Hong Kong’s Financial Services and the Treasury Bureau (FSTB) has released a paper outlining the conclusions to its consultation on a proposed licensing regime for virtual asset exchanges.

The Hong Kong government is proposing legislative changes to enhance anti-money laundering and counter-terrorist financing (AML/CTF) regulation through the introduction of a regulatory framework for so-called virtual asset services providers (VASPs).

Currently, virtual asset exchanges are regulated only by a voluntary opt-in licensing mechanism. Since the regime was introduced in November 2019, the Securities and Futures Commission (SFC) has accepted four applications for review and granted just one license to OSL.

The FSTB is now looking to bring all virtual asset exchange operators within the formal regulatory perimeter of the SFC. It launched in November 2020 a three-month consultation on a regulatory framework, seeking to gauge public views on its legislative proposals.

The Consultation Conclusions paper, released in May 2021, outlines key feedbacks the government received from the public and stakeholders such as the Bitcoin Association of Hong Kong, the Hong Kong Digital Asset Exchange and PwC, and shares its stances on these suggestions.

Peer-to-peer trading and over-the-counter trade platforms excluded

The initial proposal suggested a licensing framework for virtual asset exchanges only, and excluded over-the-counter trade and peer-to-peer trading platforms, which many respondents deplored, arguing that a broader range of virtual asset activities should be covered.

At present, exchanges are by far the most prevalent and developed avenue for users to exchange and trade virtual assets, the paper says, and since fund movements conducted outside of virtual asset exchanges are already traceable for AML/CFT purposes, there’s no need at this point in time to include these specific activities into the regulatory framework.

“For now, flexibility will be built in the licensing regime such that it may be expanded to cover forms of virtual asset activities other than virtual asset exchanges where the need arises in future,” it says. “We will nevertheless keep in view the evolving landscape in Hong Kong and consider the need for regulation as the market evolves.”

Foreign companies will be eligible for the license

The initial proposal also suggested that only locally incorporated companies with a permanent place of business in Hong Kong would be eligible for the license. While some respondents agreed, over a dozen considered that non-locally incorporated companies should also be allowed to participate in the regime.

Given the market preference, the government said it will refine the proposal to let companies incorporated elsewhere but registered in Hong Kong to apply for a license.

Professional investors only

Views were also split on the proposal of requiring licensed virtual asset exchanges to offer their services to professional investors only, with over 40% of the submissions considering that retail investors should also be allowed to participate.

But the government is adamant that, at this point in time, the risk implications of trading virtual assets and their speculative nature made these activities too risky for retail investors.

“As the virtual asset industry is an emerging sector involving higher risks than conventional financial markets, the requirement of confining the services of a virtual asset exchange to professional investors only is necessary to ensure a proper degree of protection for the investing public, in line with the policy objective of promoting the healthy and orderly development of the market,” the paper says.

“We consider that the requirement is appropriate at least for the initial stage of the licensing regime. We will continue to monitor the evolving landscape and review the position as the market becomes more mature in future.”

Broad support

Overall, the consultation revealed a broad support for the government to introduce a statutory licensing regime for virtual asset exchanges in Hong Kong, and strengthen the AML/CFT system in accordance to keep up with international standards.

Respondents also expressed support for submitting applicants to a fit-and-proper test, and agreed that the SFC should be the regulatory authority of the regime.

The government said it will prepare the amendment bill for the Anti-Money Laundering and Counter-Terrorist Financing Ordinance, which it will aim to introduce in the 2021-22 legislative session.

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