Hong Kong’s New VASP Regime sets high standards

The Anti-Money Laundering and Counter-Terrorist Financing (“AML/CTF”) (Amendment) Bill 2022 (“Amendment Bill”) was gazetted by the Hong Kong (HK) Government on June 24, 2022. The Amendment Bill modifies the AML/CTF Ordinance (Cap. 615) (“AMLO”), introducing a licensing regime for virtual asset service providers (“VASPs”) and imposing statutory AML/CTF obligations on VASPs in Hong Kong. 

According to the LegCo Brief, the Hong Kong government believes that its planned VASP regime is “more stringent and comprehensive” than the AML-focused VASP regimes implemented in Singapore, the United Kingdom, and Japan. Hong Kong’s VASP system is concerned not just with AML issues, but also with guaranteeing proper investor protection for virtual asset investors. As a result, once implemented, the VASP regime will not only impose a strict licensing system on VASP operators, but will also criminalise a wide variety of crypto-related misdeeds, regardless of whether it occurs on a regulated VASP exchange. The system also confers substantial supervisory powers on the SFC, (The Securities and Futures Commission of Hong Kong), the independent statutory body charged with regulating the securities and futures markets in Hong Kong.

A government source told CoinDesk that market participants have expressed concerns about high operating costs as a result of the requirement that they insure their assets and keep a high percentage of their assets in cold wallets. In the end, the regime’s focus is on investor protection. At the moment, it appears to be focused on spot trading and does not support staking, lending, copy trading, or leverage, which is essential for many exchanges. Essentially, the SFC does not want to see anything outside of the regular stock market.

 

Summary of the Bill:

3 November 2020: Consultation begun

11 February 2021: Response submitted

24 June 2022: Bill gazetted

1 March 2023: Regime comes into effect

1 March 2024: Grace period ends

 

Comparison of Opt-in Licensing Regime and VASP Regime

Opt-in Licensing Regime

Hong Kong demands that applicants run trading platforms for virtual assets that cater solely to professional investors and keep client money in segregated accounts. Additionally, licensed platforms are required to avoid conflicts of interest, such as principal dealers trading their own book while also serving as customer agents. Exchanges could continue providing services to consumers in Hong Kong without much regulatory control since they were never needed to get a licence. Cryptocurrencies are not securities and cannot be regulated as such, the SFC has previously stated in a document.

VASP Regime

The new regulations intend to tackle this issue by developing a legal framework expressly for these types of virtual assets. Licensing will be required. Platforms will also be available to retail investors.

 

Post-FTX Collapse

The Hong Kong Monetary Authority (“HKMA”) stated that the failure of FTX demonstrated the need for solid laws in the city’s aim of becoming a virtual asset center and that a proposed new regulatory framework will provide enough protection to investors.

CEO of the HKMA, Eddie Yue Wai-man, said the abrupt collapse of FTX, which was the second-largest cryptocurrency exchange in the world until falling bankrupt in less than a week after a run on the exchange, has prompted Yue to advocate for Hong Kong’s regulatory approach to cryptocurrencies.

Financial Secretary Paul Chan Mo-po reaffirmed Hong Kong’s commitment to virtual asset regulation after the collapse of FTX sent cryptocurrency values plummeting and caused problems that spread throughout the industry. He claimed in a blog post that the regulation is now more appealing as the sector looks for greater transparency.

 

About the New VASP Regime

Definition of Virtual Asset 

Virtual assets will be broadly defined as a cryptographically secured digital representation of value that is expressed as a unit of account or a store of economic value; either

  1. used, or intended to be used, as a medium of exchange accepted by the public for payment for goods or services, for the discharge of a debt and/or for investment; or
  2. provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with, or to vote on any change of the terms of any arrangement applicable to, any cryptographically secured digital representation of value; and can be transferred, stored or traded electronically.

 

Eligibility for VASP licensing
  • Corporate Structure and Location: The applicant must either be a Hong Kong incorporated company with a permanent place of business in Hong Kong or a foreign incorporated company registered under the Companies Ordinance (Cap. 622).
  • Financial Resources: The applicant is required to maintain adequate financial resources, including paid-up share capital and liquid capital.
  • Fit and Proper: The applicant, officers of the applicant (including responsible officers, licensed representatives, and directors), and ‘the ultimate owner’ (defined below) must be ‘fit and proper’.
  • Licensing Conditions: On granting a licence to the applicant, the SFC may impose licensing conditions. The Draft Law lists the areas of potential coverage.
  • Premises Approval: Premises for keeping records and documents must be approved by the SFC. We expect it is likely that the SFC’s current rules relating to the use of external data storage providers for the securities sector may also apply.

 

Key Licensing Triggers:
  • Carrying on business 
    • The key offence relates to carrying on a business of providing a Virtual Asset (“VA”) Service without a licence. The term appears in the context of eligibility for the transition arrangements.
    • ‘Carrying on business’ is not defined, but it is a common term in Hong Kong legislation.
  • Holding Out
    • The VA Licensing Regime extends to persons holding themselves out as carrying on business in a VA Service. As with ‘carrying on business’, this term is not defined.
  • Actively markets
    • ‘Actively markets’ and ‘actively marketing’ are not defined in the Draft law.
    • Actively marketing a service, which if provided in Hong Kong would be a VA service, to the Hong Kong public is to be regarded as
      • Holding out as carrying on a business of providing a VA Service, in respect of the marketing of the service; and
      • Carrying on business of providing a VA Service, in respect of the provision of that service.

 

Ancillary offences:
  • Issuing advertisements in respect of unlicensed persons’ provision of a VA service 
    • Prohibited Advertisement11 is an advertisement in which the advertised person holds themself out as being prepared to provide VA service where the advertised person is in fact unlicensed.
    • A person knowingly issues or possesses for the purpose of issuing a Prohibited Advertisement or a document containing the Prohibited Advertisement commits an offence.
    • There are exemptions and defences – where it is proven that the all reasonable steps and all due diligence have been taken and exercised.
  • Fraud and deception in a virtual asset transaction
    • If a person does either of the following, directly or indirectly, in a transaction involving any virtual assets:
      1. employs a device, scheme· or artifice with intent to defraud or deceive; or
      2. engages in any act, practice or course of business that is fraudulent or deceptive, or would operate as a fraud or deception.
  • Fraudulently or recklessly induce others to invest in virtual assets
    • If a person makes any fraudulent misrepresentation or reckless misrepresentation for the purpose of inducing another person to enter into, or offer to enter into, an agreement to acquire, dispose of, subscribed for or underwrite any virtual asset.
  • Maximum penalties for various offences 

a. Carrying on a business providing VA service without a VASP licence

    1. Conviction on indictment – a fine of HKD5 million and imprisonment for 7 years and, in the case of a continuing offence, a further fine of HKD100,000 for every day during which the offence continues; or
    2. Summary conviction – a fine of HKD500,000 and imprisonment of 2 years, and a further fine of HKD10,000 for every day during which the offence continues.

b. Performing any regulated function in relation to a VA service without a licence

    1. Conviction on indictment – a fine of HKD5 million and imprisonment for 7 years and, in the case of a continuing offence, a further fine of HKD100,000 for every day during which the offence continues; or
    2. Summary conviction – a fine of HKD500,000 and imprisonment of 2 years, and a further fine of HKD10,000 for every day during which the offence continues.

c. Issuing advertisements in respect of unlicensed persons’ provision of a VA service

A fine at level 5 (currently set at HKD50,000) and imprisonment for 6 months.

d. Fraud and deception in a virtual asset transaction

    1. Conviction on indictment – a fine of HKD10 million and imprisonment for 10 years; or
    2. Summary conviction – a fine of HKD1 million and imprisonment of 3 years.

e.  Failure to comply with the Order

    1. Conviction on indictment – a fine of HKD1 million and imprisonment for 2 years; or
    2. Summary conviction – a fine at level 6 (currently set at HKD100,000) and imprisonment of 6 months.

f. Fraudulently or recklessly induce others to invest in virtual assets

    1. Conviction on indictment – a fine of HKD1 million and imprisonment for 7 years; or
    2. Summary conviction – a fine at level 6 (currently set at HKD100,000) and imprisonment of 6 months.