Cryptocurrencies and blockchain technology have established a new economy and thereby brought new investment opportunities.
Without direct legislation regulating the use of cryptocurrencies in Hong Kong, there lies a certain degree of uncertainty regarding how they can be used legitimately. This article will explain (i) the relevant regulated activities; (ii) the Securities and Futures Commission (the “SFC”) regulatory approach; (iii) the licensing requirements; (iv) the licensing application process; and (v) the qualified corporations’ ongoing obligations.
What is cryptocurrency?
A cryptocurrency is a form of digital asset based on a network that is distributed, using blockchain technology, across a large number of computers that manage and record transactions. It is not issued by any central authority.
When do I need a license to engage in cryptocurrency-related investment activities?
As per the Securities and Futures Ordinance (“SFO”), any company or individual engaged in a regulated activity must apply for the relevant license, unless an exemption applies. Depending on the nature of your business, you may need to apply for more than one license to engage in the regulated activities.
Currently, there are 12 types of regulated activities and the relevant ones are described below:
Dealing in securities (Type 1)
- Making or offering to make an agreement with another person, or inducing or attempting to induce another person to enter into or to offer to enter into an agreement for or with a view to acquiring, disposing of, subscribing for or underwriting securities; or the purpose or pretended purpose of which is to secure a profit to any parties from the yield of securities or by reference to fluctuations in the value of securities.
Dealing in futures contracts (Type 2)
- Making or offering to make an agreement with another person, or inducing or attempting to induce another person to enter into, or to acquire or dispose of, a futures contract.
Advising on securities (Type 4)
- Giving advice and issuing analyses or reports on whether, which, when and terms of securities should be acquired or disposed of.
Advising on futures contracts (Type 5)
- Giving advice and issuing analyses or reports on whether, which, when and terms of future contracts should be entered into.
Providing automated trading services (ATS) (Type 7)
- Services provided by means of electronic facilities, not being facilities provided by a recognized exchange company or a recognized clearing house that offers to sell or purchase securities and futures contracts, or enter into OTC derivative transactions.
- Persons may be regularly introduced or identified to other persons to negotiate or conclude sales or purchases of securities or futures contracts or OTC derivative transactions.
- Above transactions may be novated, cleared, settled or guaranteed.
Asset management (Type 9)
- Management of real estate investment schemes, securities or futures contracts.
Bitcoin Futures traded on and subject to the rules of certain exchanges in the United States are regarded as “futures contracts”, which are defined as to include “a contract or an option on a contract made under the rules or conventions of a futures market”. Hence, entities carrying on business in dealing in Bitcoin Futures would be required to be licensed for dealing in futures contracts (Type 2). Marketing a fund investing in Bitcoin Futures will normally constitute dealing in securities (Type 1) and managing such a fund may constitute asset management (Type 9). Advising on Bitcoin Futures may fall under advising on futures contracts (Type 5).
On the other hand, digital tokens offered in initial coin offerings are characterised as “virtual commodities” and may be regarded as “securities”. Where the digital tokens offered represent equity or ownership interests in a corporation, they may be regarded as “shares”. Where digital tokens are used to create or to acknowledge a debt or liability owed by the issuer, they may be considered as a “debenture”. If token proceeds are managed collectively by the initial coin offering scheme operator to invest in projects with an aim to enable token holders to participate in a share of the returns provided by the project, the digital tokens may be regarded as an interest in a “collective investment scheme”. Shares, debentures and interests in the scheme are regarded as “securities”. Dealing in or advising on the digital tokens that fall under the definition of “securities”, or managing or marketing a fund investing in such digital tokens, and engaging in secondary trading of such tokens may constitute a “regulated activity” and require a license.
On the other hand, virtual asset trading platforms typically provide trading in non-security tokens. The activities of the operator of a centralised platform which only provides trading services in non-security tokens will fall outside the SFC’s jurisdiction. Notwithstanding that, these platforms are also subject to SFC’s licensing regime.
The licensing requirement applies regardless of whether the party is located in Hong Kong, so long as its business activities target the Hong Kong public. Investors should be aware, in the case where the relevant cryptocurrencies are regarded as “securities” or “futures contracts”, platforms offering cryptocurrency services without a license may contravene with the Securities and Futures Ordinance or the Gambling Ordinance. It should be noted that all gambling activities, unless expressly authorised under the Gambling Ordinance, are unlawful.
SFC’s regulatory approach
Regulated activities
The SFC has established the SFC Regulatory Sandbox (the “Sandbox”) to provide a confined regulatory environment for qualified firms to operate regulated activities under the Securities and Futures Ordinance. The reliability of the delivery of these financial services and the firms’ internal control systems would be examined and monitored by the SFC.
Virtual asset trading platforms
Since engaging in non-securities falls outside of the SFC’s jurisdiction, a virtual asset trading platform should operate a centralised online trading platform in Hong Kong and offer trading of at least one security token on its platform. The platform operator would then fall within the jurisdiction of the SFC and require a licence for dealing in securities (Type 1) and providing ATS (Type 7) regulated activities.
How can I qualify to operate my business in the Sandbox?
The Sandbox is available to both licensed corporations and start-up firms that intend to carry on a regulated activity under the Securities and Futures Ordinance (the “SFO”) or operate a virtual asset trading platform. The qualified firm or platform operator must be fit and proper, utilise innovative technologies and be able to demonstrate a genuine and serious commitment to carry on regulated activities through the use of financial technology. The activity should increase the range and quality of products and services, and benefit the financial services industry in Hong Kong.
The SFC may impose licensing conditions. For firms, the conditions may limit the types of clients it may serve or the maximum exposure of each client. For platform operators, the conditions may require the services to be only provided to professional investors, compliance with the “Terms and Conditions for Virtual Asset Trading Platform Operators” or monthly reports to the SFC on its business.
How can I apply for a license to be legally involved in cryptocurrencies?
Please refer to the FAQ “Do I need a license to give investment advice to others?”
What are the ongoing obligations of a qualified firm?
Licensed corporations must comply with the Financial Resources Rules under Cap. 571N Securities and Futures (Financial Resources) Rules. Firstly, it must at all times maintain financial resources including paid-up share capital and liquid capital. The paid-up share capital requirement does not apply if the licensed corporation is licensed for Type 4, Type 5, Type 9 or Type 10 regulated activity, which is subject to the specified licensing condition, or licensed for Type 6 regulated activity which is subject to both the specified licensing and no sponsor work licensing conditions.
Please refer to Schedule 1 of Cap. 571N Securities and Futures (Financial Resources) Rules for the minimum amount of paid-up share capital and liquid capital.
Qualified firms should have adequate investor protection measures in place to address actual or potential risks or concerns identified. For example, clients should be provided with a full disclosure of the potential risks and possible compensation arrangements. If the SFC no longer considers the firm as fit and proper to remain licensed, the license may be revoked.
Key Takeaways
- The SFC has jurisdiction over regulated activities involving cryptocurrencies, which require to be licensed.
- Qualified and licensed firms and virtual asset trading platforms should carry on their regulated activities in the Sandbox and comply with licensing conditions imposed.
References:
- SFC Regulatory Sandbox: https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=17EC63
- SFC Statement on security token offerings: https://www.sfc.hk/en/News-and-announcements/Policy-statements-and-announcements/Statement-on-Security-Token-Offerings
- SFC Statement on initial coin offerings: https://www.sfc.hk/en/News-and-announcements/Policy-statements-and-announcements/Statement-on-initial-coin-offerings
- https://www.info.gov.hk/gia/general/202103/17/P2021031600547.htm
- Securities and Futures Ordinance
- Securities and Futures (Financial Resources) Rules
- Circular on Bitcoin futures contracts: https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=17EC79
- Regulation of virtual asset trading platforms: https://www.sfc.hk/-/media/EN/files/ER/PDF/20191106-Position-Paper-and-Appendix-1-to-Position-Paper-Eng.pdf
Terms and Conditions for Virtual Asset Trading Platform Operators: https://apps.sfc.hk/publicreg/Terms-and-Conditions-for-VATP_10Dec20.pdf