Hong Kong proposes to regulate OTC virtual asset brokerage services: 10 key things you should know

Key Point 2: Customs & Excise will be the primary regulator

Customs & Excise is the proposed regulator of the new regime. It will have broad powers to supervise the conduct of licensees and enforce statutory and regulatory requirements. It will also be empowered to impose and modify licensing conditions. 

Customs & Excise is also the primary regulator of money service operators (MSOs), comprising remittance agents and money changers. This is different to the VATP regime, for which the SFC is the primary regulator. Reference materials we have reviewed suggest this is due to the similarities between VA OTC Service providers and money changers, over the perceived similarities with an online VA exchange. This is on the basis that they typically operate from physical premises that look and feel akin to a money exchange shop, have the same appeal to money launderers and offer the same ability to exploit vulnerable public members.[2] The Consultation Paper highlights that there are approximately 200 such shops in Hong Kong. Positioning Customs & Excise to regulate such shops, given the more physical and traditional style of policing that will be required, makes sense in this context of crime prevention over a financial regulator. However, we expect this will be a focus of consultation responses, given the importance of alignment on complex questions such as “best practices” for VA safekeeping, which is evolving at a rapid pace.

Key Point 3: OTC spot brokerage of VAs will require a licence

A new licensing and regulatory regime for providers of VA OTC services will be introduced under the AMLO. The AMLO is the primary law containing detailed anti-money laundering and counter-terrorist financing (AML/CFT) requirements for various regulated institutions in Hong Kong, as well as being the home of the licensing regime for VATPs (exchanges) that came into force on 1 June 2023.

Any person who conducts a business of providing services of spot trading of any VA in Hong Kong for any money (or vice versa)[3] will be required to be licensed by Customs & Excise, subject to all relevant requirements.

Key point 4:  Marketing is also caught

Anyone actively marketing VA OTC services will also be subject to the proposed licensing regime. This is much the same as other licensing regimes, including the AMLO VATP regime and the SFO securities and futures licensing regime.

Clients regularly grapple with what “active marketing” actually means. There are several market practices from the long-established SFO regime (which benefits from SFC guidance) and relevant court cases. However, these fall under different statutory regimes, so care is needed and we expect feedback on the Consultation Paper may include the need for guidance.

It will also be a criminal offence for any person to knowingly issue an advertisement relating to an unlicensed person’s provision of VA OTC services. This has been particularly relevant to our telecommunications and social media platform clients – diligence is key.

Key Point 5: Both digital and physical services will be covered 

The regime will cover all VA OTC services irrespective of whether their services are provided through a physical outlet or other platforms. This confirmation is beneficial to put the question beyond doubt. However, one of the most common issues some of our clients encounter is distinguishing between electronic brokerage (which will now fall under this new proposed regulatory scheme) versus the matching required for an exchange to fall under the VATP regime. Delineating between the two is vital.

Key Point 6: Existing regulated entities will be exempt

The following would be exempt from the requirement to obtain a licence:

• SFC-regulated VATPs
• SFC-licensed corporations
• HKMA-regulated banks and other authorized institutions

As shown in Key Point 1, this reflects the significant body of existing regulation of these entities, including under the VATP Guidelines and Joint Circular, as well as their AML/CTF obligations under the AMLO and related guidelines. However, it does make it especially important that regulations are harmonised to the maximum extent possible to ensure the “same activity, same risks, same regulation” principle is achieved as noted in the Consultation Paper.[4]

Key Point 7: AML/CTF is the key compliance obligation

Licensed VA OTC service operators will be required to comply with AML/CTF requirements under the AMLO, in addition to other regulatory requirements. We expect that if the proposals proceed as planned:

• Customs & Excise will also issue detailed guidelines, as it has for MSOs;
• these guidelines are likely to include “travel rule” obligations to which VATPs are subject under their own guidelines issued by the SFC – these essentially require information to move alongside VA transfers, akin to wire transfer requirements; and
• this will ultimately be beneficial to Hong Kong’s next “Mutual Evaluation” by the global standard-setter on AML/CTF, the Financial Action Task Force.

…among other areas

Other key areas of compliance will include the following:

….which is music to the ears of many

The AMLO framework for VATPs has already had a material (positive) impact for VATPs looking to establish banking services in Hong Kong. This is because VATPs can point to the fact that they are subject to the same (and arguably more) rigorous AML/CTF standards as their banking partners in Hong Kong, under the AMLO and related guidelines. Many of our VA brokerage clients also tell us that they want to see regulated pathways to operating their businesses, particularly when regulated businesses are increasingly required to partner only with other regulated businesses, as we have seen under the Joint Circular.

Key Point 8: Both local and offshore companies may be licensed, but (modest) “substance” and fit and proper requirements apply

A licence applicant can be either:

In either case, the applicant must identify suitable premises for its operation.  For digital service providers, they will be required to provide information on the address of the local management office, the correspondence address and the place for local storage of books and records. This is very similar to MSO requirements.

In determining whether a licence applicant is fit and proper, Customs & Excise will consider multiple factors such as whether the applicant (or its any directors or ultimate owners) has been convicted of offences in Hong Kong or elsewhere, has been subject to bankruptcy or liquidation proceedings or has failed (or may fail) to observe AML/CTF or other applicable rules.

Key Point 9: Business restrictions are significant and merit input

The Consultation Paper proposes restrictions on the business of a licensed VA OTC services provider. The following table summarises the key proposals, with our preliminary observations.

Key Point 10: Licensing will follow a renewable model, with transitional arrangements to support existing providers

The Consultation Paper proposes a renewable two-year licence, so that there is an appropriate review cycle of the licensee’s competence and capacity to run the business properly. This follows Customs & Excise’s MSO licensing model, but is different to the ‘perpetual’-style licences administered by the SFC and HKMA. We expect some market participants may prefer the latter for administrative ease.

The FTSB has put forward two potential transitional arrangements for brokers already operating in Hong Kong at the time of commencement of the licensing requirements. Each involves a six-month transitional period, but the second recognises that application processing might take time.

Our preliminary views, based on recent experience working with VATP, MSO and TCSP applicants, are that:

• Option 2 is preferable given application processing times may be high, particularly if (as we expect) many brokers apply;
• any deeming should occur automatically if the application is still being processed, to guard against the risk that processing times are high as noted above; and
• the timeframes should be increased if the final forms and requirements are only issued very close to – or indeed after – implementation. For example, the final VATP Guidelines were only issued after midnight on 1 June 2023 – that is, when the VATP regime had already commenced.
• In terms of overall timing, the Government will aim to introduce a bill on the proposed VA OTC licensing regime into the Legislative Council as soon as practicable. While it is difficult to predict the precise timing, we envisage this year is feasible given the desire to address the perceived gap in regulation.

Next steps

We encourage providing a response to the Consultation Paper if you have any views on the VA framework for Hong Kong, and ensuring you get the advice you need on your business model.

Please contact us if we can assist you. We have a large team with many years’ experience in VA licensing, compliance policies and procedures, diligence, offshore controls and regulatory engagement.

This alert contains a number of summaries and insights, but it is not legal advice.  VA projects, platforms and transactions are highly fact-specific and small nuances can have a large regulatory impact. We would be delighted to provide any legal advice you need.