Hong Kong’s financial regulator sets out crypto exchange rules

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Hong Kong’s securities watchdog published new rules governing operating licenses for cryptocurrency exchanges in a bid to legitimize the industry and combat fraud and investment risk.

Why it matters: Cryptocurrency-related fraud has been on the rise in Hong Kong, an important hub for virtual asset exchanges. Setting out a licensing framework is a first step in regulating the industry, with the aim to reduce investor risk.

  • Facebook’s announcement of its cryptocurrency project Libra in June boosted recognition for the assets and forced financial regulators around the world to draft policies to protect investors.
  • Hong Kong is home to dozens of crypto exchanges, including major platforms such as Bitfinex and BitMEX.
  • Prior to the release of the position paper, crypto exchanges have largely escaped any form of regulation, according to Ashley Alder, CEO of the financial regulator.

“But, regardless of its future prospects, the Libra project has galvanized regulators across the world to look far harder at the opportunities and risks inherent in virtual assets. This is a significant change from the more relaxed attitude only last year. We now fully recognize that any convincing official sector response will need, for the first time ever, to coordinate properly across two important dimensions.”

Ashley Alder during his speech on Wednesday at Hong Kong FinTech Week

Details: The Securities and Futures Commission (SFC) published its position paper on cryptocurrency exchanges on Wednesday, setting out the rules and conditions for receiving a license.

  • Virtual asset trading platforms can apply for a license starting Nov. 6 under the new regulatory standards, which are comparable to securities brokers and automated trading venues, according to the SFC.
  • The new rules stipulate that crypto exchanges may only offer its services to “professional investors” and must have stringent criteria for the listing virtual assets.
  • Moreover, platform operators will be required to adopt an external market surveillance mechanism to supplement their own internal policies and controls. Platform operators are required to have insurance policies covering the risks associated with custody of virtual assets.
  • The regulator has not granted any license in Hong Kong to offer or trade virtual asset futures contracts and is unlikely to do so because of the high-risk nature of such contracts.
  • The SFC only has the authority to regulate exchanges which trade virtual assets legally considered securities or futures contracts, Alder said. In Hong Kong, Bitcoin and the other more familiar cryptocurrencies are not securities, unlike other markets such as the US. Security tokens, or digital forms of traditional securities, do fall under SFC purview.
  • The regulator has taken an opt-in approach with the new framework, according to Alder. Investors will be able to distinguish easily between properly regulated platforms and the others.
  • Alder also pointed out that although they have established a set of standards for virtual currency trading platforms, there will still be gaps and limitations since existing legislation was not designed with cryptocurrencies in mind.

Context: Hong Kong, as Asia’s financial center, has seen a surge in cryptocurrency use over the past few years partly due to its relatively lenient regulations around virtual assets compared with mainland China. Hong Kong began introducing tougher rules for cryptocurrencies, which prompted some exchanges including Hong Kong-founded Binance and OKEx to move to other markets.

  • In February 2018, the SFC sent out warning letters to seven local exchanges after receiving complaints from investors who had been unable to withdraw virtual assets from their accounts.
  • The FSC announced in November 2018 a new framework for regulating and granting licenses to trading platforms.