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Hong Kong Launches Consultation for Crypto Trading Regulation

crypto trading regulation

Crypto service providers must be granted an SFC licence or will face closure in the jurisdiction. On Monday, Hong Kong’s Securities and Futures Commission (SFC) published a set crypto trading regulations for digital asset exchanges, and is seeking public comment.  

The official notice focuses on setting up a licensing regime for crypto service providers, and is also seeking opinions on whether licensed platforms should be allowed to serve retail investors, and what investor protection measures should be offered and applied.

“Those which do not plan to apply for a licence should start preparing for an orderly closure of their business in Hong Kong,” the notice added. 

All crypto trading platforms, new and existing “should begin to review and revise their systems and controls to prepare for the new regime,” in order to apply for the new mandatory licence.

New guidelines for operators

Monday’s consultation paper sets out proposed requirements for crypto trading operators, such as assessing clients’ risk profile and setting limits to ensure their exposure is “reasonable.”

It is proposed that operators do due diligence on tokens, and monitor them. Operators must assess the regulatory status of traded assets in each jurisdiction they provide trading services in. The SFC also proposes checks on operator liquidity and how holdings are distributed, whether if it’s concentrated, or controlled by a small number of individuals and entities.

As for trading assets, operators can only offer tokens which satisfy the SFC’s criteria for a “eligible large-cap virtual asset,” that is listed on two “acceptable indices.” Additionally, operators must perform smart contract audits on the tokens they offer to check for security flaws.

Under the new proposals, operators should not offer virtual assets that fall within the definition of “securities” if it would result in breaching Hong Kong SFC ordinance.

The SFC also proposed operators to provide a compensation arrangement to be approved to cover for risks, as an alternative to a hard limit for assets held in cold storage. Additionally, operators must monitor held customer assets daily, and adjust such arrangements accordingly.

This means that in the jurisdiction, each licensed operator may have to set up a committee to assess tokens to be listed available for trade, and set obligations for issuers to inform their operators about any events such as hard forks, airdrops, and regulatory action.

In the consultation paper, the SFC acknowledges that local industry players want to offer derivatives. In response, the SFC says that it is open to hearing about business models and demands to potentially conduct a separate review to draft up related policies.

The consultation is open through March 31, 2023, with the new licensing regime set to take effect on June 1, 2023.

What else is going on with crypto trading regulations?

Back in January, the SFC allowed retail investors to access regulated crypto-related derivative products traded on conventional exchanges. This was a huge shift from last year, as the SFC seemed unwilling to allow retail investors to access crypto under its virtual asset licensing regime.

Hong Kong was met with much confusion last week, as a tweet suggesting that the city may make crypto fully legal for all citizens on June 1 ended up being a misreading of legislation. As of now, the virtual asset service provider (VASP) framework for exchanges will let them only provide access to accredited professional investors, retail investors excluded.

If cryptocurrencies were to also be offered to retail investors, SFC CEO Julia Leung says that only “highly liquid” assets would be on the list, and that offerings would be very limited upon launch.

Hong Kong is in the midst of trying to reclaim its title of Asia’s top fintech centre, making large efforts to bring proper crypto trading regulations to a sector that is often referred to as ‘lawless land’. 

“We’re able to bring together investments globally,” Christopher Hui, secretary for Financial Services and the Treasury (FSTB) said. “We can manage and also channel these investments in a well-regulated and also sustainable manner,” citing Hong Kong’s reputation for its credibility in the traditional finance world.

As new regulations are being introduced for the crypto industry in Hong Kong, much of the local industry is hoping for clarity and stability after years of uncertainty. Local retail investors are looking forward to the day where trading in Hong Kong would be like trading in Japan, where Japanese traders are allowed to trade crypto in a regulated environment.

Hong Kong is also planning to require stablecoin licensing as early as June this year. Under the planned regulatory regime by the Hong Kong Monetary Authority (HKMA), algorithmic stablecoins like terraUSD will not be accepted in the jurisdiction. After receiving feedback from a discussion paper in 2022, the regulator said it will plan to set up a regime to supervise stablecoins, a type of cryptocurrency whose value is pegged to other assets.

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