The introduction of Hong Kong’s licensing system for cryptocurrency firms serving individual traders, especially while the United States maintains a more cautious regulatory stance, could be seen as a potential opportunity for the city, according to insiders from the industry. The prospect of establishing operations in Hong Kong has garnered increasing attention from digital asset businesses, including exchanges. This interest has grown since local regulatory authorities unveiled their licensing initiative earlier this year.

Factors Driving Change: Overview of New Regulatory Framework

In October of the year 2022, Hong Kong issued a policy statement outlining the trajectory of cryptocurrencies, often referred to as “virtual assets,” through which the government expressed its readiness to adjust its legal and regulatory framework as a component of its endeavor to establish the facilitating environment, taking into consideration the dynamic nature and inventive approach of virtual assets. The policy states that in recent years, both the Government and regulatory bodies have collaboratively established an all-encompassing structure for overseeing Virtuaхфх Asset (VA) activities, adhering to the principle of aligning regulation with activities and associated risks. A comprehensive regulatory system has been initiated for granting licenses to VA Exchanges, utilizing an “opt-in” methodology; furthermore, within the realm of asset management, directives have been disseminated concerning the administration of VA funds and discretionary accounts. Additionally, the policy mentions that the financial institutions and banks have received instructive guidance pertaining to the dissemination, trading, and advisory aspects of products related to Virtual Assets.

Hong Kong’s securities regulator has implemented stricter rules for digital asset companies starting from June 1, 2023 as part of its cryptocurrency licensing framework. 

The newly established licensing structure comprises two tiers:

• The Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO), as amended by the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022. This legislation represents Hong Kong’s inaugural virtual asset-specific legal framework, offering a comprehensive regulatory structure for Virtual Asset Trading Platform (VATP) oversight under the supervision of the Securities and Futures Commission (SFC).
• The Guidelines for Virtual Asset Trading Platform Operators (VATP Guidelines), which are included in the Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission, dated 23 May 2023. These guidelines furnish meticulous procedural specifications for the operationalization of the VATP regulatory framework within Hong Kong.

The focus is on safeguarding retail investors, as only licensed providers may engage in the provision of virtual asset services. The only Virtual Asset service currently regulated under the AMLO is the VATP transaction, whereby 

(i) mandatory sales and purchases of Virtual Assets are or are to be made, negotiated or entered into; and 

(ii) the customer’s money is received or the customer’s virtual assets are taken over by the VATP. Thus, the new licensing regime covers centralized VATPs and mechanisms that trade or support trading of virtual assets, excluding peer-to-peer platforms that simply provide a forum for offers and offers and do not trade or support trading of virtual assets on the platforms. 

The move to allow retail trading in cryptocurrencies follows a challenging year for the sector, marked by the collapse of FTX exchange. The new rules require licensing for all trading platforms and exchanges, with penalties for non-compliance. Operators must ensure compliance with local laws and regulations, and the measures include setting exposure limits for retail investors and restricting trading to established tokens. The regulations also cover marketing by unlicensed platforms, including through social media influencers.

Besides, local fund managers overseeing funds with 10% or more of their gross asset value in digital assets are required to seek an upgrade to their “Type 9” license. Initial interest has been relatively low, but there is now an increasing trend, with several managers making the upgrade in the last six months. The SFC is now more open to granting the ‘virtual asset license upgrade’ to fund managers, provided they have the necessary expertise, experience, and engage appropriate service providers such as trading platforms, custodians, fund administrators, and auditors.  

There exist certain stages within the application procedures that remain undisclosed to the public. It is believed that the licensing application process with the SFC has become smoother and quicker compared to the past. The licensing framework is designed to enable “crypto choices for individual traders,” along with facilitating “entry and exit points.” The latter aspect, in particular, holds significant importance.

Nevertheless, the city has potentially positioned itself to benefit from businesses searching for respite from regulatory crackdowns in other regions. This could involve either relocating entirely from the US or, at the very least, setting up a presence beyond its borders.

Moreover, financial regulatory bodies in Hong Kong established a scheme allowing fund managers who exclusively trade crypto investment products to register. This initiative opens avenues for alternative investment managers focusing on digital assets, particularly those associated with institutional limited partners.

Hong Kong has also taken steps to enhance its standing in the crypto sector through other avenues. The government established a Web3 “task force” earlier this year with the purpose of investigating and offering suggestions for the “sustainable and conscientious growth of Web3 in Hong Kong.” Regulators believe that the notion is that Web3 could potentially tackle and surmount obstacles in domains such as finance, trade, business processes, and even daily routines.

A significant development has occurred in Hong Kong’s legal landscape, as in April 2023, Hong Kong’s High Court has officially classified cryptocurrency as a form of property, and ruled that it is capable of being held on trust. This groundbreaking decision represents the first instance of such a determination concerning digital assets within the city-state. The significant judgment in the case of Re Gatecoin Limited (In Liquidation) brings Hong Kong in line with the stance of several comparable common law jurisdictions. This decision offers clear legal assurance regarding the validity of cryptocurrency transfers or loans, as well as the legal rights of parties should instances of fraud, theft, or breach of trust involving these assets arise. Undoubtedly, this ruling is a positive advancement for enterprises engaged in this swiftly evolving domain.

The initial response from the cryptocurrency industry to the new regulations

HashKey Exchange and OSL Digital Securities Ltd. have recently secured the first cryptocurrency exchange licenses in Hong Kong’s updated framework, allowing them to service retail clients. HashKey Exchange, affiliated with HashKey Group, revealed the license expansion to cover retail users alongside professional investors. Following suit, OSL Digital Securities, a subsidiary of BC Technology Group, also confirmed acquiring a license for serving retail customers. These two entities previously held licenses under Hong Kong’s former opt-in regime for crypto asset service providers, potentially facilitating their swift approval under the new system. 

While it’s still in the initial stages, prominent worldwide crypto exchanges like Huobi, OKX, and BitMEX have expressed their intention to establish a presence in this area. The allure surrounding Hong Kong’s cryptocurrency prospects may have been ignited by its accommodating business climate, attractive tax rates, skilled workforce, and strategic proximity to mainland China. It’s worth mentioning that the SFC is presently enabling managers to explore a broader range of digital assets for investment and create more intricate Web3-oriented products. Earlier this year, the city-state’s largest digital bank announced plans to service locally regulated cryptocurrency exchanges with fiat deposits and withdrawals.

The regulatory progress in Hong Kong seems favorable, especially as the US continues to grapple with regulatory measures for its domestic crypto sector. The Hong Kong administration is staying true to its commitment of expanding the virtual asset sector, aiming to position the region as a competitive hub for virtual assets in Asia. Hong Kong’s objective is not to impede financial innovation but to establish fairness among all stakeholders, thereby unleashing the industry’s potential, by using Web3 for the positive impact. To sum up, stricter jurisdictions’ loss is Hong Kong’s gain when it comes to crypto. 

The content of this article is intended to provide a general guide to the subject matter, not to be considered as a legal consultation.

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