Hong Kong regulators update guidelines on intermediaries’ activities related to virtual assets | Latham & Watkins LLP

The revised SFC and HKMA guidelines apply to intermediaries that distribute products or provide trading, advisory and asset management services related to virtual assets.

On October 20, 2023, the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) issued a Joint Circular to provide updated guidance to intermediaries conducting virtual asset (VA) activities. The Joint Circular revises a previous Joint Circular dated January 28, 2022 (see Latham’s Customer Alert).

The need to update the 2022 Joint Circular arose after a new regulatory regime for virtual asset trading platforms (VATP) was introduced in June 2023, allowing such platforms to include retail investors for the first time (see Latham’s Client Alert).

The Joint Circular reflects an expanded scope of investor access as regulators encourage intermediaries to offer more VA services to retail clients and also makes some administrative changes to reflect developments in the VA sector. Many of the changes will reduce some compliance issues and are likely to be welcomed by the industry. As the SFC is expected to provide further guidance on its expected standards for tokenized securities in the near future, the Joint Circular has updated the definition of VA to exclude tokens that represent securities and futures contracts.

With this updated guidance, financial services industry participants have a clear path to providing retail investors access to VA-related services. As previously and as described in our previous blog posts, intermediaries offering VA services will have additional terms and conditions applicable to their licenses in order to implement the VA regulatory framework.

This blog post outlines the key changes the Joint Circular made to the previous VA regulatory framework.

VA related product distribution

• Knowledge assessments: Intermediaries must assess whether clients have knowledge of investing in VA or VA-related products before carrying out a transaction in VA-related products (except for institutional professional investors and qualified corporate professional investors (exempt investors)).

Previously, a person could be considered to have such knowledge if he or she had conducted five or more transactions with a VA or a VA-related product within the last three years. This scoring provision has now been removed, meaning that intermediaries will need to take into account the individual’s level of trading experience and understanding (if any) when assessing whether the client has such VA knowledge. This change also applies to agents conducting VA knowledge tests for the activities listed below.

• Warnings: The Joint Circular also confirms that tax-exempt investors do not need to be provided with warnings and risk disclosures when intermediaries distribute VA-related products to them.

VA trading services

• Dealing with private customers: As SFC-licensed VATPs are now permitted to attract retail clients to trade in VAs, intermediaries are permitted to offer them VA trading services on an introducing agent or collection agent basis.

When dealing with private customers, intermediaries are expected to:

(i) assess each retail client’s knowledge of VAs and risk tolerance level;

(ii) set a limit for each retail customer to ensure that the customer’s exposure to VAs is appropriate taking into account his or her financial situation (including net worth) and personal circumstances;

(iii) when providing aggregation services, ensure that VA trading activities are conducted through an aggregation account established and managed with an SFC-licensed platform capable of servicing retail clients; And

(iv) implement appropriate controls to ensure that their retail clients can only trade VAs that make VATPs available for trading by retail investors (“appropriate large-cap VA”, i.e. the specific VA should be included in at least two acceptable issued indices be). from at least two different index providers).

• Separate accounts: Intermediaries may now allow customers to deposit or withdraw VAs from their accounts, but must ensure that such customer VAs are held in trust in separate accounts established and maintained with: (i) their partner VATPs; or (ii) Hong Kong banks (or their subsidiaries) that meet the expected standards of VA custody issued from time to time by the HKMA.
• Risk assessment: Except for tax-exempt investors, before providing VA trading services, an intermediary should assess a client’s risk tolerance, determine the client’s risk profile, and assess the suitability of the client to participate in VA trading.
• No staking etc.: Intermediaries are also prohibited from making arrangements to use customer VAs to generate income, meaning they are not permitted to offer staking, loans and other forms of income farming.
• No suitability test for placing unsolicited orders: For orders in VAs (including VAs classified as complex products) that a customer places directly on an intermediary’s trading platform or directly to its employees for routing to a VATP for execution, the intermediary is not required to ensure that the transaction takes place suitable for the customer if the agent has not made a request or recommendation.
• Inquiries/recommendations in VAs: When making a solicitation or recommendation or providing complementary VA advisory services to retail clients, the intermediary should take all reasonable steps to ensure that the VA has high liquidity (and at least one suitable large-cap VA) and VATPs is made available for trading by private investors.

VA Advisory Services

• Risk assessments: Except for tax-exempt investors, before providing VA advisory services, an intermediary should assess a client’s risk tolerance, determine the client’s risk profile, and assess whether participating in VA trading is suitable for the client.
• VAs with high liquidity: When providing VA advisory services to retail clients, the intermediary should take all reasonable steps to ensure that the VA has high liquidity (and at least one suitable large-cap VA) and VATPs available for trading by retail investors is provided.

VA Asset Management Services

• VAs with high liquidity: Intermediaries are permitted to offer discretionary VA account management services to retail clients and should take all reasonable steps to ensure that the VA has high liquidity (and at least one eligible large-cap VA) and is provided by VATPs for trading to retail investors.
• Cap on the percentage of VAs in the client’s portfolio: If a Type 1 intermediary is authorized by its clients to provide complementary VA trading services at its discretion, the intermediary should only invest less than 10% of the gross asset value (i.e. below the “de minimis threshold”) of the client’s portfolio in VAs .
• Opening to private customers: The requirement for VA fund managers to only allow professional investors to invest in their VA funds has been removed.

Future guidelines and next steps

Tokenization is increasingly seen as the next challenge for VAs as regulators promote Hong Kong as a hub for digital assets. The Hong Kong government recently issued tokenized green bonds to demonstrate and encourage market adoption of tokenization. Market participants have requested additional guidance from regulators on the tokenization of SFC-approved products (such as retail funds) and other securities.

The Joint Circular reiterates that intermediaries wishing to provide trading, advisory and asset management services in tokenized securities should comply with the guidance that the SFC is expected to issue in the near future.

Intermediaries interested in providing VA services in accordance with the Joint Circular should notify the SFC (and the HKMA, if applicable) to begin discussions about the services they wish to provide and how they will meet the requirements of the to comply with the joint circular.

Agents already offering VA services should revise their systems and controls to align with updated requirements. For intermediaries already offering VA trading services, a three-month transition period applies before the expected requirements of the Joint Circular are fully implemented. Intermediaries who wish to further expand their retail services (or make other changes to their activities) should also notify the SFC (and the HKMA where applicable).

Hong Kong regulators are expected to make further VA-related announcements during the upcoming Hong Kong Fintech Week. We will follow and report on these developments in our Global Fintech and Digital Assets Blog.

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