On 24 June 2022, the Hong Kong government gazetted the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the “Bill”)1, proposing changes to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (the “AMLO”)2. Following the Consultation Conclusions 3 on the same subject published by the Financial Services and Treasury Bureau on 21 May 2021 (please see our news update), the Bill introduces a licensing regime for virtual asset service providers (“VASPs”) and a registration regime for dealers in previous metals and stones (“DPMS”) to impose statutory anti-money laundering and counter-terrorist financing (“AML/CTF”) obligations on the two sectors. The Bill has been introduced into the Legislative Council (“LegCo”) for first reading on 6 July 2022. This news update focuses primarily on the regime for VASPs.
Scope of the proposed VASP licensing regime
The licensing regime for VASPs will come into effect on 1 March 2023 pursuant to the Bill. Under this regime, a licence issued by the Securities and Futures Commission (the “SFC”) will be required for the carrying on of a business of operating a virtual asset (“VA”) exchange.
The operation of a VA exchange is defined in the Bill as providing services through means of electronic facilities:-
- (a) whereby-
(i) offers to sell or purchase VAs are regularly made or accepted in a way that forms or results in a binding transaction; or
(ii) persons are regularly introduced, or identified to the 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 VAs in a way that forms or results in a binding transaction; and
- (b) where client money or client VAs comes into direct or indirect possession of the person providing such service.
Any person who carries or holds themselves out as carrying on a business of providing VA service; and any person, whether in or outside Hong Kong, who actively markets to the public in Hong Kong any VA services he provides or purports to provide will have to submit a licensing application to the SFC. Licensees will be required to meet fit and proper requirements and comply with the AML/CTF and other regulatory requirements.
Definition of virtual assets
Following the proposed amendments, VAs will be defined under the AMLO as a cryptographically secured digital representation of value that:
- is expressed as a unit of account or a store of economic value;
- is used, or is intended to be used, as a medium of exchange accepted by the public, for (i) payment for goods or services, (ii) discharge of a debt and/or (iii) investment; or
- provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with, or to vote on any change of terms of any arrangement applicable to, any cryptographically secured digital representation of value;
- can be transferred, stored or traded electronically; and
- satisfies other characteristics prescribed by the SFC;
- a representation of value prescribed as a virtual asset by the Secretary for Financial Services and the Treasury by notice published in the Gazette.
Echoing the clarifications made in the Consultation Conclusions, the definition of VA currently excludes any digital representation of value that4:
- is issued by a central bank or by an entity that performs the functions of a central bank or by an entity authorized by a central bank on its behalf;
- is issued by a government of a jurisdiction, or by an entity authorized by the government of a jurisdiction and acting pursuant to an authority to issue currency in that jurisdiction;
- is limited purpose digital tokens;
- constitutes securities or a futures contract;
- constitutes any float or SVF deposit of a stored value facility as defined in the Payment Systems and Stored Value Facilities Ordinance (Cap. 584);
- satisfies other characteristics prescribed by the SFC which precludes it from being a VA; or
- is prescribed not to be a VA by notice published in the Gazette by the Secretary for Financial Services and the Treasury.
To be eligible for a VASP licence, applicants must be a locally incorporated company with a permanent place of business in Hong Kong or a company incorporated elsewhere but registered in Hong Kong under the Companies Ordinance (Cap. 622). This is to ensure that the SFC can effectively monitor the operation of the licensed VASPs.
In addition, the SFC must be satisfied that:
- the applicant is a fit and proper person to be licensed for the VA service;
- the applicant will appoint at least 2 SFC-approved responsible officers (“ROs”), each of whom is a fit and proper person to be associated with the business of providing the VA service, and at least one of whom is an executive director;
- each director of the applicant is fit and proper; and
- the ultimate beneficial owner of the applicant is fit and proper.
ROs are held to be personally accountable in case of non-compliance. Only individuals licensed by the SFC to be licensed representatives and whose accreditation to a VASP are approved by the SFC may carry out regulated functions on behalf of the VASP. Licensed representatives are expected to meet the qualification requirements and should be competent to carry out VA trading services.
At the initial stage of the regime, VASPs can only provide services to professional investors5. This requirement will likely be imposed by the SFC as a licensing condition, allowing SFC room and flexibility to expand the scope of VASP services and to allow VA exchanges to operate and provide services to retail investors in the future.
Furthermore, the VASP regime will consider licensing applicants’ company and management structure, and soundness of their business models. In addition, there will be requirements for detailed risk management policies as well as listing and counter-market manipulation measures. The Bill provides a list of possible licensing conditions the SFC may impose, apart from the abovementioned conditions, it may also require AML/CTF policies and procedures, financial reporting and disclosure, virtual asset listing and trading policies, cybersecurity and more6.
Supervisory powers of the SFC
The Bill grants the SFC broad supervisory powers over licensed VASPs. These include the power to enter the premises of the licensed VASP and its associated entities for routine inspections7, request the production of documents and records8, investigate non-compliances, impose disciplinary sanctions against non-compliant licensees9 and appoint an auditor to look into the affairs of a licensed VASP and its associated entities10.
The SFC is also empowered to impose prohibitions and requirements on the operation of a licensed VASP where the circumstances so warrant11. Intervention powers of the SFC may include prohibiting the licensed VASP from entering into further transactions12 and restricting the licensed VASP from dealing with or disposing of any relevant property13.
Offences under the proposed VASP regime
Enhancing and amending AML/CTF regulations entail creating a new enforcement regime to monitor regulated VA exchange activities in Hong Kong.
Providing a VA service without the relevant licence, or actively marketing (in Hong Kong or elsewhere) to the public of Hong Kong the services of an overseas VA exchange without a licence by the SFC, will be an offence punishable, on conviction on indictment, to a fine of HK$5 million and to imprisonment for seven years, and in the case of a continuing offence, to a further fine of HK$100,000 for every day during which the offence continues; or, on summary conviction, to a fine of $500,000 and to imprisonment for 2 years and a further fine of $10,000 for each day during which the offence continues14.
Time frame and transitional period
The Bill provides for transitional arrangements for existing VA exchange business operators. The transitional period will last for 12 months beginning on 1 March 2023 for any corporation carrying on a business of providing a VA service15.
If an existing operator files an application with the SFC within the first 9 months (by 1 December 2023) and confirms that it will comply with the regulatory requirements applicable to a licensed provider of the VA service and that it has arrangements in place to ensure it complies with such requirements, the operator will be deemed to be licensed until the SFC has made a decision on its application.
The SFC will be empowered by the Bill to issue a notice to unsuitable applicants informing them that they will not have a deemed licensed status. These applicants will be required to close down their business by the end of the 12-month transitional period.
Therefore, prospective applicants for the VASP licence and VA exchanges considering entering the Hong Kong market should ensure they are operating in Hong Kong as soon as possible prior to the enactment of the Bill so they can benefit from the transitional arrangements.
Analysis and Takeaways
Despite not being named directly in the Legislative Council Brief on the Bill or the Bill itself, the definition of VA appears to apply equally to “stablecoins” in consonance with the Consultation Conclusions. It is also worth mentioning that the definition in the Consultation Conclusions did not include elements such as “the provision of rights, eligibility, or access to vote”, which are now included in the Bill. This seems to broaden the scope of VAs covered by the licensing regime.
In particular, we note that whether an NFT is a VA depends on the circumstances, and it is important to consider not merely its form but also its substance. We understand that an NFT project could sometimes involve a Decentralised Autonomous Organisation (“DAO”), a community-led organisation which allows members to vote on the direction of their entity. DAOs related tokens granting members voting rights seem to fit part of the definition of a VA under the Bill for its nature as a “governance token”. As such, it is therefore important for service providers to think about the true nature of a NFT in ascertaining whether they need to apply for a VASP licence.
It is also noteworthy that the regulatory ambit seems to align with that of the SFC as stated in its first substantive statement on NFTs released on 6 June 2022 – if an NFT is a genuine digital representation of a collectible, activities related to it do not fall within the SFC’s regulatory remit.
While it is arguable that certain NFTs may not be captured by the definition of VA at the moment, the Bill provides that the Secretary for Financial Services and the Treasury will be empowered to prescribe particular digital representation of value as a VA by publishing a notice in the Gazette, thereby expanding the scope of VAs in the future.
Please contact our Partner Mr. Rodney Teoh for any enquiries or further information. Rodney would like to thank Mr. Calvin Lo (Trainee Solicitor) and Ms. Gladys Wong (Intern) for their contributions to this news update.
This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.
1 Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the “Bill”)
2 Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615)
3 Consultation Conclusions on Public Consultation on Legislative Proposal to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong published by the Financial Services and the Treasury Bureau dated May 2021
4 Section 53ZRA(2), the Bill
5 Para 6, Legislative Council Brief Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022
6 Section 53ZRK(5), the Bill
7 Part 2, Division 2, Clause 11(1B)(a), the Bill
8 Part 2, Division 2, Clause 11(1B)(b), the Bill
9 Section 53ZSO, the Bill
10 Section 53ZSG, the Bill
11 Section 53ZSX, the Bill
12 Section 53ZSY, the Bill
13 Section 53ZSZ, the Bill
14 Section 53ZRD, the Bill
15 Schedule 3G, Part 2, the Bill
16 SFC reminds investors of risks associated with non-fungible tokens” announcement published by the Securities and Futures Commission, dated 6 June 2022