On 28 January 2022, the Securities and Futures Commission (“SFC”) and the Hong Kong Monetary Authority (“HKMA”) issued a joint-circular on intermediaries engaging in virtual assets-related activities (“VA-related activities”). This circular supersedes the circular to intermediaries on the distribution of VA funds on 1 November 2018.
Set out below is a summary of the circular:-
- Distribution of VA-related products
- Compliance with complex product requirements: Service providers for VA-related products are not subject to the same robust regulation as service providers in traditional financial markets. As a retail investor may not understand the risks involved in VA-related products, VA-related products are generally considered to be complex products. Thus, intermediaries should comply with the SFCs requirements governing the sale of complex products.
- Additional investor protection measures: Concerning the distribution of VA-related products:-
- Selling restrictions: VA-related products which are complex products should only be offered to professional investors. Appendix 3 to the circular provides a flowchart on how to determine if a VA-related product is a complex product.
- Virtual asset-knowledge test:
- Intermediaries should assess clients on their knowledge of investing in virtual assets or VA-related products prior to effecting a transaction in VA-related products on their behalf.
- This test does not apply to institutional professional investors and qualified corporate professional investors.
- If a client does not possess such knowledge, the intermediary may only proceed if (1) by doing so, it would be acting in the client’s best interests and (2) it has provided training to the client on the nature and risks of virtual assets.
- Intermediaries should ensure that their clients have sufficient net worth to be able to assume the risks and bear the potential losses of trading. Appendix 1 to the circular sets out non-exhaustive criteria for assessing a client’s knowledge.
- Securities and Futures Ordinance (“SFO”) selling restrictions: Intermediaries are reminded to observe the selling restrictions in Hong Kong. The SFO prohibits the offering to the Hong Kong public of investments which have not been authorized by the SFC. Where the VA-related products are distributed on an online platform, it must be properly designed and have appropriate access rights and controls to ensure compliance with such selling restrictions.
- Suitability obligations: Intermediaries should observe suitability obligations in the two Suitability FAQs, including:
- ensuring that any recommendations or solicitations made are suitable for clients in all circumstances;
- where the VA-related product is a derivative product, ensuring compliance with paragraphs 5.1A and 5.3 of the Code of Conduct; and
- conducting proper due diligence on the products, which would include, amongst others, understanding their risks and features (in particular the inherent high-risk nature of the underlying virtual assets), the targeted investors (including any applicable selling restrictions) and the products’ regulatory status. Additional due diligence requirements for unauthorised VA funds are set out in Appendix 4 to the circular.
- Warning statements: As part of its obligation under paragraph 5.3 of the Code of Conduct, an intermediary assessing whether to provide a client with services for VA-related derivative products should assure itself that the client understands the nature and risks of these products. In this regard:-
- Intermediaries should provide clients with warning statements (which can be a one-off disclosure) specific to virtual asset futures contracts, examples of which are set out in Appendix 5 to the circular.
- Intermediaries should provide to clients warning statements (which can be a one-off disclosure) specific to virtual assets, examples of which are set out in Appendix 5 to the circular.
- Financial accommodation: Given the high-risk nature of virtual assets, intermediaries should be cautious in providing any financial accommodation for investing in VA-related products to clients. It should assure itself the client has the financial capacity to meet the obligations arising from leveraged or margin trading in VA-related products, including in a worst-case scenario.
- Clear and comprehensible information: Intermediaries distributing VA-related products should provide information to clients in relation to VA-related products and the underlying virtual asset investments in a clear and easily comprehensible manner.
- Provision of virtual asset dealing services (VA dealing services)
- Potentially subpar regulatory standards: The majority of VA trading platforms in Hong Kong and overseas are unregulated or regulated only for AML/CFT purposes. The SFC and the HKMA are concerned that such platforms may not be subject to regulatory standards comparable to those under the SFC’s regulatory framework for VA trading platforms.
- Partnering with SFC-licensed platforms only: The SFC and the HKMA consider it appropriate and necessary to require intermediaries to partner only with SFC-licensed VA trading platforms for the provision of VA dealing services, whether by way of introducing clients to the platforms for direct trading or establishing an omnibus account with the platforms. Such services should only be provided to professional investors.
- The expected conduct requirements for intermediaries’ provision of VA dealing services under an omnibus account arrangement will be imposed by the SFC as licensing or registration conditions. These are set out in Appendix 6 to the circular.Intermediaries are required to comply with prescribed terms and conditions, under which intermediaries should only permit clients to deposit or withdraw fiat currencies from their accounts, and should not allow the deposit or withdrawal of client virtual assets, so as to minimise the risks associated with the transfer of virtual assets.
- VA dealing services are subject to all SFC/HKMA requirements: Although VA dealing services may involve trading in non-security virtual assets which fall outside the SFC’s jurisdiction, such services may have an impact on an intermediary’s fitness and properness to conduct regulated activities. Trading activities involving virtual assets also form part of the dealing services provided by intermediaries.
- Accordingly, intermediaries are expected to comply with all the regulatory requirements imposed by the SFC and the HKMA when providing VA dealing services, irrespective of whether or not the virtual assets involved are securities.
- Such services should only be provided to the intermediaries’ existing clients to which they provide services in a Type 1 regulated activity.
- VA discretionary account management services: With respect to virtual asset discretionary account management services, licensed corporations providing services which meet the de minimis threshold, i.e., a stated investment objective of a portfolio to invest in virtual assets or an intention to invest 10% or more of the gross asset value of a portfolio in virtual assets, are subject to additional requirements set out in the Proforma Terms and Conditions for Licensed Corporations which Manage Portfolios that Invest in Virtual Assets (RA9 Terms and Conditions) published in October 2019.
- Going forward, registered institutions wishing to provide such services should inform the SFC and the HKMA and will be required to comply with the RA9 Terms and Conditions which will be imposed as registration conditions.
- For discretionary account management services, where a Type 1 intermediary is authorised by its clients to provide VA dealing services on a discretionary basis as an ancillary service, the intermediary should only invest less than 10% of the gross asset value of the client’s portfolio in virtual assets.
- Provision of virtual asset advisory services
- Intermediaries that provide advisory services in virtual assets must comply with all regulatory requirements, irrespective of the nature of the virtual assets.
- Such services should only be provided if an intermediary has a Type 1 or Type 4 regulated activity licence.
- Expected conduct requirements for VA-advisory services are set out in the Terms and conditions in Appendix 6 of the circular. In particular, intermediaries should:-
- Observe suitability obligations
- Offer such services only to professional investors
- Conduct a virtual asset-knowledge test before providing services.
- Intermediaries providing advisory services in VA-related products should observe the requirements highlighted in Part 1 above
- Implementation
- There will be a six-month transition period for intermediaries serving clients of its VA-related activities to revise their systems accordingly.
- Intermediaries which do not engage in VA-related activities should ensure compliance with this circular before introducing such service. They should also notify the SFC/HKMA in advance of their intention to engage in VA-related activities.
For further information, please contact:
Kelly Ho, Hauzen LLP
kellyho@hauzen.hk
