Introduction

On 20 February 2023, the Hong Kong Securities and Futures Commission (SFC) published a Consultation Paper (the Paper) setting out its proposals for regulating VATPs under the forthcoming VATP licensing regime and seeking comments on the same.

This client alert summarises the key proposals set out in the Paper.

Background

VATPs active in Hong Kong need to be aware of:

(a) The existing licensing regime administered by the SFC under which platforms dealing in securities tokens will need to be licensed under the Securities and Futures Ordinance (SFO).

(b) The existing SFC opt-in regime for VATPs under terms and conditions published in 2019.

(c) Changes to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO), which, when they come into effect in June 2023, will introduce a new licensing regime for VATPs that carry on the business of trading non-security tokens in Hong Kong and/or actively market such services to Hong Kong investors.

(d) Proposals by the Hong Kong Monetary Authority (HKMA) to regulate stablecoins.

Mandatory licensing for all centralised VATPs operating in Hong Kong

Upon commencement of the new VATP licensing regime on 1 June 2023, all centralised VATPs carrying on business in Hong Kong or actively marketing their services to Hong Kong investors will need to be licensed by the SFC, even if they do not provide security token trading services.

From 1 June 2023, any VATP operating in Hong Kong without a valid licence will be in breach of the new VATP licensing regime unless it is eligible to operate under the transitional arrangements (see below).

Dual licensing

The Paper effectively proposes to align the regulatory requirements for VATPs trading non-security tokens under the AML licensing regime with those for platforms trading security tokens, which will continue to be licensed under the SFO. This will be done by rolling out a single consolidated application procedure. This is sensible for VATPs planning to offer trading in a number of tokens, given uncertainty as to whether some will be classified as securities.

Transitional arrangements

The Paper envisages that unlicensed VATPs may make use of transitional arrangements. Provided they have been operating with a “meaningful and substantial presence” in Hong Kong prior to 1 June 2023, such existing VATPs will have until 31 May 2024 to become licensed and may continue operating in the meantime.

Importantly, platforms which do not have such meaningful and substantive presence in Hong Kong immediately before 1 June 2023 will not be able to take advantage of this transitional arrangement and should wait until they are SFC-licensed before commencing any VATP businesses.

Factors going to whether a platform has such a meaningful presence include whether they are incorporated in Hong Kong, have a physical presence in Hong Kong, or have key personnel in Hong Kong.

There will also be a 12-month transitional period for currently licensed VATPs.

Retail access and protections

Currently, SFO-licensed platform operators can only serve professional investors and are restricted from providing services to retail investors. The Paper envisages that retail investors will be allowed to access trading services.

However, to better protect such retail investors, licensed VATPs will need to implement the following measures:

(a) Onboarding: VATPs will need to assess the client’s risk profile to determine if the client is suitable to trade VAs. VATPs must also limit each client’s exposure to VAs based on that client’s financial situation and personal circumstances. This requirement only applies to clients who are retail investors.

(b) Governance: VATPs will need to establish a token admission and review committee comprising members of the VATP’s senior management. The committee must, among others, establish and enforce criteria for VAs to be admitted, suspended or withdrawn from trading.

(c) Token due diligence and admission criteria: VATPs should consider the following non-exhaustive criteria in determining if a VA should be admitted for trading:

• The background of the VA’s management or development team.
• The VA’s regulatory status in the jurisdictions that the VATP operates in.
• The supply, demand, maturity, liquidity and other financial information about the VA.
• The market risks of the VA, including the VA’s susceptibility to price manipulation and fraud.
• The legal risks of the VA, including any pending or potential civil, regulatory, criminal or enforcement action related to the VA.
• The technical aspects of the VA, including the security infrastructure of its blockchain protocol.
• Whether the marketing materials issued by the VA’s issuer are accurate and not misleading.
• Previous major incidents associated with the VA during its development.
• Whether the VA’s touted utility or use case is fraudulent or scandalous.

VATPs should also ensure that the VA in question is an eligible large-cap VA (i.e., the VA is included in at least two “acceptable indices” issued by at least two independent index providers). VATPs should also provide the SFC with a written legal opinion to confirm that the VAs to be admitted do not fall within the definition of “securities” under the SFO.

VATPs must also conduct reasonable token due diligence, including an audit for VAs based on blockchains with a smart contract layer. Where reasonable, VATPs may rely on an independent smart contract audit.

(d) Disclosure: VATPs will need to disclose sufficient information about the VA to allow retail investors to reach an informed investment decision. Relevant information to provide includes, but is not limited to:

• Price and trading volume of the VA on the VATP in the last 24 hours.
• Issuance date of the VA.
• A brief description of the terms and features of the VA.
• Links to the VA’s website and smart contract audit report (if any).
• For VAs with voting rights, how those rights will be handled by the VATP.

(e) Prohibition on VAs amounting to securities: VATPs licensed under the new VATP licensing regime are prohibited from offering VA securities that may breach the “offers of investments regime” or the “prospectus regime” under the SFO.