Have you been keeping up to date with the latest virtual asset (VA) developments in Hong Kong? They continue to come thick and fast. We set out below a wrap-up of the most recent developments, including in relation to the new virtual asset service provider (VASP) licensing regime, warnings from the Securities and Futures Commission (SFC), amendments to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO), and what to expect in the new year.
For background information, please refer to our June 2022 and November 2022 briefings, which discuss the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (Amendment Bill) and highlights from the Hong Kong and Singapore Fintech Weeks.
- The SFC issued a statement on 13 December 2022 to the effect that VA arrangements claiming to offer returns to investors could amount to collective investment schemes and may be restricted under the Securities and Futures Ordinance. The SFC warned that investors may suffer significant loss as VA arrangements, and a vast majority of VA platforms offering VA arrangements, are unregulated.
- Following the publication of the Report of the Bills Committee dated 29 November 2022 (Bills Committee Report) on the Amendment Bill, the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022 (Amendment Ordinance) was gazetted on 16 December 2022. The Amendment Ordinance includes further changes to the new VASP licensing regime and anti-money laundering and counter-terrorist financing regulatory requirements following deliberation by the Legislative Council (LegCo).
- The implementation of the VASP licensing regime has been postponed by three months to 1 June 2023. The transitional periods under the regime have been adjusted accordingly.
- Two new criminal offences specific to fraud involving VAs will take effect on 1 April 2023 (before the commencement of the VASP licensing regime). These provisions will apply to any person (not just VASPs).
- Whether a non-fungible token (NFT) falls within the definition of VA under the amended AMLO will depend on the nature and functions of the NFT in practice. Where the characteristics of a specific NFT go beyond the boundary of a collectible, it is more likely to qualify as a VA.
- Financial institutions (FIs), now including licensed VASPs, will need to perform customer due diligence (CDD) measures before carrying out an occasional transaction that is a transfer involving VAs amounting to HK$8,000 or above. Licensed VASPs will also need to perform CDD measures before carrying out an occasional transaction involving HK$8,000 or above which is not a wire transfer or VA transfer.
- Client assets of a licensed VASP are not liable to be taken in execution against a licensed VASP or its associated entities under an order or process of a court. This serves to further protect client assets by ringfencing and excluding them from any orders or processes for enforcement of judgments and execution of those orders against a licensed VASP.
- The SFC has been diligently working on the operational and conduct regulatory requirements to apply to licensed VASPs and will consult the public on proposed measures very soon.
- A number of miscellaneous amendments have also been made to the AMLO, including amending the definition of politically exposed persons (PEPs) and facilitating a risk-based approach in determining the degree of CDD to be performed on former PEPs. These PEP-related amendments will come into operation on 1 June 2023 to provide sufficient time for preparatory work.
- The Hong Kong Monetary Authority (HKMA) has issued a circular on the passing of the Amendment Bill and will soon consult the banking sector on corresponding changes to the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Authorised Institutions) as well as specific guidance on topical issues.
SFC statement on VA arrangements
On 13 December 2022, the SFC issued a statement on virtual asset arrangements claiming to offer returns to investors to remind investors of the risks associated with VA platforms offering VA deposits, savings, earnings or staking services (collectively, VA Arrangements). The SFC observed that VA deposited by investors may be on-lent by the platform to borrowers on other platforms or decentralised lending protocols or used in investment or other activities.
The SFC warned investors that they may suffer significant or even total loss, especially in the event of fraud or collapse of a VA platform (as evident in the recent fallout of a number of VA platforms) given that VA Arrangements and a vast majority of VA platforms offering VA Arrangements are unregulated.
The SFC also warned that a VA Arrangement could amount to a collective investment scheme (CIS) under the Securities and Futures Ordinance, if the participating investors do not have day-to-day control over the management of their VAs and the VAs are pooled and/or managed as a whole by the operator to generate returns for investors. It is an offence to issue an unauthorised advertisement that is an invitation to acquire an interest in a CIS or for a person to carry on a business of marketing or distributing interests in a CIS in Hong Kong or targeting Hong Kong investors without a SFC licence, unless an exemption applies. The SFC has stressed that it will take robust enforcement action promptly to safeguard investors’ interests.
Updates to the VASP licensing regime following LegCo deliberation
Postponement and adjustment of transitional periods
The commencement of the provisions regarding the VASP licensing requirements and transitional arrangements has been postponed by three months and will now take effect on 1 June 2023. This is to allow the Administration and the SFC more time to work out the implementation details, including consultation by the SFC on the VASP regulatory requirements, and more time for VASPs to make preparations.
The key dates under the new transitional arrangements are as follows:
- 1 June 2023 – New commencement date
The provisions regarding the VASP licensing requirements and transitional arrangements take effect.
- 1 June 2023 to 29 February 2024 – Application period for deemed licensed status
A corporation that has been providing a VA service (currently limited to operating a VA exchange) in Hong Kong immediately before 1 June 2023 will be deemed to be a licensed VASP after the first 12 months of the VASP licensing regime (after 1 June 2024) if on or before 29 February 2024 it makes an application to be licensed by the SFC (the application must be acknowledged in writing by the SFC and the SFC must not have issued a “rejection notice” and decided to commence the deemed withdrawal procedure in respect of the application) and gives the SFC a confirmation that: (i) it has been operating a VA exchange in Hong Kong immediately before 1 June 2023; and (ii) it will comply with (and has arrangements in place to ensure compliance with) the regulatory requirements applicable to a licensed VASP. Deemed licensing will end on the day on which one of the following events happens (whichever happens first):
(i) the corporation’s application is withdrawn;
(ii) a refusal of the corporation’s application takes effect;
(iii) a licence is granted to the corporation.
Whether the carrying on of the business of providing a VA service will be regarded as taking place in Hong Kong will depend on the facts and circumstances. Relevant factors which may be considered by the SFC include whether the corporation is incorporated, registered or has a physical office in Hong Kong, whether the corporation’s key personnel (such as those responsible for the operation of the trading system) are based in Hong Kong and whether the hardware for the trading system is located in Hong Kong.
Similar deeming provisions apply to individual representatives of VASPs. An individual applying to the SFC to be a licensed representative (LR) must be in Hong Kong and operating a VA exchange in Hong Kong on behalf of the corporate applicant at the time of the individual’s application.
Similar deeming provisions also apply to individual responsible officers of VASPs. An individual applying to be a responsible officer (RO) must be in Hong Kong and operating a VA exchange in Hong Kong on behalf of the corporate application immediately before 1 June 2023.
- 31 May 2024 – End of closing-down period
VASPs operating a VA exchange in Hong Kong that have not applied to the SFC for a licence on or before 29 February 2024 and VASP licence applicants that have been issued a rejection notice will be required to close down their VA exchange business in Hong Kong by 31 May 2024 or within three months upon the issuance of the rejection notice (whichever is later).
Despite the postponement of the implementation of the VASP licensing regime, the following criminal offences specific to fraud involving VAs will take effect from 1 April 2023:
- Offence involving fraudulent or deceptive devices etc in transactions in VA (section 53ZRF) – It will be an offence if a person, directly or indirectly, in a transaction involving any VAs: (a) employs any device, scheme or artifice with intent to defraud or deceive; or (b) engages in any act, practice or course of business that is fraudulent or deceptive, or would operate as a fraud or deception.
- Offence to fraudulently or recklessly induce others to invest in VA (section 53ZRG) – It will be an offence for a person to make 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, subscribe for or underwrite any VAs.
These criminal offences are aimed at addressing concerns relating to fraud and will be applicable to any person regardless of whether that person is providing a VA service (currently limited to operating a VA exchange) and will therefore also be applicable to overseas VA exchanges that are not licensed by the SFC.
Deliberations on NFTs
Following the gazettal of the Amendment Bill in June 2022, the Bills Committee discussed whether NFTs are covered by the definition of VA under the amended AMLO (see Bills Committee Report). The SFC observed that tokens which are labelled as NFTs in the market may have different terms and features and noted that it is important to consider the nature and functions of the NFTs in practice rather than the marketing terminology used.
In most cases, where an NFT merely represents a genuine digital representation of a collectible, it will unlikely fall within the definition of VA. However, where the characteristics of a specific NFT go beyond the boundary of a collectible (such as containing fungible elements or allowing holders to vote on its arrangement), it may be used as a medium of exchange accepted by the public or a digital representation of value that provides holders with rights, eligibility or access to vote. If it also contains the other elements of the definition of VA under the amended AMLO (namely it is expressed as a unit of account or a store of economic value; can be transferred, stored or traded electronically; and satisfies other characteristics prescribed by the SFC), then the NFT is very likely to qualify as a VA.
Additional CDD measures in relation to VA
FIs, now including licensed VASPs, will need to perform CDD measures before carrying out an occasional transaction that is a transfer involving VAs amounting to no less than HK$8,000, whether the transaction is carried out in a single operation or in several operations that appear to be linked.
A significant change to the original Amendment Bill is that licensed VASPs will also need to perform CDD measures before carrying out an occasional transaction involving HK$8,000 or above (or equivalent) which is not a wire transfer or VA transfer, whether the transaction is carried out in a single operation or in several operations that appear to be linked. In comparison with other FIs, licensed VASPs will need to perform CDD measures for a much broader range of occasional transactions.
From the angle of investor protection, the protection of client assets is of paramount importance. The SFC has been empowered to protect a licensed VASP’s client’s assets in the event of an emergency and to prevent the dissipation of client assets in case of misconduct on the part of a licensed VASP.
Another significant change to the original Amendment Bill is the addition of a brand new section (section 53ZRT, which was previously numbered as section 53ZRSA under the amendments moved by the Administration), which provides that client assets are not liable to be taken in execution against the licensed VASP or its associated entities under an order or process of a court. Put simply, client assets are not subject to any execution orders issued by the court against the licensed VASP for the purpose of enforcing a judgment (such as writ of fi fa, warrant of distress, and charging order). This serves to further protect client assets by ringfencing and excluding them from any orders or processes for enforcement of judgments and execution of those orders against a licensed VASP.
Upcoming SFC consultation on the detailed regulatory requirements for the VASP regime
Looking ahead, as the Amendment Ordinance has been gazetted, the SFC is expected to soon consult on the detailed regulatory requirements of the VASP regime. The SFC will consider whether the professional investor-only requirement could be relaxed; and if so, the governance procedures and listing criteria for the VASP to admit tokens for secondary market trading by retail investors.
The SFC and the Financial Services and the Treasury Bureau have also been communicating with the industry on security token offerings (STOs), including in relation to the SFC’s regulatory principles for STOs and the latest regulatory direction in this area. Please refer to our November 2022 e-bulletin for more details on the SFC’s proposed relaxation of the professional investor-only requirement and guidance on STOs.
The SFC will publish guidelines under the new section 53ZTK of the amended AMLO (previously numbered as section 53ZTJ under the Amendment Bill) to specify, among others, matters the SFC will take into consideration in determining whether a person satisfies the fit and proper test in order to be licensed or to remain licensed, and to be a RO or LR. The standards to be set out in these guidelines are expected to be generally aligned with those set out in the SFC’s Fit and Proper Guidelines.
Other amendments to the AMLO
The Amendment Bill proposed a number of other changes to the AMLO which have not been amended in the Amendment Ordinance.
The definition of PEP is amended to an individual who is or has been entrusted with a prominent public function in a place outside Hong Kong. This means that the special requirements under section 10 of Schedule 2 to the AMLO applies not only to a PEP from a place outside the People’s Republic of China but also a PEP from a place outside Hong Kong. FIs will be allowed to take a risk-sensitive approach in determining the degree of CDD to be taken in respect of former PEPs who are no longer entrusted with a prominent public function.
The definition of beneficial owner for trusts has been amended to align with that of controlling person under the Inland Revenue Ordinance by clarifying that, where a trust is concerned, it includes trustees, beneficiaries and class(es) of beneficiaries of the trust entitled to a vested interest in the trust property.
Recognised digital identification systems may now be used for the purposes of CDD, which also satisfies the special requirements in situations where a customer is not physically present for identification purposes (ie, non-face-to-face situations).
The penalties for unlicensed money service operation have also been increased to enhance the deterrent effect. The maximum penalty has been increased to a fine of HK$1 million and imprisonment for two years on conviction on indictment.
Lastly, a registration regime for dealers in precious metals and stones has been introduced. Under this regime, any person seeking to carry on a business of dealing in precious metals and precious stones in Hong Kong will be required to register with the Commissioner of Customs and Excise.
The increased penalties for unlicensed money service operation and the registration regime for dealers in precious metals and stones will come into operation 1 April 2023. The remaining amendments to the AMLO listed in this section will become effective on 1 June 2023 to provide sufficient time for preparatory work.
As set out in the HKMA circular and the Bills Committee Report, the HKMA will work with the Hong Kong Association of Banks and consult the banking sector to update the HKMA’s Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Authorised Institutions) and relevant FAQs. The HKMA also intends to develop a new guidance paper on PEPs, with the help of an external consultant, to provide holistic guidance on all types of PEPs taking into account international practices.