SFC outlines new regulatory framework for virtual asset trading platforms, HKMA highlights recent FinTech initiatives, and PBOC discusses China’s forthcoming central bank digital currency.
By Simon Hawkins and Kenneth Y.F. Hui
The fourth annual Hong Kong FinTech Week conference kicked off with a major announcement from Mr. Ashley Alder, Chief Executive Officer of the Securities and Futures Commission (SFC), who introduced a new, formalized regulatory framework for virtual asset trading platforms (VATPs). A panel of central bankers also discussed stablecoins and central bank digital currencies, including the People’s Bank of China’s (PBoC) forthcoming central bank digital currency, referred to as the digital currency / electronic payment (DCEP) coin.
Last year, the SFC published its conceptual framework for the potential regulation of VATPs and, since then, the SFC has worked behind the scenes with some of Hong Kong’s existing VATPs to better understand their operations, and to explain the SFC’s regulatory expectations, while also assessing VATPs capability to comply with the SFC’s expected requirements.
Importantly, under Hong Kong’s securities laws, the SFC only has power to regulate a VATP that trades virtual assets or tokens that are legally “securities” or “futures contracts.” Bitcoin and other, more familiar, cryptoassets are not securities, and nothing in the SFC’s new framework alters this position. The new framework therefore only applies to VATPs, which include at least one security virtual asset or token for trading. Thereafter, the SFC’s new rules will apply to all of a VATP’s operations, even if the vast majority of other virtual assets or tokens traded on the platform are not securities.
Essentially, the new regulatory framework allows a VATP to “opt in” to SFC regulation by electing to trade at least one security virtual asset. The SFC’s view is that the principal benefit of being regulated is that the VATP would be able to represent itself to clients as a supervised business. Once licenses are granted to the VATPs that choose to opt in, investors will then be able to distinguish easily between regulated platforms and platforms that are not regulated.
VATPs that wish to opt in under the new framework may apply to the SFC to be licensed for Type 1 (dealing in securities) and Type 7 (providing automated trading services) regulated activities. The SFC will only accept license applications from centralized VATPs that are based in Hong Kong, so decentralized and peer-to-peer VATPs will not be able to obtain licenses (for the time being, at least).
License applicants must demonstrate that they are willing and able to comply with the expected standards under the regulatory framework published by the SFC. Under the key licensing conditions that will be imposed on licensees, a VATP operator must:
- Only offer its services to “professional investors” (i.e., the general public will not be able to trade on SFC-licensed VATPs)
- Have stringent criteria for the inclusion of virtual assets to be traded on its platform
- Obtain the SFC’s prior written approval for any plan or proposal to add any product to its trading platform
- Submit monthly reports to the SFC on its business activities
- Engage an independent professional firm acceptable to the SFC to conduct an annual review of its activities and operations and prepare a report confirming that it has complied with the licensing conditions and all relevant legal and regulatory requirements
- Only provide services to clients who have sufficient knowledge of virtual assets
- Not conduct any offering, trading, or dealing activities of virtual asset futures contracts or related derivatives
- Adopt a reputable external market surveillance system to supplement its own market surveillance policies and controls
- Ensure that an insurance policy covering the risks associated with custody of virtual assets is in effect at all times
Notably, SFC-licensed VATPs should only include security virtual assets that are (i) asset-backed; (ii) approved or qualified by, or registered with, regulators in comparable jurisdictions; and (iii) with a post-issuance track record of 12 months.
In light of the intensive assessment process and to meet the expected regulatory standards, the time required for processing a licensing application from a VATP may be longer than the 16-week period that is typically expected for a standard securities licensing application.
If a platform operator is licensed, its infrastructure, core fitness and properness, and conduct of virtual asset trading activities should be viewed as a whole. Although trading activities in non-security virtual assets or tokens are not “regulated activities,” the SFC’s regulatory remit over all of these aspects of platform operations will be engaged once a platform involves trading activities in security virtual assets or tokens, even if these activities are a small part of its business.
The SFC has stated that it will continue to monitor the evolution of cryptoassets and work with the Hong Kong government to explore the need for legislative changes in the longer term.
Other FinTech Initiatives in Hong Kong
Mr. Eddie Yue, Chief Executive of the HKMA, highlighted a series of recent initiatives aimed to foster the FinTech ecosystem in Hong Kong:
- The subsidiaries of Hong Kong Interbank Clearing Limited and Institute of Digital Currency of the PBoC have signed a memorandum of understanding to connect the digital trade finance platforms of Hong Kong and the PRC.
- The HKMA and the Bank of Thailand are conducting a joint research project to study the application of central bank digital currency to cross-border payments, with a view to facilitating HKD-THB payment-versus-payment among banks in Hong Kong and Thailand. A joint report is scheduled for release in the first quarter of 2020.
- The first-ever innovation hub of the Bank of International Settlements (BIS) commenced operations in Hong Kong in November 2019. The mandate of the BIS innovation hub is to identify and develop in-depth insights into critical trends in financial technology of relevance to central banks, to explore the development of public goods to enhance the functioning of the global financial system, and to serve as a focal point for a network of central bank experts on innovation.
- The HKMA is conducting a study on the application of artificial intelligence (AI) technology in the banking industry and will release a series of publications on this topic in the coming months. This announcement follows a circular issued by the HKMA earlier in November 2019, setting out high-level principles that banks should take into account when designing and adopting AI and big data analytics applications.
- The HKMA has jointly launched the Fin+Tech Collaboration Platform with the Hong Kong Science and Technology Parks to support FinTech development. Industry players can use the platform to organize FinTech-related activities, such as hackathons.
Central Bank Digital Currencies
In a panel entitled “Central Bank Digital Currencies: Shaping the Future of Payments,” Mr. Mu Changchun, Director-General of the Institute of Digital Currency of the PBoC, was asked about the PBoC’s plans to release the DCEP coin. Mr. Mu highlighted the following points:
- Planning for the DCEP project has been underway since 2014, when the original objective of DCEP project was to safeguard China’s currency sovereignty, in part because of the growing popularity of Bitcoin, but also because two Chinese private sector payment systems accounted for 96% of China’s mobile payments market share, making them systemically important payments infrastructures. This concentration risk concerned the PBoC, because if there were any problems with those service providers then the PBoC must be prepared to assist, and, without its own digital form of cash, offering that assistance would be difficult.
- Currently, the mobile payments market in China is fragmented among the two main private sector payments platforms, so there is no unified or generally accepted form of mobile payment (some vendors will accept one form of mobile payment and other vendors will accept a different form of mobile payment).
- The DCEP coin is targeted specifically at the retail sector only, and not at wholesale payments. The distribution model will be two-tier: the PBoC will issue DCEP coins to commercial banks and certain other institutions, and those banks/institutions will distribute the DCEP coins to the general public. To avoid disintermediating the financial system, the PBoC will not be issuing DCEP coins to the public directly.
- DCEP coins are a substitute for existing M0 currency (i.e., paper notes and coins). No interest will be paid for holding DCEP, and there also should be no implications for inflation and no impact on the PBoC’s monetary policy.
- All existing rules on cash and foreign exchange management must be observed, together with other applicable rules relating to anti-money laundering and counter-terrorist financing.
- The DCEP project is de-coupled from traditional bank account ownership so it will enhance financial inclusion, particularly in China’s rural areas. Customers will be able to open a digital wallet and receive DCEP coins without any linkage to a bank account. Therefore foreign visitors to China will also be able to open a digital wallet and have access to digital payments in China without a local bank account.
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