Authored by: Su Cheen Chuah and Joey Lee
On 28 January 2022, the Hong Kong Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) issued a joint circular on intermediaries’ virtual asset-related activities (Joint Circular), which supersedes the SFC’s circular to intermediaries on the distribution of virtual asset funds dated 1 November 2018 (2018 Circular).
The Joint Circular mainly covers the following activities relating to virtual asset-related products (VA-related products) and services: (a) distribution of VA-related products; (b) provision of virtual asset dealing services (VA dealing services); and (c) provision of virtual asset advisory services (VA advisory services). The Joint Circular defines “VA-related products” to mean products which (a) have a principal investment objective or strategy to invest in virtual assets; (b) derive their value principally from the value and characteristics of virtual assets; or (c) track or replicate the investment results or returns which closely match or correspond to virtual assets.
A. Distribution of VA-related products
The following requirements are applicable to the distribution of VA-related products:
- Complex product requirements – VA-related products are very likely to be considered complex products, and therefore the usual requirements relating to the distribution of complex products (e.g. ensuring suitability, minimum information and warning statements) will apply.
- “Professional investors” only – Except for a limited suite of products (e.g. VA-related derivative products that are traded on regulated exchanges specified by the SFC, or exchange-traded VA derivative funds that are authorised or approved for offering to retail investors by the respective regulator in a designated jurisdiction), VA-related products which are considered complex products should only be offered to professional investors.
- Virtual asset-knowledge test – Except for institutional professional investors and qualified corporate professional investors, intermediaries should (i) assess whether clients have knowledge of investing in virtual assets or VA-related products prior to effecting a transaction in VA-related products on their behalf; and (ii) ensure that their clients have sufficient net worth to be able to assume the risks and bear the potential losses of trading VA-related products. The SFC has set out non-exhaustive criteria for assessing whether a client can be regarded as having knowledge of virtual assets.
- Selling restrictions and suitability obligations –Intermediaries are also required to observe any other selling restrictions in Hong Kong and other jurisdictions which may be applicable to a particular VA-related product (e.g. prohibition on offering unauthorised investments to the Hong Kong public) and suitability obligations.
- Requirements regarding financial accommodation – When providing any financial accommodation for investing in VA-related products to clients, an intermediary should be cautious and should assure itself the client has the financial capacity to meet the obligations arising from leveraged or margin trading in VA-related products, including in a worst-case scenario. If there is no such assurance, the intermediary should not accept instructions from the client.
- Provision of information in a clear and easily comprehensible manner – Intermediaries should ensure that information relating to VA-related products and the underlying virtual asset investments are provided in a clear and easily comprehensible manner.
- Disclosure of warning statements – Intermediaries should provide warning statements (which can be one-off disclosure) to clients specific to virtual assets. The warning statements should include without limitation and where applicable, the general risks of trading in futures contracts, risks specific to virtual asset futures contracts, the continuing evolution of virtual assets and how this may be affected by global regulatory developments, price volatility, and other applicable risks.
B. Provision of VA dealing services
Intermediaries providing VA dealing services are also required to comply with the following requirements:
- Professional investors only – VA dealing services should only be provided to professional investors.
- SFC and HKMA requirements – Intermediaries are expected to comply with all the regulatory requirements imposed by the SFC and the HKMA when providing VA dealing services, regardless of whether the virtual assets involved are securities.
- Partner with SFC-licensed VA trading platform – In order to provide VA dealing services, intermediaries are required to partner only with SFC-licensed VA trading platforms.
- Existing type 1 clients only – VA dealing services can only be provided to the intermediaries’ existing clients to which they provide type 1 (dealing in securities) regulated services.
- Terms and conditions of licensing / registration – The SFC (in consultation with the HKMA, where applicable) will impose as licensing / registration conditions (Terms and Conditions) the expected conduct requirements for intermediaries’ provision of VA dealing services under an omnibus account arrangement. Under the Terms and Conditions, intermediaries will be under various obligations, including only permitting clients to deposit or withdraw fiat currencies from their accounts, and not to allowing the deposit or withdrawal of client virtual assets to minimize risks associated with such transfer.
- Terms and conditions for virtual asset discretionary account management services – In respect of virtual asset discretionary account management services, if a licensed corporation intends to invest 10% or more of the gross asset value of a portfolio in virtual assets, it will be subject to additional requirements as set in the Proforma Terms and Conditions for Licensed Corporations which Manage Portfolios that Invest in Virtual Assets which was published in 2019 (Proforma Terms and Conditions). Registered institutions should inform the SFC and HKMA if they wish to provide such services, and they will be required to comply with the Proforma Terms and Conditions.
- Discretionary account management services – Intermediaries with a type 1 licence that are authorised by their clients to provide VA dealing services on a discretionary basis as an ancillary service should only invest less than 10% of the gross asset value of the client’s portfolio in virtual assets.
C. Provision of VA advisory services
Intermediaries providing VA advisory services are required to comply with the following:
- All the regulatory requirements imposed by the SFC and HKMA when providing advisory services, regardless of the nature of the virtual assets;
- VA advisory services should only be provided to intermediaries’ existing clients to which they provide type 1 or type 4 (advising on securities) regulated services;
- Suitability obligations, and intermediaries should only offer VA advisory services to professional investors and conduct a virtual asset knowledge test before providing the services;
- Other applicable conduct requirements set out in the licensing or registration conditions and terms and conditions for licensed corporations or registered institutions providing virtual asset dealing services and virtual asset advisory services dated January 2022; and
- Where the advisory services are with regard to VA-related products, intermediaries should observe the requirements in relation to VA-related products set out in section A above and ensure the suitability of recommendations provided.
D. Implementation and transitional period
The Joint Circular will be implemented immediately for intermediaries which do not currently engage in VA-related activities. For intermediaries which are serving existing clients of VA-related activities, there will be a six-month transition period for full implementation of the requirements of the Joint Circular. In view of the implementation timeframe, both intermediaries which are currently engaging in VA-related activities and those which intend to engage in VA-related activities should commence careful assessment of the relevant VA-related products and services to ascertain the relevant requirements which will apply pursuant to the Joint Circular, and to ensure that they are properly met within the implementation timeframe.