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New legal framework for crypto in Hong Kong

In Hong Kong on June 1, 2023 will take effect the new licensing regime for crypto exchange services that will allow retail investors to trade cryptocurrencies in the city. As we already reported major global crypto exchanges has already applied for a license to city’s financial watchdog – Hong Kong Monetary Authority (HKMA).

The Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill has been passed by the Legislative Council of Hong Kong on December 7, 2022. The new regulations stipulate that all centralized virtual currency exchanges and other virtual assets service providers (VASP) operating in the city or marketing services to the territory’s investors must obtain licenses from the securities and futures authority. The regulatory requirements cover key areas such as safe custody of assets, know-your-customer (KYC) and anti-money laundering (AML) procedures, and market manipulation prevention. All legal requirements for VASPs has been issued on May, 23 in a special report by HKMA.

The transitional arrangements allow VASPs operating in Hong Kong immediately before June 1, 2023, to continue to operate without a VASP license for up to 12 months. However, VA exchanges based overseas will be prohibited from actively marketing their services in Hong Kong when the new regime takes effect.

The penalties for non-compliance with the new regulations include fines and imprisonment. The maximum penalty for operating an unlicensed virtual asset exchange is a fine of HKD 5 million and seven years’ imprisonment. The maximum penalty for market manipulation is a fine of HKD 10 million and ten years’ imprisonment.

However, the regulations will allow retail investors to trade certain «large-cap token» on licensed exchanges but not every crypto that exists. Another point is that there is still no rules issued for stablecoins. The HKMA has already proposed a Stablecoin License Regime to regulate stablecoins in Hong Kong but it is not expected to come into force until the end of the year.

The HKMA intends to build license regime that has the flexibility to bring other stablecoin structures into the scope of regulation in the future. It will cover key risks such as stablecoin governance, issuance, stabilization, and reserve management. Entities undertaking stablecoin activities in Hong Kong or actively marketing to Hong Kong will need to be licensed.

The HKMA has proposed a risk-based «same risk, same regulation» approach, and envisages introducing different licenses targeting different regulated activities. Both Hong Kong authorized banks and non-authorized banks are eligible to apply for a license to issue stablecoins. The HKMA has not finalized how it will implement the Rules, but it notes that amending the Payment Systems and Stored Value Facilities Ordinance of Hong Kong may bring in-scope stablecoins into the regulatory remit from the payment perspective.

It should be also mentioned that the Court of First Instance of Hong Kong in a landmark decision on the legal status of digital assets has ruled that cryptocurrencies satisfy the definition of «property» under Hong Kong law and are capable of being held on trust. This decision has also paved the way for the introduction of new regulations for the local cryptocurrency industry.

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