Will Hong Kong be a paradise for cryptocurrencies? An article to understand the current situation of Hong Kong policies

In recent years, trading and investment activities in crypto assets, including Bitcoin, have become increasingly active.

Author | Feng Ming

Source: Lianxin

In recent years, trading and investment activities in crypto assets, including Bitcoin, have become increasingly active.

As a global financial center and the first stop for mainland China to go global, Hong Kong is not willing to lag behind in blockchain and cryptocurrency. Previously, many politicians actively advocated seizing the blockchain opportunity, and even warned: "If Hong Kong loses the opportunity to be the first base for global virtual assets, the consequences will be more serious than losing Alibaba."

However, the decentralized and anonymous trading characteristics of cryptocurrencies also bring challenges to financial supervision. This article will take you to the current status of cryptocurrencies in Hong Kong, from regulatory framework to policy dynamics, from citizens holding cryptocurrencies to buying and selling transactions, from exchange licenses to legal cryptocurrencies...

Regulatory attitude is cautious and open

In recent years, international standard-setting bodies have been closely monitoring and exploring how to deal with the risks involved in virtual assets. Securities regulators around the world have also adopted different countermeasures. From the overall trend, Hong Kong has always maintained a cautious and open attitude towards blockchain and cryptocurrency.

There are three main regulatory agencies involved: the Hong Kong Securities and Futures Commission (SFC), the Hong Kong Monetary Authority, and the Hong Kong Insurance Authority.

The Hong Kong Securities and Futures Commission is responsible for regulating the operation of Hong Kong's securities and futures markets, and is also the main regulator of cryptocurrencies. The Hong Kong Monetary Authority is responsible for Hong Kong's financial policies and banking and currency management, playing a role similar to that of a central bank. In addition, other institutions such as the Hong Kong Insurance Authority will also coordinate the supervision of cryptocurrencies. Currently, these regulators test and regulate cryptocurrencies and blockchain technology in a controlled environment through sandbox supervision.

In Hong Kong, cryptocurrencies are classified into security cryptocurrencies, utility cryptocurrencies and virtual commodities (such as Bitcoin). Hong Kong regulators have adopted different regulatory policies for different types.

Hong Kong regulation emphasizes protecting the interests of investors first. There are relatively clear regulatory requirements and implementation rules for security-type cryptocurrencies, but there are relatively few regulatory policies for non-security-type cryptocurrencies. However, Hong Kong has not specifically legislated for cryptocurrencies and related businesses. Regulatory requirements are mainly reflected in the provisions of other laws, such as anti-money laundering, anti-fraud and anti-terrorist financing.

In addition, as the influence of cryptocurrencies continues to increase, regulators have introduced a series of regulatory policies to better protect the interests of investors.

At the Hong Kong Fintech Week held in November last year, Financial Services and the Treasury Secretary Paul Chan announced a new policy measure, namely a licensing system for regulating virtual asset service providers. Unlike the voluntary regulatory pilot program implemented by the Hong Kong Securities and Futures Commission in the regulatory sandbox at the end of 2019, the proposed licensing system is mandatory and will fully regulate the trading services of security and non-security tokens. It will require all crypto asset trading platforms to operate in the sun, obtain a license issued by the Securities and Futures Commission, and implement relevant measures under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance and other requirements to protect investors and prevent market manipulation.

Currently, the new licensing system proposals are undergoing public consultation.

Inventory of key regulatory policies

As the industry develops and changes, Hong Kong's regulatory policies are becoming increasingly clear.

In September 2017, the Hong Kong Securities and Futures Commission issued a "Statement on Initial Coin Offerings", which aims to clarify that, depending on the facts and circumstances of individual ICOs, the digital tokens offered or sold may be "securities" as defined in the Securities and Futures Ordinance and be regulated by Hong Kong securities laws.

The statement stressed that if the digital tokens involved in the ICO meet the definition of "securities", providing trading services or advice on such digital tokens, or managing or promoting funds that invest in digital tokens, may constitute "regulated activities". Individuals or institutions engaged in "regulated activities", whether located in Hong Kong or not, must be licensed by the SFC or registered with the SFC as long as their business activities are aimed at the Hong Kong public.

In December 2017, the Hong Kong Securities and Futures Commission issued a circular to licensed corporations and registered institutions regarding Bitcoin futures contracts and investment products related to cryptocurrencies. Intermediaries that provide investors with Bitcoin futures contract trading services and related services (including conveying or transmitting trading instructions) need to apply for a license from the SFC and be supervised. At the same time, the SFC also reminds investors to be careful about investment risks.

In November 2018, the Hong Kong Securities and Futures Commission issued the "Statement on the Regulatory Framework for Virtual Asset Portfolio Managers, Fund Distributors and Trading Platform Operators" (hereinafter referred to as the "Regulatory Framework"), and issued new regulations on investments in virtual assets such as cryptocurrencies.

This Regulatory Framework provides a compliance path for platform operators who are capable and willing to follow strict standards and operating practices, and distinguishes operators who hold licenses from those who do not intend to apply for licenses. The Regulatory Framework provides a path to becoming a licensed platform: First, in the initial stage, the Hong Kong Securities and Futures Commission does not issue licenses to exchanges, but communicates with applicants on regulatory standards (including anti-money laundering, anti-terrorist financing and other requirements) and the actual operation of virtual asset trading platforms; second, some exchanges will be included in the Securities and Futures Commission's regulatory sandbox, and based on the performance of these platforms in the sandbox, they will be rigorously judged whether they are suitable for supervision by the Securities and Futures Commission before issuing licenses; finally, after obtaining a license, it is necessary to enter the next stage of the sandbox, where platforms need to report more frequently, be monitored and reviewed, so that they can formulate strict internal control measures under the close supervision of the Securities and Futures Commission; they can apply to exit the sandbox only after 12 months.

In March 2019, the Hong Kong Securities and Futures Commission once again wanted to remind investors of the risks associated with virtual assets (including tokens related to STO, i.e., security tokens), and issued a "Statement on the Issuance of Security Tokens" to remind companies or individuals engaged in the issuance of security tokens of the applicable laws and regulatory requirements.

The statement emphasized that if security tokens are "securities", anyone who wants to promote and distribute security tokens (whether in Hong Kong or targeting Hong Kong investors) must be licensed or registered for Type 1 regulated activities (securities trading) under the Securities and Futures Ordinance unless an applicable exemption is obtained. Anyone who engages in regulated activities without a license is guilty of a criminal offense unless an exemption is obtained.

In October 2019, the Hong Kong Securities and Futures Commission issued the "Standard Terms and Conditions for Licensed Corporations Managing Investment Portfolios Investing in Virtual Assets", which put forward specific requirements for company qualifications, risk management, compliance audits, anti-money laundering and counter-terrorism from the perspective of virtual asset fund management companies.

In November 2019, the Hong Kong Securities and Futures Commission successively issued the "SFC's Warning on Virtual Asset Futures Contracts" and the "Position Paper on Regulating Virtual Asset Trading Platforms", which clarified the new regulatory framework for virtual asset trading platforms. The article emphasized that from November 6, 2019, companies operating central virtual asset trading platforms in Hong Kong and intending to provide trading services for at least one security token on their platform can apply to the SFC for licenses for regulated activities of Type 1 and 7. Once licensed, virtual asset trading platform operators will be placed in the SFC's regulatory sandbox. This generally means that more frequent reporting, monitoring and review will be required. Through strict supervision, the SFC will be able to highlight areas where operators should improve their internal controls and risk management.

In November 2020, the Financial Services and the Treasury Bureau of the Hong Kong Special Administrative Region Government conducted a public consultation on legislative proposals to strengthen the regulation of anti-money laundering and terrorist financing, and proposed the establishment of a licensing system for virtual asset service providers. The industry expects that this will become the 11th license in addition to the 10 financial licenses currently issued by the Hong Kong Securities and Futures Commission. According to the consultation document, activities covered by the regulation include virtual asset trading, transfer, custody and management, and the provision of financial services for the issuance of virtual assets. According to the definition of the special organization, virtual assets are "assets that express value in digital form, and the relevant assets can be bought, sold or transferred in digital form, or used for payment or investment purposes."

Financial technology is booming

Although regulation continues to strengthen, the fintech industry is highly valued in Hong Kong.

"As one of the world's leading international financial centers, Hong Kong has seen a booming local financial technology industry in recent years. It has good conditions to explore the development and application of financial technologies such as digital currencies from a relatively high starting point," said Financial Secretary Paul Chan Mo-po at the Unity Hong Kong Foundation's Unity Excellence Forum on November 23 last year.

As early as 2017, the Hong Kong Monetary Authority conducted a study on central bank digital currency (Project LionRock), and the results showed that since Hong Kong already has efficient retail payment systems and services, the application of central bank digital currency will have greater potential in wholesale and cross-border payments.

"Hong Kong has been paying attention to the development of the digital RMB of the People's Bank of China. The Financial Services Development Council has set up a working group to study how Hong Kong can seize the opportunities of the development of the digital RMB." Chan Mo-po said that if the digital RMB can be used for cross-border payments, it will further promote the connectivity between Hong Kong and the Mainland, especially the Guangdong-Hong Kong-Macao Greater Bay Area.

“The government and the HKMA are ready to actively explore various feasible solutions with the People’s Bank of China to improve and expand the channels for the two-way circulation of cross-border RMB funds.”

In fact, in addition to the central bank's digital currency, Hong Kong has been in close communication with relevant mainland departments to actively promote cross-border cooperation in financial technology between the two places. Especially in the field of cross-border payments, the HKMA is currently working with the Digital Currency Research Institute of the People's Bank of China to study the technical testing of cross-border payments using digital RMB and make corresponding technical preparations.

There are currently more than 600 fintech startups and companies in Hong Kong, and world-renowned innovation labs and accelerator programs, such as the Bank for International Settlements Innovation Hub, Accenture Fintech Innovation Lab and Deloitte Asia Pacific Blockchain Lab, have all settled in Hong Kong.

According to the Ernst & Young Global Fintech Adoption Index, the adoption rate of fintech among Hong Kong consumers reached 67% last year, ranking first in the world, ahead of the United States and Japan. A number of fintech projects and measures promoted by the SAR government have also been implemented, including the fast payment system "FPS", the trade financing platform "TradeConnect", and the new licensing framework for virtual banks, virtual insurance companies, and virtual asset trading platforms.

Judging from the overall financing performance of China's blockchain industry in 2020, blockchain companies/projects in Hong Kong have also received more capital favor due to its developed economy, good innovation environment, and many support policies for the development of blockchain-related industries.

According to incomplete statistics from Zero One Blockchain, in 2020, there were 81 financing events in China's blockchain industry, with a publicly disclosed total financing amount of 1.112 billion yuan. In terms of the number of financings, Hong Kong ranks first in the country with 17. In terms of the amount of financing, Hong Kong is far ahead with 592 million yuan, accounting for more than 50% of the country.