On February 2024, 2, the Hong Kong government launched a public consultation on legislative proposals for establishing a licensing system for virtual asset over-the-counter (OTC) service providers.
The legislative proposals focus on the following:
(i) requiring any person who provides any virtual asset and cash spot trading services in Hong Kong as a business to apply for a licence from the Commissioner of Customs and Excise;
(ii) covers all virtual asset OTC trading services, regardless of whether the services are provided through physical stores and/or other platforms;
(iii) empowering the Commissioner of Customs to monitor the compliance of licensees in combating money laundering and terrorist financing and to enforce the statutory and regulatory requirements of the new regime; and
(iv) provide transitional arrangements to enable the regulatory system to be effectively implemented.
The following is the full text of the legislative proposal.
introduction
the purpose
The Government proposes to establish a licensing system for virtual asset over-the-counter trading services. Operators must be licensed and must comply with relevant anti-money laundering and terrorist financing requirements and other regulatory requirements. This paper sets out the conceptual framework and main contents of the legislative proposals for public consultation. We welcome comments from relevant stakeholders to assist us in formulating the details of the legislative proposals.
back ground
In October 2022, the Government issued the Policy Statement on the Development of Virtual Assets in Hong Kong, which elaborated on the Government’s vision and policy approach to the virtual asset industry. The Policy Statement specifically states that the Government is committed to developing a comprehensive regulatory framework for virtual asset activities based on the principle of “same business, same risks, same rules”.
As far as virtual asset trading platforms are concerned, the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022 was enacted in December 2022 to establish a comprehensive regulatory regime that complies with the anti-money laundering and counter-terrorist financing requirements stipulated by the Financial Action Task Force (FATF) and provides investor protection. With effect from June 12, any person operating a virtual asset trading platform business must apply for a license from the Securities and Futures Commission (SFC) as the regulator and must meet the fit and proper criteria, including provisions on anti-money laundering and counter-terrorist financing, as well as investor protection requirements. The SFC has the power of supervision, investigation and intervention. Administrative and criminal penalties may be imposed on those who violate the relevant provisions.
截至2024年1月底，共有两所虚拟资产交易平台在《证券及期货条例》下持有第 1类受规管活动（证券交易）及第7类受规管活动（提供自动化交易服务）牌照。此两所平台均获得证监会批准向零售投资者提供服务。除了上述平台外，截至 2024年1月底，证监会正处理14宗根据《打击洗钱条例》提出的牌照申请。
The development of virtual assets is changing rapidly. Therefore, the government and financial regulators have been paying attention to changes in the industry landscape, market developments, risks and international discussions on regulation, and reviewing the scope of the regulatory system for virtual asset services from time to time to ensure that risks associated with industry development are properly managed.
In 2023, some fraud cases involving platforms claiming to be virtual asset trading platforms have heightened public concern about the risks of virtual asset activities. Although the activities of virtual asset trading platforms are already regulated by the relevant system, these cases reveal that virtual asset OTC shops are involved, especially some OTC shops are suspected of being one of the main channels to transfer retail investors' funds to the suspected fraud schemes (such as making false or misleading statements about the licensed status of a virtual asset trading platform). Therefore, the Government believes that it is necessary to bring virtual asset OTC services under regulation through legislative amendments to ensure that the virtual asset regulatory system implements the principle of "same business, same risks, same rules" and fully protects investors.
Legislative proposals
We propose to amend the Anti-Money Laundering Ordinance to establish a new licensing regime for virtual asset OTC service providers. Drawing on the licensing regime for virtual asset trading platforms and the licensing regime for money service operators, the proposed regime will require virtual asset OTC service licensees to comply with a number of licensing and regulatory requirements, as well as the anti-money laundering and counter-terrorist financing requirements set out below.
Under the proposed system, any person who engages in business related to any virtual asset spot trading services in Hong Kong must apply for a license from the Commissioner of Customs and Excise and must meet the fit and proper criteria and other factors that the Commissioner of Customs and Excise considers relevant. Licensed virtual asset OTC trading operators must comply with the anti-money laundering and terrorist financing requirements and other regulatory requirements set out in the Anti-Money Laundering Ordinance.
This regime will cover all virtual asset OTC trading services, regardless of whether such services are provided through physical stores or other platforms. As for virtual asset trading platforms, since they are already covered by the existing virtual asset trading platform licensing regime, the proposed new regime will explicitly exclude such trading platforms.
The Commissioner of Customs will be empowered to enforce the system in accordance with statutory requirements and monitor the compliance of licensed virtual asset OTC service providers.
Regulation of virtual asset OTC service providers
As the trading of virtual currencies and other virtual assets becomes increasingly popular, a global consensus has begun to emerge that the potential money laundering and terrorist financing risks posed by virtual assets to the international financial system must be addressed. Specifically, because virtual assets can be bought and sold pseudonymously or anonymously, and do not need to be processed by an approved central system, they face a higher risk of money laundering and terrorist financing than traditional methods of transfer, asset custody or trusteeship. Criminals can abuse these features to conduct layered transactions and convert criminal proceeds into legal tender through the traditional financial system.
In order to address the money laundering and terrorist financing risks of virtual asset activities, the FATF revised its standards contained in Recommendation 2019 in February 2, requiring each jurisdiction to regulate virtual asset service providers and monitor their compliance with anti-money laundering and terrorist financing. In short, the FATF requires each member region to impose all current anti-money laundering and terrorist financing regulations applicable to financial institutions and designated non-financial businesses and industries on virtual asset service providers. Member regions can require virtual asset service providers to comply with anti-money laundering and terrorist financing regulations consistent with those applicable to financial institutions and designated non-financial businesses and industries through a ban on virtual asset transactions or a licensing/registration mechanism.
In addition, many virtual assets have no intrinsic value, are highly speculative in nature, and are extremely volatile in price. They are also frequently involved in fraud, security loopholes and market manipulation both globally and in Hong Kong, thus posing significant challenges to investor protection.
In this regard, the licensing system for virtual asset trading platforms will take effect on June 2023, 6. Although the activities of virtual asset trading platforms are regulated by the SFC under the system, some unregulated virtual asset activities still expose ordinary investors to risks related to money laundering, terrorist financing and misconduct, especially those arising from fraud. Among them, some suspected fraud schemes even attract funds from retail investors through related virtual asset OTC shops, which use physical stores and social platforms to attract customers by fraudulent means.
According to a rough estimate based on preliminary field observations by law enforcement agencies, there are about 200 physical virtual asset OTC shops (including OTC shops operated by ATMs) operating in Hong Kong, and about 250 digital platforms or active online posts providing virtual asset trading services. Considering the role of these virtual asset OTC shops in transferring funds of general investors and operating a considerable scale of business in the Hong Kong market, there is an urgent need to bring their operations under regulation to ensure the implementation of measures to combat money laundering and terrorist financing and to protect investors.
Regulatory Scope
We propose to require that any person who operates an OTC virtual asset trading business in Hong Kong, or actively promotes the provision of OTC virtual asset trading services to the Hong Kong public, must obtain a licence issued by the Commissioner of Customs and Excise and meet the fit and proper criteria and other regulatory requirements. OTC virtual asset trading business will be defined as:
(a) Providing spot trading services of any virtual assets in the form of business;
(b) whether the service is provided through a physical store (including ATMs) or other platform (such as a digital platform); and
(c) explicitly excluding the operation of virtual asset trading platforms that are already covered by the virtual asset trading platform licensing regime.
Part (a) of the definition is intended to specify the scope of virtual asset over-the-counter spot trading activities, which includes any virtual asset spot trading business activities. The definition contains the part about "in the form of business" to exclude the sale of virtual assets between individuals (peer-topeer) unless the sale constitutes the business of one of the parties. This arrangement is in line with international standards (such as the requirements determined by the Special Organization).
Similarly, part (b) of the definition takes into account the wide range of business forms of virtual asset OTC operators. Based on the principle of “same business, same risks, same rules”, we believe that it is necessary to ensure that all forms of virtual asset OTC services are regulated by the proposed regime.
While the above proposed definition specifies the scope of virtual asset OTC service providers that are required to apply for a license, we have observed that virtual asset trading service operators may provide temporary safekeeping/temporary storage services for customers' virtual assets as part of their trading process. Considering that such temporary safekeeping/temporary storage services may involve operational risks and investor protection concerns, we welcome comments on whether virtual asset OTC service operators that provide temporary safekeeping/temporary storage services during the trading process should be covered by the proposed regulatory regime and whether specific regulatory requirements should be established for such temporary safekeeping/temporary storage services.
qualifications
To ensure that licence applicants have adequate local links to facilitate effective supervision and monitoring by the authorities, we propose that licence applicants must be (i) companies established in Hong Kong with a fixed place of business, or (ii) companies established elsewhere and registered in Hong Kong under the Companies Ordinance.
As virtual asset OTC trading services in Hong Kong are currently generally operated in the form of physical stores, applicants must provide suitable operating premises. For virtual asset OTC trading shops that operate in digital form, they must provide information such as the office address, correspondence address, and location of local books and records of local management personnel. In determining whether an applicant is a suitable person, the Commissioner of Customs and Excise will consider all relevant matters, including whether the applicant (or any of its directors or ultimate owners) has been convicted of money laundering and terrorist financing crimes or other serious crimes in Hong Kong or elsewhere; has been convicted of fraud, corruption or dishonesty in Hong Kong or elsewhere; is involved in any bankruptcy or liquidation proceedings; or has failed to comply with anti-money laundering and terrorist financing and other applicable requirements.
Regulatory requirements - permitted activities
In terms of regulated activities, licensees may conduct spot transactions in their business that convert any virtual asset into any money, or any money into any virtual asset. As for transactions that convert one virtual asset into another virtual asset, it is now recommended that licensees should not conduct such transactions. In other words, service providers who intend to provide conversions between virtual assets should consider applying for a virtual asset trading platform license.
Licensees can only remit the converted funds if they meet the specified conditions. Based on the principle of "same business, same risk, same rules", licensees must apply for a money service operator license if they provide legal currency remittance services. As for the transfer of virtual assets after selling them to customers, in order to mitigate the risks of money laundering and terrorist financing, licensees will only be allowed to transfer such virtual assets from their registered wallets to wallets for which customers can provide proof of ownership and/or control.
Licensees must apply to the Commissioner of Customs and Excise for and register all wallets used for their operations and ensure that the wallet list is constantly updated. Licensed operators are not allowed to provide other services, including any form of virtual asset advisory or referral services, the provision of virtual asset derivatives or other financial products (including but not limited to pledge, lending and margin trading). As for the direct or indirect customer virtual asset storage/temporary storage services provided by licensed operators, unless these services for the safekeeping/temporary storage of virtual assets for customers are temporary in nature and are an integral part of the transaction process, our initial thought is that such services should not be provided.
As for the types of virtual assets that virtual asset OTC operators can offer to their clients, given that such operators provide services to general investors and are therefore subject to stricter regulation to ensure adequate investor protection, we recommend that the services provided by virtual asset OTC licensees can only cover tokens that are available for retail investors to trade on at least one virtual asset trading platform licensed by the SFC, and stablecoins issued by issuers licensed by the Hong Kong Monetary Authority (HKMA) after the proposed licensing regime for stablecoin issuers is implemented. In other words, if the services provided by licensed virtual asset OTC operators include any tokens that are not available for retail investors to trade on at least one virtual asset trading platform licensed by the SFC, or any stablecoins issued by issuers that are not licensed by the HKMA, they will be in violation of the virtual asset OTC regulatory regime. This approach ensures that the tokens that retail investors are exposed to have undergone appropriate review procedures and prevents regulatory arbitrage.
Other regulatory requirements
To align requirements for virtual asset OTC operators with other regulated entities, we recommend that licensees comply with the anti-money laundering and counter-terrorist financing requirements under the Anti-Money Laundering Ordinance regarding customer due diligence and record keeping.
In addition, as virtual assets are high-tech and highly speculative in nature, and virtual asset OTC trading services are easily accessible to the general public, we believe that it is necessary to require virtual asset OTC trading licensees to comply with a set of sound regulatory requirements to ensure that they have sufficient capabilities and knowledge to properly operate virtual asset OTC trading business, so as to mitigate potential risks to investors due to system failures or security loopholes.
Taking into account that the operating model of virtual asset OTC services involves the virtual asset sector and the money service sector, we have made reference to the regulatory regime for virtual asset trading platforms and money service operators when formulating regulatory requirements, including:
(a) Appointment of a qualified Compliance Officer and a Money Laundering Reporting Officer - We consider it necessary to ensure that licensees appoint appropriate persons to be accountable for compliance with the relevant licensing requirements;
(b) Qualifications/knowledge and experience – the licensee must have a good corporate governance structure in place and its staff must have the necessary knowledge and experience in virtual assets to perform their duties effectively;
(c) Business soundness - the licensee must operate its business in a prudent and sound manner and ensure that it will not harm the interests of its customers and the public;
(d) Conduct - a licensee must act honestly and fairly and with due skill, care and diligence, and in the interests of its clients and the integrity of the market, and comply with all statutory and regulatory requirements applicable to the conduct of its business activities;
(e) Risk Management - Licensees must have in place appropriate risk management policies and procedures commensurate with the size and complexity of their businesses to mitigate money laundering and terrorist financing, cyber security and other risks that may arise from their activities; and
(f) Record keeping - A licensee shall keep proper records of transactions and fund movement for inspection by the Commissioner of Customs and Excise whenever he considers it necessary.
Virtual asset OTC operators must comply with prescribed requirements before they are issued a license by the Commissioner of Customs and Excise. Virtual asset OTC licensees who violate anti-money laundering and terrorist financing requirements and other regulatory requirements are subject to disciplinary and investigation procedures and face enforcement actions.
License period and transition period
The situation in the virtual asset market is changing rapidly, so the Commissioner of Customs and Excise needs to regularly review whether virtual asset OTC operators still have the necessary qualifications and capabilities to properly operate their businesses. To this end, we recommend that successful applicants be issued a two-year license and may apply for a two-year renewal if the Commissioner of Customs and Excise is satisfied.
To assist legitimate operators currently operating virtual asset OTC trading businesses in Hong Kong to transition to the new licensing regime, we propose to provide such operators with a transition period immediately before the licensing regime takes effect. Taking into account the purpose of investor protection and the preparation time required for the implementation of the licensing regime (such as application review), the current concept is to provide a six-month transition period.
With reference to the virtual asset trading platform regime and the registration regime for precious metals and gemstone dealers, we are considering choosing one of the following transitional arrangements:
Option 1 - No "deemed licensed" arrangement: There is a six-month transition period. During the transition period, existing virtual asset OTC service providers that were already in operation immediately before the regulatory system came into effect will be allowed to continue operating until the end of the six-month transition period if they submit a license application to the Commissioner of Customs within the first three months. After the transition period, all virtual asset OTC service providers must be licensed before they can engage in regulated activities. If the existing virtual asset OTC service providers do not apply for a license from the Commissioner of Customs within the first three months of the transition period, they must orderly wind down their business before the end of the fourth month after the transition period comes into effect.
Option 2 - A "deemed licensed" arrangement: Similar to Option 1, existing virtual asset OTC service providers that were already in operation immediately before the regulatory regime came into effect will be allowed to continue operating until the end of the six-month transition period if they submit a license application to the Commissioner of Customs within the first three months. Applicants who can meet the requirements specified by the Commissioner of Customs will be issued a "deemed license" to continue operating after the end of the transition period until the Commissioner of Customs makes a final decision on the relevant license application. The Commissioner of Customs will be empowered to withdraw or modify the "deemed license" as he deems appropriate.
Exempt
Under the existing regulatory regimes under the Anti-Money Laundering Ordinance, the Securities and Futures Ordinance and the Banking Ordinance, virtual asset trading platforms, licensed corporations and authorized institutions are already properly regulated by the SFC or the HKMA (as appropriate). Therefore, we recommend that such entities be exempted from the new licensing regime if they provide virtual asset OTC trading services. We also recommend that a similar exemption be considered for licensed stablecoin issuers after the implementation of the licensing regime for stablecoin issuers.
limit
To protect general investors from the risks brought about by unlicensed virtual asset OTC trading activities, we recommend that no person should actively promote regulated local virtual asset OTC trading services to the Hong Kong public in or outside Hong Kong unless licensed and regulated by the Commissioner of Customs and Excise to engage in regulated virtual asset OTC trading services.
Powers of licensing authority
As the licensing authority, the Commissioner of Customs and Excise will be empowered to monitor the compliance of virtual asset OTC licensees in combating money laundering and terrorist financing under the new system, as well as to enforce other statutory and regulatory requirements. Specifically, the Commissioner of Customs and Excise will have the power to enter the business premises of licensees for routine inspections, investigate suspected violations and remove criminal evidence, make arrests and searches, and impose disciplinary sanctions for violations (including civil fines and suspension or revocation of licences). In light of the enforcement experience of the virtual asset trading platform regulatory system, we are considering adding new powers to prevent access to websites or digital platforms involving unlicensed or fraudulent virtual asset OTC operators (in or outside Hong Kong).
The Commissioner of Customs and Excise will also be empowered to impose licensing conditions, and/or add, vary or amend existing conditions. As virtual asset OTC licensees may collaborate with other related businesses (such as virtual asset trading platforms or money service operators), the Commissioner of Customs and Excise will be empowered to request information from relevant authorities (such as the SFC and the HKMA) in order to detect possible violations by licensees.
Penalties
Previous cases have shown that the operation of virtual asset OTC trading services carries inherent risks, whether in terms of money laundering and terrorist financing, or other criminal activities such as fraud. In view of the seriousness of these potential illegal acts, the penalties for unlicensed virtual asset OTC trading services must have a sufficient deterrent effect. In this regard, we recommend that any person who engages in regulated virtual asset OTC trading services without a license shall be liable to a fine of HK$100 million and two years' imprisonment upon conviction through public prosecution procedures.
We also propose that any person who knowingly issues an advertisement about an unlicensed person providing over-the-counter trading services for virtual assets shall be guilty of an offence and shall be liable to a fine at level 5 (currently $5) and imprisonment for six months.
If a licensee violates the statutory anti-money laundering and terrorist financing requirements, upon conviction through public prosecution, he may be fined HK$100 million and imprisoned for two years. In addition, if a licensee commits misconduct (such as violating other regulatory requirements), he may be subject to administrative penalties, including suspension or revocation of the license, reprimand, order to make corrections, and/or a fine (not exceeding HK$50).
Offences related to fraudulent and misleading activities under the current Anti-Money Laundering Ordinance will apply to virtual asset OTC licensees. Anyone who commits fraudulent or deceptive conduct in transactions involving virtual assets is guilty of a crime and may be fined $1,000 million and imprisoned for ten years. In addition, anyone who makes a fraudulent or reckless misrepresentation to induce others to conduct transactions involving virtual assets is also guilty of a crime and may be fined $100 million and imprisoned for seven years.
Statutory appeal
We propose to amend Part 6 of the Anti-Money Laundering Ordinance to expand the scope of review by the Anti-Money Laundering and Counter-Terrorist Financing Review Tribunal to cover appeals against decisions made by the Commissioner of Customs in the future implementation of the over-the-counter licensing regime for virtual assets.
The next step of the job
We welcome comments and suggestions from the public and relevant sectors to take forward the legislative work. Respondents are invited to submit their comments and suggestions on the proposals set out in this consultation paper by 2024 April 4.
We will consider the views and suggestions received and, depending on the progress of the preparatory work, submit a draft bill on the proposed virtual asset OTC trading licensing system to the Legislative Council as soon as practicable.
Source: Bailu Living Room
Author: Bowen