NewsFlash Articles Data Fundraising BlockBeats Pro

Key information overview of Hong Kong's virtual asset trading platform regulatory document (document highlights).

Read this article in 36 Minutes

The Hong Kong Securities and Futures Commission has raised 10 key issues regarding the regulation of virtual asset trading platforms, and has provided a summary and response to the public after the consultation period.

Original Title: "Consultation Conclusions on Proposed Regulatory Requirements for Licensed Virtual Asset Trading Platform Operators by the Securities and Futures Commission"

Original Translation: Foresight News

The Securities and Futures Commission (SFC) of Hong Kong has released a summary of public consultation on the regulation of licensed virtual asset trading platforms. The SFC received 152 written submissions and has summarized and responded to 10 major issues raised by the public. The revised "Guideline on the Regulation of Virtual Asset Trading Platforms" and "Guideline on Anti-Money Laundering and Counter-Terrorist Financing for Licensed Corporations" will come into effect on June 1.

Part 1: Proposed Regulatory Amendments for Licensed Virtual Asset Trading Platform Operators

1. Do you agree that licensed platform operators should be allowed to provide services to retail investors on the premise of adopting the proposed measures to protect investors? Please explain your views.

The China Securities Regulatory Commission (CSRC) has noted that the respondent strongly supports allowing licensed virtual asset trading platforms to provide services to retail investors, and supports the regulations that establish business relationships with retail customers. They also strongly support the CSRC's requirement for licensed virtual asset trading platforms to establish a token inclusion and review committee to strengthen governance.

To ensure the protection of retail investors, licensed virtual asset trading platforms must follow a series of measures covering business relationships, governance, disclosure, and token review before providing services to retail investors. Retail investors need to understand the characteristics and risks of virtual assets. We will continue to work with investors and the Wealth Management Education Committee to carry out relevant education.

The China Securities Regulatory Commission has considered proposals to relax specific regulations related to establishing business relationships with retail customers. The commission believes that platform operators should comprehensively evaluate investors' understanding of the nature and risks of virtual assets, and make corresponding revisions to the "Guidelines for Virtual Asset Trading Platforms". The commission will release a step-by-step guide in the form of frequently asked questions (FAQs), such as how to evaluate clients' risk appetite for virtual assets and their risk-taking ability.

The conflict of interest between committee members and platform operators is also taken seriously. Therefore, platform operators should establish internal policies and procedures to properly handle these conflicts.

Before incorporating each virtual asset, licensed virtual asset trading platforms need to conduct due diligence. The China Securities Regulatory Commission has made minor adjustments to the information disclosure responsibilities in the "Guidelines for Virtual Asset Trading Platforms", stipulating that platform operators should take all reasonable measures to ensure that the disclosed specific product information is not false, biased, misleading, or deceptive. We have also revised the list of information that needs to be disclosed based on the suggestions of some respondents.

2. Do you have any opinions on the criteria for including general tokens and specific tokens?

The China Securities Regulatory Commission (CSRC) stated that licensed virtual asset trading platforms should conduct due diligence on tokens before they are included for trading. Therefore, it is not appropriate to exempt tokens that have already been included by other licensed virtual asset trading platforms from scrutiny.

We note that there are opinions that tokens included in transactions should comply with Hong Kong's laws, rules, and regulations, and that the regulatory status of the token in other jurisdictions may not necessarily be a relevant consideration for its regulation in Hong Kong. Therefore, we only require platform operators to consider the regulatory status of virtual assets in Hong Kong, and not the regulatory status of tokens in different jurisdictions where they provide trading services.

For the suggestion of requiring non-security tokens to have at least 12 months of historical records, the relevant regulations are established to address the difficulties that platform operators may encounter during the review process. Although the 12-month requirement may not prevent some tokens from experiencing recent collapse events, the purpose of establishing this regulation is to reduce the risk of fraud that is difficult to detect and to reduce the market promotion conducted before the initial token sale.

3. If the China Securities Regulatory Commission intends to allow retail investors to use licensed virtual asset trading platforms, what other regulations do you think should be implemented from the perspective of investor protection?

Some respondents advocate that licensed virtual asset trading platforms should be prohibited from providing incentives and financial benefits to retail investors for buying and selling virtual assets. Several respondents suggested that the China Securities Regulatory Commission (CSRC) could consider implementing a cooling-off period mechanism for retail customers before engaging in virtual asset trading.

The China Securities Regulatory Commission (CSRC) responded that platform operators should not provide rewards related to specific virtual assets, and this principle applies to all other intermediaries. According to this principle, platform operators should not publish any advertisements related to specific virtual assets on their platforms. Based on the feedback received, we have clearly prohibited rewards (excluding fees or fee discounts) in the "Guidelines for Virtual Asset Trading Platforms". The CSRC also hopes to remind platform operators that they have a responsibility to ensure that any materials they publish related to specific products are based on facts, fair, and objective.

Currently, the China Securities Regulatory Commission (CSRC) does not impose a cooling-off period for retail customers of intermediaries engaged in other regulated activities (including providing automated trading services). As platform operators need to ensure suitability during the process of establishing business relationships with customers, retail customers who have already established business relationships with platform operators should have been assessed as suitable for trading virtual assets. A cooling-off period after trading is also not feasible, as automated trading services involve matching customer trades, and the cancellation or termination of trades would affect other customers on the platform.

4. Do you have any comments or suggestions regarding the proposal to allow the use of third-party insurance and licensed platform operators, or the allocation of funds to entities under the same corporate group, for operation?

5. How should licensed platform operators allocate such funds, and do you have any suggestions (such as transferring them to the licensed platform operator's company account or setting up a custodial arrangement)? Please provide a detailed explanation of the arrangements you propose, and how the safeguards provided by such arrangements can provide the same level of protection as third-party insurance.

Most respondents expressed support for provisions requiring licensed virtual asset trading platforms to have insurance or compensation arrangements related to the custody of customer assets. We still believe that customer virtual assets held online and in other storage methods should be fully protected by compensation arrangements of licensed virtual asset trading platforms.

We believe that if most customers hold virtual assets in offline storage methods that are typically not susceptible to hacker attacks and other network security risks, they will have a higher level of security. Therefore, based on the fact that 98% of customer virtual assets continue to be held in offline storage methods, we are prepared to lower the security threshold for holding customer virtual assets in offline storage methods to 50%. We note that licensed virtual asset trading platforms may also tend to hold less than 2% of customer virtual assets in online and other storage methods, as platform operators may need to allocate their own funds when they cannot obtain insurance coverage for online and other storage methods.

Regarding which asset categories can constitute compensation arrangements, we agree that funds held in the form of bank guarantees, as well as funds held in the form of demand deposits or fixed deposits maturing within six months, are acceptable. As for virtual assets, we believe that holding reserve virtual assets that are the same as the virtual assets of customers who need compensation arrangements can reduce market risks caused by the volatility of virtual assets.

We have noticed that there are different opinions on whether to establish a custodial arrangement or allow licensed virtual asset trading platforms to hold allocated funds for compensation arrangements. We believe that both arrangements are acceptable, provided that the allocated funds are segregated from the assets of the platform operator and its affiliated companies, and are allocated and designated for specific purposes in a trust manner. Funds held by the platform operator or its affiliated entities should be held in independent accounts of recognized financial institutions. The "Guidelines for Virtual Asset Trading Platforms" have been amended accordingly.

We agree that licensed virtual asset trading platforms should also be able to flexibly establish a fund pool jointly or independently in the form of an insurer to provide protection for the loss of their clients' assets. The "Guidelines for Virtual Asset Trading Platforms" have made provisions for such flexibility.

Finally, we also agree that the virtual assets that constitute part of the compensation arrangement should be separated from the virtual assets of the platform operator and its affiliated companies, and held offline by their related entities.

6. Do you have any suggestions for which technical solutions can effectively reduce the risks associated with storing and managing customer virtual assets (especially those held in online storage)?

We acknowledge that third-party custodians may possess extensive technical expertise. However, there is currently no regulatory regime for virtual asset custodians in Hong Kong. Given the importance of securely safeguarding clients' virtual assets, we need to directly regulate companies that exercise control over clients' virtual assets (i.e. wholly-owned subsidiaries of licensed virtual asset trading platforms). If the seed and private keys are stored overseas, the corresponding client virtual assets will also be located outside our jurisdiction. This will severely impede our supervision and enforcement.

Thank you for sharing your opinions on how to strengthen the secure custody of virtual assets for customers in the technology industry. Our organization is currently monitoring new custody technologies, such as multi-party computation and key sharding. One of the provisions in the "Guidelines for Virtual Asset Trading Platforms" is that seeds and private keys (as well as their backups) should be securely stored and have appropriate authentication, such as being stored in hardware security modules with appropriate certification. We maintain an open attitude towards whether licensed virtual asset trading platforms can adopt different custody solutions when the security of custody schemes is agreed upon by the industry and appropriate certification for relevant schemes is available, and we have retained relevant flexibility in the wording of the "Guidelines for Virtual Asset Trading Platforms".

7. If a licensed platform operator can provide virtual asset derivative trading services, what business model would you recommend adopting? What type of virtual asset derivatives would you recommend launching for investors to buy and sell? What type of investors would be the target?

This association appreciates the detailed feedback provided by the respondent. We understand the importance of virtual asset derivative instruments to institutional investors and will carefully consider the large amount of feedback received. At the appropriate time, we will conduct an independent review.

8. Do you have any suggestions on how to incorporate other provisions of the "Terms and Conditions of Virtual Asset Trading Platforms" into the "Guidelines for Virtual Asset Trading Platforms" and improve them?

We have received feedback including: reducing the ratio of offline and online storage of virtual assets for customers, allowing affiliated parties of licensed virtual asset trading platforms to conduct proprietary trading to enhance the liquidity of the trading platform, whether platform operators can provide programmatic trading services to their customers, and whether licensed virtual asset trading platforms can provide other virtual asset-related services, such as income, deposits, and loans related to virtual assets.

We believe that to ensure the safekeeping of customer assets, the ratio of offline to online storage should not be reduced. Most virtual assets of customers should be held offline, where there is usually no risk of hacker attacks and network security risks. We remind platform operators to implement appropriate withdrawal procedures and disclose these procedures to customers.

Regarding proprietary trading, we agree to allow third-party market makers to engage in market-making activities, but the current prohibition on proprietary trading is comprehensive, even prohibiting licensed virtual asset trading platform group companies from holding any virtual asset positions. Therefore, we have revised the "Virtual Asset Trading Platform Guidelines" to allow related parties to conduct algorithmic trading through channels outside of licensed virtual asset trading platforms.

Regarding other common services in the virtual asset market, such as earnings, deposits, and loans, licensed virtual asset trading platforms are not allowed to provide these services because their main business is to act as agents and provide trading counterparties for customers. Any other activities may potentially lead to conflicts of interest and require additional safeguards, so such activities are not allowed at this stage.

9. Do you have any comments on the provisions regarding virtual asset transfers in Chapter 12 of the "Anti-Money Laundering Guidelines for Licensed Corporations and Registered Institutions Providing Virtual Asset Services under the Supervision of the Securities and Futures Commission" or any other provisions? Please explain your views.

Most respondents support or do not oppose the implementation of the transfer rules, but some suggest providing a transition period of 12 to 24 months for licensed virtual asset trading platforms. A few respondents expressed practical difficulties in strictly adhering to the transfer rules.

The transfer rule is a major measure for virtual asset service providers and financial institutions to combat money laundering/terrorist financing. The Financial Action Task Force (FATF) emphasizes that each jurisdiction needs to implement the transfer rule as soon as possible. Other major jurisdictions have already implemented or are about to implement the transfer rule. Delaying the implementation of the transfer rule in Hong Kong will affect the competitiveness of licensed virtual asset trading platforms.

The China Securities Regulatory Commission (CSRC) considers that submitting the required data as soon as possible after the transfer of virtual assets is an acceptable temporary measure until January 1, 2024, after taking into account the implementation of transfer rules in other jurisdictions. Licensed virtual asset trading platforms should comply with other transfer rules and relevant regulations from June 1, 2023, and securely submit the required data while taking temporary measures. In addition, the use of non-custodial wallets by some customers for virtual asset transfers may pose higher risks of money laundering and terrorist financing, so we have listed regulations for managing non-custodial wallet transfers in section 12.14.

Some respondents believe that the provisions regarding due diligence and additional measures for virtual asset transfers are too specific. However, the China Securities Regulatory Commission believes that they comply with the standards and guidelines of financial action special organizations. These measures should be implemented based on a risk-based approach, taking into account the products and services provided by the virtual asset transfer counterparties, customer types, and anti-money laundering and counter-terrorism financing systems in their jurisdiction. At the same time, licensed virtual asset trading platforms should consider adopting a risk-based approach to continuously monitor and screen virtual asset transfer counterparties.

Some respondents have doubts about the practice of returning virtual assets to the remitter. The China Securities Regulatory Commission believes that licensed virtual asset trading platforms should only return virtual assets in appropriate circumstances and when there is no suspicion of money laundering/terrorist financing activities. In addition, virtual assets should be returned to the account of the remittance institution, not the remitter's account, after considering the due diligence of the counterparty of the virtual asset transfer and screening of virtual asset transactions and related wallet addresses.

Most respondents support the regulation of virtual asset transfers between managed and unmanaged wallets. The China Securities Regulatory Commission (CSRC) stated that licensed virtual asset trading platforms should take reasonable measures to reduce and manage the risks of money laundering/terrorist financing related to virtual asset transfers between managed and unmanaged wallets based on risk sensitivity. The ownership or control of unmanaged wallets may change over time, and licensed virtual asset trading platforms should regularly determine the ownership or control of such unmanaged wallets based on risk sensitivity.

Two respondents requested that the China Securities Regulatory Commission clarify the scope of application of cross-border agency relationships in the field of virtual assets. The China Securities Regulatory Commission responded that when a licensed virtual asset trading platform provides services to virtual asset service providers or financial institutions located outside of Hong Kong and acting for related clients, the provisions of cross-border agency relationships apply to the platform. The China Securities Regulatory Commission has added section 12.6.5 to the "Anti-Money Laundering Guidelines for Licensed Corporations and Virtual Asset Service Providers Licensed by the China Securities Regulatory Commission" to clarify that licensed virtual asset trading platforms should continuously monitor virtual asset transactions and related wallet addresses.

Most respondents support regulations on screening virtual asset transactions and related wallet addresses, which will help licensed virtual asset trading platforms to identify the sources and destinations related to virtual assets more timely and accurately, as well as wallet addresses related to illegal or suspicious activities/sources or designated individuals involved or subsequently involved. The China Securities Regulatory Commission has added corresponding comments in section 12.7.3.

10. Do you have any opinions on the "Guidelines for Disciplinary Punishment and Fines by the China Securities Regulatory Commission"? Please explain your views.

Regarding the public's opinions on the differences between the current guidelines, the determination of the amount of fines, and how to decide whether to take disciplinary actions against companies and individuals, the China Securities Regulatory Commission responded that it agrees to apply the same set of penalty rules to licensed virtual asset trading platforms under the "Securities and Futures Regulations" and licensed virtual asset trading platforms under the "Anti-Money Laundering Regulations".

The China Securities Regulatory Commission (CSRC) emphasized that the amount of fines will not be linked to the profits gained or losses avoided, and relevant factors will be comprehensively considered based on the case. In determining whether to take disciplinary actions against companies and/or individuals, the CSRC will comprehensively consider all aspects of the behavior, including the individual's consent, connivance or negligence, as well as the deficiencies in business supervision or management. The CSRC will further clarify the responsibilities and duties of senior management personnel, especially in the field of information technology. Under the Anti-Money Laundering Regulations, regulated persons have the right to enjoy reasonable procedural rights and have appropriate appeal procedures.

Part 2: Main Measures and Implementation Details of Transition Arrangements for New Regulatory System

Licensing Application Related Matters

The respondent raised questions about the scope of "providing virtual asset services" defined in the "Anti-Money Laundering Regulations," including whether it covers off-exchange virtual asset trading activities and virtual asset brokerage activities. The China Securities Regulatory Commission responded that the Anti-Money Laundering Regulations will cover centralized virtual asset trading platforms, so platforms that only provide virtual asset services (such as off-exchange virtual asset trading and virtual asset brokerage activities) without automated trading systems and additional custody services will not be within the scope of the Anti-Money Laundering Regulations.

Regarding the dual license arrangement, respondents were asked whether they need to obtain licenses under both the Securities and Futures Ordinance and the Anti-Money Laundering Ordinance, especially since some platform operators may not intend to provide trading of securities-type tokens. The classification of virtual assets may evolve over time, and the classification of a certain virtual asset may change from non-securities-type tokens to securities-type tokens (and vice versa). In order to comply with the regulatory regime and ensure the continuous operation of the business, it is prudent for virtual asset trading platforms to apply for approval under both the Securities and Futures Ordinance and the Anti-Money Laundering Ordinance under the current regime. We will adopt a simplified application process so that the dual license application only needs to submit a comprehensive application form.

Regarding the regulations on external evaluation reports, the respondent asked whether the same evaluation expert can be used in both the first and second stage reports, and whether a virtual asset trading platform that has been established and is in operation only needs to submit the second stage report. The China Securities Regulatory Commission (CSRC) responded that the regulations on external evaluation reports aim to simplify the application process, and it is acceptable for external evaluation experts to participate in relevant work before and during the first and second stage reports. The first stage report should be submitted together with the license application. Virtual asset trading platforms are encouraged to discuss with the CSRC Fintech Group in advance when uncertain about whether the external evaluation expert they plan to hire is qualified.

Given the wide range of questions received, we will provide further guidance and answer common questions related to the new virtual asset service provider system under anti-money laundering regulations through FAQs, circulars, and issuance manuals.

Transition Arrangements:

Responders raised many questions about the transition arrangements, including eligibility for application and compliance with the Virtual Asset Trading Platform Guidelines during the transition period. We will release more information about the transition arrangements through formal communication.

Some issues involve the deletion of issuance conditions related to the "Terms and Conditions of Virtual Asset Trading Platforms" and whether compliance with the "Guidelines for Virtual Asset Trading Platforms" is a condition for issuance. The China Securities Regulatory Commission responded that, as explained in the information document, the "Guidelines for Virtual Asset Trading Platforms" will replace the "Terms and Conditions Applicable to Operators of Virtual Asset Trading Platforms", and compliance with the "Guidelines for Virtual Asset Trading Platforms" will become a condition for issuance.

Other Matters:

Regarding the proposal to allow retail investors to use licensed virtual asset trading platforms, respondents raised the question of whether it is necessary to modify the regulatory provisions for intermediaries engaged in virtual asset-related activities under the Securities and Futures Ordinance. The Securities and Futures Commission responded that it will revise the Joint Policy Statement to clarify the regulatory provisions applicable to intermediaries engaged in virtual asset-related activities.

The respondent requested additional guidance on security tokens. The CSRC responded that additional guidance will be issued at an appropriate time.

Implementation Schedule

(no translation needed for HTML tag)

Given the widespread support for the proposal, the China Securities Regulatory Commission (CSRC) will implement the "Guidelines for Virtual Asset Trading Platforms" and the "Anti-Money Laundering Guidelines", and make some modifications and clarifications to the content described in this summary document. The appendix contains annotated revised versions of the "Guidelines for Virtual Asset Trading Platforms", the "Anti-Money Laundering Guidelines for Licensed Corporations and Virtual Asset Service Providers Licensed by the CSRC", and the "Anti-Money Laundering Guidelines for Entities with Connections". The CSRC will also implement the "CSRC Disciplinary Sanctions and Fines Guidelines".

We will publish guidelines in the constitutional gazette, which will take effect on June 1, 2023.

The China Securities Regulatory Commission will release more guidelines to help the industry better understand the implementation of the new regulatory system.

The China Securities Regulatory Commission hereby expresses its gratitude to all respondents for submitting their opinions.