The Hong Kong Treasury Bureau issued a policy consultation to the whole society on November 4, as part of the legislative proposal to strengthen Hong Kong’s anti-money laundering and terrorist financing system, preparing to fully incorporate Hong Kong’s virtual asset industry into the regulatory system, and implement licensing for service providers system.
The deadline for the above policy consultation is January 31, 2021, after which it will enter the policy formulation stage. For many practitioners, the establishment of a licensing system means that in the future, there will be opportunities to engage in the issuance, trading, investment management, custody and related financial services of virtual assets in Hong Kong. But at the same time, if you are not familiar with Hong Kong’s regulatory rules and do not have a deep understanding of licensing conditions, business development may also face huge challenges. This article briefly introduces the licensing system proposed by Hong Kong this time and what specific requirements are imposed on practitioners.
Evolution of the licensing regulatory system
An important content of this policy consultation is to change the licensing system from “voluntary” to “mandatory” licensing.
It needs to be pointed out that this is not the first time that Hong Kong has implemented licensing management of virtual assets. As early as November 2019, the Hong Kong Securities Regulatory Commission (SFC) had issued the “Position Paper on the Supervision of Virtual Asset Trading Platforms” (hereinafter referred to as “position paper”) ), incorporate the licensed virtual asset trading platform into the SFC regulatory sandbox, and implement the “voluntary licensing system.”
In the policy consultation document of the Hong Kong Treasury Bureau, the licensing under the position paper is called the “voluntary licensing system”, but in fact, in the author’s opinion, “voluntary” here has the meaning of “voluntary” in our usual sense. Very different.
According to the content of the position letter, all institutions that apply for a virtual asset trading platform must first be a licensed institution before they can apply for a virtual asset trading platform. The main reason for the Hong Kong Securities Regulatory Commission to do this is that it is only empowered to supervise “securities tokens”, so strictly speaking, if it is a virtual trading platform for non-securities tokens, it does not need to be licensed.
As the Hong Kong Securities Regulatory Commission emphasized in its position paper: “Platform operators who operate a central online trading platform in Hong Kong and provide at least one security token transaction on the platform” will fall within the jurisdiction of SFC , And must have a license for Type 1 (securities trading) and Type 7 (providing automated trading services) regulated activities.
SFC also specifically emphasized that it will only regulate virtual asset trading platforms that provide virtual asset trading, settlement and settlement services and have control over investor assets (ie, central virtual asset trading platforms). If the platform only provides trading services for the direct peer-to-peer market, and its investors usually retain control of their own assets (whether legal currency or virtual assets), SFC will not accept license applications from these platforms. In addition, if the platform conducts virtual asset transactions (including the transmission of trading instructions) for customers, but the platform itself does not provide automated trading services, SFC will not accept their license applications.
In other words, all virtual asset trading platforms that want to apply for a license, as long as they involve the securities token business, actually must first obtain the No. 1 and No. 7 licenses (this is actually a mandatory requirement) before they can SFC applies for a license for a virtual asset trading platform-this so-called “voluntary” licensing system is actually very different from the “voluntary” we usually understand. It is recommended that you ignore the word “voluntary” directly, and more Understand the intentions of the Hong Kong regulatory authorities.
So, why spend so much pen and ink to introduce the above-mentioned “voluntary licensing system”? Because in this round of policy consultation, the Hong Kong Treasury Bureau made it clear that it will refer to the “voluntary licensing system” to license future virtual asset service providers. If readers do not fully understand the meaning of “voluntary” mentioned above, there may be deviations in their understanding of regulatory documents.
Top 10 licensing conditions
After understanding the compulsory licensing, let’s take a look at the specific licensing conditions proposed in this consultation document. The Hong Kong Treasury Bureau proposed 10 licensing conditions.
Condition 1: Only professional investors
That is, licensed virtual asset service providers can only provide professional investors with virtual asset related services in the initial stage. In the future, whether it will open up its service targets and expand to general retail investors, this requires SFC to continue to monitor the market conditions and make further decisions depending on the maturity of the market.
The professional investor here is a proper term. There are usually two major categories. The first category is mainly institutional professional investors, such as licensed exchanges, securities brokerage firms, banks, insurance companies, MPF schemes and collective investment schemes (ie, “funds in the Mainland”). “Products), and the management companies of these plans (similar to fund companies in Mainland China).
The second category is individuals, corporations (ie companies), trust corporations and partnership companies whose wealth has reached a specified level. As far as the second type of professional investors are concerned, the current laws in Hong Kong use wealth to define their professional status. In the industry, the usual judgment standard for individual professional investors is to see whether the investor (natural person) has investable assets of US$1 million (or equivalent currency).
It should be pointed out that professional investors need to be identified by service providers, and they need to obtain their own consent, because after being classified as professional investors, customers are largely responsible for their investment decisions.
Condition 2: The applicant’s financial ability
All licensed virtual asset service providers need to have sufficient financial capacity to operate virtual asset business, including the actual paid-up capital requirements required by the nature of the business, and current asset requirements. The Treasury Bureau’s consultation document has not listed specific requirements for equity and current assets. It is expected that some detailed regulations will be issued in the future.
Condition 3: Applicant’s knowledge and experience
Licensed virtual asset service providers and their associated entities (that is, independent corporate entities that have a controlling relationship with the service provider) must have a good corporate governance structure, and their staff must have the required knowledge and experience in order to Perform duties effectively.
The Bureau of Finance and the Treasury did not put forward specific requirements on the corporate governance structure and the knowledge and experience of its staff. However, from the perspective of this policy statement, in the future SFC is very likely to require review of the qualifications of the major shareholders and actual controllers of the applicant company and the company The educational background and work background of the directors, executives and practitioners hired.
Condition 4: Business robustness
The consultation paper recommends that licensed virtual asset service providers and their associated entities should operate virtual asset businesses in a sound business model and ensure that they will not harm the interests of customers and the public.
As for what is meant by a “stable business model”, there is no specific elaboration here, which leaves SFC with a lot of room for active judgment. It is estimated that the main reason is that virtual asset service providers may provide different business models. For example, some are engaged in virtual asset trading platform business, some are engaged in virtual asset management, and some may be engaged in virtual asset custody or token issuance, so the required ” The criteria for judging “soundness” vary.
Condition 5: Risk Management
The consultation paper pointed out that licensed virtual asset service providers must formulate appropriate risk management policies and procedures to reduce money laundering and terrorist financing risks, cyber security risks and other risks arising from regulated virtual asset activities. The relevant policies and procedures must be commensurate with the scale and complexity of the business.
Since this policy consultation is mainly initiated in response to the requirements of anti-money laundering legislation, the focus of risk management here is money laundering and anti-terrorist financing. But in fact, it is expected that SFC will also pay attention to other risk management indicators of licensed institutions, such as market risk, operational risk, and company internal control risk.
Condition 6: Separation and management of customer assets
Specifically, licensed virtual asset service providers must deposit customer assets in related entities and separate relevant assets. Licensees must also implement appropriate policies and governance procedures to properly manage and keep customer assets (including virtual assets).
Taking into account the particularity of virtual assets, it is expected that licensing agencies will raise many specific questions on how to separate and manage client assets, and require applicants to provide materials that can prove their technological strength.
Condition 7: Listing and trading policy of virtual assets
This condition requires licensed virtual asset service providers to implement and implement proper policies regarding the listing and trading arrangements of virtual assets on their platforms. Before licensees allow virtual assets to be listed on their exchanges, they must also conduct all reasonable due diligence on the virtual assets.
Judging from this threshold requirement, in the future, virtual asset service providers need to hire full-time compliance professionals who can distinguish different virtual assets and provide due diligence results that meet regulatory requirements.
Condition 8: Financial reporting and disclosure
This condition requires licensed virtual asset service providers and their associated entities to comply with specified audit and disclosure requirements and publish audited accounts.
This requirement is not much different from the current requirements for licensees and is a routine requirement.
Condition 9: Prevent market manipulation and illegal activities
Licensed virtual asset service providers must formulate and implement monitoring policies and measures to monitor trading activities on their platforms to identify, prevent and report trading activities suspected of market manipulation or violations.
This requirement is not much different from the current license requirements, and it is also a routine requirement.
Condition 10: Prevent conflicts of interest
In order to avoid conflicts of interest, licensed virtual asset service providers and their associated entities are not allowed to engage in subscribed transactions. In addition, licensees and their associated entities must establish appropriate firewalls between different functions within the corporate structure to avoid conflicts of interest; they must also formulate policies to eliminate, avoid, manage or disclose employees arising from virtual asset transactions The actual or potential conflict of interest.
This requirement is generally consistent with the current requirements for fund managers and other licensed institutions and licensees, and is also a routine requirement. However, due to the characteristics of the privacy of virtual assets and the concealment of market transaction information, how to convince the supervisor that the applicant has done enough to prevent conflicts of interest will be an important consideration in obtaining a license.
In addition to the above 10 conditions, the consultation document also proposed that virtual asset service providers also need to comply with the anti-money laundering and terrorist financing regulations set out in Schedule 2 of the “Anti-Money Laundering Regulations”. In addition, because virtual asset business is a high-tech industry and highly speculative, licensed virtual asset service providers must comply with a set of sound regulatory requirements to ensure that licensees have sufficient capabilities and knowledge to properly operate virtual assets Business to reduce the risk to investors caused by system failures, security breaches or market manipulation.
On the whole, the above 10 licensing conditions are still largely based on the current licensing requirements for regulated businesses, but some elements related to virtual assets have been added. Judging from the relevant default, the focus of whether a license can be issued is still on the applicant’s ability to control risks, whether there is a reasonable mechanism and structure design, so that risks can be monitored, and to avoid causing damage to customers, and avoid Have an adverse effect on the industry.
Taking into account the unique liquidity, security, and concealment characteristics of virtual assets, it is expected that the regulatory requirements for the paid-in capital, personnel qualifications, and security guarantees of different virtual asset service providers will be more important than traditional regulated businesses. High first line.
(Introduction to the author of this article: Hong Kong financial market expert, author of “The Investment Approach of Chinese Hedge Fund Managers Dominating the World”)
