GPS Legal | Cryptocurrency Regulation in Hong Kong

What is not a Virtual Asset?

It is worth noting that the AMLO explicitly carves out, from the definition of VA, a digital representation of value that:

is issued by central banks;
constitutes securities or a futures contract that are already regulated under the Securities and Futures Ordinance (“SFO”);
constitutes a stored value facility; or
is a limited purpose digital token (“LPDT”).

In the Financial Services and the Treasury Bureau’s (the “FSTB”) Consultation Conclusions, LPDTs are defined as assets that are non-transferable, non-exchangeable and non-fungible in nature. In line with the FSTB’s interpretation, the AMLO further provides that LPDTs include (a) customer loyalty or reward points; (b) in-game assets; and (c) tokens similar to (a) and (b) that are not intended to be convertible into money or another medium of exchange accepted by the public.

The legal nature of VAs under Hong Kong law was considered in the decision of Re Gatecoin Limited (In Liquidation) [2023] HKCFI 914 (the “Gatecoin Case”), decided by the Hong Kong Court of First Instance on 31 March 2023. This decision marked the first time a Hong Kong court explicitly recognised virtual assets as property.

Under the Gatecoin Case, the court examined whether or not VAs were “property”, The court engaged in a detailed consideration of precedents in other common law jurisdictions and noted that VAs were capable of meeting these requirements:

VAs were definable, since the public key allocated to a VA wallet was readily identifiable, distinct, and capable of being allocated uniquely to an individual account holder;
VAs were identifiable by third parties as only the holder of a private key is able to access and transfer the virtual assets from one wallet to another;
VAs were capable of assumption by third parties, as they are traded widely, an owner’s rights to VAs are respected, and VAs are a desirable investment; and
VAs have some degree of permanence or stability, as the life history of a VA is available in the blockchain.

Given the above, it was held that VAs are property for the purposes of Hong Kong law.

This classification allows VAs to be capable of being held on trust, aligning Hong Kong's legal framework with other major common law jurisdictions like the United Kingdom and Australia.

Importantly, in a circular issued on 1 November 2018, the SFC drew the distinction between utility and security tokens (see further below).

What are Stablecoins?

Stablecoins are subset of virtual assets. They are designed to maintain a stable value relative to certain assets, typically currencies.

They are generally considered a subset of VAs and are also currently not legal tender in Hong Kong.

In view of the rising interconnectedness between the traditional financial system and the VA markets, the HKMA is currently formulating a regulatory regime for stablecoin issuers in Hong Kong.

In the Conclusion of Discussion Paper on Crypto-assets and Stablecoins published in January 2023, the HKMA proposed a Mandatory Stablecoin Licensing Regime requiring entities to obtain a licence from the HKMA if:

they conduct a regulated activity in Hong Kong;
they actively market a regulated activity to the Hong Kong public;
they conduct a regulated activity concerning a stablecoin that references the value of the Hong Kong dollar regardless of whether such regulated activity is conducted in Hong Kong or actively marketed to the Hong Kong general public; or
the HKMA considers that they should be regulated, having regard to “matters of significant public interest”.

In terms of which stablecoins will be regarded as “in scope”, the HKMA prioritises those that references fiat currencies, irrespective of the underlying stabilisation mechanism.

Who is the Regulator?

In Hong Kong, cryptocurrencies are considered a form of VA that are generally categorised either as (1) security tokens; or (2) non-security tokens (e.g., utility tokens). Starting from 1 June 2023, non-security tokens are regulated in Hong Kong by the SFC to the extent that a party proposes to operate a VATP in Hong Kong (or offer VATP services into Hong Kong), even if that VATP will only list non-security tokens for trading.

As you can see from above, this is a developing area and the HKMA is also actively involved in formulating regulations. Therefore, both the SFC and the HKMA need to be monitored for developments.

So what are Security Tokens?

Security tokens are also known as “tokenised securities”. In a circular titled “Sale and Distribution of Tokenized Products” issued on 20 February 2024 by the HKMA, the HKMA referred to these as digital representation of real-world assets using distributed ledger or similar technology, but does not apply to those regulated under the SFO and governed by the relevant requirements issued by the SFC and the HKMA from time to time.

Depending on the extent and type of activities in connection with these security tokens, the activity may be considered “regulated activities” that can only be carried out with the relevant licence(s) issued by the SFC (e.g., dealing in and advising on security tokens).

Cryptocurrencies will be deemed security tokens if they fall within the definition of “securities” under the SFO. In its “Statement on initial coin offerings” (5 September 2017), the SFC further clarified that digital tokens (including any cryptocurrencies) may be considered “securities” if they:

represent equity or ownership interests in a corporation;
create or acknowledge a debt or liability owed by the issuer;
pay regular returns to investors that amount to dividend or interest; or
give their holders rights akin to that of a creditor or a shareholder (e.g., voting rights or the right to participate in the distribution of the corporation’s surplus assets upon winding up).

Therefore, most stablecoins and cryptocurrencies (e.g., Bitcoin and Ether) in the market are not regarded as securities according to the definition under the SFO.

What about Non-Security Tokens?

Cryptocurrencies that are not security tokens are considered “non-security tokens” or “virtual commodities”, which are subject to a mandatory virtual assets service provider (“VASP”) licensing regime.

On 7 December 2022, the Legislative Council passed the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the “Amendment Bill”), which implemented a mandatory licensing regime for VASPs (the “Mandatory VASP Licensing Regime”) expanding its jurisdiction to cover the trading of non-security tokens. Under the Mandatory VASP Licensing Regime, a person operating a VA exchange in (a) Hong Kong; or (b) elsewhere but actively markets to the Hong Kong public, will be regarded as carrying out a “regulated activity” (regardless of whether the VAs in question are “security” or “non-security” tokens) for which a licence from the SFC is required.

Under the Mandatory VASP Licensing Regime in Hong Kong, a VASP license is required for carrying on VA service business:

any person in Hong Kong that carries on a business of providing any VA service or holds themselves out as carrying on a business of providing any VA service (section (53ZRD(1) of the AMLO); or
any person outside Hong Kong that (i) actively markets to the public in Hong Kong any services the person provides or purports to provide, and (ii) the provision of such services, if done in Hong Kong, would constitute providing a “VA service” (section 53ZRB of the AMLO).

“VA service” is defined in Schedule 3B of AMLO to mean operating a virtual asset exchange, that is to say, providing services through means of electronic facilities:

whereby:
1. offers to sell or purchase virtual assets are regularly made or accepted in a way that forms or results in a binding transaction; or
2. persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of virtual assets in a way that forms or results in a binding transaction; and
where client money or client virtual assets comes into direct or indirect possession of the person providing such service.

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Licensing Requirements

In line with the existing licensing regime for carrying out regulated activity under the SFO, the Mandatory VASP Licensing Regime also imposes certain baseline requirements on potential applicants. For instance, applicants must:

have sufficient presence in Hong Kong;
appoint at least two responsible officers (“ROs”) to ensure compliance with the anti-money laundering (“AML”) and counter-terrorist financing (“CTF”) requirements under the AMLO, and appoint at least one of theROs as an executive director of the applicant;
meet the fit-and-proper test; and
always maintain paid-up share capital of not less than HK$5,000,000 and liquid capital of not less than the required liquid capital (the higher of HK$3,000,000 or the basic amount defined in section 2 of the SFO).

Additionally:

all assets which are beneficially owned must be sufficiently solvent with liquidity (e.g., cash, deposits, treasury bills and certificates of deposit) equivalent to at least 12 months of the company’s operatingexpenses, calculated on a rolling basis, which must be maintained in Hong Kong; and
companies are required to engage an external assessor to assess their policies, procedures, systems, and controls and submit the assessor’s report to the SFC both when submitting the licence application and afterapproval-in-principle is granted.

On granting a VATP licence, the SFC may impose any conditions on the licence, including but not limited to (a) financial resources; (b) knowledge and experience; (c) risk management policies and procedures; (d) AML/CTF policies and procedures; (e) management of client assets; (f) soundness of business; (g) financial reporting and disclosure; (h) VA listing and trading policies; (i) prevention of market manipulation and abusive activities; (j) avoidance of conflicts of interests; (k) keeping of records and accounts; and (l) cybersecurity.

Some key features of the regime include:

limitation of scope of non-security tokens to retail investors (see additional requirements under “Retail Customers”);
prohibition of providing algorithmic trading services;
prohibition of making arrangements to use the investors’ VAs to generate returns for the clients or any other parties (e.g., staking, lending and borrowing);
prohibition of offering, trading or dealing activities in VA futures contracts or related derivatives; and
admission of stablecoins for retail trading until regulatory arrangements in respect of stablecoins are in place.

Retail Customers

The Mandatory VASP Licensing Regime took effect on 1 June 2023 (the “Effective Date”). Should the VASP wish to market to retail customers, additional prerequisites to be fulfilled are as follows:

1. prior to token admission:

               (i)     the VA does not fall within the definition of “securities” under the SFO;
               (ii)     the VA is of high liquidity, making it an eligible large-cap VA (included in a minimum
                          of two acceptable indices issued by at least two different index providers); and
               (iii)     written approval is obtained from the SFC;

2. prior to opening of accounts:

               (i)     assessment of the retail investors’ knowledge in VAs and their associated risks,
                        and should this knowledge be lacking, provision of adequate training to the retail investor;
               (ii)     satisfaction of know-your-client procedures, including establishment of the true and full
                        identity, financial situation, investment experience and investment objectives of the retail
                        investor, assessment of the investor’s risk tolerance level and risk profile relevant to the
                        services to be provided; and
               (iii)     establishment of a limit with reference to the retail investor’s financial situation and personal circumstance;

3. prior to provision of services:

(i) entering into of a written client agreement containing certain specified terms; and

4. when making recommendation or solicitation:

               (i)      ascertainment of the suitability of such recommendation or solicitation, having regard
                         to information of which the VATP is or should be aware; and
               (ii)     disclosure obligations – all reasonable steps should be taken to disclose, in a prominent
                         manner, the nature and risks exposed in trading VAs and using the services provided by the VATP.

Money Laundering

The AMLO in Hong Kong applies to financial institutions (including HKMA-authorised institutions (i.e., banks), SFC-licensed corporations, licensed insurance companies, stored value facility issuers and money service operators and designated non-financial businesses and professions (for example, lawyers, certified public accountants, licensed estate agents, and trust and company services agents). Thus, all SFC-licensed entities conducting regulated activities are subject to the AML/CTF obligations of the AMLO, which also include licensed VASPs under the new regime as mentioned above. The regulated bodies should also ensure compliance with the Financial Actions Task Force’s recommendations as released from time to time.

Misselling

There is no specific legislation governing the promotion of crypto-assets in Hong Kong. The regime governing the offering/marketing of financial products in Hong Kong will only be relevant if a crypto-asset qualifies as a security.

The VASP licensing regime prohibits any person from actively marketing a regulated virtual assets activity (or services associated with a VAs exchange) to the Hong Kong public, unless licensed by the SFC.

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How we can help

This article does not purport to address all regulatory concerns relating to cryptocurrencies. Should you require further advice or assistance, we would be happy to further discuss how we can help. If you would like further information and/or assistance with respect to the information set out in this article, please contact us.

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