Why Hong Kong’s Updated Cryptocurrency Intermediary Guidelines Matter

Hong Kong is on October 20, 2023 Securities and Futures Commission (SFC) and Hong Kong Monetary Authority (HKMA) updated their joint circular on intermediaries‘ activities related to virtual assets (VA), which replaced the previous one published in January 2022.

This update came about due to industry inquiries about “expand[ing] access to retail through intermediaries i […] allow[ing] investors to directly deposit and withdraw virtual assets with/from intermediaries with appropriate safeguards”.

Rationale for updates

Analyzing the changes between the updated circular and the previous one, the focus of the update is clearly investor protection. They highlight the heightened expectations of the SFC and HKMA when intermediaries want to deal with retail customers. This approach is consistent with Hong Kong’s new Virtual Asset Trading Platform (VATP) regime. came comes into effect on June 1st and allows access to retail stores with guardrails in place.

Specifically, the updated circular states that intermediaries distributing VA-related products – other than to institutional professional investors and qualified corporate professional investors – should:

• provide information – including warnings – to clients about VA products and underlying VA investments that are clear and easy to understand; and
• provide clients with VA-specific risk disclosure statements (which may be one-off) on risks such as price volatility, hacking and market manipulation.

Strengthening protection for retail investors

The two agencies also outlined behavioral requirements – to be imposed as prescribed conditions for licensing or registration – that regulated intermediaries, before providing VA dealer services to individuals, should:

1. assess each retail client’s knowledge of VAs and level of risk tolerance;
2. set a limit for each retail client to ensure reasonable exposure to VAs given the client’s financial situation (including net worth) and personal circumstances;
3. ensure that VA trading activities are conducted through an omnibus order established and maintained on an SFC-licensed platform that is not licensed to serve professional investors only; and
4. implement adequate controls to ensure that retail clients can only trade with VAs that are available on an SFC-licensed platform for retail investors.

In addition, intermediaries – who allow customers to deposit or withdraw VAs from their accounts – should:

• only receive or withdraw such VAs through the segregated account(s) of their SFC-licensed partner platforms or authorized financial institutions (or locally incorporated subsidiaries) that meet the HKMA’s expected VA custody standards; and
• in accordance with the requirements of Chapter 12 against money laundering and terrorist financing (AML/CFT) guideline for licensed corporations and SFC-licensed VA service providers when handling such VA deposits and withdrawals.

Compliance with the VATP regime

Furthermore, intermediaries – when recommending any VA to retail clients – should take all reasonable steps to ensure that the recommended VA is:

• of high liquidity which is defined as a minimum as an acceptable virtual asset with large capital, i.e. it is included in at least two eligible indices issued by two different index providers – a similar requirement established in the VATP regime; and
• made available by SFC licensed platforms for retail investors.

The circular also adds that intermediaries providing trading, asset management or advisory services in tokenized securities should comply with existing requirements as well as new standards of conduct and guidelines on tokenized securities that may be issued by the SFC.

The updated circular provides much-needed clarity on regulatory expectations for intermediaries seeking to engage in or expand their VA-related activities to retail investors, particularly given the ongoing saga on JPEX.

Although tokenized securities are currently out of reach for retail investors, the SFC and HKMA have noted growing interest in offering such products and have included mention of the requirements that intermediaries would be subject to if they provide related services.

This is both forward-looking in terms of acknowledging market developments and also helps temper potentially unrealistic expectations about near-term retail access.