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What types of virtual assets can be included in trading?

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The tokens on the trading platform must meet the relevant standards, and retail investors can trade virtual assets with large market values.

Interpretation of HKEx Licensing Consultation Document: What Types of virtual Assets can be included in Trading

Original article by Joy PANews

Last week, market rumors circulated that Hong Kong would issue retail licenses for virtual asset trading platforms, and industry sources confirmed to PANews that the CSRC would issue consultation documents this week. On Monday February 20th Hong Kong's Securities and Futures Commission duly launched a consultation on proposals to regulate virtual asset trading platforms. The consultation will close on March 31st, in time for the new licensing regime to come into force on June 1st.

According to the consultation document published by the Securities and Futures Commission of Hong Kong, which contains more than 300 pages and more than 200,000 words, it mainly asks the Hong Kong industry 10 questions:

Does it agree that licensed platform operators should be allowed to provide services to retail investors?

对于有关一般Token纳入准则及特定 Token 纳入准则的建议，你是否有任何意见？

If the CSRC intends to allow retail investors to use licensed virtual asset trading platforms, what other regulations do you think should be implemented from an investor protection perspective?

Do you have any views on the proposal to allow a combination of third party insurance and funds set aside by a licensed platform operator or a corporation belonging to the same group of companies? Do you have any other suggestions?

Do you have any suggestions as to how the licensed platform operator should transfer such funds (for example, into the licensed platform operator's corporate account, or setting up an escrow arrangement)? Please explain in detail the arrangement you propose and how the protection provided by the arrangement can provide the same level of protection as third party insurance.

Do you have any proposals for technical solutions that can effectively mitigate the risks associated with the custody of customers' virtual assets, especially virtual assets held in online storage?

If licensed platform operators can provide virtual asset derivative trading services, which business model would you recommend? What kind of virtual asset derivatives do you propose for investors to buy and sell? What kind of investors will the target be?

Do you have any views on how to improve the other provisions of the Terms and Conditions of the Virtual Asset Trading Platform while incorporating them into the Virtual Asset Trading Platform Guidelines?

Do you have any comments on the provisions of Chapter 12 of the Anti-Money Laundering Guidelines for Licensed Corporations and SFC Licensed Virtual Asset Service Providers relating to the transfer of virtual assets or any other provisions? Please state your opinion.

Do you have any comments on the CSRC Guidelines on Disciplinary Penalties? Please state your opinion.

Of the 10 issues, none has attracted more attention than whether trading platforms will be allowed for retail investors, what assets they can trade and what derivatives they can trade. Other issues relate to operational details, security and anti-money laundering, such as third-party insurance and technical solutions for asset custody.

The CSRC will issue licences for virtual assets, with the intention of allowing them to be sold to retail investors

"The volatility of the virtual asset market and the collapse of FTX not only reveal the risks arising from the increasing interconnectedness within the virtual asset ecosystem and between the virtual asset market and the traditional financial system, but also highlight the importance of effective regulation and supervision of the virtual asset industry," the document said.

而此前香港根据《证券及期货条例》下的现行制度，只有向客户提供证券型 Token 交易服务的虚拟资产交易平台，才属于证监会的监管范围，也意味着证监会此前并无权利向仅提供非证券型 Token 交易服务的虚拟资产交易平台发牌或进行监管。

随后香港特区政府于 2020 年 11 月发表了一份咨询文件，征询公众对于建议在《打击洗钱及恐怖分子资金筹集条例》下建立虚拟资产服务提供者发牌制度的意见。政府建议，在香港提供非证券型 Token 交易服务的中央虚拟资产交易平台（即中心化交易平台）应获证监会发牌并受其监管。

However, as the licensing framework for virtual assets was a new concept, the SFC considered that, even though there were adequate safeguards in place to protect investors, it would be prudent to restrict licensed virtual asset trading platforms under the Securities and Futures Ordinance to professional investors at least at an initial stage. So until now, Hong Kong has been very cautious about licensing, with only OSL in 2020 and Hahskey in 2022 obtaining licences for trading platforms only to offer services to professional investors.

On October 31, last year, Hong Kong issued the "Policy Declaration on the Development of virtual assets", which released the open and friendly attitude towards virtual assets, also released the wind of providing services to retail investors, and said that the CSRC is allowing retail investors (retail investors) to buy and sell virtual assets to start a public consultation.

The document reveals that, despite the public consultation, the CSRC intends to offer its services to retail investors. 'Many argue that denying retail investors access to licensed virtual asset trading platforms could harm investors in a disguised way by driving them to unregulated overseas virtual asset trading platforms that are easily accessible online,' the document notes. And the failure of any of these unregulated virtual asset trading platforms would make it difficult for retail investors to recover any losses. This is evident from the collapse of FTX.

The CSRC added that in January 2022, it allowed retail investors for the first time access to a small number of regulated virtual asset-related derivatives traded on traditional trading platforms. Subsequently, in October 2022, a recognition system was established for virtual asset futures trading platform trading funds (virtual asset futures ETF). So far, China Securities Regulatory Commission has approved three virtual asset futures ETFs according to the system. Samsung Bitcoin Futures active ETF was listed on the Hong Kong Stock Exchange in January this year. Dongying South listed Bitcoin and Ethereum futures ETFs in Hong Kong in December.

As a result, retail investors in Hong Kong already have indirect access to virtual assets through compliance products. Therefore, no matter from the actual situation and regulatory trend, facing retail investors has been the change that the CSRC has to allow, so as to make the regulation passive to active.

Users need to make a risk assessment before trading

While the SFC proposes to allow all types of investors, including retail investors, to use trading services provided by operators of licensed virtual asset trading platforms, this is only subject to a range of appropriate investor safeguards.

A licensed platform operator is required to conduct a knowledge assessment of investors before providing any services to them. If the customer fails this assessment, the operator may only provide services to the customer after providing training to the customer. The operator should assess the risk tolerance level and risk status of the customer, and determine the risk status of the customer based on this, and assess whether the customer is suitable to participate in the transaction of virtual assets. The operator shall also set an upper limit for each customer to ensure that the risks taken by the customer with respect to the virtual assets are reasonable in the judgment of the Platform operator, taking into account the financial situation and personal situation of the customer. The ceiling should be reviewed periodically to ensure that it remains appropriate.

This means that in future Hong Kong residents will also need to take a risk assessment test after registration before they can officially trade. It is worth mentioning that in the informal consultation, there is a proposal to set a uniform hard cap on the maximum amount of virtual asset risk retail investors can take on virtual asset trading platforms. But given that everyone's financial situation is different, the CSRC suggested that platforms assess their customers' risk tolerance levels and risk profiles according to appropriate systems.

上线 Token 需符合有关准则，散户可交易大市值虚拟资产

证监会建议，持牌平台营运者应设立一个 Token 纳入及检讨委员会，以负责订立、实施及执行有关将虚拟资产纳入以供买卖的准则，就任何建议的硬分叉 ( hard fork ) 或空投 ( airdrop )、发行人业务的任何重大改变或任何针对发行人的监管行动而通知持牌平台营运者的责任。

Token 纳入及检讨委员会至少应由主要负责管理主要业务、合规、风险管理及资讯科技的高级管理层成员组成。 Token 纳入及检讨委员会应至少每月向董事会汇报，而汇报内容应至少包含可供零售客户买卖的虚拟资产的详情及其他注意到的问题。

The CSRC wishes to stress that the virtual assets themselves are not under the supervision of the CSRC and have never reviewed or reviewed the offer and promotion documents of the virtual assets. In view of this, the SFC intends to take a more prudent approach by introducing a set of objective criteria to be complied with by licensed platform operators in determining the availability of a particular virtual asset to retail customers.

持牌平台营运者对于在纳入虚拟资产以供买卖之前就虚拟资产进行合理的尽职审查，及确保它们符合 Token 纳入准则方面，负有最终责任。

持牌平台营运者亦应持续地监察获纳入的虚拟资产，并确保它们持续地符合有关准则。应考虑的因素包括：a）虚拟资产的管理层或开发团队的背景；b ) 虚拟资产在平台营运者提供交易服务的各个司法管辖区的监管状况，及其监管状况会否亦影响平台营运者的监管责任；c ) 虚拟资产的供求、市场成熟程度及流通性，包括其市值，平均每日成交量，往绩纪录 ( 例如已发行至少 12 个月，不包括证券型 Token )，其他平台营运者是否亦就该虚拟资产提供交易，有没有相关交易组合 ( 例如法定货币兑虚拟资产 )，及该虚拟资产在哪些司法管辖区可供买卖；d ) 虚拟资产的技术层面；e ) 发行人所发出的虚拟资产推广材料，其内容应为准确及不具误导性；f ) 虚拟资产的开发情况；g) 虚拟资产的市场风险，包括虚拟资产持仓高度集中或由少数个人或实体所控制、价格操纵和欺诈，及较广泛或较狭窄采纳该虚拟资产对市场风险的影响；h) 与虚拟资产相关的法律风险，i ) 虚拟资产所提供的效用，所促成的崭新用例，或所展示的技术、结构或加密经济创新是否看来具有欺诈或极为不当的成分。

除一般的 Token 纳入准则外，持牌平台营运者如有意向零售客户提供虚拟资产，亦应确保所挑选的虚拟资产属于合资格的大型虚拟资产，除了遵守上述一般的纳入准则，还需要符合下列特定 Token 纳入准则。

"Eligible large virtual assets" means virtual assets that are included in at least two "accepted indexes" launched by at least two independent index providers (and at least one that is experienced in the indexes of traditional non-virtual asset financial markets). "Acceptable Index" means an index with clearly defined objectives to measure the performance of the largest virtual assets in the market and which meets the following criteria: a) The index should be investable, meaning that the component virtual assets concerned should be sufficiently liquid. b) The index shall be calculated in an objective manner and based on rules. c) Index providers should have the necessary expertise and technical resources to develop, maintain and review the methodology and rules of index preparation. d) The methodology and rules for the compilation of the index should be well documented, consistent and transparent.

According to this guideline, BTC and ETH clearly meet the requirements and can be sold to retail investors. Other crypto assets need to be further studied.

To maintain a paid-up capital of not less than HK $5 million to establish an insurance system

The platform operator is required to maintain at all times a paid-up share capital of not less than HK $5 million (the "minimum paid-up Share Capital"). The Platform operator shall at all times beneficially hold in Hong Kong fully liquid assets such as cash, deposits, Treasury bills and certificates of deposit (but not virtual assets) in an amount equal to the actual operating expenses of the Platform operator on an ongoing basis for at least 12 months.

In addition, platform operators should establish and implement strict internal monitoring measures and governance procedures for private key management to ensure that all cryptographic seeds and private keys are securely generated, stored and backed up. The seeds and private keys are stored in Hong Kong.

A licensed platform operator shall have compensation arrangements approved by the Securities and Futures Commission to provide an appropriate degree of protection against risks associated with the custody of a customer's virtual assets, such as the event of a hacking attack on the platform or a breach by a licensed platform operator or its associated entity. Regarding the provisions on investor protection insurance, the CSRC recommends:

a) A licensed platform operator shall have a compensation arrangement approved by the CSRC for the risks associated with the custody of the client's virtual assets.

b) The licensed platform operator shall monitor the total value of customers' virtual assets in its custody on a daily basis to ensure compliance with the relevant compensation requirements.

c) Where a licensed platform operator allocates its own funds or the funds of a corporation belonging to the same group of companies to comply with the relevant requirements, it should ensure that such funds are held in trust and are earmarked for the relevant purpose. Such funds should also be separated from the assets of the licensed platform operator, its associated entity or corporation belonging to the same group of companies as the licensed platform operator.

A list of trading platforms will be announced after the licence takes effect

With effect from 1 June 2023, any virtual asset trading platform operating its business in Hong Kong or actively promoting its services to investors in Hong Kong without a valid licence will be in breach of the licensing requirements of the Virtual Asset Service Provider Regime under the Money Laundering Ordinance unless it is eligible to participate in the transitional arrangement.

The Commission has proposed a 12-month transition period for operators of licensed platforms under the Securities and Futures Ordinance to comply with the requirements relating to their existing customers or the virtual assets they are currently selling. Details of the transitional arrangements will be provided when the requirements of the Virtual Asset Trading Platform Guidelines, the Anti-Money Laundering Guidelines Applicable to Licensed Corporations and SFC Licensed Virtual Asset Service Providers and other Guidelines are finalised.

To be eligible to participate in the transitional Arrangement, a virtual asset trading platform must be an existing platform with a meaningful and substantial business presence in Hong Kong before 1 June 2023. To continue to operate in Hong Kong from 1 June 2023 to 31 May 2024, subject to compliance with the Anti-Money Laundering Ordinance. Specific considerations include whether the company is established in Hong Kong, whether it has a physical office in Hong Kong, whether its Hong Kong staff have central management or control, whether key personnel are based in Hong Kong, whether the operation is already in service and has a large number of customers and trading activities in Hong Kong.

For existing virtual asset trading platforms to be eligible to participate in a licensed arrangement, they must, within the period from 1 June 2023 to 29 February 2024 (i.e., nine months from 1 June 2023), Submit online licence applications under the virtual Asset Service Provider Regime under the Anti-Money Laundering Ordinance.

A virtual asset trading platform not operating in Hong Kong immediately before 1 June 2023 May operate its business in Hong Kong or actively promote its services to investors in Hong Kong only after it has been formally licensed under the virtual Asset Service Provider regime under the Anti-Money Laundering Ordinance. It is a criminal offence to carry out any unlicensed activity.

In the interim, it may be difficult for the public to tell whether a virtual asset trading platform is operating legally or not. To allay concerns, the CSRC plans to publish several lists on its website to inform the public of the different regulatory status of virtual asset trading platforms. By publishing these lists, the CSRC hopes to deter unlicensed virtual asset trading platforms from offering their services to the public.