How Will Hong Kong’s New Virtual Asset Licensing Regime Affect The Industry?

Together, the Amended Ordinance and the existing laws, such as the Securities and Futures Ordinance (SFO), will provide greater regulatory coverage of the industry and strengthen Hong Kong’s position as an international financial centre. In this regard, Hong Kong’s new virtual licensing regime is the first comprehensive VASP regulatory framework in the world to incorporate a full range of investor protection features in compliance with the obligations and standards prescribed by the FATF.

Virtual Asset Definition

Virtual assets are defined as a cryptographically secured digital representation of value that (i) is expressed as a unit of account or a store of economic value; (ii) either (a) is used, or intended to be used, as a medium of exchange accepted by the public for payment for goods or services, for the discharge of a debt and/or for investment; or (b) provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with, or to vote on any change of the terms of any arrangement applicable to, any cryptographically secured digital representation of value; and (iii) can be transferred, stored or traded electronically.

The above definition would include Bitcoin, altcoins such as Ethereum, Binance Coin, and XRP, and, as set out in the Consultation Conclusions published by the Financial Services and the Treasury Bureau, stablecoins, irrespective of the underlying assets. As to non-fungible tokens (NFT), whilst terminology and features may differ in the market, the Government indicated that, if an NFT merely represents a genuine digital representation of a collectible, it will unlikely fall within the definition.  

Whilst the definition is very broad, it does not cover central bank digital currencies, digital representations of fiat currencies, financial assets already regulated under the SFO, or “limited purpose digital tokens”. The latter includes non-transferable, non-exchangeable and non-fungible closed-loop, limited purpose items, such as loyalty tokens and gaming coins.

The Amended Ordinance also enables the Securities and Futures Commission (SFC), by way of publishing a notice in the Hong Kong Government Gazette, to prescribe specific characteristics that will bring a crypto asset within (or specifically exclude it from) the definition of a virtual asset.

VASP Licensing Requirement

Any person carrying on a business of providing a virtual asset service (VAS) in Hong Kong, or holding themselves out as providing a VAS, will need be licensed as a VASP by the SFC. Separately, it will be an offence for a person to actively market any VAS it provides in or outside Hong Kong to the public in Hong Kong without a VASP licence.

Currently, the only activity defined as “providing a VAS” is the operation of a virtual asset exchange (VA Exchange). As a result, any person operating a VA Exchange in Hong Kong will need to apply for a VASP licence or cease operations in Hong Kong.

Whilst the Amended Ordinance contains transitional provisions for operators of VA Exchanges carrying on business in Hong Kong before 1 June 2023 (see below), VA Exchanges based overseas will be prohibited from actively marketing their services in Hong Kong when the new regime takes effect on 1 June 2023.

To become licensed, a VASP will have to satisfy a fit and proper test, conduct customer due diligence and record keeping, avoid conflicts of interests, and meet other regulatory requirements on investor protection, such as safe custody of client assets and financial soundness.

Any VASP already licensed under the existing voluntary opt-in regime under the SFO will be exempted from the new VASP licensing requirement. In this regard, regulation under the opt-in regime and the new VASP licensing regime are intended to be consistent with both being administered by the SFC. As a result of this consistency, there was little room contemplated for a VASP dealing with investors who are not professional investors. In light of public and market feedback and noting that the virtual asset space has gained significant prevalence in the market with the entry of financial institutions, the SFC has issued the “Consultation Paper on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the SFC” in February 2023 and proposed to allow retail access to licensed VA Exchanges, subject to robust investor protection measures which provide additional safeguards for retail investors, for example ensuring that the virtual assets for retail access are eligible large-cap virtual assets based on criteria specified by the SFC. 

Transitional Arrangements

VA Exchanges operating in Hong Kong immediately before 1 June 2023 will be permitted to continue to operate without a VASP licence for up to 12 months. If such a VA Exchange wishes to continue its operations in Hong Kong after that 12 month period, it must apply to the SFC for a VASP licence.

As a further transitional arrangement, if an existing VA Exchange submits a licensing application to the SFC on or before 29 February 2024, it will be permitted to continue to operate beyond the 12 month transitional period (i.e. beyond 31 May 2024) under a deemed licence if its already submitted licence application is still pending. This deemed licence will be valid until the earlier of (i) the SFC’s grant of the licence or its refusal to grant the licence; and (ii) the withdrawal of the VASP licensing application. The SFC also has the power to issue a notice to any VASP applicant that it considers unsuitable for licensing that they are not eligible for deemed licensed status before the end of the 12 month transitional period.

Lastly, if an existing VA Exchange withdraws its licensing application or the SFC refuses to grant it a VASP licence, that VA Exchange will have at least three months to close down its business in Hong Kong, subject to the right to apply for an extension.

Licensing Requirements

Hong Kong incorporated companies having a permanent place of business in Hong Kong and overseas companies which are registered non-Hong Kong companies under the Companies Ordinance are eligible to apply to be licensed as VASPs. Conversely, overseas companies which are not registered non-Hong Kong companies under the Companies Ordinance, individuals, and businesses such as partnerships and sole traders, which do not have a separate legal personality, are not eligible to apply for or obtain a VASP licence.

A fitness and properness test must be satisfied by the applicant itself, its responsible officers (ROs), its licensed representatives (if any), its directors, and each person defined as an “ultimate owner”. The SFC will take into consideration a number of factors in determining whether a person is fit and proper. These factors are based on the fitness and properness criteria used for corporations licensed under the SFO and their responsible officers and licensed representatives. Such criteria include the person’s educational and other qualifications and experience; financial status and solvency; and competence, honesty and financial integrity. Any failure to comply with the AML/CTF obligations or other obligations of licensed VASPs and any conviction in Hong Kong or elsewhere for any AML/CTF offence or other offence involving fraudulent, corrupt or dishonest conduct would impact the fitness and properness of the person.

An applicant for a VASP licence must appoint at least two ROs. The requirements for the ROs of a VASP reflect the requirements applicable to ROs of licensed corporations under the SFO. The ROs are responsible for overseeing the operations of the VASP and ensuring it complies with its regulatory requirements, including applicable AML/CTF requirements. Similar to licensed corporations under the SFO, any individual that provides VAS on behalf of a VASP will need to be approved by the SFC as a licensed representative of that VASP.

Lastly, the applicant for a VASP licence must obtain the SFC’s approval for the premises (non-domestic premises suitable for storing relevant documents and records) which will be used to keep the records and documents required to be kept under the Amended Ordinance. Once granted, a VASP licence will continue until revoked by the SFC.

New Enforcement And Supervisory Regime

A new enforcement and supervisory regime will be implemented to monitor regulated virtual asset business activities in Hong Kong. Mirroring securities legislation, the Amended Ordinance creates an offence of fraudulently or recklessly inducing others to invest in virtual assets and an offence regarding the use of fraudulent or deceptive devices in transactions in virtual assets.

Moreover, the SFC will be granted broad disciplinary powers over licensed VASPs and their responsible officers and senior management, such as the power to publicly reprimand the person, to revoke the person’s licence (if any), and to prohibit the person from applying to be licensed in relation to any VAS.

The SFC will also have wide supervisory powers, such as to enter the premises of a licensed VASP and its associated entities, to inspect and make copies or any specified business record, and to make inquiries of a licensed VASP, its associated entities, its related corporations, related corporations of its associated entities, or certain information holders, concerning any specified business record or transaction.

Gavin Cumming
Mr. Cumming joined the firm in 2005 and has day-to-day responsibility for the firm’s non-contentious financial services practice. He is recognized by AsiaLaw Leading Lawyers as a leading lawyer in financial services regulation. Mr. Cumming has broad and deep experience in corporate, commercial and tax matters with a particular focus on strategic and operational initiatives of asset managers, investment banks, private banks and other wealth managers, insurance companies, broker-dealers and market infrastructure operators. He has a wealth of experience in electronic trading and clearing systems, the formation of private funds, including hedge funds and private equity funds, capital raising for funds, the authorization of public funds for sale to the retail public, private equity portfolio transactions, change of control transactions involving regulated financial institutions, and ongoing compliance issues for regulated financial institutions.