Hong Kong sets out regulatory framework for virtual asset trading platforms, emphasises investor protection
- Operators can decide whether they want to apply for a licence from the SFC
- Framework seeks to address key regulatory concerns, such as safe custody of assets, know-your-client requirements
Hong Kong’s Securities and Futures Commission has issued a new regulatory framework for granting licences to centralised virtual asset trading platforms, with a strong emphasis on protection for investors and their virtual assets.
The commission has adopted an opt-in approach, which means operators can decide whether they want to apply for a licence. The framework is in the public’s interest as it will allow “investors to choose to participate only in those cryptocurrency platforms or ‘exchanges’ that agree to be regulated and supervised,” Ashley Alder, the SFC’s chief executive, said on Wednesday.
“The safe custody of a user’s cryptocurrency assets and cybersecurity are major concerns. There have been many instances of platforms being hacked, with investors suffering substantial losses. Trading rules may not be transparent and fair, and cryptocurrency markets are vulnerable to manipulation,” he added.
A regulated entity is likely to find it easier to establish banking ties to facilitate a conversion between cryptocurrency and fiat money, some analysts have said. The lack of such support is said to be the key reason for the collapse in April of Gatecoin, one of the oldest virtual exchanges in Hong Kong after several banks refused to deal with its money flow on compliance concerns.
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Under the new framework, platforms trading only bitcoin will not be awarded licences as the cryptocurrency is not recognised as a security. Moreover, under Hong Kong law the commission can only regulate securities or futures products, so a platform that wants a licence will need to offer at least one security token, or a product structured like traditional securities.
The commission will also not accept licence applications from platforms that only provide a direct peer-to-peer marketplace for transactions by investors who typically retain control over their own assets.
“At this stage, the SFC will focus its efforts on the regulation of virtual asset trading platforms that provide trading, clearing and settlement services for virtual assets, and have control over investors’ assets, ie, centralised virtual asset trading platforms,” according to a 61-page position paper issued by the commission.
Alder admitted the framework had its limitations. “The SFC’s usual authority to take legal action against market participants for misconduct will not apply to licensed virtual asset trading platforms. That’s because these platforms are not recognised stock exchanges or futures markets,” he said.
“We also recognise that Hong Kong hosts dozens of virtual asset trading platforms which, while posing serious investor protection concerns, may decide not to seek an SFC licence under the new regulatory framework,” he added, suggesting that the commission might address this regulatory gap at a later date.
The new framework comes after a year-long regulatory sandbox – a pilot scheme to test tokens and platforms – during which several exchange operators worked with the commission to develop rules and regulations for the sector under Hong Kong’s Securities and Futures Ordinance.
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Alder said the commission would also alert investors that futures contracts currently offered by exchanges, particularly those involving leverage, could potentially be illegal while the contracts could be “extremely risky”.
“It also makes clear that those who offer virtual asset futures for trading may well be conducting an illegal activity, either under the Securities and Futures Ordinance, or the Gambling Ordinance,” he said.
Currently, a number of cryptocurrency exchanges, such as BitMEX, OKEX and CoinFlex, which have offices in Hong Kong, offer leverage trading, which in some cases could involve leverage of up to 100 times. These exchanges, have, however, made it clear they do not offer trading services to Hong Kong users.
Among other things, the commission requires that 98 per cent of clients’ virtual assets must be kept in“cold wallets”, which refers to private keys being kept offline, without access to the internet and hence being more secure. Operators cannot put more than 2 per cent of clients’ virtual assets in “hot wallets”, or placing private keys online, where they face a higher risk of hacking or phishing.
Platform operators will also need to ban retail investors from trading, and they must have insurance cover as well as other safeguards for the protection of customers’ virtual assets.
Virtual asset exchange operators that want to be licensed by the SFC must meet with all the requirements for stockbrokers and alternative trading systems.
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Hugh Madden, the chief executive of Hong Kong-listed BC Group, which operates a digital asset exchange and other blockchain-related businesses, said the new licensing framework will accelerate the acceptance of digital assets as a new class of financial instruments in Hong Kong and the region.
“BC Group believes Hong Kong-based digital asset platforms will eventually all need to be licensed under the framework to remain competitive,” he said.
Anthony Ng, CEO of Coinsuper Premium, a cryptocurrency exchange that offers trading to professional investors and is backed by a dozen private-equity investors such as Sky9 Capital and others, said the company will apply for a licence.
“We have engaged in discussions with the SFC on the regulatory framework in the past one year. [The new licensing regime] strengthens and protects the integrity and soundness of Hong Kong's virtual assets markets for the benefit of investors and the industry,” he said.
