The Securities and Futures Commission (SFC) has released a set of guidelines to pave the way for the issuance of operating licenses to cryptocurrency exchanges based in the city.
The financial regulator released the position paper a year after it proposed a “sandbox” approach to regulate the dozens of crypto exchange operators in the city, including some of the world’s largest.
“After an in-depth examination of their unique technical and operational features, we concluded that some could be regulated by us,” SFC chief executive Ashley Alder said in a speech before the commission published its new regulations.
It also comes after Chinese President Xi Jinping called for the stepped-up development of blockchain technology in the country on Oct. 24.
In recent years, a huge number of cryptocurrency traders in the region, mainly from mainland China, have shifted their operations to over-the-counter (OTC) trading platforms based in Hong Kong. That was after China banned crypto trading in 2017.
In his speech on Wednesday, Alder said that as late as 2018, cryptocurrencies were of “marginal importance”. Governments saw them as “problematic” but did not see them as posing a systematic risk.
However, after Facebook unveiled its plan to introduce its own cryptocurrency called Libra, there has been an “explosion of interest” in so-called stablecoins.
Regardless of its prospects, the Libra project has prompted regulators to take a harder look at the opportunities and risks inherent in virtual assets, Alder said, noting that it was “a significant change from the more relaxed attitude only last year”.
The SFC chief said he wants to avoid the term “cryptocurrencies” because it falsely implies that they are equivalent to money. The commission prefers the term “virtual assets”.
Alder acknowledged that virtual assets have been moving further into conventional financial markets, with safe custody and derivatives trading now being offered by traditional firms and coverage provided by insurers.
The 61-page regulatory framework covers custody and know-your-customer (KYC) rules, among other issues.
Alder said the SFC’s policy work concentrates on investment funds with exposure to virtual assets as well as platforms for the public to trade virtual assets.
“The safe custody of a user’s crypto-assets and cybersecurity are major concerns,” he said, and crypto traders need “SFC-regulated brokers or advisers, who would otherwise provide a valuable layer of protection”.
Assets as securities
The SFC is now inviting licensing applications from platform operators, but exchanges can continue to choose not to be regulated. It said the new regulations allow platform operators to “opt-in” to regulation.
Alder stressed that the SFC only has jurisdiction over virtual assets or tokens that are legally “securities” or “futures contracts”.
Bitcoin and the other more familiar assets are not regarded as securities, according to the SFC.
Crypto exchanges can receive an operating license provided they trade at least one virtual asset that is deemed a security.
Under the new regulatory framework, trading platforms must have insurance covering the risk of virtual assets being lost or stolen, and use an external market surveillance mechanism, along with guidance on fitting these to blockchain, hot and cold wallets, protocol forks and airdrops.
Licensees must only provide services to “professional investors” and they must provide monthly reports to the SFC on its business activities in a format prescribed by the SFC.
The guidelines also list the criteria for licensed platforms to decide on the inclusion of a new virtual asset for trading. Licensed platforms must obtain the SFC’s prior written approval for any plan or proposal to add any product to its trading platform.
Alder also noted that some crypto exchanges based in Hong Kong may decide not to seek an SFC license under the new regulatory framework” because they think the regulatory expectations are too difficult or too costly.
He emphasized that the new regulations can only be “an interim measure”, thus enabling innovation while addressing new risks properly.
“The jury is still out on whether some virtual assets – especially those that have no intrinsic value – have a useful social function or can be considered as equivalent to conventional financial assets,” Alder said. “But it is clear that if we do regulate operators in the virtual asset space, we should hold them to the same standards as the rest of the financial system.”
In a separate statement on Wednesday, the SFC warned investors about purchasing bitcoin futures in Hong Kong. Alder said in his speech that exchanges allowing trading of such products “may well be conducting an illegal activity”.
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