Hong Kong financial license application and acquisition

The SFC has confirmed that it will allow licensed platform operators to provide non-securities brokerage services to retail investors.

The service of cryptocurrency trading is subject to compliance with a series of appropriate investor protection measures, including business with customers.

measures in terms of establishment, token inclusion, token due diligence program and information disclosure.

1. Establish business relationships and knowledge assessment with customers

Regulators are ready to allow virtual asset trading platforms to accept business from retail investors, but require them to take steps to protect investors. One of the measures is to assess investors' understanding of virtual currencies. For example, check whether they have taken any courses, have relevant work experience, and how many times they have bought and sold virtual currency before. The point is, as long as they have bought and sold five or more times in the past three years, it cannot be assumed that they understand enough. Even if retail investors understand virtual assets, platforms still have an obligation to assess their risk tolerance.

In general, if a platform wants to accept retail investors, it must first prove that investors have sufficient understanding of the characteristics and risks of virtual currencies and assess their risk tolerance.

2. The platform needs to be well preparedGeneral Token Inclusion Criteria

If the platform wants to accept any currency for trading, it must do due diligence on it. Now regulators are relaxing the rules. The platform only needs to consider the regulatory status of virtual assets in Hong Kong, not around the world. For example, see whether this virtual currency is a security token in Hong Kong. However, the platform still has to ensure that its operations comply with the laws of all jurisdictions in which it does business.

Because if it is illegal in other places, it will still affect the platform's operating qualifications in Hong Kong.

The answer is no. Because it is too costly to submit a legal opinion for each virtual currency, the regulator has canceled the requirement for platforms to submit written legal opinions on each virtual currency. However, platforms still need to ensure that they are only operating non-securities tokens on their platforms, so during approval, regulators may require platforms to provide legal opinions on certain specific tokens.

Qualified large virtual assets refer to virtual assets that are simultaneously included in the indexes of at least two independent index providers.

At least one of the index providers specializes in providing traditional financial market indices. These indices must meet certain conditions to be recognized:

1) These indices must be investable, meaning that the virtual assets they include have sufficient liquidity.

2) The calculation method of the index must be objective and regular.

3) Index providers must have sufficient expertise and technical support to provide and review these indices.

4) The methodologies and rules for compiling these indices must be clearly documented, transparent and consistent.

According to this standard, Bitcoin and Ethereum clearly meet the requirements and can be opened to individual investors for trading.

In addition to prohibiting trading platforms from offering security-type virtual currencies to retail investors for buying and selling. It indicates that since the value of stablecoin may be unstable, there is a high risk of large-scale redemption. Before stablecoins are regulated in Hong Kong, they should not be included in the platform for retail investors to buy and sell. The Hong Kong Monetary Authority issued regulatory proposals on stablecoins in January 2023.

It is expected that regulatory policy for stablecoins will be implemented in 2023/2024.

This question goes back to how the Hong Kong Securities Regulatory Commission defines virtual asset services. The following is its definition:

According to Schedule 3B of the Anti-Money Laundering Ordinance and the VASP Guidelines, the activities of virtual asset services (VA Service) are defined as: only operating a virtual asset exchange, that is:

(a) providing, by electronic means, services that:

(1) The service:

A. Offers to buy or sell virtual assets are routinely made or accepted in a manner that creates or results in binding transactions; or

B. People frequently introduce or identify each other with the intention of negotiating or completing the sale of virtual assets, or they frequently introduce or identify each other with the reasonable expectation that they will negotiate or complete the sale of virtual assets in a certain manner, and negotiate or complete such sales in such a manner that a binding transaction is formed or results in the occurrence of a binding transaction; and

(2) in the provision of such service, client funds or client virtual assets are directly or indirectly held by the person providing the service; and

(b) any virtual asset trading activities and ancillary services provided by the platform operator to its customers that are conducted outside the platform, and any activities conducted in relation to virtual asset trading activities that are conducted outside the platform.

Look at this issue in stages. The application pace in 2018 and 2019 was relatively slow, mainly because the sandbox program required time for the CSRC to gain a deeper understanding and learn the operations of the industry. But in June this year, when the CSRC had a certain understanding of the industry, the new VASP licensing system began to be implemented. Therefore, future license applications are expected to be faster and smoother. In particular, for those companies that already have operations in Hong Kong before June 6, they need to submit an application before March 1 next year in order to continue operating. It is expected that more than ten or even dozens of companies will submit applications before this deadline. Therefore, the Hong Kong government and the Securities and Futures Commission have been prepared for this and expect to process a large number of license applications. I believe that with the current preparation and process, the speed of applications will be significantly improved in the future.

First, for any token to be traded by retail users, it must have a liquidity history of at least 12 months. This is a fundamental requirement that ensures the stability and reliability of the token. Secondly, the token needs to be listed on at least two indices, and these indices cannot be limited to the virtual currency field, but also need to include some traditional indices such as Bloomberg. The existence of these conditions ensures that tokens listed on compliant exchanges in Hong Kong are strictly screened and certified.

However, things may be different in the future. Many institutions in Hong Kong and overseas are already preparing to carry out consulting work on indexes. As these indices are built and improved, it is foreseeable that the variety of tokens available for trading will increase in the future. This is not only one of the CSRC's strategies to protect retail investors, but also reflects the intention to gradually open up the market while ensuring safety. Of course, given the various security incidents that have occurred in Hong Kong in recent years, the SFC will be more inclined to protect retail investors and may even sacrifice the speed of listing to ensure safety. Overall, although the market will gradually open up in the future, the process will be steady and cautious.

Talking about history, the Hong Kong government issued a statement on Bitcoin business around 2013, suggesting that some institutions could operate by obtaining an MSO license from the Customs. However, the Customs later stated that Bitcoin does not fall into the category of currency and institutions purely engaged in Bitcoin business do not need an MSO license.

If Hong Kong plans to become a web3 hub, stablecoins may become a more prominent topic. The HKMA has already published a document on stablecoins in 2020 or 2021, and mentioned that a more specific stablecoin regulatory framework may be introduced this year. As a key link between the virtual currency industry and the traditional financial industry, stablecoins are of great significance to the entire cryptocurrency industry. If stablecoins can be effectively regulated, the demand for OTC may decrease accordingly.

In addition, regarding the issue of STO, if stablecoin regulation or licensing can be introduced, it will effectively connect the virtual currency ecosystem with traditional industries. For example, if a No. 1 brokerage firm can accept stablecoins, then settlement may be able to be carried out within the brokerage firm. This will greatly promote anti-money laundering supervision and may bring more financial innovations, such as lending, derivatives and other OTC market products. Therefore, the development of stablecoins may become the key to the integration of Hong Kong's cryptocurrency circle into traditional industries and rapid development. In general, although OTC remains an important part of the Hong Kong market, the construction and supervision of stablecoins and their related ecosystems may become a more important focus in future regulatory policies.

Global compliant exchanges have formed an interconnected network, and compliance has become an inevitable trend.

The Hong Kong government’s virtual currency and web3 declaration announced last year has laid out a clear roadmap, including ETF exchange licenses and policies such as the possible introduction of stablecoins this year. Therefore, whatever happens to exchanges such as JPex is unlikely to have a fundamental impact on the overall policy of the Hong Kong government. With the implementation of the licensing system, the number of problematic exchanges is expected to decrease. Therefore, both within the industry and at the government level, concerns about these unexpected events should be limited because the future strategy is already clear.

Hong Kong and Singapore each have their own characteristics in terms of cryptocurrency regulation and development, and it is not easy to directly compare the two. Hong Kong has traditionally placed more emphasis on capital markets, while Singapore may be more inclined towards conservative or fixed-income investments. Therefore, for currency bond funds or financing development, Hong Kong may be a better choice because of its long financing history and numerous investment institutions.

In terms of regulatory experience, Singapore is indeed two to three years ahead of Hong Kong, which gives local companies an earlier start and more experience accumulation. This early experience may give Singapore a slight advantage in policy receptivity and corporate adaptability.

However, recent events seem to suggest that Hong Kong may have an advantage in some respects. Especially in the past year, Hong Kong's handling of cryptocurrency issues has demonstrated its determination and aggressiveness. For example, the Hong Kong Monetary Authority asked major banks why they did not allow virtual currency companies to open accounts, a proactive move rarely seen globally. The Hong Kong government clearly wants to build Hong Kong into a web3 center and has adopted a whole-of-government collaborative strategy. In contrast, Singapore’s attitude may have become more conservative after the FTX incident, and its previously rapid pace of development has slowed down.

Nevertheless, Hong Kong and Singapore are both good locations for the development of the cryptocurrency circle, especially in the context of regulatory uncertainty in the United States. Asia will undoubtedly become a hotspot for the development of virtual currencies.