FSTB Proposals for a New Licensing Regime for Virtual Asset Exchanges under the AMLO
3. FSTB PROPOSALS FOR A NEW LICENSING REGIME FOR VIRTUAL ASSET EXCHANGES UNDER THE AMLO
The FSTB published a consultation in November 2020 proposing a new licensing regime for virtual asset exchanges under the AMLO, which will require any person seeking to conduct the “regulated VA activity” of operating a virtual asset exchange in Hong Kong to obtain a VASP licence from the SFC, even if the exchange only trades virtual assets which are not securities. The proposed regime aims to implement the FATF requirement for jurisdictions to regulate virtual asset service providers (VASPs) for AML / CFT purposes and supervise their compliance, a requirement introduced in February 2019 with the revision of FATF’s standards. The application of the proposed regime will however be much narrower than the FATF’s definition of VASPs, which also covers businesses involved in transferring virtual assets, providing safekeeping and/or administrative services of virtual assets or instruments enabling control over virtual assets (including certain wallet providers) or providing financial services related to the offer or sale of virtual assets (e.g., ICOs). This is because the FSTB considers virtual asset exchanges to be the most prevalent and developed virtual asset activity in Hong Kong, therefore warranting the introduction of a tailored licensing regime, with the potential for expansion of the regime at a later date.
If the new licensing regime takes effect, virtual asset exchanges will have 180 days to obtain a VASP licence.
3.1 Scope of Regulated Activity of Operating a Virtual Asset Exchange
Definition of a Virtual Asset Exchange
A virtual asset exchange will be defined as any trading platform which is operated for the purpose of allowing an offer or invitation to be made to buy or sell any virtual asset in exchange for any money or any virtual asset (whether of the same or a different type) and which comes into custody, control, power or possession of, or over, any money or any virtual asset at any point in time during its course of business. This definition will require centralised virtual asset exchanges to be licensed, however peer-to-peer trading platforms (that is platforms that only provide a forum for buyers and sellers of virtual assets to post their bids, with or without automated matching mechanisms) are excluded from the definition, provided that the actual transaction is conducted outside the platform and the platform is not involved in the underlying transaction by coming into possession of any money or virtual asset at any time. Decentralised virtual asset exchanges should therefore fall outside the scope of the licensing regime.
Definition of Virtual Assets
The proposals will largely align the definition of virtual assets with FATF’s definition (i.e., digital representations of value that can be digitally traded, or transferred, and can be used for payment or investment purposes). The AMLO will define a virtual asset as a digital representation of value that: is expressed as a unit of account or a store of economic value; functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes; and can be transferred, stored or traded electronically. The definition will therefore cover virtual assets which are not securities, such as Bitcoin and Ethereum. Stablecoins (i.e., virtual assets backed by assets) will also fall within the definition. Digital representations of fiat currencies (including CBDCs), financial assets already regulated under the SFO and closed-loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible including air miles, credit card rewards, gift cards, customer loyalty programmes and gaming coins, will be excluded.
3.2 Virtual Asset Exchange Licensing Requirements
The FSTB is proposing that only Hong Kong-incorporated companies with a permanent place of business in Hong Kong will be eligible for licensing as a virtual asset exchange. So, natural persons and businesses without a separate legal personality (e.g., sole traders or partnerships) will not be licensed. Virtual asset exchanges that are incorporated offshore will also not be eligible for licensing under the new regime.
The FSTB also proposes to prohibit the active marketing of a regulated VA activity or similar activity (i.e., services associated with a virtual asset exchange), whether in Hong Kong or elsewhere, to the public in Hong Kong without a VASP licence. This provision is similar to section 115 of the SFO and, since the SFC will not license an offshore entity, will prevent an offshore virtual asset exchange from marketing its services to Hong Kong investors. An offshore exchange that wants to be able to market to Hong Kong investors will therefore need to establish a Hong Kong subsidiary which will need to be licensed as a VASP by the SFC.
Licensing applicants will be required to appoint at least two responsible officers who will be responsible for ensuring the firm’s compliance with the AML/CTF requirements and other regulatory requirements. As is the case for licensed corporations, all executive officers will need to be approved as responsible officers of a licensed virtual asset exchange.
The licensing applicant, its responsible officers and the ultimate owners of the corporate entity will need to satisfy a fit-and-proper test, which will assess the person’s experience and qualifications and require that they have not been convicted of any money laundering or terrorist financing offence or other offence involving dishonesty and are not the subject of any liquidation or bankruptcy proceedings. Any change to the responsible officers or ultimate owners will require the SFC’s prior approval, however the FSTB do not clarify who will be regarded as an “ultimate owner” of a virtual asset exchange for these purposes.
3.3 Obligations of Licensed Virtual Asset Exchanges
Licensed virtual asset exchanges will be required to observe the AML/CFT requirements under Schedule 2 to the AMLO, which prescribes certain requirements relating to customer due diligence and record-keeping.
The regulatory standards for virtual asset exchanges licensed under the AMLO will be essentially the same as those for exchanges licensed under the SFO regime to ensure a level playing field for all virtual asset exchanges. The SFC will be empowered to impose licensing conditions and other regulatory requirements and may vary them where appropriate. These will include:
- restrictions on providing trading services to professional investors only, although the SFC may relax this position in the future as markets mature;
- a required minimum paid-up share capital requirement and, depending on the nature of business, a liquid asset requirement (to be set by the FSTB);
- licensed virtual asset exchanges will be required to have a proper corporate governance structure staffed by personnel with appropriate knowledge and experience;
- requirements relating to operating their virtual asset business in a prudent and sound manner and ensuring that client and public interests are not adversely affected;
- putting in place appropriate risk management policies and procedures for managing money laundering and terrorist financing, cybersecurity and other related risk;
- ensuring the proper segregation of client assets and ensuring adequate policies and governance procedures are in place to ensure the proper management and custody of client assets;
- implementing and enforcing robust rules for the listing and trading of virtual assets on their platforms. In particular, they will need to perform all reasonable due diligence on virtual assets before listing them for trading;
- following specified auditing and disclosure requirements and publishing audited accounts;
- implementing written policies and controls for the proper surveillance of activities on a virtual asset exchange to identify, prevent and report any market manipulative or abusive trading activities; and
- to avoid any conflicts of interest, licensed virtual asset exchanges will be prohibited from engaging in proprietary trading or market-making activities on a proprietary basis.
3.4 Proposed SFC Powers in Respect of Licensed Virtual Asset Exchanges
The SFC will be empowered to supervise the AML/CFT conduct of licensed virtual asset exchanges and to monitor, investigate and enforce their other obligations under the AMLO licensing regime. The SFC will also be given certain powers in relation to entering and inspecting premises and documents in order to investigate instances of non-compliance and will be empowered to impose administrative sanctions (including suspending or revoking a licence). The SFC will also be provided with intervention powers to impose restrictions and prohibitions on the operations of a licensed exchange and its associated entities in certain circumstances, for example where it is necessary to protect client assets.
The FSTB also propose to amend Part 6 of the AMLO in order to expand the scope of reviewable decisions of the AML/CFT Review Tribunal to cover appeals against future decisions made by the SFC in relation to implementing the VASP licensing and supervisory regime.