Navigating through fintech regulatory resilience in Hong Kong

October 11, 2023 09:36

As the JPEX incident continues to unfold, compliance with regulatory laws has become the industry's most pressing concern. Digital asset retail trading has now become legalized in Hong Kong even though it is subjected to stringent licensing rules. From June 2023, the Securities and Futures Commission of Hong Kong (SFC) enacted the travel rule that applies to all VASPs in the city to secure the transparency of transactions. All these measures will drive the development of the digital asset industry in Hong Kong.

Following the JPEX incident, more scrutiny was promised by the regulator. Overall, measures aimed at bringing digital asset closer to traditional financial and banking services as well as introducing extra safeguards have been widespread in the region, such as setting requirements for asset segregation, liquid reserves and insurance, banning lending and staking or imposing risk disclosures and promotion rules. A potential scenario may happen where only a small number of applying companies obtain licenses while many unlicensed ones, including overseas entities, operate beyond regulatory reach.

Importance and challenges of complying with the travel rule

To better deal with the volatility of the digital asset sector, there is a need for industry players to meet compliance standards and prepare for regulatory changes relating to anti-money laundering (AML) and Know-your-Customer (KYC) requirements, during the customer onboarding process.

Among all those regulations, the travel rule is a high priority for the SFC as, in its opinion, any delay could make the Hong Kong digital asset market less competitive. However, it poses a significant challenge for digital asset companies to implement, particularly in Hong Kong.

When we analyze the global progress of the travel rule, we can observe that the number of countries implementing it has not seen a significant increase, and the requirements associated with it vary across different countries. This may put jurisdictions where the travel rule is already in force, such as Hong Kong, at a disadvantage. In order to tackle this issue effectively, universal adoption and consistent application of the travel rule are necessary.

Complying with the travel rule involves several processes, including identifying the originator and beneficiary of the transaction and verifying the eligibility of the counterparty VASP based on various parameters. Conducting thorough due diligence on one's own can be challenging, which is why many choose to join networks with pre-verified entities. However, these networks may not have interoperability, resulting in additional costs and complexities. There are various factors to consider, both in terms of compliance, aspects such as interoperability, effective transaction monitoring, AML screening, and ongoing VASP due diligence mechanisms, are all important areas of focus for the SFC. Furthermore, procedural issues related to data collection, transfer and storage are also a cause for concern.

While reliance on a provider may be necessary for VASP due diligence, the regulation does not allow to fully delegate this process to another party. Thus, VASPs should conduct their own evaluations of counterparties or, as it may not be feasible, at least ensure transparency in third-party due diligence processes.

In short, the fintech industry in Hong Kong is undergoing significant regulatory changes, especially with the implementation of the travel rule. To navigate these challenges successfully, industry players must prioritize compliance with AML and transaction monitoring requirements, while also addressing the specific challenges posed by the travel rule. By fortifying compliance measures and embracing regulatory resilience, the digital asset industry in Hong Kong can see a more robust development.

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Deputy Head of Legal at Sumsub