U.S. sanctions in response to Hong Kong’s national security law – and Beijing’s tighter grip over the city’s financial system – could pose challenges for local crypto brokerage firms.
The U.S. Senate passed the Hong Kong Autonomy Act on Thursday to penalize China for eroding Hong Kong’s autonomy. The bill is in response to a new national security law that broadly criminalizes acts of sedition, collusion, terrorism and subversion, which could include publicly criticizing the Chinese Communist Party. The law is already sending a chill over free expression in Hong Kong.
The bill stipulates that the U.S. government should restrict foreign banks and subsidiaries of U.S. banks in Hong Kong from accessing the U.S. dollar system if they conduct significant transactions with persons or entities that contribute to weakening Hong Kong’s autonomy.
No specific banks have been targeted and the bill does not provide the criteria that determine whether a bank deserves a sanction. The U.S. Treasury Secretary will decide on what behavior would result in a sanction on a bank, according to the bill.
This could take a toll on cryptocurrency companies in Hong Kong. In particular, it could affect crypto brokerages, which are highly dependent on the U.S. dollar system to settle and clear transactions. Hong Kong is an important crypto hub, especially in Asia. Major mainland China-originated crypto exchanges such as OKCoin and Huobi have offices, and offer crypto trading services, in Hong Kong, given its relatively crypto-friendly regulations.
“The most successful cryptocurrency companies here are dependent on their access to the U.S. dollar system,” said Leo Weese, the president and co-founder of the Bitcoin Association of Hong Kong, a non-profit organization. “They move money around, they are big brokers and if they somewhat lose that access they are in trouble.”
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That access is important to large crypto brokerage companies because fiat currencies transactions between investors and brokerage are settled and cleared by banks in U.S. dollars, Weese said.
“Even though you are in Asia, you still rely a lot on U.S. banking,” said Charles Yang, head trader at Genesis Block, one of the largest over-the-counter (OTC) desks that primarily offers cross-border crypto brokerage services in Hong Kong.
OTC desks are different from cryptocurrency exchanges, through which trades are based on a market price. With OTC desks, brokers help traders find counterparties.
For most Asia-based brokerage companies (OTC desks), if they can not easily transfer money to U.S. counterparties, then it slows down flows and trading volume will be much lower, Yang said.
“If there is any further friction from the U.S. policy, it could be very damaging to our business,” Yang said.
Increasing frictions, limiting banks
Hong Kong Securities and Futures Commission (SFC) started to accept licensing applications from virtual asset trading platforms last November in a bid to offer a clearer regulatory framework for digital asset trading services providers.
Major international investors have also set their sights on Hong Kong-based crypto firms. OSL, one of the largest crypto exchanges that provide trading brokerage and custodian services in Hong Kong, secured a $14 million investment from Fidelity International via an equity shares acquisition. Amber Group, a Hong Kong-based startup that offers a range of financial services such as trading and lending for crypto investors, secured $28 million in a Series A funding round from U.S.-based investors such as Coinbase Ventures and Polychain Capital.
While it is still unclear what exact sanctions the U.S. government will impose on Hong Kong, there are two scenarios that could hurt brokerage companies, Yang said.
Crypto-friendly U.S. banks, such as Silvergate and Signature, provide 24/7 instant crypto settlement services. The U.S. government could limit what amounts and where these banks can send money, which would increase friction for money transfers back to Hong Kong, Yang said.
Crypto brokerage companies could also face difficulties in wiring money from Hong Kong to the U.S., Yang said. For example, many such companies use the Bank of Communications, which is one of the largest state-owned commercial banks in mainland China. If that bank is sanctioned by the U.S. government, the companies won’t be able to wire their money to their U.S. bank accounts, Yang said.
Another concern is that more scrutiny would prolong transaction times, according to Yang.
“The banks would flag Hong Kong-related transactions more often, they would hold the transactions and do a compliance query, and that could take a few days to resolve, which means there will be a lot of friction,” Yang said.
“If the money transfers between Hong Kong, London and the U.S. are being blocked, or being made more expensive, then the Hong Kong brokers won’t have as much of the need to really be here because [Hong Kong] won’t be able to serve the local market as efficiently,” Weese said.
The bill vaguely refers to officials and foreign persons who “materially contribute to the contraventions of China’s obligation.” After the president signs the bill, U.S. Secretary of State Mike Pompeo will have 90 days to identify Chinese officials and foreign persons who are involved in anti-democracy activities, such as cracking down on protests, and report them to Congress. The Secretary of the Treasury will then have 60 days to submit a list of foreign institutions that conduct “significant transactions” with these persons, according to the bill.
“If the bill goes into effect, money transfers between banks in Hong Kong will face more surveillance and the risks of being frozen due to the new sanctions,” said Jason Wu, the CEO of Definer, a crypto lending firm with a focus on cross-border transactions between the U.S. and China.
While some crypto investors can use cash or face-to-face trading to trade crypto with fiat currencies, many have to register with brokerage firms in compliance with Anti-Money Laundering (AML) and Know-Your-Customer (KYC) regulations by Hong Kong’s financial authorities, especially the block trades in millions of dollars, Wu said.
“Any money transfer in large amounts in a bank in Hong Kong will raise a flag for both the Chinese and U.S. financial regulators,” Wu said.
Cross-border money transfers between the U.S. and Hong Kong already faced stricter scrutiny even before the bill, according to Wu.
People in Hong Kong have been trying to transfer their money to overseas bank accounts since the unrest started in March 2019. Both the Chinese and U.S. governments are closely watching these financial transactions, Wu said.
The future of Hong Kong’s financial system
The bill is not the only U.S. attempt to dismantle Hong Kong’s financial and economic privileges as Beijing weakens the city’s autonomy. The U.S. government has issued restrictions on visas for Chinese officials and threatened to revoke Hong Kong’s special trade status.
“I think for now there is no intention to mess with Hong Kong’s financial system and scare companies away, but of course things could quickly change,” Weese said of China’s national security law.
“Neither the Chinese nor the U.S. government has disclosed what exact measures they will take to influence Hong Kong’s financial system,” Wu said. “One extreme case is that Hong Kong becomes like any other city in mainland China and wire transfers would be much more difficult.”
“If you make wire transfers in mainland China, there will be many limitations such as going through more scrutiny with financial authorities such as the State Administration of Foreign Exchange (SAFE), which makes it difficult to make the transfers, Wu said. However, it is much easier in Hong Kong because it is in the international settlement system.
One extreme case is that Hong Kong becomes just like any other city in mainland China in terms of financial freedom, Wu said.
In mainland China, where banks are restricted from processing money transactions related to crypto, most investors trade and make purchases via peer-to-peer trading services provided by over-the-counter desks with third-party payment cash apps.
“Usually what happens in such situations is that the market continues to exist with much higher spreads but served by different individuals or smaller brokerages. At least that’s how we’ve observed it in other places,” Weese said.
“The very largest brokerages only exist in places where they can efficiently buy and sell a million or 10 million dollars worth of bitcoin,” Weese said.