What does a HK financial license require to operate virtual assets?

Recently, the Hong Kong Treasury Department passed the "Policy Statement on the Development of Virtual Assets in Hong Kong", stating that Hong Kong will build a world virtual asset center, which has strongly boosted market confidence. As the saying goes, we are not afraid of legal punishment, but we are afraid of having no law to rely on. Hong Kong's increasingly clear regulatory norms provide a visible way out for financialized virtual asset practitioners.

Today, the Sajie team continues to bring you an interpretation of Hong Kong’s virtual asset licensing and regulatory rules, detailing the nature and purpose of various financial licenses and the specific licenses that virtual asset platforms should obtain, providing all-round compliance support for everyone’s licensing in Hong Kong.

1. The nature and regulatory scope of virtual assets

Before talking about regulation, we first need to know the definition of virtual assets by Hong Kong regulators. According to the public documents of the Securities and Futures Commission of Hong Kong (hereinafter referred to as the "SFC"), we can clearly see that virtual assets are assets that express value in digital form. They can be in the form of digital tokens (such as cryptocurrencies, functional tokens, or tokens backed by securities or assets), any other virtual commodities, encrypted assets or other essentially the same assets, regardless of whether such assets constitute "securities" or "futures contracts" as defined in the Securities and Futures Ordinance.

From the above definition, we can see that the Hong Kong government's definition of virtual assets is very broad. As long as it is an asset that can express value in digital form, whether it is a cryptocurrency (token, including NFT) generated by blockchain technology, a virtual commodity or valuable data, and whether it has financial attributes, it is equally included in the superordinate concept of "virtual assets". So, in Hong Kong's existing "licensing supervision" framework, do the Securities and Futures Commission and the Treasury Bureau, as the main regulators, have to regulate all "virtual assets"? The answer is no.

According to Article 4 of Part I of the "Position Paper on Regulating Virtual Asset Trading Platforms" (hereinafter referred to as the "Position Paper") issued by the SFC on November 6, 2019: The SFC has no right to license or regulate platforms that only buy and sell non-security virtual assets or tokens. The reason is that such virtual assets do not constitute "securities" or "futures contracts" under the Securities and Futures Ordinance, and the businesses operated by these platforms do not constitute "regulated businesses" under the Ordinance. Therefore, under the current Hong Kong regulatory framework, only platforms that provide securities-type virtual assets or token trading services to customers (in other words, financial securitization token trading) are within the scope of supervision of the SFC. In other words, ordinary non-financial securitization virtual asset transactions (pure digital artworks) do not fall within the regulatory framework.

2. Detailed explanation of Hong Kong Securities and Futures Commission license

For those who are not familiar with the financial regulatory system in Hong Kong, it is difficult for them to have a deep understanding by simply telling them which license type is needed to operate virtual assets. Therefore, today, Sister Sa’s team will give you an in-depth interpretation of the Hong Kong Securities Regulatory Commission’s licensing and regulatory system.

To understand the licensing and regulatory system, we must first understand what behaviors constitute "regulated activities" in the Hong Kong Securities and Futures Ordinance. This is because the Hong Kong Securities and Futures Commission currently regulates the futures and securities markets by subdividing them into 12 business areas. The so-called "licensing" is to issue administrative licenses for different securities and futures businesses.

What we usually call a license number X means obtaining an administrative license for the Xth type of regulated activities. For example, a legal entity that obtains a license number 1 can legally conduct securities trading business in Hong Kong. In order to better understand the licensing system of Hong Kong's financial supervision, the Sajie team briefly summarizes the traditional uses of the 10 types of licenses (the regulation of licenses number 11 and 12 has not yet been implemented and will not be discussed here):

In actual operation, it is actually more complicated. For example, the No. 1 license is divided into a large No. 1 license and a small No. 1 license. The administrative license scope of the large No. 1 license is basically the same as that of securities firms in mainland China. If you hold a small No. 1 license, you cannot open an account, deposit funds, or place orders, but you can legally share commissions (this business is a gray area in China, but it is legal in Hong Kong if you hold a small No. 1 license). Similarly, the No. 6 license also has a difference in whether it can serve as a sponsor. The No. 9 license also has a difference in public and private offerings. The small 9 can only do private offerings.

3. What licenses are actually required to land in Hong Kong?

According to the requirements of the "Position Paper" issued by the SFC in 2019, if a platform operator operates a virtual asset trading platform in Hong Kong and provides trading of at least one security token on its platform, it will fall under the jurisdiction of the SFC and must hold License No. 1 (Securities Trading) and License No. 7 (Providing Automated Trading Services). In fact, from the latest list of licensed virtual asset trading platforms published by the SFC on August 22, 2022, we can find that the licensed platform OSL Digital Securities Limited actually holds License No. 1 and License No. 7.

The Sajie team believes that the No. 1 and No. 7 licenses are two sets of licenses issued by the CSRC after actually inspecting the business conducted by OSL and negotiating with it. They have certain guiding significance for the subsequent licensing supervision of virtual asset platforms, but this does not mean that the No. 1 and No. 7 licenses are standard for all virtual asset trading platforms. In the "Statement on the Regulatory Framework for Virtual Asset Portfolio Management Companies, Fund Distributors and Trading Platform Operators" (hereinafter referred to as the "2018 Statement") issued by the CSRC in November 2018, the CSRC clearly stated that two types of virtual asset portfolio management companies will be supervised by the CSRC:

1. Companies that manage funds that invest entirely in virtual assets that do not constitute "securities" or "futures contracts" and distribute such funds in Hong Kong. Such companies are required to hold a Type 1 (Securities Dealing) license as they distribute these funds in Hong Kong.

2. Virtual asset trading platforms that manage a portfolio of "securities" and/or "futures contracts" are required to hold a Type 9 license (asset management). If such virtual asset trading platforms also manage a portfolio that is fully or partially (subject to the de minimis exemption requirements) invested in virtual assets that do not constitute "securities" or "futures contracts", the SFC will also monitor the relevant management work by imposing licensing conditions.

In addition, the Sajie team believes that the No. 4 license should not be ignored. As mentioned earlier, the No. 4 license is a consulting license. Units holding this type of license can give investors some appropriate investment advice. In actual operations, investment institutions generally apply for the No. 4 license in pairs with the No. 1 license in order to facilitate securities transactions. Then, if you want to operate a virtual asset platform for financial securitization, you will inevitably have to provide investors with some virtual asset investment consulting services, which falls within the scope of supervision of the No. 4 license.

A summary: If a virtual asset trading platform for financial securities wants to legally land in Hong Kong, and does not hold custody of user assets, then license No. 1 and license No. 7 are rigidly required, otherwise license No. 9 is required to operate legally. License No. 4 and other licenses are not necessary at present, but it depends on the specific business, and the possibility of obtaining a license in the future is not ruled out.

At this point, someone may ask: If a financial securities virtual asset platform wants to land in Hong Kong, then only through the decentralized acquisition of licenses 1, 4, 7, and 9, pieced together into a company or formed an operating entity, will it meet the requirements of licensed supervision? The answer is no, this kind of cleverness is not acceptable, unless the existing licensed virtual asset trading platform is directly acquired under its umbrella, "patchwork" will not help. In other words, it is extremely difficult to land in Hong Kong through the acquisition path at present. It can only be obtained by registering a legal entity in Hong Kong (currently Hong Kong only allows legal persons to hold licenses, and natural persons and organizations without legal person status such as DAOs cannot be approved for licenses) to apply for a license and operate in compliance.

In addition, we need to mention a major positive. In the consultation summary of the Hong Kong Treasury Bureau in 2021, it clearly stated that virtual asset platforms should adopt open licensing supervision. This means that as long as the licensed virtual asset service provider has not been revoked by the SFC (for example, due to violations or cessation of operations), its license will remain valid all year round (and there may not even be a need for regular inspections). This is because the Treasury Bureau believes that licensed virtual asset service providers must make considerable investments to establish large-scale and technologically advanced systems to operate competitive virtual asset exchanges, so regulators have an obligation to provide a sufficiently clear and stable operating environment to provide them with business convenience.

Final Thoughts

Another point worth noting is that even for licensed virtual asset trading platforms, from the perspective of maintaining financial stability and social stability, Hong Kong currently only allows "professional investors" to trade on virtual asset trading platforms.

According to Hong Kong regulations, professional investors are defined by the amount of liquid assets: (1) a trust entity must hold total assets of more than HK$40 million (or equivalent foreign currency); (2) a corporate entity or partnership must hold an investment portfolio of more than HK$8 million (or equivalent foreign currency), or total assets of more than HK$40 million (or equivalent foreign currency). (3) An individual must hold an investment portfolio of more than HK$8 million (or equivalent foreign currency). In other words, the threshold for investors is high, and retail investors are not allowed to enter the market for the time being.

The Sajie team believes that in the future when regulation is more mature and virtual assets are more fully developed, it is only a matter of time before retail investors enter the market. Hong Kong has a lot to do in building China's future virtual economic center.