In their recent Joint Circular to intermediaries1 on 20 October 2023, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) set out their updated policy and approach on regulation of virtual asset-related2 activities (VA-related activities) and virtual asset-related products (VA-related products).
Regulatory Approach Updated
The initial regulatory approach taken by the SFC in 2018 was to impose an overarching “professional investors only” restriction on various types of VA-related activities.
As VAs expanded into mainstream finance and increasingly different types of VA-related products became available, the regulatory approach evolved. In particular, the SFC has allowed SFC-licensed VA trading platforms (VATPs)3 to serve retail investors and has also authorised VA futures exchange traded funds for public offering in Hong Kong.
In light of the rapid developments in the global VA market and against the backdrop of recent VA-related incidents and investigations relating to players in Hong Kong and elsewhere, the SFC and the HKMA have reviewed and updated their existing policy on regulating intermediaries engaging in VA-related activities.
The updated policy covers: (i) the distribution of VA-related products, (ii) providing VA dealing services, (iii) providing VA asset management services; and (iv)providing VA advisory services.
The Joint Circular supersedes the joint circular on intermediaries’ VA-related activities published by the SFC and the HKMA released on 28 January 2022.
- Intermediaries currently providing VA dealing services to non-qualified corporate investors and individual professional investors4 – and wish to continue doing so – should revise their systems and controls to align with the updated requirements. A 3-month transition period will be allowed for intermediaries serving existing clients of their VA dealing services before full implementation.
- Intermediaries not currently engaged in VA-related activities, or planning to extend their VA dealing services to non-qualified corporate professional investors, individual professional investors or retail investors, should ensure that they are able to comply with the updated requirements before introducing such services.
- The SFC and the HKMA clarify that intermediaries may continue to provide VA-related services to their existing clients who have been assessed to possess knowledge of VAs based on the results of their VA knowledge tests conducted before the date of the Joint Circular.
A. Distribution of VA-related products
1. The SFC and the HKMA are imposing additional investor protection measures on the distribution of VA-related products, on top of requirements under the complex product regime5. The objective is to address the uneven global regulatory landscape as well as complement the existing regulatory regimes applicable to VA-related activities.
2. The additional measures target specific risks and investor protection issues associated with VA-related products. These include counterparty risks on service providers6 – which are unregulated or subject to light-touch regulation only – and lack of pricing transparency and potential market manipulation in VA spot markets.
3. The additional measures are:
(a) Selling restrictions
- VA-related products are considered as complex products and should only be offered to professional investors (PI).
- The PI restriction does not apply to a limited suite of VA-related derivative products that are traded on regulated exchanges specified by the SFC7, and exchange-traded VA derivative funds authorised or approved for offering to retail investors by respective regulators in designated jurisdictions8. Nonetheless, as these products are complex exchange-traded derivatives caught by the complex product regime, intermediaries are still subject to the relevant requirements under that regime.9
(b) VA-knowledge test
- This measure applies to investors other than institutional PIs and qualified corporate PIs10.
- Intermediaries should assess whether a client has knowledge of investing in VA or VA-related products before effecting a transaction on the client’s behalf. A one-off knowledge assessment conducted by an intermediary prior to entering into a transaction in a VA-related product will satisfy this requirement.
- If a client lacks such knowledge, the intermediary can only proceed after providing adequate training to the client on the nature and risks of VAs.
- The SFC and the HKMA have provided a list of non-exhaustive criteria for assessing client knowledge:
- whether the client has undergone training or attended courses on VA or VA-related products;
- whether the client has current or previous work experience related to VA or VA-related products; and
- whether the client has prior trading experience in VA or VA-related products.
- Intermediaries should also ensure that clients have sufficient net worth to assume the risks and bear the potential losses of trading VA-related products.
4. Other selling restrictions
The SFC and the HKMA remind intermediaries to comply with the selling restrictions in Hong Kong and other jurisdictions which may apply to a particular VA-related product:
(a) In particular, if a VA-related product is caught by Part IV of the Securities and Futures Ordinance (SFO), offering the product to the Hong Kong public is prohibited unless authorised by the SFC. An example is a VA-related product which is a collective investment scheme.
(b) Depending on the selling restrictions specific to a particular jurisdiction, exchange or product, a VA-related product may or may not be offered to retail investors.11
(c) Where the VA-related products are distributed on an online platform, it must be properly designed and have appropriate access rights and controls to ensure compliance with applicable selling restrictions.
5. Suitability obligations
Intermediaries should also observe the applicable suitability obligations, as supplemented by the Suitability FAQs12, including:
(a) ensuring that recommendations or solicitations made are suitable for clients, by diligently assessing whether the nature and features of the VA-related product (including the effects of gearing and the risks of the underlying VAs) are suitable for the client and in the client’s best interest, taking into account the client’s risk tolerance, financial situation and other circumstances;
(b) where the VA-related product is a derivative product, ensuring compliance with paragraphs 5.1A and 5.3 of the Code of Conduct; and
(c) conducting proper due diligence on the VA-related products, including understanding their risks and features, the targeted investors and the products’ regulatory status, and conducting additional due diligence on non-SFC authorised VA funds13.
6. Risk disclosures and warning statements
(a) As part of its obligation under paragraph 5.3 of the Code of Conduct in assessing whether to provide a client with services for VA-related derivative products, an intermediary should satisfy itself that the client understands the nature and risks of these products. Intermediaries should provide clients with risk disclosure statements specific to VA futures contracts14, including leveraged trading increasing the client’s exposure to the volatility of the underlying VA.
(b) Intermediaries should also provide information and warning statements to clients in relation to VA-related products and information on the underlying VA investments in a clear and easily understandable manner.
(c) The above requirements do not apply to institutional PIs and qualified corporate PIs.
7. Financial accommodation
Intermediaries should be cautious in providing any financial accommodation to clients for investing in VA-related products, given the high-risk nature of VAs. An intermediary should satisfy itself that the client has the financial capacity to meet the obligations arising from leveraged or margin trading in VA-related products, even in the worst-case scenario.
B. Provision of VA dealing services
8. Intermediaries are required to partner only with SFC-licensed platforms
(a) The SFC and the HKMA require intermediaries to partner only with SFC-licensed VATPs for providing VA dealing services. SFC-licensed VATPs for the present purpose include only those currently licensed by the SFC pursuant to the AMLO or the SFO. It does not include any VATP deemed to be licensed or approved during the transition period pending the SFC’s approval of its VATP licence application under the VATP licensing regime15.
(b) The rationale is to provide adequate investor protection. The regulators are concerned that many overseas VATPs may not be subject to regulatory standards comparable to those under the SFC’s licensing and regulatory regime, or may not be regulated at all.
(c) The partnering up arrangement between an intermediary and a SFC-licensed VATP may take the form of the intermediary introducing clients to the SFC-licensed VATP, or the intermediary establishing an omnibus account with the SFC-licensed VATP.
9. Intermediaries must be licensed / registered for dealing in securities
(a) At present, the SFC and the HKMA are only prepared to allow intermediaries licensed or registered for Type 1 regulated activity (dealing in securities) to provide VA dealing services, and only to their Type 1 clients.
(b) Where an intermediary acts as an introducing agent
- Where an intermediary provides VA dealing services to its Type 1 clients as an introducing agent, the intermediary should not (i) relay orders on the clients’ behalf to the SFC-licensed platforms; or (ii) hold client assets for the introducing services (whether fiat currencies or VAs). These restrictions will be imposed on the intermediary as licensing or registration conditions.
- Under the introducing agent model, the SFC-licensed platform will have to onboard the clients of the intermediary as its own clients and trade with them directly through the platform. Trading accounts with the platform will be designated in the names of the respective clients. The intermediary should enter into a written agreement with the SFC-licensed platform to set out the respective responsibilities of the intermediary and the SFC-licensed platform under the introducing arrangement.
(c) Where an intermediary establishes an omnibus account
- Where an intermediary provides VA dealing services to its Type 1 clients under an omnibus account, the conduct requirements will be imposed on the intermediary as licensing or registration conditions. These conditions and the applicable conduct requirements are set out in Appendix 6 to the Joint Circular.
- All intermediaries will be subject to a licensing or registration condition requiring them to comply with the SFC-prescribed terms and conditions (Terms and Conditions)16. These Terms and Conditions align with the requirements under the VATP regulatory framework, to the extent that they are relevant to the performance of the dealing function by the intermediaries.
- The SFC and the HKMA draw intermediaries’ particular attention to the following Terms and Conditions:
1. Before providing VA dealing services to retail clients, intermediaries should:
- assess each retail client’s knowledge of VAs and risk tolerance level;
- set a limit for each retail client to ensure that the client’s exposure to VAs is reasonable with reference to the client’s financial situation, including net worth and personal circumstances;
- ensure that the VA dealing activities are conducted through an omnibus account established and maintained with an SFC-licensed platform which is not subject to the licensing condition that it can only serve PIs; and
- implement adequate controls to ensure that their retail clients can only trade in those VAs that are made available by the SFC-licensed platform for trading by retail investors; and
2. Intermediaries which allow clients to deposit or withdraw VAs from their accounts should only receive or withdraw such client VAs through the segregated account(s) established and maintained with:
- their partnered SFC-licensed platforms; or
- authorised financial institutions17 (or subsidiaries of locally incorporated authorized financial institutions) which meet the expected standards of VA custody issued by the HKMA from time to time.
Intermediaries should also comply with the requirements under Chapter 12 of the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers) when handling these VA deposits and withdrawals.
(d) Intermediaries providing dealing services in tokenised securities should comply with the existing requirements governing dealing in securities and the conduct requirements and guidance on tokenised securities issued by the SFC from time to time.
C. Provision of asset management services for VAs
10. Intermediaries must be licensed / registered for asset management
(a) At present, the SFC and the HKMA are only prepared to allow intermediaries licensed or registered for Type 9 regulated activity (asset management) to perform asset management activities for VAs meeting the de minimis threshold.
(b) The de minimis threshold is met where there is a stated investment objective of a portfolio to invest in VAs or an intention to invest 10% or more of the gross asset value of a portfolio in VAs. Intermediaries acting as VA portfolio manager or providing discretionary account management services are subject to the additional requirements set out in the Proforma Terms and Conditions for licensed corporations or registered institutions which manage portfolios that invest in VAs18. These requirements will be imposed on the intermediary as licensing or registration conditions.
(c) The SFC and the HKMA also clarify that where a Type 1 intermediary provides VA dealing services on a discretionary basis to a client (with the client’s express authorisation) wholly incidental to its Type 1 services, the intermediary should only invest less than 10% of the gross asset value of the client’s portfolio in VAs.
(d) Intermediaries providing asset management services in tokenised securities should comply with the existing requirements governing asset management and the conduct requirements and guidance on tokenised securities issued by the SFC from time to time.
D. Provision of VA advisory services
11. Intermediaries must be licensed / registered for dealing in or advising on securities
(a) At present, the SFC and the HKMA are only prepared to allow intermediaries licensed or registered for Type 1 regulated activity (dealing in securities) or Type 4 regulated activity (advising on securities) to provide VA advisory services. and only to their Type 1 or Type 4 clients respectively.
(b) The VA advisory services form part of an intermediary’s advisory business. Intermediaries should comply with all the regulatory requirements imposed by the SFC and the HKMA when providing advisory services, whatever the nature of the VAs.
(c) The conduct requirements for VA-advisory services are set out in the Terms and Conditions (see Appendix 6 to the Joint Circular). In particular, intermediaries providing VA-advisory services are expected to comply with the suitability obligations.
(d) When recommending any VAs to retail clients, intermediaries should take all reasonable steps to ensure that the VA recommended:
- is of high liquidity19; and
- is made available by SFC-licensed platforms for trading by retail investors.
(e) Intermediaries providing advisory services in tokenised securities should comply with the existing requirements governing advising on securities and the conduct requirements and guidance on tokenised securities issued by the SFC from time to time.
Finally, the SFC and the HKMA remind intermediaries to notify them in advance if:
(a) they intend to engage in any activities involving tokenised securities and VAs, including providing dealing and advisory services in VA-related products, tokenised securities and VAs, and providing VA asset management services; or
(b) they intend to make any changes to these activities conducted, including changes in the type of clientele served.
Virtual assets activities and the VA market are one of the key areas of development for the HKSAR Government. Quoting from Financial Secretary Paul Chan’s keynote speech at a recent global regulatory forum, the Hong Kong Government is committed to implementing a robust and consistent regulatory regime for VAs, following the “same activity, same risk, same regulation” principle.
A robust regime with rules applied in a consistent manner, agilely balancing investor protection, market stability and technological advancement, is crucial to a healthy and sustainable VA market in Hong Kong.
Link to SFC/HKMA Joint Circular:
Joint circular on intermediaries’ virtual asset-related activities (hkma.gov.hk)
2 See definition of “virtual assets” or VAs in section 53ZRA of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO). VA-related products refer to any investment products which: (a) have a principal investment objective or strategy to invest in VAs; (b) derive their value principally from the value and characteristics of VAs; or (c) track or replicate the investment results or returns which closely match or correspond to VAs.
4 See section 15 of the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) for the meanings of non-qualified corporate professional investors and individual professional investors.
5 The complex product regime refers to the requirements in paragraph 5.5 of the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) and Chapter 6 of the SFC’s Guidelines on Online Distribution and Advisory Platforms.
11 In some jurisdictions such as Mainland China, the sale of VA-related products to Mainland investors may be prohibited. Further, the rules of an established futures exchange governing VA futures contracts traded on the exchange may prohibit the offering of such futures contracts to retail investors.
12 This refers to the Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons and the Frequently Asked Questions on Triggering of Suitability Obligations (see here).
19 In assessing the liquidity of a specific VA for trading by retail clients, intermediaries should at a minimum ensure that the VA is an eligible large-cap VA (i.e. it should have been included in at least two acceptable indices issued by at least two different index providers).