After the implementation of the VASP system, the China Securities Regulatory Commission (CSRC) will regulate the securities-type token transactions conducted by virtual asset trading platforms (involving 1 and 7 number plates) in accordance with the existing system under the Securities and Futures Regulations and non-securities-type token transactions in virtual assets trading platforms (involving VASP licenses) in accordance with the VASP system under the Anti-Money Laundering Regulations. 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 rules and ensure the continuous operation of the business, the CSRC requires virtual asset trading platforms (along with their proposed responsible personnel and licensed representatives) to apply for approval in accordance with the existing system under the Securities and Futures Regulations and the VASP system under the Anti-Money Laundering Regulations to obtain dual licenses and approvals. The CSRC will provide simplified application measures for the dual license system. It is worth noting that this arrangement by the CSRC is consistent with the author’s expectations when interpreting the revised Anti-Money Laundering and Terrorist Financing (Amendment) Bill in 2022. For details on licensing applications, please read:
1. VASP License Business Interpretation and Application Details Effective June 2022!
2. Hong Kong VASP Compliance Guidelines: Detailed Interpretation of the Travel Rule that Must Be Complied With Starting June 1, 2023
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I. Can VASP licensed exchanges provide services to retail investors?
The CSRC confirmed that licensed platform operators will be allowed to provide non-securities-type token trading services to retail investors, but only if they adopt a series of proper investor protection measures, including measures for establishing a business relationship with customers, token inclusion, token due diligence plans, and information disclosure, among other things.
1. Establishing a Business Relationship with Customers and Conducting Knowledge Assessments
The regulatory authorities are prepared 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, they can check whether they have taken courses, have relevant work experience, or have traded virtual currencies before. The key point is that if they have bought or sold five or more times in the past three years, they cannot be considered to have sufficient understanding. Even if retail investors understand virtual assets, the platform still has an obligation to assess their risk tolerance.
Overall, in order for a platform to accept retail investors, it must first demonstrate that investors have sufficient understanding of the characteristics and risks of virtual currencies, and evaluate their risk tolerance.
2. The platform needs to establish general token inclusion criteria
For a platform to accept any currency for trading, it must conduct due diligence on it. Now that regulatory agencies have relaxed their rules, platforms only need to consider the regulatory status of virtual assets in Hong Kong, rather than around the world. For example, they can check whether this virtual currency is a security token in Hong Kong. However, the platform still needs to ensure that its operations comply with the laws of all jurisdictions where it conducts business, because if it violates the law 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 the cost of submitting a legal opinion for each virtual currency is too high, regulatory agencies have cancelled the requirement for the platform to submit a legal written opinion for each virtual currency. However, the platform still needs to ensure that only non-securities tokens are operating on the platform, 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 that are included in the indexes of at least two independent index providers at the same time.
At least one of the index providers specializes in providing traditional financial market indexes. These indexes must meet certain conditions to be recognized:
1) These indexes must be investable, that is, the included virtual assets have sufficient liquidity.
2) The calculation method of the index must be objective and rule-based.
3) The index provider must have sufficient professional knowledge and technical support to provide and review these indexes.
4) The compilation methods and rules of these indices must have clear records, transparency and consistency.
Based on this standard, Bitcoin and Ethereum are clearly eligible and can be opened for individual investor trading.
4. Stablecoin trading should not be allowed for retail clients until stablecoin regulations are implemented
Regulators have prohibited trading platforms from providing securities-type virtual currencies for retail investors to buy and sell. This is because stablecoins may have unstable values and pose a high risk of large-scale redemptions. Before 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 (HKMA) has issued regulatory recommendations on stablecoins in January 2023.
It is expected that the regulatory policy on stablecoins will be implemented in 2023/2024.
Do OTC, market makers, and trusts need to apply for a VASP license?
This question depends on how the Securities and Futures Commission (SFC) of Hong Kong defines virtual asset services. The SFC’s definition is as follows:
According to Schedule 3B and the VASP Guidelines of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance, a virtual asset service (VA Service) related activity is defined as:
Providing services that:
A. Involve the making or acceptance of an offer to buy or sell virtual assets, which often results in a binding transaction or the formation of a binding transaction, or may result in a binding transaction;
B. Often involve the introduction or identification of two or more persons to each other, in order for them to negotiate or conclude the buying or selling of virtual assets, or in reasonable expectation of such negotiation or conclusion taking place, and which often results in a binding transaction or the formation of a binding transaction, or may result in a binding transaction; and
(i) the customer funds or customer virtual assets are directly or indirectly managed or controlled by the person providing the service; and
(ii) any virtual asset transaction activities and incidental services provided by the platform operator to its customers outside the platform, and any activities carried out in relation to virtual asset transactions conducted outside the platform.
Therefore, (1) centralized virtual asset trading platforms operating in Hong Kong and (2) offshore centralized virtual asset trading platforms that actively promote their services to Hong Kong investors are both within the scope of virtual asset services if they engage in the above activities. According to section 53 ZRD of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance, any entity that provides virtual asset services must obtain a VASP license from the SFC.
Currently, apart from the above virtual asset services, other businesses such as OTC exchanges, market makers, futures contracts, and derivatives are still not qualified and temporarily have no applicable laws, but it is not ruled out that Hong Kong’s financial and treasury departments will include other virtual assets through announcements published in the Gazette in the future.