The Hong Kong Securities Regulatory Commission issued the rules for the supervision of virtual asset exchanges. Currently, no one has obtained a license.

Author: Qin Xiaofeng

Source: Planet Daily

Yesterday at 17 pm, Hong Kong's financial regulator, the Hong Kong Securities and Futures Commission, issued the "Warnings on Virtual Asset Futures Contracts" and "Standards: Regulating Virtual Asset Trading Platforms".

Ashley Alder, Chief Executive Officer of the Hong Kong Securities Regulatory Commission, said

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"The framework will enable the virtual asset trading platform to be regulated by the Securities and Futures Commission. This is a major development, and I proposed this direction at this time last year."

The SFC said that so far, no one has been licensed by the SFC or approved to sell or trade virtual asset futures contracts in Hong Kong. In view of the risks involved in these contracts, the SFC is unlikely to grant licences or recognition for the operation of the relevant contracts in order to protect the investors.

Only supervise trading securities-based token platforms

The regulatory standards adopted by the CSRC on virtual asset trading platforms are similar to those of traditional licensed securities brokers and automated trading venues. These include: keeping assets safely, knowing your customers (KYC), combating money laundering and terrorist fundraising, market manipulation, accounting and auditing, risk management, etc. The SFC will only grant licenses to standards-compliant platforms.

However, the document also states that the SFC does not have the authority to issue or supervise platforms that only buy or sell non-securities virtual assets or tokens. Because the virtual assets operated by these platforms are not in the category of "securities" or "futures contracts" under the Securities and Futures Ordinance, they are not regulated.

Of course, there are also some platforms that may be hybrid, both securities and non-securities. However, as long as there is a token that belongs to securities, it is regulated by the CSRC.

However, the document does not discuss the assets of ICO-type tokens that are not issued under the securities framework.

In addition, for applicants for licences, the SFC requires that they be "appropriate candidates" or the SFC refuses to grant licences. When reviewing the platform operator's application for a license, the SFC will consider the way in which the virtual asset trading platform operates its virtual asset trading business, especially if the operator complies with (or is willing and able to comply with) regulatory standards.

In addition, the SFC stipulates that platform operators can only provide their services to professional investors and ensure that their customers fully understand virtual assets. They must also establish strict inclusion criteria to screen the virtual assets they buy and sell on the platform. In addition, the licensed platform will be included in the SFC Supervision Sandbox and will be subject to close and rigorous supervision during a period of time.

In addition to the above conditions, the SFC requires the platform operator to ensure that (or its associated entities) store 98% of the customer's virtual assets in the cold wallet, and the hot wallet storage assets do not exceed 2%. Moreover, platform operators and their associated entities should minimize the transfer of assets from offline wallets that hold most of their virtual assets.

Once a hacker breaks in, investors often have difficulty recovering losses. The CSRC will require platform operators to ensure that the insurance they purchase is always effective. In addition, all hot wallet assets should be 100% guaranteed, and cold wallet storage assets should be largely protected, for example 95%.

At present, there are dozens of virtual asset trading platforms in Hong Kong. Due to the strict application standards set by the CSRC, the SFC expects that some platforms may decide not to apply for a license from the Securities and Futures Commission under the new regulatory framework.

The SFC said: This is their free choice, as long as they can ensure that the virtual assets traded on their platforms are not "securities" or "futures contracts" under the Securities and Futures Ordinance.

Thor, a CEO of a cryptocurrency exchange in Hong Kong, said that according to the SFC's regulatory rules, STO exchanges are currently explicitly regulated, and other non-securities token exchanges are not regulated. Thor also said that Bitcoin already has a large share of digital assets and is an essential asset in digital asset exchanges. Because it is decentralized, no country or individual can control its price. It can only be said to be an impact. There is currently no effective monitoring method. The assets of the STO category must be regulated and must be compliant, so the exchanges that regulate the trading of securities-type tokens exclude the bitcoin assets.

Earlier, the chairman of the Hong Kong Securities Regulatory Commission said that bitcoin is not a security.

Futures contracts are risky and illegal

Regarding futures contracts, the Hong Kong Securities and Futures Commission also issued risk warnings.

The virtual asset prices under virtual asset futures contracts are extremely volatile, and the highly leveraged nature of virtual asset futures contracts also doubles the risk faced by investors. In addition, the complexity and inherent risks of these products may be difficult for general investors to understand.

In addition, the platform for selling or trading virtual asset futures contracts involves manipulating markets and violating activities. Trading rules for virtual asset trading platforms may not be clear and fair, and some platforms may change trading rules, such as suspending trading or canceling transactions, resulting in significant losses to investors.

The SFC has suggested that the platform for selling or trading virtual asset futures contracts may be illegal in Hong Kong.

In Hong Kong, any trading platform or person who sells virtual asset futures contracts or provides trading services for virtual asset futures contracts without proper licence or approval may be in breach of the Securities and Futures Ordinance (Cap. 571) or Gambling Ordinance (Chapter 148).

Depending on the form of the virtual asset futures contract, they may be considered as "futures contracts" within the meaning of the Securities and Futures Ordinance. Unless an exemption applies, any person operating a platform for the sale or trading of "futures contracts" must be licensed or endorsed under the Securities and Futures Ordinance. So far, no one has been licensed by the SFC or approved to sell or trade virtual asset futures contracts in Hong Kong. In view of the risks involved in these contracts, the SFC is unlikely to grant licences or recognition for the operation of the relevant contracts in order to protect the investors. Virtual asset futures contracts may also be interpreted as CFDs under the Gambling Ordinance.

Persons who contravene the relevant provisions of the Securities and Futures Ordinance or the Gambling Ordinance may be prosecuted and will be subject to criminal sanctions upon conviction.

In addition, the SFC has repeatedly reminded investors that investing in virtual assets may expose them to a variety of significant risks, particularly lack of liquidity, high price volatility and potential market manipulation activities. As outlined above, these risks may increase further when investing in virtual asset futures contracts.

Regulatory guidelines have been issued: Only one fund is eligible?

In 2018, the Hong Kong Securities and Futures Commission also issued regulatory guidelines on cryptocurrency funds and exchanges, the “Declaration on the regulatory framework for management companies, fund distributors and trading platform operators for virtual asset portfolios”.

However, Reuters research shows that only one year after the Hong Kong Securities and Futures Commission (SFC) announced preliminary provisions for encrypted investment funds, only one encryption fund meets the relevant conditions, namely Diginex, which is based in Hong Kong.

Reuters said that in addition to Diginex, other funds are withdrawing from Hong Kong to "circumvent" the Hong Kong Securities Regulatory Commission. The study pointed out that although many companies are still applying for approval, they do not really intend to obtain a license, but only to make a surface effort. However, external factors with low volume are still there, including the potential legacy of the bear market, which may make the encryption fund cautious.

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