Hong Kong Virtual Asset Trading Platform Operators Licensing Regime: Dual Licensing Regime and Key Personnel Requirements

Hong Kong is all set with adopting a dual licensing regime (VATP Licensing Regime) applicable to virtual assets trading platform operators (Platform Operators) that will be administered by the Securities and Futures Commission of Hong Kong (HKSFC). The HKSFC released its Consultation Conclusions (Consultation Conclusions) on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the HKSFC on 23 May 2023.

In the Consultation Conclusions, the HKSFC considered responses from the public and has finalized the following guidance in support of the launch of the VATP Licensing Regime, effective 1 June 2023 (collectively, the Guidance):

• Guidelines for Virtual Asset Trading Platform Operators (VATP Guidelines);
• Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers) (AML Guideline for LCs and SFC-licensed VASPs);
• Prevention of Money Laundering and Terrorist Financing Guideline issued by the Securities and Futures Commission for Associated Entities of Licensed Corporations and SFC-licensed Virtual Asset Service Providers (AML Guideline for AEs); and
• Disciplinary Fining Guidelines.

Dual Licensing Regime

It is essentially “dual” in nature as the HKSFC has clarified that if you conduct “Relevant Activities”¹ in relation to

• a “security token” meaning a cryptographically secured digital representation of value which constitutes “securities” as defined in section 1 of Part 1 of Schedule 1 to the Securities Futures Ordinance (SFO); or
• a “virtual asset” or “VA” or “token” as defined in section 53ZRA of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO)²,

you will need to become licensed with the HKSFC by 1 June 2023, unless you, as: 

If the HKSFC considers that the licence application meets the deeming conditions⁴, no notice will be issued to the Platform Operator, and the Platform Operator will automatically be deemed to be licensed from 1 June 2024 until its licence application is approved, withdrawn or refused (whichever is earlier).

All Platform Operators that currently provide trading services in “security tokens” should be licensed with the HKSFC to carry on Type 1 (dealing in securities) and Type 7 (automated trading services) regulated activities under the SFO and will be regarded as falling within the HKSFC’s jurisdiction upon the commencement of the VATP Licensing Regime given the HKSFC’s adoption of the “same business, same risks, same rules” principles.

In short, VA trading operators operating centralized Platforms that provide trading services in virtual assets using automated trading engines and also provide ancillary custody services will need to be licensed and regulated by the HKSFC if they carry on their business in Hong Kong or actively market their services to Hong Kong investors.⁵

In other words, currently, the provision of other services relating to non-security tokens or virtual assets defined under the AMLO without an automated trading engine and ancillary custody services, for instance, a platform which operates as an order routing facility or a single bulletin board, as well as peer-to-peer trading platforms, over-the-counter VA trading activities, VA brokerage activities and standalone VA payment or custodian systems, are not subject to any Hong Kong licensing requirements.

The HKSFC will process the licence application for both “securities tokens” and “virtual assets” simultaneously upon receipt of the application and strongly encourages applicants to obtain both licences under the SFO and AMLO, respectively, given the changing legal status of tokens that may fall under the definition of “securities” under the SFO.

KEY PERSONNEL REQUIREMENTS

Highlighted are the key personnel requirements (both internal and external) under the VATP Guidelines.

INTERNAL

It is pivotal that the following personnel have been identified to meet the HKSFC’s regulatory requirements (i.e. fitness and properness, as well as competency) in support of the applicant (Applicant)’s licence application with the HKSFC under the VATP Licensing Regime. Highlighted below are key matters that the HKSFC will have regard to in its assessment of the Applicant’s personnel:

Specifically, the VATP Guidelines require that the Platform Operator appoint one or more independent risk manager(s) (Risk Manager) who has the appropriate qualifications and authority to oversee and monitor the Platform Operator’s risk exposures and systems. The Risk Manager is expected to assume independent responsibilities and segregated from the duties of front office personnel.

Board of Directors (Board)

In addition to the ROs and MICs, the directors (executive director, shadow director or otherwise named) of the Applicant are regarded as part of senior management (Senior Management) and expected to be composed of individuals with an appropriate range of skills and experience in understanding and operating the Applicant’s Regulated Activities.

Token admission and review committee (Committee)

To be elaborated further, the HKSFC expects the Applicant’s Board to establish the Committee consisting members from Senior Management (at least the corresponding MICs of the functions below of the Platform Operator) who are principally responsible for managing the key business line, compliance, risk management and information technology that will report to the Board on matters relating to the admission of VA onto the Platform.

Summary

In establishing the corporate governance framework of the Applicant, the HKSFC will review the organizational structure, especially the management structure, including the roles, responsibilities, accountability and reporting lines of Senior Management. Additionally, the HKSFC will assess whether the Board, including committees of the board (i.e. Committee), and Senior Management are organized in a manner that enables the Board to address and control the activities of the Applicant.

EXTERNAL Service Providers

Prior to the Applicant’s submission of its licence application to the HKSFC, the Applicant should exercise due skill, care and diligence in the selection and appointment of the following parties given their respective responsibilities in the operations of the Applicant’s conduct of Regulated Activities.

However, the introduction of the new VATP Licensing Regime that needs to work harmoniously with the existing licensing regime applicable to traditional financial intermediaries calls for more than foresight, but a balancing act between being open-minded about innovation and being responsible for investor’s protection.

Therefore, an understanding of the HKSFC’s approach and fundamental principles in processing licence applications remain the cornerstone in the preparation of the Applicant’s licence application:

1. “To be licensed or not to be” requires a careful analysis of whether you are “in-scope” or “out-scope” of the VATP Licensing Regime and when as the outcome of this analysis will likely change within the year given that the licence application process will essentially be protracted. Questions pertaining to the correct characterization of your business model, whether you are able to meet the eligibility criteria and how should you approach this process would factor into this analysis with your legal adviser.
2. If you have reached the commercial decision to proceed with obtaining a licence because you have a presence in Hong Kong, preparation work prior to consulting with the HKSFC should begin and be focused on your “readiness” to meet the requirements under the VATP Guidelines. No consultation with the regulator should proceed without obtaining appropriate legal advice at the outset.
3. The search for talent is much easier said than done these days. Coupled with the HKSFC’s assessment criteria of requiring ROs and MICs to be fit and proper on the one hand and competent on the other hand, an eligibility assessment would need to be conducted against all internal personnel with your legal advisers to abridge the pre-acceptance period of the Applicant’s application with the HKSFC.
4. In view of the HKSFC’s emphasis on adopting a robust corporate governance framework, the Applicant will need to engage in extensive internal discussions regarding the allocation of internal resources and duties, as well as, early consultation with external personnel as a prelude prior to papering the licence application to the HKSFC with your legal adviser.

For Sidley’s insights on key structural and operational requirements (Infrastructure) applicable to Platform Operators, please see here.

¹ Under the VATP Guidelines, “Relevant Activities” is defined as:
(a) providing services through means of electronic facilities:
(i) whereby:
A. offers to sell or purchase virtual assets are regularly made or accepted in a way that forms or results in a binding transaction; or
B. 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
(ii) where client money or client virtual assets come into direct or indirect possession of the persons providing such service; and
(b) any off-platform virtual asset trading activities and incidental services provided by the Platform Operator to its clients, and any activities conducted in relation to off-platform virtual asset trading activities.
² Pursuant to, among others, the Report of the Bills Committee on Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022, a determination of what falls within the definitions will require a case-by-case analysis, but it is acknowledged that bitcoins, altcoins, certain government tokens and stablecoins (except digital representations of fiat currencies) will likely fall within the definitions. While, “limited purpose digital tokens” (e.g. air miles, customer loyalty or reward points and gift cards) and other assets regulated under the Payment Systems and Stored Value Facilities Ordinance (Cap. 584 of the Laws of Hong Kong) should fall outside of the definitions.
3  The HKSFC will consider factors, including, whether (i) the platform operator is incorporated in Hong Kong; (ii) the platform operator has a physical office in Hong Kong; (iii) the platform operator’s Hong Kong staff have central management and control over the Platform; (iv) the platform operator’s key personnel (for example, those responsible for the operation of the trading system) are based in Hong Kong; and (v) the centralized trading platform’s operation is live with considerable number of clients and volume of trading activities in Hong Kong.
⁴ In accordance with section 3 of Schedule 3G to the AMLO, a platform operator will be deemed if (i) the platform operator has been operating a VA trading platform in Hong Kong immediately before 1 June 2023, (ii) it has made a licence application under section 53ZRK of the AMLO by 29 February 2024 and the HKSFC has acknowledged receipt of the application, (iii) it has confirmed by 29 February 2024 that it has been operating a VA trading platform immediately before 1 June 2023, (iv) it has confirmed by 29 February 2024 that it will, upon being deemed to be licensed, comply with, and have arrangements in place to ensure it complies with, the relevant legal and regulatory requirements, and (v) the HKSFC is satisfied that the platform operator has a reasonable prospect of successfully showing to the HKSFC that it is capable of complying with the relevant legal and regulatory requirements.
⁵ For services provided relating to virtual assets involving “securities” or “futures contracts”, defined under the SFO, for example, virtual assets fund management, discretionary account management, distribution of VA-related products and provision of virtual assets advisory services, please refer to the “Joint circular on intermediaries’ virtual asset-related activities” issued on 28 June 2022.
⁶ The HKSFC will have regard to conviction of an offence (relating to money laundering or terrorist financing) under the AMLO, the United Nations (Anti-Terrorism Measures) Ordinance (Cap. 575 of the Laws of Hong Kong), the Drug Trafficking (Recovery of Proceeds) Ordinance (Cap. 405 of the Laws of Hong Kong) or the Organised and Serious Crimes Ordinance (Cap. 455 of the Laws of Hong Kong) or an offence for which it was necessary to find that the person had acted fraudulently, corruptly or dishonestly.
⁷ Circular to Licensed Corporations regarding Measures for Augmenting the Accountability of Senior Management issued 16 December 2016 represents the HKSFC’s view that there are eight core functions (overall management oversight, key business line, operational control and review, risk management, finance and accounting, information technology, compliance and anti-money laundering and counter-terrorist financing) that the Applicant should be required to appoint at least one individual responsible for managing that function, though an individual may be responsible for more than one function. The ROs are expected to act as the MIC for overall management oversight and key business line.
⁸ The auditors are required to report on matters relating to Custody of Client Assets and Record Keeping for both the Platform Operator and Associated Entity, and additionally Financial Soundness of the Platform Operator.
⁹ Platform Operator should choose insurance company based on verifiable and quantifiable criteria, including a valuation schedule of assets insured, maximum coverage per incident and overall maximum coverage, as well as any excluding factors.
¹⁰ Separate and “independent” external assessors can be engaged for the review of different areas depending on their respective expertise, experience and track records. “Independence” of the external assessor is defined in the sense that the service provider of a particular system should not act as the external assessor for the same system.
¹¹ If VA is made available to retail clients, VA must be “eligible large-cap VA” included in at least two “acceptable indices” issued by at least two independent index providers.