Original source: "Consultation Conclusions on Proposed Regulatory Requirements Applicable to Operators of Virtual Asset Trading Platforms Licensed by the Securities and Futures Commission》

Original compilation: angelilu, Foresight News

Original compilation: angelilu, Foresight News

The Securities and Futures Commission of Hong Kong (SFC) released the conclusions of the public consultation on the proposals for the regulation of licensed virtual asset trading platforms. The SFC received 152 submissions. The main issues were summarized and responded to, and an overview of the main content follows. The Securities Regulatory Commission stated that the revised Hong Kong "Guidelines for Virtual Asset Trading Platform Operators" and "Guidelines for Combating Money Laundering" will come into effect on June 1.

Part I: Amendments to Proposed Regulations Applicable to Licensed Virtual Asset Trading Platform Operators

The SFC noted that respondents strongly supported allowing licensed virtual asset trading platforms to provide services to retail investors and expressed support for the requirement to establish business relationships with retail clients. They also strongly supported the Commission requiring licensed virtual asset trading platforms to set up representative Token inclusion and review committees to strengthen governance.

To ensure the protection of retail investors, licensed virtual asset trading platforms are required to follow a series of measures covering business relationships, governance, disclosure and token review before providing services to retail investors. Retail investors need to understand the characteristics and risks of virtual assets. The Association will continue to cooperate with investors and the Financial Education Committee to carry out relevant education work.

To ensure the protection of retail investors, licensed virtual asset trading platforms are required to follow a series of measures covering business relationships, governance, disclosure and token review before providing services to retail investors. Retail investors need to understand the characteristics and risks of virtual assets. The Association will continue to cooperate with investors and the Financial Education Committee to carry out relevant education work.

The SFC has considered proposals to relax certain rules for establishing business relationships with retail clients. The Commission believes that platform operators should comprehensively assess investors’ understanding of the nature and risks of virtual assets, and revise the Guidelines for Virtual Asset Trading Platforms accordingly. How to evaluate the customer's risk acceptance and risk acceptance ability of virtual assets).

Conflicts of interest involving committee members and platform operators were also taken seriously. To this end, platform operators should establish internal policies and procedures to properly handle these conflicts.

Licensed virtual asset trading platforms need to conduct due diligence before including each virtual asset. The China Securities Regulatory Commission has fine-tuned the information disclosure responsibilities in the "Guidelines for Virtual Asset Trading Platforms", stipulating that platform operators should take all reasonable measures to ensure disclosure specific product information is not false, biased, misleading or deceptive. We have also revised the list of information to be disclosed based on suggestions from some of the respondents.

2. Do you have any comments on the proposal regarding general token inclusion guidelines and specific token inclusion criteria?

We note that it is not necessarily a relevant consideration that comments indicating that a token being included in the exchange should comply with Hong Kong regulations, rules and regulations, and that other jurisdictions do not have an impact on the regulatory status of the token in Hong Kong . Therefore, we only require platform operators to consider the regulatory status of virtual assets in Hong Kong, and not require platform operators to consider the regulatory status of tokens in different jurisdictions where they provide trading services.

The proposal to require non-security tokens to have at least a 12-month history comes in response to the difficulties platform operators may encounter during the review process. While the 12-month rule may not have prevented the recent crashes of some tokens, it was designed to reduce the risk of fraud that would be difficult to reasonably detect and reduce the amount of marketing that takes place before a token’s initial offering.

The proposal to require non-security tokens to have at least a 12-month history comes in response to the difficulties platform operators may encounter during the review process. While the 12-month rule may not have prevented the recent crashes of some tokens, it was designed to reduce the risk of fraud that would be difficult to reasonably detect and reduce the amount of marketing that takes place before a token’s initial offering.

3. If the CSRC intends to allow retail investors to use licensed virtual asset trading platforms, from the perspective of investor protection, what other regulations do you think should be implemented?

Some respondents advocated that licensed virtual asset trading platforms should be prohibited from providing incentives and pecuniary benefits to retail investors for buying and selling virtual assets. Several respondents indicated that the SFC could consider a cooling-off period mechanism before retail clients trade in virtual assets.

The SFC responded that platform operators should not offer remuneration related to specific virtual assets, a principle that applies to all other intermediaries. According to this principle, platform operators should not publish any advertisements related to specific virtual assets on the platform. Based on comments received, we have explicitly prohibited gratuities (other than discounts on fees or charges) in the Guidelines for Virtual Asset Trading Platforms. The SFC also wishes to take this opportunity to remind platform operators of their responsibility to ensure that any material they post in relation to a particular product is fact-based, fair and objective.

Currently, the SFC does not impose a post-account cooling-off period on retail clients of intermediaries engaged in other regulated activities, including the provision of automated trading services. Since platform operators need to ensure suitability in the process of establishing business relationships with customers, retail customers who have already established business relationships should have been assessed by platform operators as suitable for buying and selling virtual assets. A post-trade cooling-off period is also not feasible, as automated trading services involve matching clients' trades, unwinding or canceling trades would affect other clients on the platform.

4. Do you have any comments or other suggestions on the proposal to allow a combination of third party insurance and funds allocated by licensed platform operators or corporations belonging to the same group of companies?

5. Do you have any proposals on how the licensed platform operator should transfer these funds (for example, transfer to the licensed platform operator's corporate account, or set up an escrow arrangement)? Please elaborate on your proposed arrangement and how the protection provided by the arrangement would provide the same level of protection as third party insurance.

The majority of respondents expressed support for the requirement for licensed virtual asset trading platforms to have insurance or compensation arrangements for the risks associated with the custody of client assets. We continue to believe that customer virtual assets held online and in other storage should be fully protected by compensation arrangements for licensed virtual asset trading platforms.

We believe that if most of the customer's virtual assets are held in offline storage that usually does not suffer from hacker attacks and other cybersecurity risks, there will be a high level of protection. Therefore, on the basis that 98% of customers' virtual assets continue to be held in offline storage, we plan to reduce the protection threshold for holding customers' virtual assets in offline storage to 50%. We have noticed that licensed virtual asset trading platforms may also tend to hold less than 2% of customers’ virtual assets in online and other storage methods because platform operators need to allocate their own funds when they cannot obtain insurance protection in online and other storage methods. assets.

With regard to what asset class could constitute a compensation arrangement, we agree that bank guarantees and funds held in demand deposits or time deposits maturing within six months are both acceptable. As far as virtual assets are concerned, we believe that the benefit of holding the same reserve virtual assets as the client's virtual assets subject to the protection of the compensation arrangement is to reduce the market risk caused by the volatility of virtual assets.

We note that there is disagreement on whether to establish an escrow arrangement for compensation arrangements or to allow licensed virtual asset trading platforms to hold set aside funds. In our view, both arrangements are acceptable provided that the funds set aside are segregated from the assets of the platform operator and its group companies, set aside and earmarked in trust. Funds held by the platform operator or its affiliated entities should be held in segregated accounts at accredited financial institutions. The Guidelines for Virtual Asset Trading Platforms have been revised accordingly.

We agree that licensed virtual asset trading platforms should also have the flexibility to jointly or individually set up a fund pool in the form of an insurer to provide protection for the loss of their client assets. The "Virtual Asset Trading Platform Guidelines" have provided for the above-mentioned flexibility.

Finally, we also agree that virtual assets forming part of compensation arrangements should be segregated from those of platform operators and their group companies and held in offline storage by their affiliated entities.

6. Do you have any suggestions for technical solutions that can effectively reduce the risks associated with custody of customers' virtual assets (especially holding virtual assets in online storage)?

We recognize that third party custodians may have significant technical expertise. However, Hong Kong currently does not have a regulatory regime for virtual asset custodians. Given the importance of safe custody of customers' virtual assets, we need to directly supervise companies that exercise control over customers' virtual assets (i.e. wholly-owned subsidiaries of licensed virtual asset trading platforms). If the seed and private key are stored overseas, the corresponding customer virtual assets will also be located outside our jurisdiction. This will seriously hinder our monitoring and enforcement.

We thank respondents for sharing their views on how technological developments can enhance the safekeeping of customers' virtual assets. The Council is monitoring new custodial techniques, such as multi-party computation and key sharding. One of the provisions of the "Virtual Asset Trading Platform Guidelines" is that the seed and private key (and its backup) should be stored securely with appropriate authentication, such as stored in a hardware security module (Hardware Security Module) with appropriate authentication. We are open to allowing licensed virtual asset trading platforms to adopt different custody schemes when the industry has reached a consensus on the security of the custody scheme and appropriate certification of the relevant schemes has emerged, and we will state in the wording of the Guidelines for Virtual Asset Trading Platforms Relevant flexibility is preserved.

7. If a licensed platform operator can provide virtual asset derivatives trading services, which business model would you recommend? What kind of virtual asset derivatives do you recommend launching for investors to trade? What kind of investors will be targeted?

The Council appreciates the detailed comments submitted by the respondents. We understand the importance of virtual asset derivatives to institutional investors and will seriously consider the large number of comments received. In due course we will conduct an independent review.

8. Do you have any comments on how to improve the Virtual Asset Trading Platform Guidelines while incorporating other provisions in the Virtual Asset Trading Platform Terms and Conditions?

The opinions we received include: reducing the ratio of offline and online storage of customers' virtual assets, allowing affiliates of licensed virtual asset trading platforms to conduct proprietary transactions to enhance the liquidity of the trading platform, whether platform operators can submit Its customers provide program trading services, and whether the licensed virtual asset trading platform can provide other virtual asset-related services, such as income, deposits and loans related to virtual assets.

We believe that in order to ensure safe custody of client assets, the ratio of offline to online storage should not be reduced, and the majority of client virtual assets should be held offline where there are usually no hacker attacks and cybersecurity risks. We remind platform operators to implement proper withdrawal procedures and disclose these procedures to clients.

Regarding proprietary trading, we agree to allow third-party market makers to carry out market trading activities, but the current prohibition on proprietary trading is comprehensive, and even prohibits group companies of licensed virtual asset trading platforms from holding any virtual asset positions. Therefore, we have revised the "Guidelines on Virtual Asset Trading Platforms" to allow related parties to conduct program transactions through channels other than licensed virtual asset trading platforms.

With regard to other common services in the virtual asset market, such as earnings, deposits, and lending, licensed virtual asset trading platforms are not allowed to provide these services because the main business is to act as an agent and provide counterparties to customers. Any other activity may raise a potential conflict of interest and require additional safeguards and therefore is not permitted at this stage.

9. Do you have any comments on the regulations on virtual asset transfers or any other requirements in Chapter 12 of the "Guidelines on Anti-Money Laundering Applicable to Licensed Corporations and Virtual Asset Service Providers Licensed by the Securities and Futures Commission"? Please explain your opinion.

Most of the respondents support or do not oppose the implementation of transfer rules, but some respondents suggested a 12 to 24-month transition period for licensed virtual asset trading platforms, and a small number of respondents indicated that there are practical difficulties in strictly following the transfer rules.

The money transfer rule is a major measure for virtual asset service providers and financial institutions in combating money laundering/terrorist financing. The Financial Action Task Force (FATF) emphasized that jurisdictions need to implement transfer rules as soon as possible. Other major jurisdictions have implemented or will soon implement transfer rules. Delay in implementing transfer rules in Hong Kong will affect the competitiveness of licensed virtual asset trading platforms.

The SFC considers that submitting the required data as soon as possible after a virtual asset transfer is an acceptable interim measure until 1 January 2024, taking into account the implementation of transfer rules in other jurisdictions. Licensed virtual asset trading platforms should comply with other transfer rules and related regulations from June 1, 2023, and securely submit the required data while taking interim measures. In addition, the use of non-custodial wallets by some customers for virtual asset transfers may pose a higher risk of money laundering and terrorist financing, so we set out the regulations governing non-custodial wallet transfers in paragraph 12.14.

A minority of respondents felt that the provisions on counterparty due diligence and additional measures for virtual asset transfers were too specific, and that the SFC considered them to be in line with FATF standards and guidance, and that these measures should be implemented in accordance with a risk-based approach, considering virtual asset transfers The types of products and services offered by the counterparty, the category of clients, and the AML/CFT regime in the jurisdiction in which it is located. At the same time, licensed virtual asset trading platforms should consider adopting a risk-based approach to continuously monitor and screen virtual asset transfer counterparties.

Some respondents expressed concern about the practice of returning virtual assets to remitters, and the SFC believes that licensed virtual asset trading platforms should only be used in appropriate circumstances and when there is no suspicion of money laundering/terrorist financing activities, and when considering virtual asset transfers The virtual assets are returned only after the due diligence of the counterparty and the screening of the virtual asset transactions and related wallet addresses. In addition, the returned virtual assets should be refunded to the account of the remittance institution, not the account of the remitter.

Most of the respondents support the regulations on the transfer of virtual assets to and from non-custodial wallets, and the CSRC stated that licensed virtual asset trading platforms should take reasonable measures based on risk sensitivity to reduce and manage money laundering related to the transfer of virtual assets to and from non-custodial wallets / Terrorist financing risk. The ownership or control of non-custodial wallets may change over time, and licensed virtual asset trading platforms should regularly determine the ownership or control of non-custodial wallets based on risk sensitivity.

Two respondents asked the SFC to clarify the scope of application of cross-border agency relationships in relation to virtual assets. The SFC responded that when a licensed virtual asset trading platform is located outside Hong Kong When financial institutions provide services, the regulations for cross-border agency relationships apply to the platform. The SFC has added a new paragraph 12.6.5 to the "Guidelines on Anti-Money Laundering Applicable to Licensed Corporations and Virtual Asset Service Providers Licensed by the SFC" to clarify that licensed virtual asset trading platforms should continuously monitor virtual assets Transaction and associated wallet address.

The majority of respondents support the requirement to screen virtual asset transactions and associated wallet addresses, which would help licensed virtual asset trading platforms to more timely and accurately identify the source and destination of virtual assets, and those involved or subsequently involved in illegal transactions. or wallet addresses related to suspicious activity/source or designated person. The SFC has added a corresponding note to paragraph 12.7.3.

10. Do you have any comments on the "Guidelines of the China Securities Regulatory Commission on Disciplinary Penalties and Fines"? Please explain your opinion.

In response to public comments on how the guidance differs from the current system, how the amount of fines is determined, and how to decide whether to take disciplinary action against companies and individuals, etc., the SFC responded by agreeing that the same set of fines should apply to securities companies under the Securities and Futures Ordinance. Licensed virtual asset trading platform and licensed virtual asset trading platform under the Anti-Money Laundering Ordinance.

The China Securities Regulatory Commission emphasizes that the amount of the fine should not be linked to the profit obtained or the amount of loss avoided, and relevant factors should be considered comprehensively according to the circumstances of the case. In deciding whether to take disciplinary action against a company and/or an individual, the SEC will consider all the circumstances of the conduct, including the consent, connivance or negligence of the individual, as well as a lack of oversight or management of the business. The CSRC will further clarify the responsibilities and scope of duties of senior management, especially with regard to information technology functions. Under the Anti-Money Laundering Ordinance, regulated persons are entitled to due process rights and have appropriate appeal procedures.

Part II: Major Measures and Implementation Details of the Transitional Arrangements for the New Regulatory System

• Matters related to license application

• Respondents questioned the scope of "providing virtual asset services" as defined in the Anti-Money Laundering Ordinance, including whether it covers over-the-counter virtual asset trading activities and virtual asset brokerage activities. The SFC responded that the anti-money laundering regulations will cover centralized virtual asset trading platforms, and therefore, platforms that only provide virtual asset services (such as off-exchange virtual asset transactions and virtual asset brokerage activities) without automated trading systems and additional custodial services will Not covered by money laundering regulations.

• Regarding the dual licensing arrangement, respondents asked whether it is necessary to obtain licenses under both the SFO and the AMLO, especially since some platform operators may not intend to offer trading in security tokens. The classification of virtual assets may evolve over time, and the classification of a virtual asset may change from a non-security token to a security token (and vice versa). In order to comply with the requirements of the licensing regime and ensure the continuous operation of the business, it is prudent for virtual asset trading platforms to apply for approval under both the Securities and Futures Ordinance and the Anti-Money Laundering Ordinance under the current regime. We will adopt a simplified application process so that dual license applications only need to submit one consolidated application form.

• With regard to the regulation of external valuation reports, respondents asked whether the same valuation expert could be used for both Phase 1 and Phase 2 reports, and whether established and operating virtual asset trading platforms were only required to submit Phase 2 reports. The CSRC’s regulations on responding to external assessment reports are aimed at simplifying the application process. It is acceptable practice for external assessment experts to participate in relevant work before and during the first and second phase reports. The first phase reports should be submitted together with the license application. Encourage virtual asset trading platforms to discuss with the CSRC Fintech Group in advance when they are not sure whether the external evaluation experts to be hired are qualified.

Given the wide range of questions received, we will issue further guidance in the form of FAQs, circulars and licensing manuals addressing frequently asked questions related to the new VASP regime under the AMLO.

• Matters related to transitional arrangements:

• Respondents raised many questions about transitional arrangements, related to application eligibility and compliance with the Guidelines on Virtual Asset Trading Platforms during the transitional period. We will publish more information on the transition arrangements in a circular.

Some issues relate to the removal of licensing conditions related to the Virtual Asset Trading Platform Terms and Conditions, and whether compliance with the Virtual Asset Trading Platform Guidelines will become a licensing condition. The SFC responded that, as explained in the information document, the "Guidelines for Virtual Asset Trading Platforms" will replace the "Terms and Conditions Applicable to Operators of Virtual Asset Trading Platforms", and compliance with the "Guidelines for Virtual Asset Trading Platforms" will become a licensing condition.

• something else:

• Regarding the proposal to allow retail investors to use licensed virtual asset trading platforms, respondents raised whether there is a need to amend the regulatory requirements for intermediaries under the Securities and Futures Ordinance when engaging in virtual asset-related activities. In response, the China Securities Regulatory Commission will amend the joint circular to clarify the regulatory requirements applicable to intermediaries engaged in virtual asset-related activities.

Respondents requested additional guidance on security tokens. The SFC will issue additional guidance in due course.

• In view of the general public support for the relevant proposals, the CSRC will implement the "Guidelines on Virtual Asset Trading Platforms" and "Guidelines on Combating Money Laundering", and make some amendments and clarifications to the contents stated in this summary document.appendixappendix

• Including the revised version of the "Guidelines for Virtual Asset Trading Platforms", "Guidelines for Anti-Money Laundering Applicable to Licensed Corporations and Virtual Asset Service Providers Licensed by the Securities and Futures Commission" and "Guidelines for Anti-Money Laundering Applicable to Associated Entities" . The CSRC will also implement the "CSRC Disciplinary Penalty Guidelines".

• We will proceed to gazette the guidelines, which will come into effect on 1 June 2023.

• The SFC will issue more guidelines to give the industry a better understanding of the implementation of the new regulatory regime.