1. Introduction
Hong Kong, an international financial hub, is now a focal point in the cryptocurrency sector. Amid global regulatory shifts, Hong Kong's journey – from the JPEx incident in 2023 to current practices – offers a unique look at evolving crypto dynamics. This study explores Hong Kong's regulatory framework, focusing on authorities like the HKMA and SFC, and their impact on market players.
This study delves into the regulatory landscape of cryptocurrencies in Hong Kong. It examines the approaches of regulatory authorities such as the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC), assessing how these measures impact players in this market.
2. Overview of Hong Kong's Cryptocurrency Market
Before we can paint a clear picture of the crypto market in Hong Kong we must first define some of the key terms used to describe different types of tokens and their utility:
Security Tokens
Digital tokens, including cryptocurrencies, are classified as "securities" if they meet criteria such as representing company equity, acknowledging issuer's debts, offering returns akin to dividends, or giving holders rights like voting or a share in liquidation assets. For example, Tykhe Capital introduced the PRINCE Token in 2023 as the first security token offering (STO) offered by HK real estate funds for professional investors. It is sanctioned by HK SFC and it’s subject to regulatory greenlight.
Non-Security Tokens
Cryptocurrencies outside the realm of security tokens fall under "non-security tokens" or "virtual assets," with stablecoins being a subtype.
Other Tokens
Payment Tokens: Mainly used for buying goods and services, like Bitcoin, these tokens don’t represent company stakes or provide inherent rights. Their trade can incur capital gains tax.
Utility Tokens: These digital assets grant access to specific services within their issuing networks. Unlike investment tools, they're meant to add practical value within their ecosystems.
Market Trends
The "Worldwide Crypto Readiness Report 2023" ranks Hong Kong top globally in crypto readiness, scoring 8.36. Crypto traders in Hong Kong benefit from a 0% tax rate, with numerous crypto ATMs and blockchain companies. This suggests a possible shift in China's stance on digital assets, viewing Hong Kong as a pivotal gateway for international crypto trade, akin to Guangzhou's historical "Thirteen Factories."
Hong Kong's market mainly focuses on large-scale transactions for institutional and high-net-worth individuals. Platforms like HashKey and OSL cater to this segment. HashKey's retail platform, launched on August 3, 2023, has already surpassed $600 million in trades, with a record single-day volume of $100 million on October 30. OSL, meanwhile, targets professional investors and businesses, requiring brokerage services for retail trading.
Key Market Players in Hong Kong's Crypto Sphere
Exchanges
Top Tier: HashKey Exchange and OSL, holding licenses No. 1 and No. 7.
Second Tier: License applicants including OKX, HKVAEX, HKbitEX, Hong Kong BGE, and Victory Fintech (Victory Securities), etc.
HashKey leads in product development, particularly in mobile platforms, among Hong Kong-based trading platforms. Its trading volume has seen a steady increase to $80 million since November, although it's important to note that there is a potential for volume inflation. License restrictions limit these platforms to Bitcoin and Ethereum spot trading, excluding staking, leverage, wealth management, and contracts, posing significant challenges in customer acquisition and business expansion over time.
Investor Demographics
Between July 2022 and June 2023, Hong Kong based marketplaces saw about $64 billion in crypto transactions, nearing Mainland China's $86.4 billion, despite having just a fraction of Mainland China's population. This is largely due to Hong Kong's robust over-the-counter (OTC) trading market, catering to institutional investors and high-net-worth individuals, resulting in a more substantial number of transactions above $10 million compared to Mainland China. However, Hong Kong lags in retail trading, with only a 3.1% share of local retail users engaged in the crypto market, compared to the global average of 4%.
Additional Market Contributors
This includes cryptocurrency wallet providers, crypto funds, payment service providers, and blockchain development firms, all vital for technological and service support in the crypto market.
3. Hong Kong's Crypto Regulatory Framework: Authorities, Regulations, and Licenses
Key Regulatory Bodies
Hong Kong Monetary Authority (HKMA): Oversees banking and monetary policies, including crypto-related transactions and services.
Securities and Futures Commission (SFC): Regulates securities and futures markets. SFC and HKMA jointly issued guidelines on virtual asset activities, outlining regulatory methods for crypto asset distribution, trading, and advisory services.
Typical Regulatory Requirements
Anti-Money Laundering (AML) and Counter-Terrorist Financing (CFT): Proposed amendments by the Financial Services and the Treasury Bureau (FSTB) to include exchanges offering non-security crypto assets under SFC's supervision.
Licensing Requirements
Virtual Asset Service Provider (VASP) License
Providers of Virtual Asset services in Hong Kong must possess a VASP license from SFC, adhering to high standards akin to those for major banks and asset managers. This system became effective on June 1, 2023.
10 types of Licensing
The SFC also stipulates the 10 types of regulated activities and provides detailed definitions for each of them. These activities are:
Type 1: Dealing in securities
Offer stock and stock option trading and brokerage services to clients.
Execute bond transactions on behalf of clients.
Handle the purchase and sale of mutual funds and unit trust funds for clients, including the distribution and underwriting of these securities.
Type 2: Dealing in futures contracts
Type 3: Leveraged foreign exchange trading
Type 4: Advising on securities
Advise clients on the sale and purchase of securities.
Provide clients with research reports and analyses on various securities.
Type 5: Advising on futures contracts
Type 6: Advising on corporate finance
Type 7: Providing automated trading services
Run an electronic trading platform facilitating the matching of client buy and sell orders.
Type 8: Securities margin financing
Type 9: Asset management
Manage clients' securities or futures contract investment portfolios and funds under full discretionary authority.
Type 10: Providing credit rating services
Licenses Nos. 1, 4, 7, and 9 are particularly significant for crypto companies, as they cover securities trading, advice on securities, automated trading services, and asset management respectively.
While the Type 9 License is intended for traditional finance companies seeking to legally operate crypto funds need to apply to the SFC in order to get approval for conducting digital currency operations within their funds. Interestingly, the scope of crypto fund operations can expand with improved performance.
Hong Kong Crypto Compliance Fund Example
Sinohope Asset Management (Hong Kong) Limited (“SINOHOPE ASSET”) is a fully regulated virtual asset management institution holding SFC Type 4 (Advising on Securities) and Type 9 (Asset Management) licenses. As the first SFC-licensed Virtual Asset (“VA”) fund manager that manages active VA funds, it accepts both fiat and VA subscriptions and has launched the first VA discretionary managed account services in Hong Kong. Sinohope Asset specializes in Bitcoin and Ethereum funds, a multi-strategy virtual asset fund, and a private equity fund focusing on virtual asset mining.
4. Applying for Licenses in Hong Kong’s Crypto Sector
Essential Licenses for Crypto Funds
Asset Management License (Type 9): Necessary for managing investment portfolios, particularly crypto asset portfolios, under full discretion.
License for Providing Advice on Securities (Type 4): Required if offering investment advice or issuing securities-related research.
Virtual Asset Service Provider (VASP) License: Essential for funds involved in trading or managing virtual assets classified as securities, or operating virtual asset trading platforms.
Other Licenses: Depending on business activities, licenses like Providing Advice on Futures Contracts (Type 5) or Providing Automated Trading Services (Type 7) might be needed.
It is crucial that the fund adheres to the regulatory requirements in all pertinent sectors as stipulated by the Hong Kong Securities and Futures Commission (SFC). Additionally, the fund must also address tax compliance and adhere to anti-money laundering (AML) and counter-terrorist financing (CFT) norms.
Application Platform: WINGS
The WINGS platform serves as an all-encompassing system that integrates electronic spreadsheet and data submission services for the SFC.
To submit a license application to the Commission, users must first register and log into the WINGS platform. Once logged in, navigate to "Submission Management > New Submission > Application > Licensing applications" in the menu to begin the application process.
The platform features a well-equipped help center, including a textual User Guide and an Online Demo video tutorial, both accessible from the bottom right corner of the website's main page.
Capital Requirements
Note: Capital requirements vary by license type but typically include proof of shareholders' funds' source and legality, capital requirements for business operations, and legal mandates on registered capital. Regular financial reporting is mandated, with monthly or semi-annual submissions to the SFC, depending on the license type.
Management Personnel Requirements
A hedge fund manager must have at least two responsible officers (ROs) approved by the SFC to supervise the business. At least one of them should be fully competent and ordinarily based in Hong Kong.
The SFC accepts that some ROs may be based offshore, provided they can effectively delegate their supervisory responsibilities.
Application Timeline
Around six months for a new financial license from the SFC, while amending an existing license typically takes 3-4 months.
Application Process
Fill out the application form via the WINGS platform, either through a personal or a consultant company sub-account. Upon submission, track progress and pay required fees through WINGS.
Detailed application fee information can be found in the relevant table:
5. Hong Kong’s Crypto-Friendly Banks
In April 2023, Hong Kong's regulators encouraged banks to support virtual asset companies, aiming to position Hong Kong as a hub for the cryptocurrency sector. Banks were urged to enable crypto-related companies to open accounts for typical business needs like corporate payroll and office rent, but banks aren’t allowed to engage with these firms directly in crypto trading.
This directive, promoting a more crypto-accommodative approach, was communicated by the HKMA and SFC to key banks such as HSBC, Standard Chartered Bank, and Bank of China.
Banks are advised to use a “risk-based approach” when dealing with accounts linked to crypto companies’ client assets. The HKMA clarified that unlike Mainland China's ban since September 2021, working with crypto companies isn't illegal in Hong Kong.
Despite these regulatory encouragements, many digital asset startups in Hong Kong have faced challenges when trying to open bank accounts, often being turned away upon mentioning virtual assets.
In a positive shift, certain banks, including the Hong Kong branches of China CITIC Bank, Shanghai Pudong Development Bank, China Communications Bank, and the virtual bank ZA Bank backed by ZhongAn Financial Services, are increasingly open to providing services to crypto firms. HashKey Pro, one of Hong Kong's licensed virtual asset exchanges, has established partnerships with ZA Bank and China Communications Bank for fiat currency transactions.
ZhongAn Virtual Finance Limited, a joint venture formed in August 2018 by ZhongAn Online, Sinolink Group, and CITIC Bank International, applied for a virtual banking license in Hong Kong. ZhongAn Online, established in November 2013, is a collaboration between Ant Group, Tencent, and Ping An Insurance. Ant Group's Alipay played a crucial role in the development of China's e-commerce sector and in breaking the banking monopoly in payments. There is anticipation for ZhongAn's significant impact in the cryptocurrency arena.
6. Compliance Challenges and Strategies in Hong Kong's Crypto Sector
Compliance Challenges
License and Professional Investor Restrictions
The process of obtaining a cryptocurrency license is intricate and lengthy, often extending beyond six months. A crucial aspect of this process is securing a qualified Responsible Officer (RO). However, finding ROs with the requisite skills is challenging due to their scarcity and the associated high human resource costs. In the fast-evolving and periodically volatile cryptocurrency market, efficient time management is essential. Furthermore, applicants must ensure robust financial backing throughout the process to deal with the complexity of the procedures and possible delays.
In early November, the Hong Kong SFC issued a "Circular on intermediaries engaging in tokenised securities-related activities," signaling a significant development: tokenised securities offerings are now accessible beyond just professional investors. This indicates that Hong Kong, while adhering to regulatory standards, permits the public offering of tokenised funds and similar products to retail investors.
However, sources familiar with the matter indicate that due to concerns over investor protection and risk management, Hong Kong is unlikely to see tokenized funds for retail investors in the near future. Tokenization's potential to improve market liquidity hinges on adequate market demand, a robust price discovery process, and active trading. Presently, the market's awareness of tokenisation is limited, and challenges persist in terms of token liquidity and potential market manipulation. As a result, many tokenized funds lack a secondary market and face difficulties in gaining approval for trading on virtual asset exchanges.
Tax Compliance
Hong Kong taxes only local business profits, with a 15% rate for non-corporate entities and 16.5% for corporations.
Key features include no sales tax, no capital gains tax, and usually no tax on dividends.
From January 1, 2023, certain offshore passive incomes remain tax-exempt under specific conditions.
Digital asset taxation, as per revised DIPN 39, depends on asset classification and transaction nature. Income from Initial Token Offerings and long-term held digital assets have specific tax implications for example.
Cryptocurrencies that are received by employees as payment are subject to salary tax.
Fiat Currency Access
Traditional banks' caution towards cryptocurrencies limits the number of reliable fiat channels for crypto funds, increasing intermediary exchange costs.
Cryptocurrency Transfer Regulations
No specific law governs private peer to peer crypto transfers. If a conversion to fiat is involved, it falls under Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) requiring Customer Due Diligence for transactions over HK$8,000. It’s important to note that records related to these transactions must be kept for at least five years.
AML Requirements
Hong Kong's AMLO is applicable to a diverse range of financial entities. This includes banks under the Hong Kong Monetary Authority, companies authorized by the SFC, licensed insurance companies, stored value facility issuers, and money service operators.
Additionally, AMLO extends its reach to certain non-financial professions and businesses such as lawyers, certified public accountants, licensed real estate agents, and trust and company service providers. As stipulated by AMLO, all entities authorized by the Securities and Futures Commission to conduct regulated activities, including newly authorized Virtual Asset Service Providers (VASPs), are required to adhere to Anti-Money Laundering/Counter-Terrorist Financing (AML/CTF) obligations.
Furthermore, these entities must ensure their policies and practices align with the latest recommendations of the Financial Action Task Force (FATF).
Strategies for Navigating Hong Kong's Crypto Compliance Landscape
Legal and Financial Consulting
Engaging experts for real-time regulatory advice and strategic guidance helps funds adapt to legal changes, minimize compliance risks, and maintain operational stability. These advisors play a crucial role in liaising with regulators.
Internal Compliance System
Developing a robust internal system is critical for investment scrutiny, risk assessment, and ongoing compliance monitoring. Regular audits and staff training ensure adherence to current regulatory norms.
Collaborating with Banks
Demonstrating a track record of compliance and professional management is essential to meet banks' AML and KYC standards. Regular interactions with banks help foster transparency and trust while partnering with crypto-friendly banks enhances service stability and financial product quality.
Proactively Engaging with Regulators
Active participation in events like Hong Kong Fintech Week and regular engagement with bodies like the SFC and HKMA is vital for staying informed and connected, ensuring a deep understanding of the regulatory climate.
Monitoring & Transaction Surveillance Tools
Incorporating sophisticated tools like Chainalysis or OKLink for AML monitoring is vital. These solutions provide real-time insights into transactions, aiding in regulatory compliance and highlighting suspicious activities.
7. Conclusion
In the intricate world of Hong Kong's cryptocurrency market, primarily catering to sophisticated investors, navigating the complex regulatory environment is key. Market participants are encouraged to seek expert guidance, implement strong internal compliance frameworks, and employ cutting-edge technology. This approach is essential for meeting the rigorous standards established by the HKMA and SFC, especially under the new VASP licensing framework.
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