The Hong Kong Securities Regulatory Commission issued a position on the supervision of virtual asset trading platform [Simplified full text]

Original Source: https://www.sfc.hk/web/TC/files/ER/PDF/20191106%20Position%20Paper%20and%20Appendix%201%20to%20Position%20Paper%20(Chi).pdf

Position book

Regulatory virtual asset trading platform

Part 1 – The CSRC's regulatory approach to the virtual asset trading platform

1. The Securities and Futures Commission (SFC) published a conceptual framework on 1 November 2018 that could regulate the virtual asset trading platform and stated that the SFC would consider whether it would be appropriate to base its existing powers on the platform. Operators issue and regulate them.

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2. After the announcement, the SFC met with the virtual asset trading platform operators to discuss their business and explain the regulatory requirements of the SFC. After an in-depth review of the technical, operational and other areas of virtual asset trading, the SFC concluded that certain central platforms providing securities and non-securities token trading services would be suitable for the framework set out in this position book. Regulated.

3. The SFC has therefore adopted a set of strict regulatory standards on the virtual asset trading platform that are comparable to those applicable to licensed securities brokers and automated trading venues. This involves handling safe deposits of assets, knowing your customers, and combating money laundering. And major regulatory concerns regarding terrorist fundraising, market manipulation, accounting and auditing, risk management, conflicts of interest, and acceptance of virtual assets for trading. The SFC will only grant licenses to platforms that meet the expected standards.

4. However, it must be clarified that the SFC does not have the authority to issue or supervise a platform that only buys or sells non-securities virtual assets or tokens. The business of these platforms does not constitute a "regulated business" under the Ordinance, as it does not belong to the "securities" or "futures contracts" under the Securities and Futures Ordinance. This explains why under the current regulatory framework, only the platform that provides securities-type virtual assets or token trading services to customers is within the scope of supervision of the CSRC.

5. Once the platform for the selection of securities-type virtual assets or tokens is included in the trading range, investors can easily distinguish between regulated and unregulated platforms. This is the new regulatory framework described in this position book. A big feature. However, the SFC understands that many virtual assets are highly speculative and volatile, and many do not have any real value, whether they are bought or sold on regulated or unregulated platforms. Investors should only participate in virtual asset transactions only if they have a comprehensive understanding and ability to manage the risks involved.

6. The SFC also wishes to state that even if the virtual asset trading platform is licensed and regulated by the Securities and Futures Commission, the virtual assets traded on the platform are not suitable for the traditional sale of "securities" or "collective investment projects". Any approval or registration provisions of the prospectus. There are no other mandatory disclosure requirements in Hong Kong that apply to non-securities virtual asset offers. In addition, even if the virtual asset traded on the licensed platform is a securities token, as long as the token is only sold to professional investors7, it will not be subject to the Hong Kong investment offer approval procedure and the prospectus registration system.

7. It is also important to note that Sections XIII and XIV of the Securities and Futures Ordinance allow the SFC to take action on market misconduct in the securities and futures markets, but this does not apply to licensed virtual asset trading platforms. It is the “securities” or “futures contracts” in which the virtual assets are not listed or traded on the market.

8. At present, there are dozens of virtual asset trading platforms in Hong Kong, which have caused serious concern in investor protection. Some platforms may decide not to apply for a license from the Securities and Futures Commission under the new regulatory framework. This is their free choice as long as they ensure that the virtual assets traded on their platforms are not "securities" or "futures contracts" under the Securities and Futures Ordinance. They may think that the regulatory requirements of the SFC are too onerous and they prefer to operate a completely unregulated business. In view of the restrictions on the regulatory power of the Securities and Futures Commission, the SFC may have decided to suspend any regulatory measures on the increasingly prevalent virtual asset trading platform to more fully address the booming virtual asset industry after the new legislation is enacted. However, even in the face of inherent restrictions, the SFC has decided that it is clearly in the public interest to take action at present, allowing investors to choose to trade on the platform that they agree to be subject to the framework regulation and supervision currently adopted by the SFC.

9. Although some of the regulatory gaps identified in this document can only be resolved through amendments, the SFC has developed a set of platforms suitable for licensed securities brokers and automated trading venues for platforms that are willing and able to obtain licenses. Strict standards with similar standards. However, the SFC will continue to monitor market development and discuss with the Hong Kong Government whether there is a need to amend the law in the long run.

10. The regulatory standards described above are detailed in Part III of this document. The SFC welcomes platform operators who are committed to and able to comply with the licensing standards and continuing ethics requirements to apply for a licence. The licensed platform will also be included in the SFC Supervision Sandbox and will be subject to close and rigorous supervision during a period of time.

11. The main licensing conditions include that the platform operator can only provide its services to professional investors, must have strict inclusion criteria to screen for virtual assets that can be bought and sold on its platform, and provide services only to customers who fully understand virtual assets. . In addition, the platform operators will be required to adopt a reputable external market monitoring system to complement their own market monitoring policies and monitoring measures. The platform operator should also ensure that the insurance period in which the risks involved in the custody of the virtual assets are taken into effect.

12. The adoption of the new regulatory framework will enable the SFC to develop its future regulatory strategy through close monitoring interaction with the evolving and rapidly evolving industry.

Part II – Background

A. Global environment

13. Virtual assets express value in digital form, also known as "cryptocurrency", "encrypted assets" or "digital tokens". The total market capitalization of virtual assets worldwide is currently estimated to range from $200 billion to $300 billion, with approximately 3,000 digital tokens and over 200 virtual asset trading platforms8. Despite a period of turbulent periods in 2019, there is no indication that the virtual asset market will be weak.

14. Although the initial coin offering (ICO) boom seems to have subsided, other forms of virtual asset fundraising have been favored. For example, a security token offering (STO) generally has traditional securities sales attributes, but involves the use of blockchain technology to express asset ownership or economic rights in digital form. The initial exchange offering (IEO) also increased significantly. IEO generally involves the use of blockchain technology to exclusively launch tokens for the first time on a virtual asset trading platform. It has been reported that the total amount of funds raised by the IEO in the second quarter of 2019 exceeded $1.4 billion.

15. At present, there is another type of virtual asset commonly known as "stablecoin". Stabilizing coins usually claim to have a set of mechanisms that seek to be backed up by fiat currencies, commodities or a basket of cryptocurrencies to stabilize the value of the currency. These virtual assets have caused significant regulatory concerns in central banks and financial regulators around the world, especially if such virtual assets are intended for global adoption.

16. Other virtual asset investment products have also emerged. Since 2017, US-sized exchanges have successively sold bitcoin futures, all of which are regulated by the Commodity Futures Trading Commission. The SFC also noted that other forms of virtual asset derivatives (including cryptocurrency options, swaps and CFDs) have increased. These are just a few examples, from which it can be seen how the field of virtual assets is gradually extending to the financial market and entering certain securities regulatory systems.

17. In addition, as more and more traditional financial institutions and service providers enter the market, the ecosystem of virtual assets is steadily expanding and becoming more complex, providing services comparable to traditional mainstream financial institutions. For example, multiple traditional custodians are studying the provision of encrypted custodian services or technology solutions. In order to meet the needs of virtual asset companies, the Big Four accounting firms have extended their services to this category. Large-scale insurance companies and insurance brokers are increasingly open to providing insurance coverage and services to the virtual asset industry. Furthermore, a number of traditional financial institutions are studying the use of private blockchains to develop their own cryptocurrencies for real-time and cross-border funding transfers.

18. The SFC elaborated on the risks involved in virtual assets in the November 1 statement, partly due to the inherent nature of virtual assets. The risks include money laundering, terrorist fundraising, fraud, volatility, liquidity and market manipulation and violations. The statement also highlights the specific inherent risks of operating a virtual asset trading platform. Since some platforms are designed to deliberately deviate from the scope of any regulatory system, they are not subject to any regulatory standards. These platforms are not only seriously inadequate for investors, but also cause significant concern in the safekeeping of assets and network security. When the operation of the platform was interrupted, there have been reports that the platform has been hacked from time to time, causing investors to suffer significant losses. In addition, the trading rules of the platform may lack transparency and fairness.

19. In recent years, international standards bodies have been closely monitoring and exploring how to deal with the risks involved in virtual assets. Although the Financial Stability Board's assessment still indicates that virtual assets do not pose significant risks to global financial stability, there is a consensus among securities regulators that virtual assets pose policy issues related to investor protection. Although the advisory report issued by the International Securities Regulatory Commission (IOSCO) in May 2019 did not determine whether the encrypted assets belong to the regulatory body of the securities regulator, the report has been on the virtual asset trading platform. Jurisdictions with legal regulatory authority for trading activities list a number of key considerations and suggest a series of corresponding measures.

20. Various securities regulators have also adopted different countermeasures. Some jurisdictions prohibit virtual asset activities, while others set up special regulatory regimes for such activities. Multiple jurisdictions take a more detailed approach, such as classifying tokens and indicating which categories fall within their existing system. There are still some jurisdictions that still adopt a wait-and-see attitude.

B. The regulatory guidelines adopted by the CSRC on virtual assets

21. The public can trade virtual assets through several channels, including ICO, investment funds, central trading platforms and over-the-counter counters. As with other securities regulators in major jurisdictions, the SFC's initial approach was to clarify how virtual assets and certain activities involving those assets would be regulated by their existing regulatory regimes. This policy needs to be categorized according to the terms and characteristics of each token, and the terms and characteristics may evolve over time. In this regard, the SFC issued a number of statements and circulars stating its regulatory position and strengthening investor education and regulatory action against persons suspected of having committed misconduct. After the above measures, the ICO activity in Hong Kong has decreased, and in some cases, the issuer canceled the ICO transaction. Securities tokens have also been removed from the virtual asset trading platform, and Hong Kong investors have been denied participation in ICO or ICO trading on virtual asset platforms.

22. However, virtual asset trading platform operators have found ways to operate outside the supervision of the SFC and other Hong Kong regulators. At present, there are dozens of virtual asset trading platforms with operations in Hong Kong, including some of the world's larger platforms. Some platforms offer virtual asset futures contract trading, and such contracts involve extremely high risks due to volatile fluctuations and high leverage.

23. In November 2018, the SFC decided to adopt a new set of guidelines to incorporate some of its virtual asset activities involving investors into its regulatory powers based on its existing powers.

24. The first part of this policy addresses the management and distribution aspects of funds that are wholly or partially invested in virtual assets. If the SFC Licensed Investor Company intends to invest more than 10% of the hybrid portfolio in a virtual asset, it will be subject to the additional requirements set out in the November 1 statement. The SFC also sets out in another circular17 the criteria to be met by licensed corporations that distribute virtual asset funds. The combined effect of the above measures is that investors' rights will be guaranteed at the fund management level or at the distribution level or both.

25. The second part deals with the central virtual asset trading platform, the subject of this document. The regulatory framework recommended by the Association in the November 1st Statement applies to a central virtual asset trading platform in which virtual assets operating and trading in Hong Kong include at least one securities token.

26. After the announcement, the SFC met with the virtual asset trading platform operators to discuss their operations and explain the regulatory requirements of the SFC. The SFC has invited platforms with active trading, broad customer base, significant local businesses and a sound corporate governance structure to participate in more in-depth discussions and to assess their ability to comply with expectations.

27. In automated trading venues or stock and futures exchanges, investors trade through licensed intermediaries, but virtual asset trading platforms are different, they are directly in contact with the public. In view of this, and after completing the exploration and analysis, the SFC has concluded that certain types of central virtual asset trading platforms can be applied to the standards required by licensed automated trading service providers or brokers. Similar regulatory standards. As a result, the SFC will begin accepting applications for licenses from platform operators who are committed and capable of complying with the expected licensing standards and continuing ethics.

28. The regulatory framework for the virtual asset trading platform will be discussed in detail in Part III.

29. In addition, the SFC issued a statement today indicating that the platform for selling virtual asset futures contracts may violate Hong Kong law.

For example, because such futures contracts carry great risks, investors should remain vigilant when investing.

Part III – Regulatory Framework for Virtual Asset Trading Platforms

A. Licensing and supervision

30. The regulatory framework for the virtual asset trading platform is elaborated below. The regulatory standards under this framework are based on and are consistent with the current regulations applicable to licensed automated trading service providers and securities brokers, and are consistent with the standards set out in the advisory report organized by the International Securities Regulatory Commission.

Licensing system

31. Virtual asset trading platforms typically offer transactions for non-securities tokens. As stated in the November 1st Statement and this document, the activities of the central platform operator, if only providing non-securities token trading services, are outside the jurisdiction of the SFC. In view of this, the SFC has introduced a regulatory framework to incorporate the virtual asset trading platform that is intended to be licensed into its regulatory scope.

32. The SFC is empowered to grant licences to persons who carry out "regulated activities" as defined in the Securities and Futures Ordinance. Under this regulatory framework, if the platform operator operates a central online trading platform in Hong Kong and provides at least one type of securities-based token transaction on its platform, it will be within the jurisdiction of the CSRC and must have the first License for regulated activities of Class (Securities Trading) and Type 7 (providing automated trading services). Where the qualified platform operator complies with other licensing requirements (including appropriate candidate criteria), the SFC may grant a licence to the business of the virtual asset transaction.

33. At this stage, the SFC will endeavour to regulate the virtual asset trading platform (the central virtual asset trading platform) that provides virtual asset trading, settlement and settlement services and controls the assets of investors. If the platform only provides trading services in a direct peer-to-peer market, and its investors usually retain control of their own assets (whether legal or virtual), the SFC will not accept license applications from these platforms. If the platform conducts virtual asset transactions (including the transmission and sale instructions) for the customers but does not provide automated trading services themselves, this Council will not accept their licence applications.

Regulatory system

34. Once the platform is licensed, its infrastructure, core appropriate candidates and virtual asset trading activities should be considered as a whole. Although the trading activities of non-securities tokens are not “regulated activities”, as long as the platform involves the trading activities of securities tokens (even if only a small part of their business), the regulatory area of ​​the SFC covers the All relevant areas of platform operations.

35. Trading activities involving non-securities tokens and trading activities involving securities tokens may be intermixed and form part of an integrated business.

36. According to section 116 of the Securities and Futures Ordinance, unless the applicant for the licence is a suitable candidate, the SFC must refuse to grant the licence. The SFC may consider the status of any other business of the corporation in accordance with section 129 of the Ordinance when considering the eligibility of a person for the appropriate person (whether at the initial stage or as a continuing requirement). Therefore, the Council will consider the way in which the licensee operates a non-securities token business on the grounds that this may affect the licensee's eligibility for appropriate candidates for regulated activities. This practice has also been reflected in the regulatory power of the SFC as set out in section 180 of the Ordinance. The scope of the regulatory powers extends to the inspection and inquiry of any records and documents relating to any transaction or activity that may affect the business of a licensed corporation.

37. Therefore, when reviewing the licence application of the platform operator, the SFC will consider the way in which the virtual asset trading platform operates its overall virtual asset trading business, in particular whether the operator has complied (or is willing and able to comply) Regulatory standards.

38. In view of this, the platform operator applying for a licence should be aware that when operating a virtual asset trading business, whether it involves a securities token or a non-securities token, and whether or not the business is on its platform, All relevant regulatory requirements should be followed.

39. In addition, the SFC will require the platform operator to ensure that all of its virtual assets trading activities (referred to as related activities) that the company group actively promotes or conducts in Hong Kong are a single legal entity licensed by the Securities and Futures Commission. Undertake, including all virtual asset transactions on platforms and non-platforms, and any activities that are purely for the provision of related trading services. Limiting all activities to a single legal entity allows the SFC to implement comprehensive monitoring. On the other hand, it can also minimize any part of the business that is subject to the supervision and supervision of the Securities and Futures Commission. . Pay attention to the block rhythm, download the block rhythm APP, get the latest information

B. Regulatory standards

Licensing conditions

40. If the SFC decides to grant a licence to a qualified platform operator, the licensing conditions will be imposed to address the specific risks associated with its operations. The licensing conditions that may be imposed under section 116(6) of the Securities and Futures Ordinance are set out below:

(a) Licensees may only provide services to professional investors. The term "professional investor" is defined in Section 1 of Part 1 of the First Schedule to the Securities and Futures Ordinance and the Securities and Futures (Professional Investors) Rules.

(b) The licensee must comply with the attached terms and conditions applicable to the operator of the virtual asset trading platform (as amended from time to time).

(c) The licensee must obtain prior written approval from the SFC for any plans or recommendations that introduce or provide new or accompanying services or activities or make significant changes to existing services or activities.

(d) The licensee must obtain prior approval from the SFC for any plans or recommendations to add any product to its trading platform.

(e) The licensee must provide monthly reports to the SFC on the business activities in the form prescribed by the SFC. The report must be submitted to the SFC within two weeks of the end of each calendar month and at the request of the SFC.

(f) The licensee must appoint an independent professional company acceptable to the SFC to conduct an annual review of the licensee's activities and operations and to prepare a confirmation that it has complied with the licensing conditions and all relevant legal and regulatory requirements. Report. The first report must be submitted to the SFC within 18 months from the date of approval of the licence. Subsequent reports should be submitted to the SFC within four months of the end of each financial year and at the request of the SFC. .

41. The licensed platform operator must comply with all licensing conditions imposed on any relevant activity. Any breach of any licensing conditions will be considered a "misconduct" under Part IX of the Securities and Futures Ordinance and may have a negative impact on the eligibility of the platform operator to continue to be licensed and may result in the SFC Take disciplinary action (such as revoking a license, publicly condemning or fine).

Terms and conditions applicable to virtual asset platform operators

42. As mentioned above, one of the licensing conditions will require the platform operator to comply with the prescribed terms and conditions. The licensing conditions and terms and conditions are set out in Appendix 1 to this document, and the criteria set out are mainly for the operation of the virtual asset trading platform in carrying out related activities.

43. The terms and conditions are based on the following benchmarks:

A platform operator is a licensed corporation and is required to comply with the relevant provisions of the Securities and Futures Ordinance and its subsidiary legislation. In carrying out any relevant activities, the platform operators are also required to comply with all relevant regulatory requirements contained in the Code of Conduct and the guidelines, circulars and FAQs issued by the SFC from time to time.

b. As some of the existing requirements explicitly refer to "securities" and "regulated activities", the SFC has amended the relevant provisions and added relevant terms and conditions to apply the same or similar concepts to the relevant activities. .

c. In addition to the above-mentioned current regulations, the SFC has also added additional requirements in response to the unique characteristics of virtual assets and the technology involved. Pay attention to the block rhythm, download the block rhythm APP, get the latest information

44. The main terms and conditions are set out below.

Safekeeping assets

45. The virtual asset trading platform not only matches the market of buyers and sellers, but also holds virtual assets on behalf of its customers.

46. ​​The SFC considers that the operational framework and technology adopted by any virtual asset trading platform seeking to obtain a licence should ensure that the same guarantees are provided to customers as traditional financial institutions in the securities industry. Trust structure

47. The platform operator should hold the client's assets for the client through a company in a trust mode and the company must be (i) the associated entity of the platform operator under the Securities and Futures Ordinance; (a) a "trust or corporate service provider licence" within the meaning of the Anti-Money Laundering and Terrorist Financing Ordinance (Cap. 615); and (iv) the entire operator of the platform A subsidiary owned by the company ("Connected Entity"). This provision should help protect customers' virtual assets and ensure that these assets are properly separated from the platform's assets.

48. There is a certain degree of uncertainty as to whether virtual assets constitute "property" under the laws of Hong Kong. The court has not yet made any ruling on this issue. The legal classification of virtual assets may affect the rights of customers in the insolvency proceedings. Although this uncertainty cannot be resolved in the short term, the SFC believes that this will not hinder the regulatory framework implemented at this stage. At the same time, the Council will require that if it is licensed, the platform operator will be required to fully disclose any significant legal uncertainties to its clients, in particular any law that may be owned by the client in relation to the virtual assets it buys or sells on the platform. Uncertainty related to the nature of the claim.

49. Investors should be aware that while certain risks associated with the custody of virtual assets should be diminished, there are still other risks, especially those associated with cyber attacks such as hacking.

Online and offline wallets

50. The SFC will require platform operators and their associated entities to establish and implement written internal policies and governance procedures to ensure compliance with the rules regarding the custody of customer virtual assets. For example, the "online wallet" storage method refers to the practice of storing the private key of the virtual asset on the Internet, so it is vulnerable to external threats such as hacking and social engineering (such as fake fraud). The "offline wallet" storage method refers to the practice that the private key is stored offline (ie, without access to the Internet), so it is safer. The SFC will require platform operators to ensure that (or their associated entities) store 98% of their virtual assets in online wallets and limit their virtual assets held in online wallets to no more than 2%. Platform operators and their associated entities should also minimize the allocation of assets from offline wallets that hold most of their virtual assets.

51. Furthermore, given the unique characteristics of virtual assets, platform operators and their associated entities should have detailed procedures for handling hard forks or air drops from an operational and technical perspective.

52. Platform operators and their associated entities should also establish adequate procedures for handling the deposit requirements of client virtual assets to prevent losses resulting from theft, fraud and other dishonest practices, professional misconduct or inaction.

Insurance

53. In the event of a hacker, it is often difficult for investors to recover the loss. The CSRC will require the platform operator to ensure that the insurance coverage is valid at the moment, and its coverage should cover the risks involved in holding the virtual assets of the customer in online storage (full coverage), and the custody is held in offline storage. The risks involved in the customer's virtual assets (most of the guarantees, such as 95%). Pay attention to the block rhythm, download the block rhythm APP, get the latest information

Private key management

54. Access to and retention of virtual assets is only possible by digitally signing transactions using private keys. Therefore, the basics of keeping virtual assets are to manage the relevant private keys securely. The SFC believes that platform operators and their associated entities should establish and implement strict internal controls and governance procedures in managing private keys to ensure that all encrypted seeds and keys are securely generated, stored and backed up.

55. For detailed regulations on the custody of client assets, please refer to paragraphs 7.1 to 7.19 of the relevant terms and conditions.

Know your customers

56. The platform operator should comply with the rules applicable to licensed clients in recognizing your customers and should take all reasonable steps to establish the true and full status, financial status, investment experience and investment objectives of each of its clients.

57. Unlike traditional stock exchanges, virtual asset trading platforms allow investors to enter directly. Easy access to the trading platform, coupled with the complexity and inherent risks of virtual assets, has caused significant investor protection issues. The SFC will require the platform operator to ensure that the customer has a full understanding of the virtual assets (including knowledge of the risks associated with the virtual assets) before providing any services to the customer 24.

58. If the customer does not have the knowledge, the platform operator can only provide services to the customer if they have provided training to the customer and have inquired about the customer's personal status to ensure that the service provided is suitable for the customer.

59. The platform operator should also assess the concentration risk by setting the transaction limit or position limit (or both) by reference to the client's financial position to ensure that the client has sufficient net assets to cover the risks and possible transactions. loss.

60. For detailed rules regarding your customers, please refer to paragraphs 6.6 to 6.10 of the relevant terms and conditions.

Combating money laundering and terrorist fundraising

61. Since many virtual assets are bought and sold anonymously, they often lead to money laundering and terrorist fundraising risks. The SFC expects that platform operators should establish and implement adequate and appropriate anti-money laundering and terrorist fundraising policies, procedures and monitoring measures (collectively referred to as anti-money laundering/terrorist fundraising systems) to fully manage the risks.

62. The platform operator should also refer to any new guidance issued by the SFC and the latest content of the activities recommended by the Special Tasks of the Financial Action Special (Special Organization) for virtual assets (such as the notes to Recommendation No. 15 and “Applicable to Virtual Assets and "Guidance for a Risk-based Approach to Virtual Assets and Virtual Asset Service Providers", regularly review the effectiveness of the anti-money laundering/terrorist fundraising system and, where appropriate, strengthen Measures.

63. Platform operators can use virtual asset tracking tools so that the platform can track the record of specific virtual assets on the blockchain. These tools can support a variety of common virtual assets and can match transaction records with databases containing known addresses related to criminal activity, such as addresses for ransomware attacks, money laundering or crypto transactions, and will identify The transaction arrived is marked. In the event of these transactions, the platform may refuse to establish a customer business relationship with the person involved.

64. When adopting these tracking tools, platform operators should bear in mind that they have the primary responsibility for fulfilling their obligations to combat money laundering and terrorist fundraising. They should also note that the search for backtracking tools is limited and their effectiveness may be Attenuated by anonymous enhancement techniques or mechanisms designed to disrupt transaction records, including hybrid services and privacy coins.

65. For detailed provisions on combating money laundering/terrorist fundraising systems, please refer to paragraphs 13.1 to 13.2 of the relevant terms and conditions.

Prevent market manipulation and violations

66. Market manipulation and non-compliance activities are reported to be quite common in the virtual asset world, and the most commonly used methods are not significantly different from those used in other asset classes, such as spoofing and layering. ) and the "pump-and-dump scheme" of "singing high bulk cargo".

67. The SFC believes that platform operators should establish and implement written policies and monitoring measures to properly monitor activities on their platforms to identify, prevent and report any market manipulation or non-compliance transactions. The relevant policies and monitoring measures should cover a number of areas, including taking steps to limit or suspend trading immediately after the discovery of manipulation or non-compliance activities (such as temporarily freezing the account).

68. Market surveillance tools (used frequently by global exchanges and regulators) developed to detect market manipulation activities in traditional asset classes can also be used to monitor virtual asset classes with minor adjustments.

69. As an additional safeguard, the platform operator should use an effective market surveillance system provided by a reputable independent supplier to identify, monitor, detect and prevent any market manipulation or non-compliance activities on its platform, and Provide the SFC with access to this system when necessary to perform its own monitoring functions.

70. For detailed provisions on prevention of market manipulation and non-compliance activities, please refer to paragraphs 5.1 to 5.4 of the relevant terms and conditions.

Accounting and auditing

71. The SFC will require the platform operators to select and appoint auditors for their financial statements with appropriate skill, prudence and diligence, and should take into account their experience in auditing virtual assets related businesses. Performance records and their ability to audit platform operators.

72. For detailed accounting and auditing requirements, please refer to paragraphs 12.1 to 12.2 of the relevant terms and conditions.

Risk Management

73. The platform operators and their associated entities will need to establish a sound risk management framework to enable them to identify, measure, monitor and manage all risks arising from their business and operations.

74. Platform operators should also require customers to inject funds into their accounts in advance. Only in a few cases, the SFC may allow institutional professional investors to conduct day-to-day settlement transactions outside the platform. Platform operators must not provide any financial accommodation to customers to purchase virtual assets.

75. For detailed requirements on risk management, please refer to paragraphs 8.1 to 8.2 of the relevant terms and conditions.

Conflict of interest

76. It has been reported that the virtual asset trading platform acts as both an agent of the client and a principal trader who trades for its own books. In order to avoid any potential or actual conflict of interest, platform operators should not engage in proprietary trading or self-operated bookmakers if they are licensed. If the platform plans to use bookmaker services to increase the liquidity of its market, the SFC generally expects that this arrangement will be conducted on an arm's length basis and will be provided by independent external parties using normal user access.

77. Platform operators and their associated entities should also have policies in place to restrict employees from trading on virtual assets to eliminate, avoid, manage or disclose actual or potential conflicts of interest.

78. For detailed provisions on conflicts of interest, please refer to paragraphs 10.1 to 10.7 of the relevant terms and conditions.

Virtual assets for sale

79. The platform operator should establish a function responsible for the establishment, implementation and implementation of:

a. Rules that apply to the responsibilities and limitations of the virtual asset issuer (for example, to notify the platform operator of any proposed hard fork or airdrop, any significant change in the issuer's business, or any regulatory action against the issuer) responsibility);

b. the criteria and applications for the inclusion of virtual assets in their platforms (which take into account the criteria contained in the relevant terms and conditions);

c. The criteria for suspending, suspending and revoking the trading of virtual assets on its platform, the options available to customers holding the virtual assets, and any notice period.

80. Platform operators should conduct all reasonable due diligence on these virtual assets prior to trading any virtual assets on their platforms and ensure that they continue to meet all the criteria incorporated into their platforms. The following is a list of factors that the platform operator must consider when applicable (not exhaustive):

a. The background of the management or development team of the virtual asset issuer;

b. The regulatory status of the virtual assets in the various jurisdictions where the platform operators provide trading services, including the availability and trading of virtual assets under the Securities and Futures Ordinance, and whether the regulatory status will also affect the regulatory obligations of the platform operators;

c. Supply and demand of virtual assets, market maturity and liquidity, including their market capitalization, average daily volume, whether other platform operators also provide services to facilitate the trading of virtual assets, and whether there are related transaction combinations (such as legal currency Virtual assets), and in which jurisdictions the virtual assets have been sold;

d. The technical aspects of the virtual asset, including the security infrastructure of the blockchain protocol for the virtual asset, the size of the blockchain and network (especially whether it is vulnerable to 51% attacks25), and the type of consensus algorithm;

e. The level of activity of the development community;

f. The extent of ecosystem access;

g. The virtual asset promotion materials provided by the issuer should be accurate and not misleading;

h. the development of virtual assets, including the results of any of its related projects contained in its white paper (if any), and any significant events related to its history and development;

i. For virtual assets within the definition of "securities" within the meaning of the Securities and Futures Ordinance, the platform operator should only include virtual assets that meet the following description: (i) asset-backed; (ii) Approved by a regulatory body in a comparable jurisdiction (which is approved by the SFC from time to time), deemed eligible or registered; and (iii) has a 12-month post-release track record.

81. For detailed provisions on the licensing of virtual assets, please refer to paragraphs 4.1 to 4.6 of the relevant terms and conditions.

25 Refers to a group of miners attacking the blockchain by more than half of the mining rate or computing power of the control network.

Part IV – Future Directions

82. Starting from November 6, 2019, companies operating a central virtual asset trading platform in Hong Kong and intending to provide trading services on at least one securities token on their platform may apply to the Securities and Futures Commission for categories 1 and 7. Licensed for regulated activities.

83. Applicants must demonstrate their willingness and ability to comply with the expected standards under the regulatory framework described in this document.

84. Given the rigorous assessment process and the need to ensure that the expected regulatory standards are adhered to, the processing time for a licence application submitted by a virtual asset trading platform may be longer than the processing of a standard licence application.

85. Once the virtual asset trading platform operator is licensed, it will be placed in the SFC Supervision Sandbox. This generally means that reporting, monitoring and inspection will be required more frequently. Through close supervision, the CSRC will be able to highlight areas where operators should improve their internal controls and risk management.

86. It is important to emphasize that some of the regulatory constraints described in this document can only be resolved by amending the legislation. The SFC will continue to monitor the evolution of cryptographic assets and discuss with the Hong Kong Government whether there is a need to amend the law in the long run.

For enquiries, please contact the SFC Financial Technology Unit ([email protected]). Securities and Futures Commission Securities and Futures Commission Intermediary Division

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