoided, whichever is higher, without automatically linking the amount of the fine to the amount of profit obtained or loss avoided. As for the respondent’s doubts about the specific amount of the fine and the factors to be considered, SFC will adopt the same fine criteria as the Securities and Futures Ordinance. SFC will not automatically link the amount of the fine to the amount of profit obtained or loss avoided. Instead, SFC will flexibly respond to changes in the market based on relevant factors when determining the amount of the fine for each case, such as the nature, characteristics, and possible multiple offenses or omissions constituting the offense. As for how to decide whether to take disciplinary action against individuals and/or companies, SFC will consider the behavior of the company and individuals, and as far as the people involved in the management of the company are concerned, whether the behavior involves their consent, acquiescence, or negligence, and the lack of supervision or management in the business.

Conclusion

The summary of the “Virtual Asset Consultation” shows that the Hong Kong government is striving to dynamically balance support for virtual asset trading platform practitioners and protection of virtual asset investors’ interests. In this process, the SFC not only designs the obligations that virtual currency trading platform practitioners should fulfill under the framework of the “Anti-Money Laundering Guidelines,” but also fully considers protecting the interests of retail investors such as “scatterers” based on this foundation. This promotes the long-term stable development of the financial market. The establishment of this mechanism also provides a sense of security for investors outside Hong Kong who invest in the virtual currency market in Hong Kong. The SaJie team still adheres to the previous point of view, that is, Hong Kong and the mainland have shown “complementary” characteristics in the field of virtual asset development, and this complementary characteristic may become more prominent in the future. SFC’s prudent response to the feasibility, safety, and sustainability of “licensed virtual platform-led, SFC-regulated, and retail investors entered” shows that SFC is trying to establish a transparent and highly operational mechanism in the “consultation file,” which is a big step to help the Greater China region enter the Web3.0 era. This will not only promote the development of the digital economy, but also greatly enhance the vitality and competitiveness of the Greater China market.

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