HK regulator proposes 'sandbox' approach for crypto exchanges

November 01, 2018 14:55
SFC chief executive Ashley Alder hinted at the possibility of licensing cryptocurrency exchanges in Hong Kong. Photo: Bloomberg

The Securities and Futures Commission (SFC) is proposing a "sandbox" approach in regulating cryptocurrency exchanges in Hong Kong, SFC chief executive Ashley Alder said on Thursday.

In a speech at the Hong Kong Fintech Week 2018, Alder said a sandbox approach will allow the regulator to discover if it would be appropriate for crypto exchange operators to be regulated.

He also hinted the possibility of licensing cryptocurrency exchanges in a longer term, an approach adopted by Japan.

“If, and only if, we decide at the Sandbox stage that we should regulate, we would consider granting a license,” Alder said, adding that “the platform would then be subject to intensive reporting and monitoring to ensure that strict internal controls operate as expected and investor interests are protected”.

In the speech, Alder did not specify any timeline for the plan and participating exchanges. 

Addressing the growing trend of virtual assets including cryptocurrencies, Alder said: “These are activities of special interest to securities regulators as, superficially, these platforms seem to mimic conventional funds and stock exchanges.”

A report by the Financial Stability Board this summer concluded that virtual assets and platforms used to trade them did not yet pose a threat to global economic or financial stability, mainly because the size of the crypto market was still too small to have an impact on a global scale.

However, Alder said Hong Kong has seen some of the world’s largest platforms set up in the city, and “a sizeable population of investors who have an interest in trading virtual assets through unregulated trading platforms,” as well as a growing demand for funds which invest in virtual assets.

As calls for investor protection rise, Alder said the SFC will set out the exact regulatory standards expected of virtual asset fund managers.

Funds intending to invest more than 10 percent of a mixed portfolio in virtual assets will need to observe new requirements for crypto assets, whether or not those crypto assets amount to “securities” or “futures contracts”.

Only professional investors should be allowed to participate for the time being, he said, adding that the regulator will also provide specific guidance on the regulatory standards for the distribution of all funds with crypto exposures, offering investor protection at both fund management and distribution levels.

But the new regulation will not cover managers of “pure” crypto funds, he said.

In February the SFC said it would crack down on cryptocurrency exchanges that operate in the city without a license or violate local securities laws.

In his speech on Thursday, however, Alder acknowledged that some crypto market activities are not legally capable of being regulated by the SFC if the virtual assets involved fall outside the legal definition in Hong Kong of “securities” or “futures contracts”.

He said the virtual asset market is “very young”, and the trading rules may not be transparent and fair.

“Outages are not uncommon, as is market manipulation and abuse,” he said.

“There are also outright scams or frauds, as seen in many failed initial coin offerings (ICOs),” he said, referring to the new way for companies and blockchain projects to raise capital by issuing their own digital coins or “tokens”.

– Contact us at [email protected]