The Hong Kong Securities and Futures Commission and the Hong Kong Monetary Authority issued a joint circular on Friday, 28 January, giving the financial-services industry the green light to do crypto business.
For licensed institutions that have been nervous about handling assets without regulatory clarity, the message from Hong Kong’s two key regulators means such fears can be put to rest.
“This is massive!” said Jehan Chu, co-founder of Kenetic, a Hong Kong-based blockchain company and investor.
In keeping with the SFC’s moves in recent years, the circular buttresses support for a regulated crypto industry servicing accredited wealthy individuals and corporations.
“This model is the one we’ve been expecting for years,” said Gary Tiu, executive director and head of regulatory affairs at BC Technology Group.
The circular opens the door to banks and brokers to offer digital-asset trading services to professional investors. They can do so in two ways: through an omnibus account (in which assets trade in the institution’s name), or as an introducing broker.
Institutions must ensure crypto products are suitable for clients, whether they are selling (distributing) or advising on them. The SFC/HKMA circular says VA products should be considered complex products, and therefore unsuited to retail.
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“For example,” reads the circular, “an overseas VA non-derivative ETF would very likely be considered a complex product and it should only be offered to professional investors.”
To deal in them will require institutions conduct an internal assessment of the client’s knowledge of virtual assets, and establish a fiduciary role.
“If a client does not possess such knowledge,” the circular says, “the intermediary may only proceed if, by doing so, it would be acting in the client’s best interests [emphasis added] and it has provided training to the client on the nature and risks of virtual assets.”
Wealth managers already must ensure suitability protocols for traditional investment products. Crypto will require additional processes and know-how, but private banks and brokers will already have a suitability framework in place. For those firms that deal in multi-asset portfolios, they can now add crypto.
The circular makes an exception for a handful of overseas regulated exchanges recognized by the SFC that are allowed by their respective regulators to offer VA derivative products to retail investors. Hong Kong will not require these products pass a suitability test.
“This will give private banks and institutions the opportunity to access virtual asset ETFs or exchange-traded products without worrying that the SFC will reject their request to do so,” said a head of digital at a global asset manager. “It is one step easier than going directly into virtual assets, as they do not have to set up the infrastructure.”
Regardless of the product, any institutions doing VA business must engage partner that is based in Hong Kong and has a virtual-asset license if they want a dealing function onshore. This is the case even if the virtual asset is not considered a security.
This means financial institutions acting as intermediaries would not be dealing directly in virtual assets; their execution role would be only as a payment gateway between fiat currency and virtual assets. (The circular does not touch on the prospect of Hong Kong issuing central-bank digital currency and its potential role in these relationships.)
The VA license scheme was announced by SFC in 2020. So far, only OSL, which is operated by BC Technologies, has a VA license for dealing (it also has the only license for a VA exchange). Other blockchain companies such as HashKey and HKbitEX have submitted applications.
“This gives banks and brokers a light lift to do their first trade,” Tiu said. “There’s no need for them to invest in the infrastructure and conduct the due diligence in what is a safe environment for them to meet client needs.”
For the moment, however, OSL has a lock on servicing financial institutions for local product as a custodian and broker of virtual assets, including responsibility for cybersecurity. Financial institutions can bypass local VA licensees if they bring in VA ETFs from overseas exchanges recognized by the SFC.
Of course, it is now likely that SFC will grant more VA dealing licenses, and not just to blockchain companies. Banks, brokers, and wealth managers will likely be filing for their own licenses.
“This [circular] clarifies access to overseas products, so it means more competition,” says the head of digital at a global fund house.
BC’s Tiu acknowledges that many institutions will want to develop full capabilities: “The race has already started for banks and brokers to become a one-stop shop, and some are ready. We welcome competition because it’s good for the space.”
The fate of retail
The circular does not address one big unknown, which is the fate of unregulated crypto exchanges and brokers that serve retail customers. These businesses are not directly impacted by the circular and will continue their operations.
They may find themselves under competitive pressure, however, as institutional money flows to regulated operators.
Nor does the circular help bring retail investors under a protected, regulated regime: they remain outside, and therefore vulnerable, so long as financial institutions can only deal in crypto with professional investors.
The fate of retail may have to wait until the city’s Legislative Council revisits the Anti-Money Laundering Ordinance, which it is expected to do later this year. The entire crypto space in Hong Kong has been only regulated by existing AML and KYC rules for payment purposes – a relatively light regime, with no oversight of crypto spot markets.