HONG KONG — On Monday, at the opening of Hong Kong FinTech Week, regulators declared the city’s ambitions to be a virtual asset hub. The government announced that it will hold consultations for allowing retail investors to invest on licensed platforms and is open to considering virtual asset futures exchange-traded funds (ETF).
The irony is that Hong Kong, just a few years back, was already a hub. Ask people who’ve been in the crypto scene for a while and they’ll point to how Bitmex had an office, complete with a shark tank, right above the Securities and Futures Commission (SFC), Hong Kong’s financial regulator.
Then the SFC started knocking on doors, and exchanges started to worry they’d be punished for listing tokens without getting legal opinions on whether they were securities within the jurisdiction. The costs were prohibitive, as getting a legal opinion could run US$10,000 per token.
The regulator issued warnings about leverage. It introduced an opt-in process whereby virtual asset service providers (VASP) could obtain licenses for dealing in securities and providing automated trading services. It was rigorous. Only two firms heard positive news – BC Group which runs exchange OSL is the only firm to have its licenses, and HashKey Group has an in-principle approval.
And it seemed that once its licensing regime came in and wasn’t opt-in anymore, platforms wouldn’t be able to service retail investors. (In the meantime, retail investors continued to use unlicensed exchanges.)
Across the border, China banned firms offering crypto services. Hong Kong’s politicians insisted that the city was still governed under the “one country two systems principle” – meaning the city is part of China but can organize its own affairs. But firms had doubts that Hong Kong could keep its autonomy when it came to deciding how to regulate crypto. They left in droves for Singapore and other jurisdictions.
COVID-19 restrictions compounded difficulties for businesses. This time last year, Hong Kong had among the toughest Covid-19 rules in place, including a three-week hotel quarantine for those coming to the city. The city hemorrhaged talent. Now, inbound travelers no longer need to quarantine, though they still need to go for tests. The city says it’s back to business as usual. The question is whether businesses and talent will return.
Licensing regime sets high bar
The VASP licensing regime comes into force in March 2023 and applicants will get a nine-month grace period. Hong Kong will not have an opt-in regime anymore. Either exchanges are licensed or they cannot operate in the city.
The VASP regime offers clarity. Without clear regulation, “we were basically self-regulating, benchmarking ourselves against the strictest regulatory standards,” said Amber Group managing partner Annabelle Huang. She added that the company has held itself to the toughest standards of crypto regulation globally in jurisdictions it operates in.
Padraig Walsh, partner at law firm Tanner De Witt, characterizes the proposed regime as bringing Hong Kong up to the expected standards under the Financial Action Task Force. “One of the areas where there was anticipation for progress was in relation to anti-money laundering and [know your customer rules] for virtual assets,” he said.
According to him, Hong Kong’s approach is designed and intended for the long term. The licenses are “not intended for the many, but the few,” he said.
Market players have expressed that they consider the VASP regime strict, a government source told CoinDesk. They see high operating costs, given a requirement that they insure their assets and hold a high percentage of assets in cold wallets.
Ultimately, the regime’s emphasis is on investor protection, this source said. At this point, it seems to be focused on spot trading, and does not allow staking, lending, copy trading nor the bread-and-butter for many exchanges – leverage. In essence, the SFC doesn’t want to see anything not found in the traditional stock market.
Other jurisdictions have introduced regulation and then made modifications. Singapore, for instance, has signaled to the market that it will ramp up compliance obligations. Hong Kong has set a high bar from the start.
Hong Kong “absolutely lost ground to a couple of neighboring jurisdictions,” HashKey Chief Operating Officer David Leahy said. But in his view, the strength of Hong Kong’s capital markets still make it a dominant force in the region.
“When we talk to the digital asset desks, investment banks, and licensed intermediaries, there is significant demand,” he said.
Hong Kong created “a very detailed set” of regulations for licensed crypto companies, said BC Group Executive Director Gary Tiu. It took the group’s digital platform business OSL more than two years to obtain its licenses from the SFC and start dealing in securities and providing automated trading services.
Tiu said that many people thought Singapore was more crypto-friendly, while Hong Kong was very strict. “The two regimes are starting to converge in the middle,” he said.
Some investors like its strictness. Tiu said that he sees a lot of non-Hong Kong institutional interests spending a lot of time to understand the Hong Kong platform.
“They believe the Hong Kong regime provides them the right level of protection that they don't see in other places,” he said.
Walsh said there was a period of time, maybe a year ago, where there was a perception that Singapore was forging ahead and Hong Kong wasn’t. “I don’t think that’s the case now,” he said, citing the complexity of Singapore’s application process and the long time taken to process license applications, which even the regulator describes as “painfully slow.”
Open to discussing retail
In January, SFC had said that only professional investors could invest in crypto, meaning individuals or corporations with a portfolio worth upwards of HK$8 million (US$1 million) — and crypto didn’t count.
The industry welcomes the SFC’s willingness to reconsider retail investors and have a public consultation on the subject.
“It’s a great opportunity,” said Leahy of HashKey, which plans to bring its exchange to market in the second quarter of next year.
He’s waiting to hear if listing requirements will be the same for both retail and professional investors, and if the professional investor designation falls away.
“They are very focused on the quality of the projects that are listed on exchanges,” he said of the SFC.
If the SFC were to allow retail investors to invest, it would legitimize what is already happening. “If they don’t open to retail, given this asset class is becoming popular, these retail investors will invest through unregulated service providers outside of Hong Kong,” Michael Wong, partner at law firm Dechert, said. “If you regulate it at least you have some control.”
Wong said the SFC may bring in a suitability requirement and have investors fill in questionnaires to show they understand the risk profiles of what they’re buying. SFC-licensed trading platforms may be required to provide hotlines or physical branches to assist retail investors, giving them the chance to complain to the regulator if platforms act dishonestly, he said.
In his view, investors will likely move to regulated exchanges unless the unregulated ones offer them services like lending and staking.
There are still areas where firms want more clarity. Walsh is waiting for the application guidelines.
“We have enough to be able to assess whether a particular business falls within the scope that needs a license or is outside that perimeter,” he said. “But we don't really have enough to know what they would need to do.”
The licensing regime requires exchanges to have two responsible officers to ensure compliance with anti-money laundering and counter-terrorist financing requirements among others. But those with such qualifications may not be familiar with virtual assets, Asia Crypto Alliance co-founder Viven Khoo said. She’s fielded calls from people with this qualification on how they protect themselves when overseeing a business that includes virtual assets.
There is concern that some non-regulated companies may abuse the grace period by submitting an application knowing that they will not be successful, just to be able to max out what they can, she added. Some players in the market are lobbying for moderate restrictions in the interim.
Still, the regime “leaves some room going forward,” Khoo said. “If legislators decide they want to open it more broadly, they don’t need to go through another set of legislative changes.”
If the regime does relax, it will likely be gradual. “The regulator has said they will monitor the first-stage license holders and consider further changes,” the government source told CoinDesk. “If they have no intention to do so, generally they will not say so.”
The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups. As part of their compensation, certain CoinDesk employees, including editorial employees, may receive exposure to DCG equity in the form of stock appreciation rights, which vest over a multi-year period. CoinDesk journalists are not allowed to purchase stock outright in DCG.