The Securities and Futures Commission (SFC) has announced a regulatory regime that virtual asset trading platforms operating in Hong Kong can opt into, provided that at least one of the virtual assets traded on the platform falls within the definition of “securities” under the Securities and Futures Ordinance (SFO).
The new regulatory regime was announced by the SFC CEO Mr. Ashely Alder at Hong Kong Fintech Week 2019, with the details set out in the SFC’s position paper of 6 November 2019 on the regulation of virtual asset trading platforms (Position Paper).
The Position Paper is an extension of the SFC’s statement of 1 November 2018 on the conceptual framework for the potential regulation of virtual asset trading platform operators. This year, the SFC announced a holistic approach in licensing and regulating eligible virtual asset trading platforms, together with detailed terms and conditions applicable to the licensed platforms. Through an opt-in licensing mechanism, the SFC wishes to help investors distinguish regulated platforms (which must have investor protection measures in place to maintain their SFC licences) from unregulated platforms.
Each virtual asset trading platform operating in Hong Kong should review the Position Paper carefully to determine whether it would benefit from regulated status and to make an assessment of the changes it would need to make to its business to satisfy the SFC’s requirements.
Legislative backdrop to the regulation of virtual asset trading platforms
The SFC derives its powers from the SFO. The SFO does not regulate virtual assets or the activities of virtual asset trading platforms, unless the virtual assets fall within the definition of “securities” (referred to in this article as securities tokens) or “futures contracts” under the SFO. Accordingly, unless and until the SFO is amended, the SFC can only operate an opt-in regulatory regime for virtual asset trading platforms that elect to include one or more securities tokens on the platforms. Trading of virtual assets that are not securities tokens will not be subject to the insider dealing, market misconduct or other provisions of the SFO, even if the relevant platform is licensed by the SFC.
SFC approach to virtual asset trading platforms
From 6 November 2019, a centralized virtual asset trading platform that offers trading of not less than one security token in Hong Kong can apply for a Type 1 (Dealing in Securities) and Type 7 (Providing Automated Trading Services) licence. Eligible platform operators will be licensed and placed in the SFC’s regulatory sandbox. Where the platform operator is part of a group of companies and wishes to apply for an SFC licence, all virtual asset trading business activities of the group in Hong Kong and the active marketing of such trading services to Hong Kong investors must be conducted by one group entity only and it is that group entity that must apply for the SFC licence.
Once a platform operator is licensed with the SFC, its entire business operations (covering trading of both security tokens and non-security tokens) will be subject to the SFC’s oversight. A licensed platform operator will need to comply with specific licensing conditions and additional terms and conditions, as further discussed below. Although the SFC does not have enforcement power over the licensed platform’s activities relating to non-security tokens, the SFC will take disciplinary action against licensed platform operators for breaches of the specific licensing conditions relating to the entire activities of the platform. Non-security tokens traded on a licensed platform will not be authorized by the SFC nor will their offering documents require registration under the Companies (Winding Up and Miscellaneous Provision) Ordinance.
The SFC will focus its resources on licensing and regulating centralized platforms providing trading, clearing and settlement services of virtual assets. At this stage, the SFC is not prepared to accept licensing applications from operators of (i) decentralized platforms which provide a direct peer-to-peer marketplace for investors, or (ii) order routing systems for virtual asset trades.
Operators of unlicensed virtual asset trading platforms in Hong Kong need to ensure that no “securities” or “futures contracts” as defined in the SFO will be traded on their platforms.
Regulatory requirements for licensed platforms
An SFC licensed virtual asset platform operator (Licensed Operator) will be subject to:
The proposed licensing conditions will require a Licensed Operator to:
The terms and conditions are largely based on the existing framework for the regulation of securities and futures contracts under the SFO and its subsidiary legislation, the Code of Conduct for Persons Licensed by or Registered with the SFC, guidelines and circulars issued by the SFC, with additional requirements applicable specifically to virtual asset trading activities.
We set out below the key requirements under the terms and conditions:
Warnings on virtual asset futures contracts
When issuing the Position Paper, the SFC also warned investors of the risks of trading virtual asset futures contracts. The SFC noted that “virtual asset futures contracts” typically include instruments that allow investors to speculate on the prices of the underlying virtual assets at a future date and have similar features to a “contract for differences” under the Gambling Ordinance. Unless an exemption applies, authorization for conducting gambling activity in Hong Kong may be required for entering into a virtual asset futures contract that is a contract for differences. The SFC has neither licensed nor authorized any platforms in Hong Kong to offer or provide trading services in virtual asset futures contracts, and has indicated it is unlikely to grant such licence or authorization due to the risks associated with these instruments.
Asset managers investing in or trading over-the-counter derivative instruments, where the underlying are virtual assets, need to be aware of the SFC’s warnings and consider the implications on their investment and trading activities. On 1 June 2018, the SFC issued a circular to intermediaries on compliance with notification requirements, in which it asked licensed intermediaries to notify the SFC before engaging in virtual asset activities. If an asset manager manages a fund that invests more than 10% of its gross asset value in virtual assets, the asset manager will be subject to separate terms and conditions (as discussed in our article of 22 October 2019).