Fintech Market Overview

This article does not constitute legal advice.

Digital assets in Hong Kong

Fintech Software

A voluntary, opt-in licensing regime for VATPs (the Voluntary Licensing Regime) has been introduced by the SFC pursuant to its Position Paper: Regulation of Virtual Asset Trading Platform (the Position Paper), issued on 6 November 2019. The SFC has reiterated in the Position Paper that VATP operators that trade only non-security virtual assets are not regarded as carrying out 'regulated activities' for the purpose of the SFO, and that these platform operators would not be eligible to apply for an SFC licence under the Voluntary Licensing Regime. Nevertheless, if a platform operator decides to 'opt-in' to the SFC's regulatory remit by offering at least one security token on its platform, the SFC would be empowered to grant licences for Type 1 (dealing in securities) and Type 7 (providing automated trading services) regulated activities. The SFC will take a holistic approach with the 'infrastructure, core fitness, properness and conduct' of all virtual asset trading activities (whether the virtual assets are traded as securities or not) being viewed as a whole and subject to the SFC's supervision.1

If the SFC decides to grant the licences (Types 1 and 7) to a VATP operator (the licensed VATP operator), it will impose certain licensing conditions, which are outlined in the terms and conditions attached to the Position Paper. The licensed VATP operator is also required to comply with all other regulatory requirements as set out in the SFC Code of Conduct and guidelines, circulars and FAQs published periodically by the SFC.1

However, this voluntary opt-in licensing regime under the Position Paper may potentially be supplemented by the mandatory licensing regime set out in the Consultation Conclusions published by the Financial Services and Treasury Bureau (FSTB) in May 2021. These were published following a public consultation conducted between 3 November 2020 and 31 January 2021 on various legislative proposals to enhance the anti-money laundering and counter-terrorist financing regulation in Hong Kong, including a proposal to introduce a new licensing regime for virtual asset services providers (VASPs) under the AMLO. Under this new licensing regime for VASPs (the VASP Licensing Regime), a person who operates a 'virtual asset exchange', namely a VATP, that comes into custody, control, power or possession of any money or virtual assets will be required to apply for a licence from the SFC (VASP licence). Peer-to-peer trading platforms, to the extent that the actual transactions are conducted outside the platform and the platform is not involved in the underlying transactions by coming into possession of any money or any virtual asset at any point in time, would not be regarded as virtual asset exchanges under this definition. Similarly, over-the-counter trades would not be covered by the VASP Licensing Regime, at least in the initial stage.1

On 28 January 2022, the SFC and the HKMA published the Joint Circular on intermediaries' virtual asset-related activities (the Joint Circular), which sets out their updated regulatory framework on the distribution of virtual asset-related products, the provision of virtual asset dealing services and the provision of virtual asset advisory services. Only intermediaries licensed or registered for Type 1 regulated activities (dealing in securities) may provide virtual asset dealing services if partnered with VATPs licensed by the SFC. Further, intermediaries may only offer these virtual asset dealing services to existing clients who are professional investors.1

Section 103 of the SFO prohibits the advertisement of offers and invitations to participate in a collective investment schemes (CIS) unless one of the exemptions applicable to the Prospectus Requirement and SFC Authorisation, as referred to in Section II, applies. CIS is defined in Paragraph (d) of the definition of 'securities' of Schedule 1 of the SFO, which includes interests in CISs. A CIS is an investment product that is collective in nature, the definition of which embraces and modernises the concepts of unit trust, mutual fund corporation and investment arrangements. The definition under Schedule 1 can be narrowed down to a more concise four-part test of what a CIS generally requires:

  1. an arrangement in respect of property;
  2. participants in the scheme do not have day-to-day control over the management of the property;
  3. the property is managed as a whole by or on behalf of the person operating the arrangements, or the contribution of the participants and the profits or income from which payments are made are pooled; and
  4. the purpose of the arrangement is for participants to participate in or receive profits, income or other returns from the acquisition and management of property. 1

    Therefore, if a product constitutes an interest in a CIS, it will also fall within the definition of 'securities' and be subject to all the licensing requirements for securities-related regulated activities under the SFO.1

    On 27 March 2020, the IRD issued its revised Departmental Interpretation and Practice Notes (DIPN) No. 39, laying out its treatment of different digital assets. The IRD treats tokens differently based on the function of the tokens rather than how they are labelled. It divides digital assets into three types: payment tokens, security tokens and utility tokens. While the DIPN has provided certain guidelines on the treatment of digital assets, a number of issues remain unclear, which require further clarification by the IRD (e.g., whether a transfer of security tokens gives rise to stamp duty obligation).1

    Any person who markets and distributes security tokens (whether in Hong Kong or targeting Hong Kong investors) is required to be licensed or registered for Type 1 regulated activity (dealing in securities) under the SFO. Only marketing to professional investors is currently allowed.1

    The SFC and the HKMA published the Joint Circular in January 2022, which sets out their updated regulatory framework on the distribution of virtual asset-related products and the provision of virtual asset dealing and advisory services. The Joint Circular provides much-needed clarity on Hong Kong's regulatory framework on virtual asset-related activities. Importantly, the Joint Circular makes it clear that certain limited virtual asset-related derivative products traded on regulated exchanges may be offered to retail investors. The HKMA issued a circular in January 2022 making it clear that it does not intend to prohibit authorised institutions from investing in, lending against or allowing their customers to use credit cards or other payment services to acquire virtual assets, provided that adequate risk-management controls are adopted. Together, the Joint Circular and the HKMA circular may prove to be a first step in opening a small door for virtual asset-related products to enter the mainstream economy and become part of people's daily lives in Hong Kong.1

    Smart contracts in Hong Kong

    Fintech in Hong Kong

    Fintech in other countries

    1. https://thelawreviews.co.uk/title/the-financial-technology-law-review/hong-kong
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