Hong Kong’s first step in regulating crypto comes with high costs, but exchanges are undeterred
- Hong Kong’s new licensing requirements for crypto exchanges come with greater burdens for exchange operators, but many still want a foothold in the city
- The rules, which now allow for retail trading, came into force this month, marking the first step in Hong Kong’s bid to become a virtual asset hub
Hong Kong’s long-awaited cryptocurrency rules kicking off a new regulatory regime for virtual assets went into effect on Thursday, which experts say is placing a greater burden on exchanges in the city but is so far not deterring business.
The city’s retail trading rules and licensing guidelines, finalised last week, represent one of the most exacting regulatory frameworks for centralised crypto exchanges in the world, as Hong Kong opens its arms to the volatile digital asset sector following a series of meltdowns last year.
As of this month, crypto exchanges must seek a licence with the Securities and Futures Commission (SFC) to sell and market to Hong Kong consumers. As the SFC starts to process licence applications, exchanges that already have a large presence in the city have a one-year window to continue operations while they prepare to comply with the new rules or exit the market.
“The significant compliance obligation has not deterred interest from crypto firms hoping to gain a foothold in Hong Kong,” said Joy Lam, a partner at law firm Baker McKenzie in Hong Kong. “We have been inundated with requests from existing and new market entrants who want to become licensed in Hong Kong.”
The centralised exchanges that decide to stay will have to comply with a broad range of requirements covering areas including user onboarding, asset custody, cybersecurity and corporate governance. They also need to conduct due diligence on the cryptocurrency tokens they admit, and offer only those with large market capitalisations and high liquidity, according to the SFC.
“It will require intensive preparation and investment cost to set up a trading platform capable of meeting the requirements,” Latham & Watkins lawyers wrote in a blog post published on Tuesday.
Christopher Hui, Hong Kong’s secretary for financial services and the treasury, said at an event in March that more than 80 companies from mainland China and abroad had expressed interest in setting up Web3 businesses in Hong Kong.
SFC finalises rules for retail cryptocurrency trading in Hong Kong from June 1
BitMEX – once a top exchange known in the industry for offering derivative products that allow traders to leverage their capital up to 100 times – said last week that it is launching a separate app for users in Hong Kong that only offers spot trading.
Releasing a new app for the city separate from BitMEX’s main global service is “the safest and most compliant way in ensuring that it’s fully in line with the expectations of the Hong Kong regulators”, CEO Stephan Lutz said.
Gate.io, a 10-year-old cryptocurrency exchange, also launched a dedicated platform for the city on Tuesday called Gate.HK. The firm is “actively pursuing” licensing in the city because of “the region’s strategic significance as a global financial hub” and the recent introduction of the SFC’s licensing regime, CEO Kevin Lee said.
However, not all exchanges will be fully licensed right away because of the grace period.
“This means that during this one-year transitional period, we are going to have a mix of both licensed exchanges and unlicensed exchanges operating with varying standards, so investors need to be cautious and do their homework before selecting a crypto exchange to use,” said Baker McKenzie’s Lam.
The SFC will increase investor education going forward to make sure they are aware of the risks of trading through unregulated exchanges, Elizabeth Wong, the SFC’s director of licensing, said at a press briefing last week.
Meanwhile, the local crypto industry is hoping that regulators will soon widen the scope of legitimate virtual asset activities to include things like derivatives and stablecoins, which are cryptocurrencies backed by another asset, usually by being pegged to fiat currency.
“There is a huge demand from institutional players such as hedge funds for well-regulated crypto derivatives markets, however the current [virtual asset trading platform] regime does not allow Hong Kong exchanges to offer these products, potentially forcing this activity offshore,” said Peter Brewin, co-leader for crypto and Web3 at PwC Hong Kong.
“The ability to provide a regulated trading venue for crypto derivatives could attract significant business into Hong Kong and the volumes have the potential to be significantly higher than for spot trading,” Brewin added.
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Gaven Cheong, head of investment funds at Tiang & Partners, the PwC legal network firm in Hong Kong, said that increased interest over the coming year will likely see an expansion of the types and number of tokens that retail investors in the city can access. It could also drive the proliferation of stablecoin issuances and an increase in traditional banking and financial institutions partnering with licensed exchanges to offer services like fiat currency conversions.
While many in the industry acknowledge that the new regulations are a big first step in offering clarity in the crypto space, the industry is also looking ahead at next steps.
“[Hong Kong] regulators have done a splendid job presenting the lay of the land for virtual assets with guardrails in place,” said Esme Pau, head of internet and digital asset research for Hong Kong and China at Macquarie Capital. “Looking forward, it will be critical to uphold the guardrails and streamline the entire virtual assets ecosystem value chain.”
