After the implementation of the VASP system, the China Securities Regulatory Commission (CSRC) will regulate security token transactions on virtual asset trading platforms (involving license plates 1 and 7) under the current system of the Securities and Futures Ordinance, and also regulate non-security token transactions on virtual asset trading platforms (involving VASP licenses) under the VASP system of the Anti-Money Laundering Ordinance. In practice, it is often difficult to determine whether a virtual asset belongs to securities, and some virtual assets may change their characteristics over time.
To avoid violating any issuance regulations and ensure the sustained operation of their business, virtual asset trading platforms (along with their proposed responsible personnel and licensed representatives) are required by the CSRC to apply for approval according to both the current system of the Securities and Futures Ordinance and the VASP system of the Anti-Money Laundering Ordinance to obtain dual licenses and approvals. The CSRC will provide simplified application measures for the dual licensing system. It is worth noting that the CSRC’s arrangement is consistent with the author’s expectations when interpreting the 2022 Anti-Money Laundering and Terrorist Financing (Revised) Ordinance Draft in 2022.
1. Can VASP-licensed exchanges provide services to retail investors?
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The CSRC has confirmed that licensed platform operators will be allowed to provide non-security token trading services to retail investors, but only if a series of proper investor protection measures are in place, including measures related to establishing business relationships with customers, token inclusion, token due diligence review schemes, and information disclosure.
1) Establishing business relationships with customers and knowledge assessment
Regulators are preparing to allow virtual asset trading platforms to accept business from retail investors, but require them to take measures to protect investors. One of these measures is to assess investors’ understanding of virtual currencies. For example, whether they have taken courses, have relevant work experience, or have bought and sold virtual currencies before. The key point is that, even if retail investors understand virtual assets, the platform still has an obligation to assess their risk tolerance.
Overall, if a platform wants to accept retail investors, it must first demonstrate that investors have sufficient understanding of the characteristics and risks of virtual currencies and assess their risk tolerance.
2. The platform must have general token admission criteria
If a platform wants to accept any currency for trading, it must conduct due diligence on it. Now that regulators have relaxed the rules, the platform only needs to consider the regulatory status of virtual assets in Hong Kong, not around the world. For example, see if this virtual currency in Hong Kong belongs to a security token. However, the platform still needs to ensure that its operations comply with the laws of all jurisdictions in which it does business.
Because if it is illegal elsewhere, it will still affect the platform’s operating qualifications in Hong Kong.
2. Does each token need to submit a legal opinion?
The answer is no, because it is too expensive to submit a legal opinion for each virtual currency, and regulatory agencies have cancelled the requirement for the platform to submit a written legal opinion for each virtual currency. However, the platform still needs to ensure that they only operate non-securities tokens, so when approving, regulatory agencies may require the platform to provide legal opinions on certain specific tokens.
3. Can only trade “qualified large virtual assets”
Qualified large virtual assets refer to virtual assets included in the index of at least two independent index providers at the same time.
At least one index provider specializes in providing traditional financial market indexes. And these indexes must meet certain conditions to be recognized:
1) These indexes must be investable, that is, the virtual assets included have sufficient liquidity.
2) The calculation method of the index must be objective and regular.
3) Index providers must have sufficient professional knowledge and technical support to provide and review these indexes.
4) The compilation methods and rules of these indexes must have clear records, transparency and consistency.
According to this standard, Bitcoin and Ethereum clearly meet the requirements and can be opened for individual investors to trade.
4. Retail customers should not be allowed to trade stablecoins until the stablecoin regulatory system is implemented.
Regulators have prohibited trading platforms from offering security-type virtual currencies for retail investors to buy and sell. They state that due to the potential instability of stablecoins, there is a high risk of large-scale redemptions. Until stablecoins are regulated in Hong Kong, they should not be included in platforms for retail investors to buy and sell. The Hong Kong Monetary Authority has issued regulatory proposals regarding stablecoins in January 2023.
It is expected that the regulatory policy for stablecoins will be implemented in 2023/2024.
5. Do OTC exchanges, market makers, and trusts need to apply for a VASP license?
This question goes back to how the Hong Kong Securities and Futures Commission defines virtual asset services. The following is their definition:
According to Schedule 3 B of the Anti-Money Laundering Ordinance and the VASP Guidelines, activities related to virtual asset services (VA Service) are defined as: only operating virtual asset exchanges, namely:
(a) providing services that meet the following descriptions through electronic means:
(1) Such services:
A. Offers to buy or sell virtual assets are frequently made or accepted in a manner that creates or results in binding transactions; or
B. Persons frequently introduce or identify each other to negotiate or complete the purchase or sale of virtual assets, or they frequently introduce or identify each other to negotiate or complete such transactions in a manner that creates or results in binding transactions; and
(2) In such services, customer funds or customer virtual assets are directly or indirectly controlled by the person providing such services; and
(b) Any virtual asset trading activity and ancillary services conducted outside the platform provided to customers by the platform operator, and any activities carried out in relation to virtual asset trading conducted outside the platform.
Therefore, for (1) centralized virtual asset exchanges operating in Hong Kong, and (2) offshore centralized virtual asset exchanges actively promoting their services to Hong Kong investors , if they engage in the above-mentioned activities, they fall within the scope of virtual asset services. According to Section 53ZRD of the Anti-Money Laundering Ordinance, any entity that operates a virtual asset service must obtain an SFC VASP license.
Currently, except for the aforementioned virtual asset services, other businesses such as OTC exchanges, market makers, futures contracts, and derivatives are currently not yet qualified and have no applicable laws, but it is not ruled out that the Hong Kong Financial Services and Treasury Bureau will include other virtual asset services through announcements published in the Gazette in the future.
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