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Money laundering concerns prompt consultation on regulation of virtual asset service providers in Hong Kong

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Robins Charlotte
Charlotte Robins

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Matt Bower

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Da Roza Andre
Andre Da Roza

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Adrian Fong

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Huang Jeffrey
Jeffrey Huang

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Chan Karen
Karen Chan

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09 November 2020

The Financial Services and Treasury Bureau (FSTB) issued the Public Consultation on Legislative Proposals to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (Consultation Paper) proposing:

(i) a licensing regime for virtual asset trading platforms in Hong Kong, including anti-money laundering obligations;

(ii) a two-tier registration regime for dealers in precious metals and stones; and

(iii) other miscellaneous items (including in relation to non-face-to-face customer due diligence).

Amendments are proposed to be made to Hong Kong’s Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO), and are being made in response to the Financial Action Task Force’s recommendations for Hong Kong and recognition that virtual assets pose significant money laundering and terrorist financing risks to the international financial system and considerable challenges to investor protection, the consultation noting their frequent association with fraud, security breach, and market manipulation. 

This bulletin briefly looks at items (i) the impact these proposed changes may having on virtual asset trading platforms, and (ii) in respect of proposed changes to non face to face CDD.

Virtual asset trading platforms

Non-security virtual assets trading platforms (VA platform) will be required to be licensed by the Securities and Futures Commission (SFC). For these purposes, a virtual asset (VA) is “a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purpose”. The SFC already operates an “opt-in” licensing regime, established in November 2019, in relation to the trading of VAs that fall within the “securities” definition (security tokens) under the Securities and Futures Ordinance (Cap. 571) (SFO). 

Key highlights of the proposed regulatory framework include the requirement for the VA platform operator (which must be a Hong Kong-incorporated company with a permanent place of business in Hong Kong) and its ultimate owners to be “fit and proper”. This is not dissimilar to the requirements imposed on other licensing regimes introduced in AMLO, for example trust or company service providers and money service operators. In addition, there is the need for “responsible officers” to also be fit and proper. The term “responsible officer” is new to AMLO but is well entrenched in the SFO. We would expect to see draft legislation and guidance issued by the SFC (empowered to do so under the proposed changes to AMLO) further clarifying the roles and responsibilities of the “responsible officer”. 

Further, the SFC will be given the power to impose licensing conditions on the VA platform such as: (i) limiting the platform’s services only to “professional investors”; (ii) requirements on policies and procedures around listing and trading, market manipulation, risk management and segregation and management of client assets; and (iii) prohibiting the applicant and its associated entities from engaging in proprietary trading or market-making activities. These obligations go beyond those imposed on other regimes under AMLO, but are areas that the SFC already requires platforms trading security tokens to comply with under their opt-in regime.  In addition, the SFC will have the statutory power to intervene in the business of the VA platform under certain circumstances to protect client assets – allowing the SFC to prohibit the platform from entering into further transactions, restricting it from disposing of its property including client assets, and to require the platform to maintain its property in a specified manner.    

This proposal will not only target VA platform operators that carry on business in and from Hong Kong, but also those who “actively market” to the Hong Kong public such services or similar activity. Again, the concept of “active marketing” is already well-established in the Hong Kong securities regime, but the line is increasingly blurry for digital-only businesses with multiple access points (e.g. websites, mobile apps) and a global presence. If this aspect of the proposal goes forward, VA platforms operating overseas will need to carefully consider the legislative wording and whether limits need to be placed in respect of Hong Kong. 

With the increasing popularity and sophistication of the VA market, there has also been a proliferation of VA payment systems and custodian providers. The FSTB has put the market on notice that regulating VA platform operators may only be the first step as “flexibility will be built in the licensing regime such that it may be expanded to cover forms of VA activities”. Hong Kong could see an expanded role for the SFC as not only the securities and futures regulator, but also the supervisor for the broader VA market. 

The proposed VA definition is not intended to cover digital representations of fiat currencies (e.g. digital currencies issued by central banks) or financial assets (e.g. securities and authorized structured products) already regulated under the SFO, or peer-to-peer trading platforms. The SFC’s opt-in regime also does not cover “offering, trading or dealing activities in virtual asset futures contracts or related derivatives”. In respect of the FSTB proposal, Ashley Alder, the CEO of the SFC, noted in a speech that “[o]nce this new regime is in place, all virtual asset trading platforms in Hong Kong would be regulated, supervised and monitored under one of two regimes”. The changes will need to be looked at closely to determine whether platforms dealing in VA futures contracts and crypto-derivatives will be caught.

Those who carry out a VA activity without a licence shall be guilty of a criminal offence, punishable on conviction on indictment to a fine of HK$5,00,000 and to imprisonment for 7 years. Notably, in the case of a continuing offence, a further fine of HK$100,000 for every day during which the offence continues would be imposed. In the words of the consultation, “the penalty level for unlicensed VA activities should be high enough to achieve the necessary deterrent effect”. Separate sanctions would be available for those who fail to comply with the proposed AML/CTF requirements, including suspension or revocation of licences and remedial orders. 

Non face to face CDD

Amongst the miscellaneous proposals, of a digital nature there are welcomed proposals to relax customer due diligence requirements in non-face-to-face situations by allowing independent and reliable digital identification systems to be used for customer identification and verification purposes.

Comments on the Consultation Paper should be submitted to the FSTB by 31 January 2021. The FSTB intends to introduce a bill into the Legislative Council in 2021.

This bulletin is not intended to be a complete summary of the Consultation Paper. If you have any questions, please do not hesitate to contact Charlotte Robins, Matt Bower, Andre Da Roza, Adrian Fong, Jeffrey Huang and/or Karen Chan.

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