How Hong Kong’s stricter crypto regulations aim to boost investor confidence

The following is a guest post from Anndy Lian.

Hong Kong has been a major financial hub for many years, and in recent years, it has shown increasing interest in blockchain and cryptocurrency technologies. The government of Hong Kong has indicated its support for the industry’s development, and many initiatives are underway to help create a favorable environment for crypto and blockchain businesses.

Hong Kong has a well-established regulatory framework for financial services, which has helped attract many crypto and blockchain companies. The Hong Kong Monetary Authority (HKMA) has launched several initiatives to support the development of blockchain and digital currencies. For example, the HKMA is working on developing a central bank digital currency (CBDC), and has also launched a blockchain-based trade finance platform.

Many active blockchain and cryptocurrency communities in Hong Kong provide support and resources for businesses and developers in the industry. Many events and conferences related to blockchain and cryptocurrency in the city help create networking opportunities and promote the industry’s growth.

In December 2022, the Legislative Council of Hong Kong passed an amendment to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO), introducing a licensing regime for virtual asset service providers (VASPs).

Hong Kong’s New Regulatory Framework

Hong Kong has recently implemented new regulatory frameworks for cryptocurrency trading and services. The updated Anti-Money Laundering Ordinance is in line with the Financial Action Task Force (FATF) Recommendation 15, which requires virtual asset service providers (VASPs) to adhere to anti-money laundering (AML) and countering the financing of terrorism (CFT) regulations.

The new regulations require all VASPs operating in Hong Kong to obtain a license from the Securities and Futures Commission (SFC). Without a license, individuals and businesses cannot offer VA services or declare themselves as a provider.

The Hong Kong government closely regulates all activities related to the provision of virtual asset (VA) services. The term “VA services” encompasses a broad range of electronic services that include, but are not limited to:

• (a) Offering virtual assets for sale or purchase regularly, resulting in a binding transaction; regularly introducing or identifying persons to other parties with the purpose of negotiating or concluding virtual asset transactions that are binding or with the reasonable expectation of doing so;
• (b) Possessing direct or indirect control over client money or client virtual assets in the provision of such services.

It is important to note that crypto trading platforms that allow trading in financial products such as securities and futures contracts are not subject to the new licensing regime, as they are already regulated under the Securities and Futures Ordinance. Another thing to note is that the new licensing requirements extend to all crypto exchanges registered in Hong Kong under the Companies Ordinance, including those based outside of Hong Kong that actively target Hong Kong citizens in their marketing efforts.

Prohibition on Unlicensed VA Service Providers

The amended Ordinance also prohibits unlicensed persons from performing regulated functions related to the business of providing VA services. Such functions may include the buying or selling of virtual assets, managing virtual asset portfolios, and providing virtual asset custodian services.

Unlicensed individuals or businesses cannot advertise VA services in Hong Kong. The SFC can take enforcement actions against unlicensed entities, including issuing fines and revoking licenses.

Impact on VASPs

The new regulations have significant implications for VASPs operating in Hong Kong. The licensing process is rigorous and requires VASPs to demonstrate compliance with AML/CFT requirements. Licensed VASPs are subject to ongoing supervision and monitoring by the SFC.

The licensing process requires VASPs to provide detailed business information, including ownership structure, management team, and risk management systems. VASPs must also conduct customer due diligence and transaction monitoring to detect and report suspicious activities.

VASPs that fail to comply with the regulatory requirements may face severe consequences, including fines, license revocation, and reputational damage. The regulations aim to promote a safe and stable virtual asset market in Hong Kong and protect the interests of investors and consumers.

Benefits of the New Regulatory Framework

The new regulatory framework for virtual asset services in Hong Kong has several benefits for VASPs and investors. Firstly, the regulations provide clarity and certainty about the legal and regulatory environment for virtual asset services in Hong Kong. This clarity can help attract more investors and businesses to the market.

Secondly, the regulations promote transparency and accountability in the virtual asset market. Licensed VASPs must maintain proper records, conduct regular audits, and report suspicious activities to the relevant authorities. These requirements can help deter fraud and other illicit activities in the market.

Thirdly, the regulations help promote a level playing field for all VASPs operating in Hong Kong. The licensing process ensures that all VASPs meet the same high standards and are subject to the same regulatory requirements. This can help create a more competitive and fair market for virtual asset services in Hong Kong.

How to get the license?

Crypto businesses must obtain a license from the Securities and Futures Commission, the regulatory body for securities and futures markets. To get a license, the business must pass a ‘fit and proper’ test that involves criminal background checks, AML/CFT performance history, financial standing, educational or other qualifications, reputation, experience, character, reliability and financial integrity of the person. The business must also apply for approval of the premises to keep records or documents required under the Ordinance. Additionally, each director of the applicant and the ultimate owner must be determined as ‘fit and proper’ to be associated with providing the VA service.

To meet the regulatory requirements of the new Ordinance, licensed crypto businesses must introduce AML/CTF measures, including customer due diligence, transaction monitoring and record-keeping, screening clients against international sanctions and watchlists for PEP status, and screening clients in adverse media. They must also comply with Travel Rule requirements and appoint an eligible auditor within one month after becoming a licensed provider. Furthermore, they must prepare financial statements and other documents for prescribed periods and submit them with the auditor’s report to the Commission within four months after the end of the financial year to which they relate.

The licensed provider must also submit an annual return to the Commission and pay a prescribed fee within one month after each anniversary of the license’s grant date. Finally, the licensed person must notify the Commission in writing of any change in information that the licensed person or ultimate owner has provided under the requirements of the Ordinance, including intended cessation of business or intention to change the address at which it proposes to provide any VA service.

Final words

The SFC will have broad powers to supervise AML/CTF and regulatory compliance by licensed VASPs, including imposing sanctions. Businesses that operate without a license or violate AML rules can face significant fines and imprisonment for senior management. In the case of fraudulent activities or deception involving virtual assets, fines can reach up to 10,000,000 HKD (1,277,000 USD) and imprisonment for up to 10 years.

The new regulations will come into effect on April 1, 2023. Some provisions, including licensing requirements, will go into effect on June 1, 2023. Businesses are advised to start preparing for the new regulations as soon as possible and reviewing their AML/CTF policies and controls to identify potential gaps in the requirements.

Overall, implementing these new regulations is expected to attract more institutional investors to the Hong Kong cryptocurrency market, as they will have greater confidence in the safety and legitimacy of the industry. The move also brings Hong Kong’s cryptocurrency regulations in line with global standards and best practices.

Hong Kong has experienced significant events since 2019 that have had a major impact on the city and its people. Hong Kong has faced many challenges, from protests and political unrest to the COVID-19 pandemic to the introduction of national security law and political changes. I hope the city’s new crypto agenda pushes a critical step forward. By embracing the opportunities of new technologies, protecting investors, and promoting transparency, Hong Kong can continue to be a leader in the global financial industry.

Some “#AnndyLian Food for Thought” before I end this article:

The Japanese government recognized early on that allowing retail investors to participate in the cryptocurrency market could help drive adoption and promote innovation. My question is: “Will Hong Kong follow Japan’s approach to allowing retail investors to trade cryptocurrencies in a regulated environment?”

This could be one of their selling points. I am eager to find out.