Hong Kong’s Virtual Assets Regulations

17 August 2023 

Hong Kong’s new regulations and guidelines for licencing of Virtual Asset Trading Platforms (VATPs) have numerous features that specifically address and provide greater protection for retail investors from not only scams and fraud, but also overexposure to the asset class.

A key component of the Hong Kong regulations is the requirement for VATPs to conduct a comprehensive assessment of a retail investor's understanding of the nature and risk of virtual assets (e.g. crypto currencies, non-fungible tokens) (VAs).  This is a far more in-depth Know Your Customer (KYC) requirement than what we currently have in Australia, focused on verifying identity.

Included in the guidelines for VATP’s[1] effective from 1 June 2023, a licensed VATP should take all reasonable steps to establish the true and full identity of each of its clients and for retail clients also their financial situation, investment experience and investment objectives. 

Except for institutional and qualified corporate professional investors, a VATP should:

• assess a client’s risk tolerance level

• determine the client’s risk profile

• assess whether it is suitable for the client to participate in the trading of VAs

• take into account the client’s overall holdings in VAs

Essentially the guidelines place a duty on the managers of the VATP to reasonably ensure that a retail customer’s investment is suitable in their personal circumstances. 

Mark Bailey, Joshua Ho, Emma Sun

The Newly Implemented VATP obligations

VATPs now have an overarching requirement in Hong Kong to operate honestly, fairly, and in the best interest of their clients and market integrity.  This includes several specific obligations including:

• performing due diligence for assets listed on a platform

• meeting competency requirements

• custody of client assets

• managing the location of seeds and private keys

• senior management responsibilities

• continuous disclosure and reporting

• internal and external audit requirements

In addition, Hong Kong has updated its Anti Money Laundering (AML) /Counter Terrorist (CT) guidelines[1].  These updates highlight the specific risks presented by VAs, particularly in relation to the speed of international transactions and the use of technology to obfuscate illicit activity.

There are  clear requirements for VATPs to comply with their AML/CT obligations.  These requirements may slow down the on-boarding process for VATPs, thereby increasing operating costs (as well as transaction fees) and reducing revenues.  However, having represented many victims of scams and fraud, we see how these measures will protect retail investors.

A more comprehensive retail investor on-boarding process will:

Limit the VA investments of those most vulnerable to scams and fraud.  

HC Blockchain, Hall Chadwick’s specialist Blockchain division, has observed a high correlation between victims of scams and fraud and retail investors who:

• were overly exposed to VAs, in some cases entire life savings.

• lack a comprehensive understanding of the nature or risks of investments.

• were emotionally vulnerable or overly trusting.

• have recently acquired access to cash or other liquid assets (e.g., property settlement, inheritance, retirement). 

Raise the standards on fraudulent actors opening an account with a VATP and prohibiting them from opening multiple accounts where they typically seek to quickly cash out their ill-gotten gains.  

The increased AML/CT obligations of VATPs also subject their transactions to a higher level of scrutiny.

These guiderails don't interfere with blockchains, allowing them to do what they do best – facilitating fast, accurate, low-cost international transactions.

Retail investors need other countries to act as Hong Kong has. Regulatory equivalence across the world protects retail investors and provides a level playing field for VATPs. VATPs seeking low-regulatory environments will stand out and become less trusted brands in the market as consumers should be attracted to VATPs that offer safety.

Further, lower risks associated with compliant VATPs mean that the issues of debanking we're experiencing in Australia should become a thing of the past and result in reduced costs once losses are taken into account.

The Future ofAustralia’s Regulatory Environment?

The Australian Blockchain industry has invested enormously in seeking regulation.  It is disappointing that there's still more talk than action.  Will developments in Hong Kong mean that the Australian industry now suffers due to its low and uncertain regulatory environment?

The Australian regulatory landscape has barely improved since 2021 and does not appear prepared for the current let alone future strategies and technologies of fraudsters and scammers that have improved their business models that now leverage:

• Increased crypto use cases providing increased off-ramp opportunities.

• AI-enabled tools to bypass KYC and generate sophisticated phishing materials.

• Increased sophistication of decentralized exchanges and non-custodial wallets.

Australian regulators and lawmakers need to evaluate Hong Kong's approach to understand its effect on our industry.  Is it enhancing the integrity of the industry, promoting responsible development and protecting retail investors.  A week is a long time in the blockchain industry and the Hong Kong regulations have already been in place for 10 weeks.    

Like bees to honey, another crypto bull market will attract all types of unscrupulous individuals, as well as vulnerable and overenthusiastic retail investors.

If a crypto boom were to occur tomorrow, would Australia be ready?

[1] Securities and Futures Commission, Guidelines for Virtual Asset Trading Platform Operators, June 2023

[2] Securities and Futures Commission, Guideline on Anti-Money Laundering and Counter Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers), June 2023