Hong Kong: Licensing regime for Virtual Asset service providers

Latest Developments

Following discussions and consultations for a new approach to regulating virtual assets that began in 2018, the Hong Kong licensing regime for Virtual Asset service providers took effect on 1 June 2023 (Commencement Date). Under the new regime, all centralised Virtual Asset Trading Platforms (VATPs) which carry on business in Hong Kong, or actively market to Hong Kong investors must be licensed by the Securities and Futures Commission (SFC).

The VATP licensing framework is outlined in the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO) amended by the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022 and the accompanying Guidelines for Virtual Asset Trading Platform Operators (VATP Guidelines) appended in the Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the SFC dated 23 May 2023, which sets out practical implementation details of the framework in Hong Kong.

Prior to the implementation of the new licensing regime under the AMLO, only VATPs providing trading services in security tokens were regulated by the SFC under the Securities and Futures Ordinance (Cap. 571) (SFO), whereas trading of virtual assets that were non-security tokens were not subject to the SFC’s oversight. In 2018, the SFC introduced an opt-in regime for VATPs to voluntarily come under the SFC’s regulatory remit under the SFO by trading at least on security token. However, with the commencement of the new licensing regime in June 2023, trading of non-security tokens is also now subject to regulation.

It is worth noting that the regulation of VATPs under the AMLO will operate in parallel with the SFO regime, where VATPs engaging in the trading of security tokens will be regulated by the SFC under the SFO, while those engaging in the trading of non-security tokens will be regulated under the AMLO. Cognisant of the fact that a virtual asset’s classification may change over time (from a non-security token to a security token, or vice versa), the SFC encourages VATP operators to apply for licences under both the SFO and the VATP regimes to become dually-licensed, in order to facilitate business continuity and to avoid the risks of contravening licensing requirements under either regime as the business of VATPs evolve and develop.

As part of the licensing regime, the SFC will be empowered to impose conduct requirements on, and exercise supervisory and disciplinary powers in respect of, licensed VATPs.

Summary

(i) The Licensing Regime

The VATP licensing regime under the AMLO will apply to:

• Any person in Hong Kong that carries on a business of providing any VA service (as defined below) or holds themselves out as carrying on a business of providing any VA service; and
• Any person outside Hong Kong that (i) actively markets to the public in Hong Kong any services the person provides or purports to provide, and (ii) the provision of such services, if done in Hong Kong, would constitute providing a “VA service”.

“Virtual assets” (VA) refer to a cryptographically secured digital representations of value or rights which may be transferred, stored or traded electronically, irrespective of whether or not they amount to “securities” or “futures contracts” as defined under the Securities and Futures Ordinance (SFO) but excludes digital representations of fiat currencies issued by central banks.

Whether non-fungible tokens (NFT) fall within the scope of VA depends on its terms and features. NFTs that are “genuine digital representations of a collectable” would unlikely fall within the definition of VA.

It is important to note that under the AMLO for, Secretary for Financial Services and the Treasury (Secretary) has the power to prescribe, by notice, any digital representation of value to be a VA or not a VA, either generally or in any particular case. In other words, the Secretary has the power to declare what types of VA are subject to regulatory oversight.

“VA service” is defined in the ALMO to mean operating a VA exchange, that is to say, providing services through means of electronic facilities-

• Whereby-
  • Offers to sell or purchase VA are regularly made or accepted in a way that forms or results in a binding transaction; or
  • Persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VA in a way that forms or results in a binding transaction; and
• Where client money or client VA comes into direct or indirect possession of the person providing such service.

The licensing regime restricts a person from carrying on a business in Hong Kong of providing a virtual asset service or holding himself out as doing so unless the person holds a licence from the SFC to do so. However, based on the above definition of “VA service”, the only VA service presently regulated under the licensing regime for Virtual Asset service providers is the operation of a VATP. As such, virtual asset payment systems and virtual asset custodian services are unlikely to be in-scope for licensing purposes.

In summary, the features of the licence regime include the following:

• The applicant must be either a Hong Kong incorporated company or an overseas company that is registered as a non-Hong Kong company under the Companies Ordinance.
• The SFC must be satisfied that the applicant is “fit and proper”.
• The applicant must have at least 2 persons who will act as “responsible officers” of the applicant.
• The SFC must be satisfied that each director of the applicant is a fit and proper person to be associated with the business of providing the relevant VA services.
• The SFC must be satisfied that the “ultimate owner” (if any) of the applicant is a fit and proper person to be associated with the business of providing the relevant VA services. The “ultimate owner” of the applicant is defined to include any individual who:
  • Owns or controls (directly or indirectly) more than 25% of the issued share capital of the VASP;
  • Controls more than 25% of the voting rights as its general meetings; or
  • Exercises ultimate control over its management.
  • A person may not become the ultimate owner of a licensed provider unless that SFC has given its approval to such person. 

The SFC must approve the premises to be used by the applicant for keeping records and documents required under the licensing regime. The premises must be non-domestic and suitable for storing records.

Specific requirements are introduced for customer due diligence.

Licensed VATPs may provide services to both professional investors and retail investors, subject specific investor protection measures as set out in the VATP Guidelines, including among others, onboarding requirements, governance and disclosure obligations.

Licenses granted by the SFC will be open-ended, meaning they will continue unless revoked by the SFC (e.g. due to misconduct or the VATP ceasing operations).

As the SFC is the regulator, applicants for a licence must also comply with SFC codes, guidelines and circulars relating to VA licensees, in addition to complying with the statutory requirements under the AMLO.

(ii) Regulation of virtual assets market misconduct

The AMLO outlines a range of sanctions for unlicensed activities and fraudulent or deceptive behaviour in VA transactions, including fines and imprisonment. These include:

• A person carrying on a business of providing a VA service or actively marketing the provision of a VA service without licence is liable, on conviction on indictment, to a fine of HK$5 million and to imprisonment for seven years, or on summary conviction to a fine of $500,000 and to imprisonment for 2 years (section 53ZRD);
• Knowingly issuing an advertisement relating to an unlicensed person’s provision of VA service is liable on conviction to a fine at level 5 (currently at $50,000) and to imprisonment for 6 months (section 53ZRE);
• A person engaging in fraudulent or deceptive behavior in any transaction involving VAs is liable on conviction on indictment to a fine of $10,000,000 and to imprisonment for 10 years, or on summary conviction to a fine of $1,000,000 and to imprisonment for 3 years (section 53ZRF); and
• A person fraudulently or recklessly inducing others to invest in VAs is liable on conviction on indictment to a fine of $1,000,000 and to imprisonment for 7 years, or on summary conviction to a fine at level 6 (currently at $100,000) and to imprisonment for 6 months (section 53ZRG).

The SFC also has various enforcement powers to implement the licensing regime, including disciplinary measures against licensees, and can intervene to protect client assets in emergencies.

How could it be relevant for you?

If a service provider is operating a VATP in Hong Kong, it must obtain a license from the SFC. If a license is not obtained, it is expected to cease operations by 1 June 2024. If an unlicensed VA service provider operates a VATP outside Hong Kong but actively markets its services to customers in Hong Kong, it will be considered to have breached the AMLO. Licensed VATPs will have to comply with all specific investor protection measures as set out in the VATP Guidelines in order to serve retail customers.

The new licensing regime under the AMLO ensures that any VATP operating in or targeting the Hong Kong public adheres to rigorous conduct standards, protecting investors from potential fraud and financial instability by mandating comprehensive regulatory requirements, including measures for investor protection and anti-money laundering. For investors, this provides an additional layer of security and confidence when engaging with VATPs, as licensed platforms are subject to regular audits and must adhere to stringent financial soundness and ethical standards. This not only instils confidence in investors but also elevates the credibility and stability of the virtual asset market in Hong Kong.

Next Steps

To provide for sufficient time to comply with the requirements of the AMLO, transitional arrangements are available under the licensing regime. Consisting of two stages, (i) the non-contravention arrangement from the Commencement Date to 31 May 2024; and then (ii) a deeming arrangement takes place from 1 June 2024 until the application is approved, refused or withdrawn.

• VATPs which were not in operation in Hong Kong before the Commencement Date shall not commence business without being licensed.
• A pre-existing VATP that was in operation in Hong Kong with a meaningful and substantial presence before the Commencement Date can continue to operate during the 12-month non-contravention period.
• After the deeming arrangement takes place from 1 June 2024 no VATP can operate in Hong Kong unless it is licensed or deemed to be licensed.
  • To qualify as a deemed licensee, a pre-existing VATP shall submit the licence application by 29 February 2024, and it will be deemed licensed even after the end of the non-contravention period, until the earlier of: (i) the SFC’s grant or refusal of its licence; or (ii) the withdrawal of the licence application.
  • ‘New’ VATPs (i.e. those not operating in Hong Kong before the Commencement Date) cannot benefit from the transitional arrangements. Applicants may submit the application any time from the Commencement Date.
  • The transitional arrangements also apply to individuals performing regulated functions for pre-existing VATPs. If these individuals wish to benefit from the deeming arrangements, they must apply to be a responsible officer or licensed representative of a pre-existing VAT.

*Information is accurate up to 27 November 2023