Virtual assets - the SFC's regulatory strategy for a dynamic industry
In November 2018, the SFC published a proposed framework for virtual asset trading platforms. A few months ago, the SFC followed this with the publication of a position paper on the regulation of virtual asset trading platforms. On the same day, the CEO of the SFC, Ashley Alder, gave a speech at FinTech week and the SFC also issued a warning on virtual asset futures contracts.
We have distilled the messages from the SFC as follows:
1. The SFC says it has no power to regulate businesses who deal in pure virtual assets, that is, assets that do not fall within the definitions of "securities" or "futures contracts" under the SFO.
2. However, the SFC will consider licensing a centralised online trading platform offering at least one security token and which has control over investors' assets.
3. The SFC will not accept licensing applications from platforms:
a. which only provide a direct peer-to-peer marketplace for transactions;
b. where investors typically retain control over their own assets; or
c. which trade virtual assets for clients, including order routing, but do not provide ATS themselves.
4. Licensees must comply with the Terms and Conditions for Virtual Asset Trading Platform, which is at Appendix 1 of the Position Paper.
5. These include, for example:
a. requirements relating to safe custody of assets, KYC/AML and market manipulation;
b. specific criteria relating to hot/cold wallets, hard forks, airdrops, etc.;
c. provision of services only to professional investors; and
d. requirements with respect to insurance.
6. The SFC is unlikely to grant a licence to carry on a business in virtual asset futures contracts. The SFC even goes so far as to note that "virtual asset futures contracts may also be construed as contracts for differences under the Gambling Ordinance… persons who breach the relevant provisions of the SFO or the Gambling Ordinance may be prosecuted and, if convicted, subject to criminal sanctions." This is a strong warning.
7. Licensed platforms will be placed into the SFC's Regulatory Sandbox.
Ashley Alder said in his speech that the SFC recognises that it must be open to the benefits of innovation, but its "bottom line" is that it needs to "stay vigilant about the risks of new technology."
This is clear from the recent statements from the SFC, which are robust, stringent and very comprehensive. It is likely that they only want committed and professional entities to apply and have set the bar for a licence (at least for trading platforms) quite high. Having said that, this could mean that platform operators looking to operate in Hong Kong could have a competitive advantage in being an SFC-licensed entity.
The regulatory regime continues to evolve, as the SFC continues to refine its approach, we expect more changes. As Ashley Alder said in his speech "…watch this space – there will be much more to come."
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