Hong Kong SFC Enhances Investor Protection with Revised Virtual Asset Policy

By 0xK2 10/21/23 5:03 AM

The Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) have recently revised their policy regarding virtual asset-related products (VA-related products) to address the evolving landscape of virtual assets. The primary focus of this update is to enhance investor protection and align regulations with the current market dynamics.

The Evolution of Virtual Asset Regulation

The SFC’s journey into regulating virtual assets began in 2018 when it initially restricted various activities related to virtual assets to professional investors only. Since then, the landscape of virtual assets has transformed significantly. With a growing range of investment products providing exposure to virtual assets, the SFC has expanded its scope, including allowing licensed virtual asset trading platforms to serve retail investors and permitting public offerings of virtual asset futures exchange-traded funds.

Complex Products and Retail Investors

Despite the growing popularity of virtual assets worldwide, regulatory standards remain uneven, presenting risks for investors. Various service providers in the virtual asset ecosystem, including custodians, fund administrators, virtual asset trading platforms, and index providers, may be unregulated or subject to minimal oversight. This disparity in regulation can result in additional risks, such as counterparty risks and issues related to investor protection, including pricing transparency and market manipulation.

Considering the complexity and risks associated with virtual asset products, the SFC and the HKMA have imposed additional investor protection measures:

1. Selling Restrictions: VA-related products categorized as complex should only be offered to professional investors. Retail investors will have limited access to these products.

2. Virtual Asset-Knowledge Test: Intermediaries must assess a client’s knowledge of virtual assets and related products before executing transactions on their behalf. If clients lack the necessary knowledge, intermediaries must provide training to ensure they understand the nature and risks involved.

Special Considerations for Derivative Products

A limited set of VA-related derivative products traded on specified exchanges will be exempt from the “professional investors only” restriction. While these products will not be subject to the suitability requirement, intermediaries must still conduct a virtual asset-knowledge test for additional safeguards.

For all other exchange-traded VA-related derivative products, the full scope of complex product requirements and additional investor protection measures will apply.

Compliance with Regulatory Standards

Intermediaries are expected to adhere to the regulatory standards and adhere to selling restrictions specific to Hong Kong and other applicable jurisdictions. They should also consider the client’s risk tolerance, financial situation, and the suitability of virtual asset products when making recommendations.

Given the high-risk nature of virtual assets, intermediaries should be cautious when providing financial accommodations to clients. Adequate assurance of a client’s financial capacity is crucial to prevent potential losses.

Virtual Asset Dealing Services

To ensure adequate investor protection, intermediaries are required to partner exclusively with SFC-licensed VA trading platforms. Such platforms are subject to regulatory standards consistent with SFC’s framework, offering increased security for investors.

Intermediaries must comply with all regulatory requirements when providing VA dealing services, and these services should only be offered to clients with whom they engage in Type 1 regulated activities.

Asset Management and Advisory Services

For virtual asset portfolio managers and virtual asset discretionary account management services, intermediaries meeting specific criteria are subject to additional requirements. They should ensure that the investments align with the client’s financial situation and risk tolerance.

Provision of advisory services in virtual assets should also comply with regulatory standards, including observing suitability obligations.

Transition Period and Notification

Intermediaries currently serving existing clients with VA dealing services will have a three-month transition period to align with the updated requirements. Those planning to extend their VA dealing services should ensure compliance before introducing these services. Intermediaries must notify the SFC and HKMA in advance if they intend to engage in activities related to tokenized securities and virtual assets or make changes to their existing activities.

In summary, the updated policy seeks to enhance investor protection and align regulations with the dynamic virtual asset market. The measures aim to strike a balance between expanding retail access through intermediaries and ensuring the safety and suitability of virtual asset products for investors. Intermediaries operating in Hong Kong must carefully review and adjust their practices to comply with the new regulatory framework.

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