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The Hong Kong Government introduced the Anti-Money Laundering and Counter-Terrorist Financing Bill 2022. The Bill aims to bring the legislation for virtual assets service providers (VASP) into line with FATF recommendations. According to the recently adopted amendments, the Bill will enter into force on June 1, 2023.
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Defining Virtual Assets
The Bill defines virtual assets as a secured digital representation of value that:
- Is expressed as a unit of account or a store of economic value.
- Either:
– is used as a medium of exchange accepted by the public for payment for goods or services, discharge of a debt, or investment; or
– provides rights to vote on the management of the affairs in connection with any secured digital representation of value; or
– provides rights to vote on any change of the terms of any arrangement applicable to any secured digital representation of value. - Can be transferred, stored or traded electronically.
- Satisfies other characteristics the Hong Kong Securities and Futures Commission (SFC) prescribes.
SFC may recognise other assets as virtual by publishing a relevant notification.
Virtual assets regulation excludes:
- digital representations of fiat currencies;
- other already regulated financial assets;
- central bank digital currencies;
- stored value facilities;
- credit card rewards, gift cards, customer loyalty programmes, gaming coins, and other closed-loop, limited-purpose items.
What about NFTs?
NFTs may or may not be classified as virtual assets. To decide whether NFTs are regulated, it is necessary to look at the nature and functions of the NFTs. An NFT won’t fall under the virtual asset regulation if it only images an exact digital copy of a collectable (digital image, piece of art, video, or music). The characteristics of a particular NFT may qualify as a virtual asset if they cross the line from collectable to a financial asset. It may be fungible or fractionalised NFTs structured as securities, etc.
Virtual asset service providers which operate in Hong Kong must obtain a VASP license from the SFC. In current affairs, virtual asset exchange is the only activity considered to be a virtual asset service. The operation of a virtual exchange involves providing services under the following conditions:
- Either,
– Offers to sell or buy virtual assets are made or accepted in a way that forms or results in a binding transaction; or
– Persons are introduced or identified to other persons so that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of virtual assets in a way that forms or results in a binding transaction; and - Where the client’s money or virtual assets come into direct or indirect possession of the person providing such service.
The SFC may alter the list of regulated services by publishing an appropriate notice.
Only domestic and overseas companies registered under the Hong Kong Companies Ordinance (Cap. 622) are eligible to become VASPs. SFC will only accept an application for a VASP licence from applicants with a separate legal personality. Thus, partnerships, sole traders, or overseas companies not registered in Hong Kong cannot obtain a license.
Existing virtual asset exchanges will be able to operate without a license until May 30, 2024. A VASP licence will be required if they wish to continue running after the end of the specified period.
VASP Licensing Requirements
Fit and proper test
The applicant, its responsible officers, licensed representatives, and UBOs had to meet a fitness and properness test, which includes:
- financial status or solvency of the person;
- educational or other qualifications or experience regarding the nature of the functions;
- the ability to carry on the regulated activity competent, honest and fair way;
- reputation, character, reliability and financial integrity;
- non-conviction for AML/CFT offence involving fraudulent, corrupt or dishonest conduct.
Responsible officers
Each virtual asset service provider must have at least two officers responsible for compliance with regulatory requirements. At least one of the responsible officers must be an executive director of the VASP. At least one of them must live in Hong Kong. Each responsible officer must be approved by SFC, subject to a fit and proper test and other conditions imposed by SFC.
Licensed representative
Licensed representatives must be appointed and approved by SFC to carry out regulated functions on behalf of the VASP. To be authorised as a licensed representative, an individual must meet the SFC’s qualification requirements, including fit and proper test requirements. He also should be competent in carrying out virtual asset trading services. The licensed representative must always keep the SFC informed of his contact details. The specified details include residential address, telephone number and electronic mail address. He is also obliged to inform SFC of any change in the details within seven business days after the change occurs.
Premises for keeping records or documents
The virtual asset service provider must keep records or documents only at premises that the Commission approves. Those premises must be non-domestic and suitable for keeping records or documents required under any specified requirement established by SFC.
Obligations for VASPs
AML/CFT requirements
Under the Bill, VASPs in Hong Kong must follow customer due diligence and record-keeping requirements. Among other things, VASP carrying out a transfer of virtual assets that amount to not less than $8,000 must get the details of the originator and recipient of the transfer and submit the information to the financial institution acting for the recipient or an intermediary financial institution. VASP must keep records of the virtual assets transaction for at least five years.
The ultimate owner (UBO)
Any person that owns or controls, directly or indirectly, more than 25 % of the issued share capital (voting rights) of the VASP or exercises ultimate control over the corporation’s management must be approved by SFC as an ultimate owner. Each ultimate owner shall also meet fit and proper requirements and other conditions established by SFC. In addition, UBO must inform SFC about the particulars of his contact details and any change in them. . In addition, UBO must inform SFC about the particulars of his contact details and any change in them.
Licensing conditions
SFC may impose licence conditions on
- financial resources; knowledge and experience;
- risk management policies and procedures;
- AML/CFT financing policies and procedures;
- management of client assets; the soundness of the business;
- financial reporting and disclosure; virtual asset listing and trading policies;
- prevention of market manipulation and abusive activities;
- avoidance of conflicts of interest;
- keeping of accounts and records by licensed providers and their associated entities;
- provision of contract notes, receipts, statements of account and notifications;
- financial statements and other documents, and the auditor’s report;
- business conduct of licensed providers and their licensed representatives;
- notification of changes;
- cybersecurity.
Notification requirements
Virtual asset service provider must notify in writing SFC about:
- any change in the information provided to SFC – within seven business days after the change;
- intended cessation of virtual asset service providing – not later than seven business days before the intended cessation;
- a change in the address at which VASP provides virtual asset service – at least seven business days in advance;
- any change in the VASP’s directors – within seven business days after the change;
- a licensed representative ceases to act for a VASP.
Also, VASP’s wholly owned subsidiary, as well as the company that receives or holds in Hong Kong client assets of VASP (associated entities), will notify SFC about becoming or ceasing to be an associated entity within seven business days.
Annual fee and annual return
VASPs in Hong Kong are obliged to pay SFC a prescribed annual fee within one month after each anniversary of the date of grant of the licence or by another date approved by the SFC by written notice. The amount of the prescribed annual fee is as follows:
- payable by VASP – 4,740 USD for one virtual asset service (equals application fee);
- payable by a licensed representative:
- who is not approved as a responsible officer of the VASP – 1,790 USD for one virtual asset service;
- who is approved as a responsible officer of the VASP – 4,740 USD for one virtual asset service.
VASP must submit the annual return to the SFC within the same period as the annual fee. The annual return must include the following information:
the reporting period of the licensed person; a complete description of any change in the information submitted to SFC (if it has not been provided to SFC).
Appointment of the auditor
VASP and its associated entities (auditable entities) must appoint an auditor within one month after authorisation. An officer or employee of the VASP or its associated entities is not eligible to be an auditor. Auditable entity obliged to:
- notify the SFC of the date on which the auditable entity’s financial year ends by written notice within one month after the authorisation;
- submit financial statements, together with a report of the prescribed auditor, to the SFC within four months after the end of the financial year to which they relate;
- notify SFC about any changes (removing, replacement, ceasing) of the prescribed auditor in 1 business day after the notifiable circumstance occurs
- report on any cases of non-compliance with codes or guidelines published by SFC or adversely affecting to a material extent the financial position of the auditable entity (reportable matter).
SFC may appoint an auditor to examine and audit the accounts and records of auditable entities if:
- it has reasonable cause to believe that the auditable entity has failed to comply with any specified requirement
- or it received a written report by a prescribed auditor concerning a reportable matter, qualification, or adverse statement.
Sanctions
The Bill contains a lot of offences regarding virtual assets services, including criminal ones. A list of the violations and penalties for it includes but is not limited to the following:
- Providing virtual asset service without authorisation – up to 5,000,000 HKD fine, up to 7 years imprisonment, and a further fine of 100,000 HKD for every day during which the offence continues (in the case of a continuing offence).
- Offence to issue advertisements relating to an unlicensed person’s provision of virtual assets service – up to 50,000 HKD fine and up to 6 months imprisonment.
- Offences involving fraudulent or deceptive devices etc. in transactions in virtual assets – up to 10,000,000 HKD fine and up to 10 years imprisonment.
- Offence to fraudulently or recklessly induce others to invest in virtual assets – up to 1,000,000 HKD fine and up to 7 years imprisonment.
- Violation of responsible officers appointment – up to 100,000 HKD fine and a further fine of 2,000 HKD for every day during which the offence continues (in the case of a continuing offence).
- Becoming an ultimate owner of VASP without SFC approval – up to 1,000,000 HKD fine, up to 2 years imprisonment, and a further fine of 5,000 HKD for every day during which the offence continues (in the case of a continuing offence).
SFC Powers in Respect of Licensed Virtual Asset Exchanges
As a primary regulatory, SFC has a lot of powers to overview the VASPs. Besides auditor appointment and proceeding applications, SFC has the competence:
a) to revoke or suspend VASP’s licence and responsible officer approval;
b) to reprimand the regulated person;
c) to order the regulated person to take any action to remedy any contravention;
d) to order the person to pay a monetary penalty;
e) to prohibit the regulated person from applying for a license;
f) to prohibit a licensed provider from entering into particular transactions;
g) to prohibit a licensed provider from dealing with the certain property;
h) to conduct routine inspections of VASPs;
i) request production of documents and records;
j) investigate breaches and sanction licensed persons involved in the breaches etc.
b) to reprimand the regulated person;
c) to order the regulated person to take any action to remedy any contravention;
d) to order the person to pay a monetary penalty;
e) to prohibit the regulated person from applying for a license;
f) to prohibit a licensed provider from entering into particular transactions;
g) to prohibit a licensed provider from dealing with the certain property;
h) to conduct routine inspections of VASPs;
i) request production of documents and records;
j) investigate breaches and sanction licensed persons involved in the breaches etc.
Summary
The rapid growth of virtual asset technologies has led to new laws and regulations being introduced by regulators around the world. Hong Kong’s choice to focus only on virtual asset exchanges appears reasonable. Among the virtual asset activities in Hong Kong, virtual asset exchanges are by far the most widespread, according to the SFC report. Generally, virtual assets activity outside of virtual assets exchange is relatively limited. Besides, when VA interfaces with financial institutions, their fund movements can be traced. But, the current definition of virtual asset service is flexible, as it may be revised by the SFC if necessary.
Anyway, Hong Kong’s new VASP regime is a recent addition to the virtual assets landscape, and it will be interesting to see whether the new system impacts the growth of the virtual assets industry there.
Companies looking to establish their presence in the virtual assets sector can benefit from professional company formation services in Hong Kong to navigate the regulatory requirements and ensure compliance with the VASP licensing regime.
