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How Will Hong Kong’s Proposed New Digital Asset Licensing
Regime Affect the Industry?
Legislative Proposal to Regulate “Virtual Asset Service
Providers”
In June, 2022, the government proposed legislation to regulate
virtual asset service providers (“VASPs”) and to combat
fraud and deceptive practices in transactions of “virtual
assets”.
New Legislation Works Alongside Existing Securities
Legislation
Proposed new legislation will fill gaps in regulation as digital
assets may fall outside existing securities and futures laws.
Together, the new law and existing laws will provide greater
regulatory coverage of the industry.
Players in Digital Asset Industry Will Need to Assess Which
Regime Applies
Existing laws regulate “securities” and “futures
contracts”. Digital assets in the form of
“securities” can be created or adopted to opt-into
existing regulation. Proposed new law will regulate “virtual
assets” including digital assets that constitute neither
“securities” nor “futures contracts”.
Existing Securities Regime and New Regime Expected to be
Consistent
Any VASP already licensed under the opt-in regime will be
exempted from the new VASP licensing requirement. Regulation under
the opt-in regime and the proposed new licensing regime are
intended to be consistent with both administered by the Securities
and Futures Commission (“SFC”).
Expansion of Regulatory Coverage Will Limit Retail
Activity
Consistency of regulation under new VASP licensing regime and
existing opt-in securities regime suggests little room for dealing
with investors other than professional investors where either
regime applies.
Scope of Securities Regulation for Digital Assets
Existing securities regime covers:
Typical securities
Regulated investment agreements
Other structured products
Definition of “Securities”
“Securities” includes shares or debentures; rights,
options or warrants in respect of any share or debenture; interests
in collective investment scheme; other interests commonly known as
securities
Regulated Investment Agreements
“Securities” may include an agreement the (actual or
pretended) purpose or effect of which is to provide (conditionally
or unconditionally) to any party a profit or other returns
calculated by reference to changes in the value of any property
Structured Products
“Securities” may include instruments under which some
or all of the return or the method of settlement is determined by
reference to:
changes in the price, value or level of any securities,
commodity, index, property, interest rate, currency exchange rate
or futures contracts, or
the (non-)occurrence of any specified event(s) (other than
those relating only to the issuer/guarantor)
Scope of Virtual Asset Regulation
Virtual asset regulation will apply to “virtual
assets”, meaning assets which meet 3 criteria:
Unit of Account or Store of Value
Electronic Dealing
Medium of Exchange or Voting Rights
What Constitutes a Unit of Account or Store of Value?
A unit of account or store of value should meet the following
criteria:
Cryptographically secure
Digital representation of value
Expressed as a unit of account or a store of economic
value
What Constitutes Electronic Dealing?
A virtual asset must be able to be transferred, stored or traded
electronically.
What Constitutes a Medium of Exchange
A virtual asset is a medium of exchange if it functions (or is
intended to function) as a means accepted by the public for the
payment for goods or services or for the discharge of a debt, or
for investment purposes.
What Constitutes Voting Rights?
A virtual asset has voting rights if it offers a vote on the
management, administration or governance of the affairs in
connection with, or a vote on any change of the terms of any
arrangement applicable to, any cryptographically secured digital
representation of value.
Exclusions from Virtual Asset Regulation
Limited purpose digital tokens (e.g. customer loyalty points,
in-game asset, those similar to the foregoing and not intended to
serve as a medium of exchange)
Financial assets (already regulated under the Securities and
Futures Ordinance (SFO))
Stored value facilities (SVF) deposit (already regulated under
the Payment Systems and Stored Value Facilities Ordinance)
Digital assets issued by central banks
Virtual Asset Regulation Override
Regardless of the legal definition
Hong Kong Government may prescribe by notice whether a digital
representation of value, generally or in a particular case, is or
is not a virtual asset.
SFC may prescribe by notice any characteristics necessary for a
digital representation of value to be a virtual asset.
What Entities are Subject to Virtual Asset Licensing?
Licensing requirements apply to “virtual asset
service” providers:
Service must be offered electronically
Offers to sell or buy virtual assets must be regularly made in
a way that forms or results in a binding transaction OR persons
must be regularly introduced or identified to negotiate or
conclude, sales or purchases
Client money/virtual assets come into possession of the service
provider
Timetable for New Virtual Asset Licensing Regime
The proposed new regime is expected to come into effect on March
1, 2023. Under transitional arrangements, pre-existing business may
continue without being granted a license in the 1st year of the
regime and thereafter, if they apply by November 30, 2023 to the
SFC for a license, they may continue unless and until the SFC
refuses the licensing application or the application is
withdrawn.
Anti-fraud Offences
Mirroring securities legislation, the proposed new legislation
will create an offence for fraudulently or recklessly inducing
others to invest in virtual assets and an offence for use of
fraudulent or deceptive devices in transactions in virtual
assets
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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