Clarification around HK's virtual assets policy comes amid FTX collapse

Hong Kong’s regulators are moving towards the acceptance of virtual assets, with their latest statements suggesting plans to open the industry to more types of investors soon.

While proposed changes to Hong Kong’s virtual assets (VA) regime by the city’s regulators – as announced at the city’s recent Fintech Week event – may fall short on detail, they indicate a movement towards the broader acceptance of the virtual asset class, experts believe.

The incremental and risk-based approach that Hong Kong is taking is not surprising, given that the city’s financial authority, the Securities and Futures Commission (SFC) is a risk-based regulator, explained Mark Parsons, partner at Hogan Lovells and head of the firm’s Asia Pacific regulatory practice. He told FinanceAsia that this is particularly fitting, given Hong Kong’s position in the broader context of China.

In May 2021, China made it illegal for finance and payments firms to provide cryptocurrency-related services and later that year, it introduced a blanket ban on all cryptocurrency transactions and mining.

“China’s own move against VAs has been very severe. A lot of people thought that it would be the end for VAs in Hong Kong, but it is obvious that this is not the outcome here,” Parsons said.

Although the latest announcements do not fully embrace VA, they provide a pathway towards liberalisation of the space and offer positive change that will pave the way for further opening, he added.

The SFC revealed a number of significant initiatives through a policy statement published at last month’s FinTech Week. These include: ongoing consultation with the industry to allow retail investor participation in VA trading – an activity currently restricted to professional investors; review of property rights for tokenised assets and smart contracts; and consideration to permit crypto-based exchange traded funds (ETFs) to list in Hong Kong.

Additionally, it published a circular setting out the requirements under which the SFC would authorise exposure to ETFs, clarifying that these would initially be restricted to tracking Bitcoin and Ether futures.

Michael Wong, partner within the investment funds and financial services practice at Dechert, views the proposed availability of crypto futures ETFs in Hong Kong largely as symbolic, because retail investors are already able to invest into existing US crypto futures ETFs – which potentially offer better liquidity and limit tax disadvantage.

But having clear regulation around these ETFs marks an important first step, opined Clifford Chance partner, Rocky Mui. He explained that, regardless of whether local or international ETF providers later have the incentive to launch such products in Hong Kong, “it’s more about opening up the market.”

Parsons said that indeed, his firm has seen interest from clients around the launch of Bitcoin-backed investment products.  Retail investors would likely start to access the market through ETFs since investment inclusion in such funds requires review, which implies that the underlying assets they offer exposure to, have been vetted to a degree, he explained.

Overall, the experts that FA spoke to welcome the proposed changes.

“It feels like we are moving away from the impulsive characterisation of VA as complex assets,” Parsons said, suggesting that these should be seen as risky an investment option as any other.

Investor protection and FTX impact

The challenge for regulators will be to put in place VA regulation that simultaneously protects investors, but does not stifle the industry, Wong said.

Discussing the impact that followed the collapse of what was – until last week – the world’s second largest crypto-exchange, FTX, Wong suggested that the event’s repercussions could heighten regulatory awareness and scrutiny of where the gaps or weaknesses in existing proposals might lie.

In particular, the collapse may prompt regulators to take a closer look at the business of “exchanges” and lay out how each of their activities might be regulated. In the crypto world, these bodies perform a number of roles beyond those of traditional security exchanges, such as market making.

Vivien Khoo, co-founder and chair of VA industry association, Asia Crypto Alliance, told FA: “Whilst still early days since the implosion of FTX, given that some of the key issues [that led to the firm’s crash] appear to be around a lack of transparency, segregation of assets, appropriate leverage ratios and liquidity requirements, we may expect to see some additional requirements imposed on virtual asset operators if they do not already operate in line with the current risk control requirements for financial institutions.”

Hong Kong’s financial secretary, Paul Chan Mo-po, suggested in a blog post that the fallout of FTX does not change Hong Kong’s ambitions of becoming a crypto hub.

The special administrative region currently has two licensed exchange operators: OSL Digital Securities, which was granted licences to deal in securities (Type 7 licence) and provide automated trading services (Type 1 licence) in December 2020; and Hash Blockchain, which received similar permissions earlier this month.

However, compared to global counterparts such as Binance and the now-defunct FTX, the two licensed firms are restricted in their activities. For example, they are not permitted to carry out lending and staking.

Chinese participation?

A pertinent question for virtual asset players in Hong Kong is whether there will be room for Chinese participation in the region’s new and developing market.

If so, “that China connection and the volume of capital that it implies, means that Hong Kong has bigger potential [than Singapore] to become a VA hub for the region,” Parsons said.

Monetary Authority of Singapore (MAS) governor, Ravi Menon, reaffirmed Singapore’s ambitions to become a crypto hub at the city-state’s own rival fintech event two weeks ago, but noted that MAS would continue to discourage retail participation in cryptocurrencies, in line with its key goal to ensure investor protection.

“Singapore’s proposed consultation on matters such as investor protection, especially for the retail segment, veers towards requiring virtual asset service providers (VASPs) to be more accountable; for example, requiring VASPs to determine customers’ familiarity with the type and level of risks they are undertaking,” said Khoo.

Overall, the direction of travel in Singapore indicates heightened scrutiny and accountability on VASPs, she added.

Hong Kong has taken an independent position in terms of how to regulate VAs compared to both Singapore and mainland China. “But as far as Chinese investor participation in Hong Kong’s VA regime, it’s too early to tell,” concluded Mui.

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