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introduction
2020 was an unprecedented year! As the first year of the new decade draws to a close, it will appear that the blockchain is poised to make a rebound with two major events taking the wider community by storm.
First, it was announced that China Construction Bank (the “CCB”) had partnered with the Fusang Exchange to raise up to $ 3 billion through a publicly traded debt on a blockchain. Although CCB eventually suspended issuing digital bonds to address a number of issues related to the concept of bond, this is a clear sign that traditional financial institutions are taking blockchain technology seriously once again and are moving from mere skeptics. blockchain to blockchain evangelicals. The second event is obviously the rise in the price of bitcoin once again. Towards the end of November, Bitcoin rebounded to an all-time high, once again reaching US $ 19,129.30 at 1 BTC on November 24, 2020.
Security Token
Security tokenization has received increasing attention in recent years, and regulators around the world have responded to the rise in digital assets and the development of cryptocurrency exchanges. Although CCB’s latest tokenization project has been suspended, it prompts reflection on Hong Kong’s current position in relation to virtual assets and more specifically security tokens.
In the Statement on Security Token Offerings issued by the Securities and Futures Commission (the “SFC”), the SFC referred to security tokens as having features of traditional securities and are digital representations of ownership of assets, such as gold or real estate, or economic rights, such as a share of profits or revenue, using blockchain technology.
Security tokens, as a kind of virtual asset, are often offered to professional investors and are different from utility tokens, which are another type of token. Since security tokens are a form of security, they require SFC approval. Utility tokens on the other hand provide holders with the right to use a network to consume products or services while the security token itself represents a resource. Since utility tokens are, as the name suggests, utility only and not security, the issuance of utility tokens under Hong Kong’s existing laws will not require SFC approval.
Hong Kong’s current regulatory framework on trading in virtual goods
In November 2019, the SFC defined an ‘opt-in’ regulatory framework for virtual asset trading platforms to clarify how virtual assets and certain specific activities involving these assets would fit under the existing regulatory regime. It was later revealed last month, however, that the SFC intends to bring all virtual asset exchanges under its auspices, abandoning the previous year’s “opt-in” approach. This new direction will obviously require changes to Hong Kong’s existing laws (to be discussed further below).
Pending the passage of the new law desired by the SFC, the Regulatory Regime 2019 will continue to apply. According to the regulatory framework of 2019, a platform that offers the trading of at least one security token would fall under the jurisdiction of the SFC and is required to apply for a license type 1 (securities trading) and type 7 (provision of automated trading services).
The SFC will impose licensing terms on platform operators to address specific risks associated with their operations, such as requiring them to:
1. offer its services exclusively to professional investors;
2. serve only customers who have sufficient knowledge of virtual resources;
3. maintain strict criteria for including virtual assets on their platforms and obtain
subject to written approval by the SFC for any plans to offer new services or products; is
4. Engage independent professional firms acceptable to the SFC to conduct an annual review of their business and operations and submit reports to the SFC.
Furthermore, platform operators are required to comply with the prescribed terms and conditions, including:
1. hold all client assets in a separate account established by the entity associated with the platform operators;
2. meet the Know-Your-Client requirements to establish the true and full identity, financial situation, investment experience and investment objectives of each client;
3. establish and implement anti-money laundering and counter-financing of terrorism policies and controls to manage risks as many virtual assets are traded anonymously; is
4. establish and implement policies and controls to identify, prevent and report any abusive trading or market manipulation activity.
Any violation of a licensing condition may be considered misconduct under Part IX of the Securities and Futures Ordinance (“SFO”) and may result in disciplinary action by the SFC, such as license revocation, reprimand public or fine. On the bright side, thanks to intense SFC oversight, any licensed exchange operating in Hong Kong will have great credibility with its clientele and associated reputation (instead of being an unregulated exchange).
Going forward
In November 2020, the Hong Kong Bureau of Financial Services and Treasury released a consultation paper outlining a proposed new licensing regime for virtual asset service providers that would require any virtual asset exchange based in Hong Kong is licensed by the SFC.
Interestingly, the current regulatory framework in Hong Kong only applies to centralized exchanges, where virtual asset trading platforms have control over investor activities, but not to decentralized exchanges, where investors trade on a direct basis from person to person. Although under the proposed new licensing regime, virtual asset service providers operating virtual asset exchanges in Hong Kong or targeting Hong Kong customers will be required to apply for a license with the SFC, the regime does not still proposes to include decentralized exchanges.
The consultation period will end on January 31, 2021 and the framework of the new licensing regime remains to be seen.
Conclusion
Applications of blockchain technology have grown rapidly in various areas. In particular, the issuance of digital tokens via blockchain has increasingly been seen as an alternative to traditional debt financing. In September 2020, the SFC agreed in principle to license a cryptocurrency company for its application to operate a virtual asset trading platform involving security tokens, subject to final approval by the SFC at compliance with certain conditions. The license would make it possible to operate an automated brokerage and trading service for digital assets. More licenses are expected to be granted to virtual asset trading platforms by the SFC in the near future, and a more comprehensive regulatory regime for virtual asset and blockchain businesses may be introduced by regulators to provide greater protection and clarity to market players.
