This article was written by Urszula McCormack and Alice Molan.
The long-awaited regime for virtual stored value facilities now has a deadline. This alert summarises the key features and impacts. The new regime will significantly enhance Hong Kong’s regulation of innovative fintech products and start levelling the playing field on risk management, licensing, AML/CTF and other conduct controls.
Licensing start date – obtain a licence or cease operations
The regulation of non device-based (or virtual) stored value facilities (SVF) in Hong Kong has been the subject of consultation and discussion for a number of years. It has now been confirmed that the deadline for obtaining a licence from the Hong Kong Monetary Authority (HKMA) for issuers, and those that facilitate the issue of SVFs, is 13 November 2016. From this date, if a licence has not been obtained, those persons must exit the Hong Kong market or pursue a different business model.
New payment methods – changing risk
Individuals are increasingly using payment methods and technology outside the traditional banking sphere to move money and pay for goods and services. The regulation of SVFs under the updated Payment Systems and Stored Value Facilities Ordinance (Cap 584) (Payments Ordinance) is a measure to regulate the changing financial services market, to address risk for users of these payment methods and the associated risk to Hong Kong’s financial system in general.
These risks have long been known. For example, the global standard-setter on anti-money laundering and counter-terrorist financing (FATF) issued a report in 2006, and a follow-up in 2010, in respect of the money laundering and terrorist financing (ML/TF) risk associated with new payment methods, including internet and telephone transactions and digital currencies.
Hong Kong introduced a licensing regime for money changers and remittance agents in April 2012, but gaps remain.
Triggers for licensing
A licence will be required under the Payments Ordinance where a person issues, or facilitates the issue, of an SVF. It is also an offence to knowingly promote or assist a person without a licence to issue, or facilitate the issue of, an SVF.
What it means to be licensed
Obtaining a licence to issue, or facilitate the issue of, SVFs is not the end of the compliance story. There are a number of flow-on compliance obligations that are raised by the SVF licensing regime. Some of these are described below.
Anti-money laundering and counter-terrorist financing (AML/CTF) framework
Applicants for an SVF licence will be required to demonstrate to the HKMA that they have adequate and appropriate systems of control for preventing or combating possible ML/TF.
The customer due diligence (CDD) framework set out in Schedule 2 to the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (Cap 615) (AMLO), will not apply to non-device based SVFs or device-based SVFs with a maximum value that may be stored on the device of under HK$3,000. However, the HKMA is entitled to promulgate guidelines in respect of measures to prevent, detect or combat ML/TF, with which licensees must have adequate systems and controls to comply. The HKMA has stated that it intends to issue a dedicated AML/CTF Guideline for SVF licensees. It is not clear what, if any, CDD requirements will be set out in these guidelines.
Protection of the “float” and “SVF deposit”
In establishing an SVF framework, licensees must protect the “float” and the “SVF deposit”. That is, licensees must protect the amount remaining on the SVF and any amount deposited for the use of the SVF.
Part of the criteria for obtaining an SVF licence is that there are adequate risk management policies and procedures in place for managing the float or SVF deposit to ensure that there will always be sufficient funds for the redemption of the stored value that remains on the facility. This includes ensuring that the float or SVF deposit is kept separate from other amounts.
The HKMA is also entitled to add licence conditions to an SVF licence, including imposing requirements on the administration, maintenance, management, use and regulation of the float or SVF deposit.
Fitness and proprietary, prudential and financial resources
SVF issuers must satisfy a number of requirements in order to obtain an SVF licence, including obligations relating to internal systems, their directors and chief executives and the their financial viability.
- Fit and proper; A person may not be a director or chief executive of an SVF licensee without the consent of the HKMA. The HKMA must refuse to give its consent if it is not satisfied that the person is fit and proper and may withdraw its consent if it no longer considers that the person meets this standard. There are also fit and proper requirements applying to controllers and managers of the SVF licensee.
- Prudential standards; Prudential and risk management processes and procedures must be in place to manage the risk arising out of the management of the SVF scheme and the HKMA must be satisfied of these procedures before granting a licence.
- Financial resources; An applicant for an SVF licence must satisfy the HKMA that its financial resources are adequate for operating the SVF scheme. This requires there to be at least HK$25million in paid-up share capital or the equivalent convertible currency approved by the HKMA. Alternatively, the applicant must satisfy the HKMA that their other financial resources are equivalent to, or exceed, the share capital requirement.
What does this all mean for other financial institutions?
The good news for existing banks and other financial institutions is that:
- some are exempt from the new regime – in particular, licensed banks and other “authorized institutions” regulated by the HKMA will not require a licence;
- the regulatory playing field will become more competitive as compliance controls capture more of their innovative fintech competitors; and
- there will be greater certainty in relation to how SVFs are regulated and the AML/CTF obligations to which they are subject, which should assist in making onboarding SVFs as customers more straightforward.
However, a range of regulatory gaps remain in relation to the regulation of fintech products, as well as key technologies such as blockchain, so all proposals (whether internal or in relation to customers) must be assessed carefully on a case-by-case basis.
While the licensing obligation does not commence until 13 November 2016, SVF issuers, and those that facilitate the issue of SVFs, must start preparing their application materials now. The application materials that the HKMA expects to see are detailed includes submission of reports of independent assessment on six key areas, including float management and AML/CTF risk assessments.
We recommend factoring in a lead time of at least 3 months to prepare applications, plus adequate time for advice, internal approvals, systems enhancements and the drafting of policies and procedures.
If a licence has not been obtained by 13 November 2016, issuers and facilitators must have exited the market (or changed their business model) by this time.