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Updated SFC HKMA Joint Circular on Virtual Asset Activities - A New Era For Retail Investors
2023-10-25

On 20 October 2023, the Securities and Futures Commission ("SFC") and the Hong Kong Monetary Authority ("HKMA") issued a joint circular ("Circular")[1] to SFC regulated intermediaries ("SFC Intermediaries") on their regulatory expectations for virtual asset ("VA") related activities ("VA Activities"), in respect of (i) the distribution of VA-related products ("VA-related Products"), (ii) the provision of VA dealing services, (iii) the provision of VA advisory services and (iv) the management of portfolios investing into VAs. The Circular superseded the SFC's previous circular dated 28 January 2022[2] ("2022 Circular").

 

The Circular has implemented a number of changes to the regulatory requirements regarding VA Activities in light of the latest market developments, including that VA trading platforms licensed pursuant to Securities and Futures Ordinance ("SFO") and/or Anti-Money Laundering and Counter-Terrorist Financing Ordinance ("AMLO") ("VATPs") are allowed to serve retail investors and VA futures exchange traded funds ("VA Futures ETFs") are authorized for public offering in Hong Kong. The relevant proforma terms and conditions applicable to SFC Intermediaries which have sought SFC's "approval" to deal in, advise on, or manage portfolios that invest in VAs ("T&Cs") have also been updated accordingly.

 

Key Changes and Takeaways

 

We have summarised below the key changes and takeaways under the Circular:

 

VA Activities

Key Changes / Takeaways

Distribution of VA related Products

  • In relation to the VA knowledge test ("VA Knowledge Test") which SFC Intermediaries will have to conduct for its client prior to effecting a transaction in VA-related Products (non-exhaustive criteria of which are set out under Appendix 1 of the Circular), SFC Intermediaries are no longer allowed to consider such client to have passed the VA Knowledge Test solely if the client has executed five or more transactions in any VA or VA-related product within the past three years.

  • For risk disclosure statements which should be provided to clients (except for institutional professional investors and qualified corporate professional investors[3]), SFC Intermediaries should also disclose, other than risk disclosures already set out under the 2022 Circular, (i) the legal uncertainty of whether VAs can be regarded as "property" under the law; and (ii) difficulties in verifying the ownership of VAs.

VA Dealing Services

  • It remains that VA dealing services (including acting as introducing agent or as broker under an omnibus account) can only partner with SFC-licensed VATPs.

  • SFC Intermediaries may provide VA dealing services to retail clients, but it must (i) notify the SFC, (ii) ensure that the VA dealing activities are conducted through omnibus accounts established and maintained with a VATP that is not subject to the licensing condition that it can only service "professional investors" (as defined under the SFO), and (iii) ensure that the retail clients can only trade VAs made available for trading by retail investors.

  • SFC Intermediaries should not make any arrangements with their clients on using the client VAs received or held by the SFC Intermediaries with the effect of generating returns for the clients or any other parties (i.e. SFC Intermediaries may not use client VAs for staking, lending and other purposes).

  • For orders in VAs (including VAs classified as "complex products") which are placed by a client directly on the VATP, or directly to staff of an SFC Intermediary for onward passing to the VATP for execution, the SFC Intermediary is not required to ensure that the transaction is suitable for the client if there has been no solicitation or recommendation made by the SFC Intermediary.

  • If an SFC Intermediary makes a solicitation or recommendation to retail clients on VAs, the SFC Intermediary should take all reasonable steps to ensure that the VAs solicited or recommended are of high liquidity.

  • Except for institutional and qualified corporate professional investors, an SFC Intermediary, before providing services in VA dealing activities, should assess with due skill, care and diligence a client’s risk tolerance level, determine the client’s risk profile and assess whether it is suitable for the client to participate in the trading of VAs.

  • The VA Knowledge Test (as amended in the Circular) continues to be applicable.

  • SFC Intermediaries may now receive client VAs, but must do so through and hold these client VAs on trust for their clients in a segregated account(s) established and maintained with a VATP or an authorized financial institution (or a subsidiary of a locally incorporated authorized financial institution) which meets the expected standards of VA custody issued by the HKMA from time to time.

  • SFC Intermediaries should also comply with the requirements under Chapter 12 of the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers) ("SFC AML Guidelines") when handling client VA deposits and withdrawals.

  • SFC Intermediaries should notify the SFC (and HKMA, where applicable) in advance if they intend to provide dealing services in tokenised securities and should comply with the existing requirements governing dealing in securities and the expected standards of conduct and guidance on tokenised securities issued by the SFC from time to time.

VA Advisory Services

  • SFC Intermediaries may provide VA advisory services to retail clients, but it must (i) notify the SFC, and (ii) ensure that the VAs recommended are made available for trading by retail investors by VATPs.

  • Except for institutional and qualified corporate professional investors, an SFC Intermediary, before providing services in VA dealing activities, should assess with due skill, care and diligence a client’s risk tolerance level, determine the client’s risk profile and assess whether it is suitable for the client to participate in the trading of VAs.

  • The VA Knowledge Test (as amended in the Circular) continues to be applicable.

  • If an SFC Intermediary provides advisory services to retail clients on VAs, the SFC Intermediary should take all reasonable steps to ensure that the VAs solicited or recommended are of high liquidity.

  • SFC Intermediaries should notify the SFC (and HKMA, where applicable) in advance if they intend to provide advisory services in tokenised securities and should comply with the existing requirements governing advising on securities and the expected standards of conduct and guidance on tokenised securities issued by the SFC from time to time.

VA Fund Management Services (for fund managers managing portfolios which meets the De Minimis Threshold[4])

  • The previous T&Cs relating to VA Fund Management is substantially similar to the SFC’s "Fund Managers Code of Conduct" (applicable to all SFC fund managers). Accordingly, in the latest T&Cs appended in the Circular, the SFC has removed certain duplicated terms.

  • The SFC has removed the hard-wired requirement that a VA fund manager may only allow professional investors to invest in a VA fund.

  • SFC Intermediaries may provide VA discretionary account management services to retail clients, but it must (i) notify the SFC, and (ii) ensure that the VAs recommended are made available for trading by retail investors by VATPs.

  • The SFC and the HKMA clarified that they are only prepared to allow SFC intermediaries licensed or registered for Type 9 (asset management) regulated activity to provide asset management activities in respect of VAs which meet the De Minimis Threshold.

  • SFC Intermediaries should notify the SFC (and HKMA, where applicable) in advance if they intend to provide asset management services in tokenised securities and should comply with the existing requirements governing asset management and the expected standards of conduct and guidance on tokenised securities issued by the SFC from time to time.

 

Intermediaries which are already providing VA dealing services to non-qualified corporate professional investors and individual professional investors and wish to continue providing such services to them should align their systems and controls with the updated requirements. There will be a three-month transition period (which expires on 19 Janaury 2024) for intermediaries which are providing VA dealing services before the full implementation of the expected requirements in the Circular.

 

Intermediaries which do not currently engage in VA-related activities or which plan to extend their VA dealing services to non-qualified corporate professional investors, individual professional investors, or retail investors should ensure that they are able to comply with the requirements in the Circular before introducing such services. 

 

SFC Intermediaries are also reminded to notify the SFC (and the HKMA, where applicable) in advance if they intend to make any changes to the activities they conduct (including changes in the type of clientele served).

 

Conclusion

 

The SFC and HKMA have made some considerable changes to the regulatory requirements relating to VA Activites in the Circular, many of which can be considered as crypto-friendly and are generally welcomed by the industry. Despite the recent controversies and incidents relating to VAs, the Circular appears to signify an unwavering determination of policy makers and regulators in Hong Kong for Hong Kong to become Asia's virtual asset hub. Some of the changes in the Circular also appear to be hinting at allowing access by retail investors to SFC-authorised VA-spot mutual funds and ETFs (before the US SEC is able to approve its first), as well as introducing regulatory guidance on tokenization and securities token offering (STOs) - we shall closely monitor any new VA-related regulatory policies which may be announced during the Hong Kong Fintech Week in the first week of November.

 

Howse Williams' Virtual Assets Practice

 

Howse Williams' Virtual Asset team is at the cutting edge of virtual assets legal work and has been actively advising clients within the virtual assets ecosystem in relation to virtual asset and tokenized funds, and the complex and rapidly evolving regulatory framework in relation to virtual assets. We regularly advise on both transactional and contentious and non-contentious regulatory matters, therefore making us unique in the market.

 

Amongst others, our lawyers have advised various virtual asset fund managers (including one of the first) in securing regulatory approval from the SFC to manage 100% virtual asset funds, which led to nominations at leading industry awards.  Our lawyers have acted as legal counsel for a Hong Kong asset manager to receive the first “no further comment” letter from the SFC to launch a tokenised fund investing in certain Hong Kong real estate development project, as well as advising on multiple regulatory investigations concerning virtual asset trading platforms and the first liquidation of a crypto exchange in Hong Kong.

 

[1] https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=23EC44

[2] https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=22EC9

[3] "Institutional professional investors" is defined under paragraph 15.2 of the SFC's "ode of Conduct for Persons Licensed by or. Registered with the Securities and Futures Commission" ("SFC Code of Conduct") as persons falling under paragraphs (a) to (i) of the definition of "professional investor" in section 1 of Part 1 of Schedule 1 to the SFO. "Qualified corporate professional investors" refers to corporate professional investors which have passed the assessment requirements under paragraph 15.3A and gone through the procedures under paragraph 15.3B of the SFC Code of Conduct.

[4] "De Minimis Threshold" means where funds (or portions of funds) that invest in VAs have (a) a stated investment objective to invest in VAs; or (b) an intention to invest 10% or more of the gross asset value of their portfolio in VAs.

 

 

About Us

 

Howse Williams is an independent law firm which combines the in-depth experience of its lawyers with a forward thinking approach.

 

Our key practice areas are corporate/commercial and corporate finance; commercial and maritime dispute resolution; clinical negligence and healthcare; insurance, personal injury and professional indemnity insurance; employment; family and matrimonial; property and building management; banking; fraud; distressed debt; investment funds; virtual assets; financial services/corporate regulatory and compliance.

 

As an independent law firm, we are able to minimise legal and commercial conflicts of interest and act for clients in every industry sector. The partners have spent the majority of their careers in Hong Kong and have a detailed understanding of international business and business in Asia.

 

Disclaimer: The information contained in this article is intended to be a general guide only and is not intended to provide legal advice. Please contact [email protected] if you have any questions about the article.

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