On 20 October 2023, the Securities and Futures Commission (“SFC“) and the Hong Kong Monetary Authority (“HKMA“) issued a joint circular (“Joint Circular“) to provide updated guidance to intermediaries conducting virtual asset (“VA“) related activities, including (a) distribution of VA-related products[1], (b) VA dealing services, (c) VA asset management services; and (d) VA advisory services. The Joint Circular supersedes the previous joint circular issued on 28 January 2022.

Background

The SFC’s initial regulatory approach was to impose a “professional investors only” restriction on various types of VA-related activities. However, in light of the rapid growth of the VA landscape , and the new licensing regime for VA trading platforms which came into effect on 1 June 2023 which allows VA trading platforms to provide services to retail investors, retail investors now have increased exposure to VA activities. Although VAs are becoming more popular globally, the regulatory landscape in different jurisdictions remains varied, and the SFC and the HKMA are of the view that risks associated with VAs and VA-related products may be difficult for retail investors to understand. Hence, it is necessary for the SFC and the HKMA to review and update their policies to provide further guidance on intermediaries conducting VA-related activities.

A. Distribution of VA-related Products

The SFC and the HKMA will impose the following investor protection measures specifically relating to the distribution of VA-related products, in addition to the requirements under the complex product regime[2]:

Selling restrictions – Subject to certain exceptions, VA-related products which are considered to be complex products should only be offered to professional investors. Intermediaries should also observe specific selling restrictions in Hong Kong and other jurisdictions which are applicable to a particular VA-related product.

VA knowledge test – Before effecting a transaction on behalf of a client (other than institutional professional investors[3] and qualified corporate professional investors[4] (“Exempt Investors“)), intermediaries should assess whether such client has knowledge of investing in VAs or VA-related products, for instance, whether the client has undergone training or attended courses, or has had other work or trading experience in relation to VAs or VA-related products. If a client lacks such knowledge, the intermediary may only proceed after it has provided adequate training to such client on the nature and risks of the VAs and VA-related products.

Suitability obligations – Intermediaries should observe the suitability obligations as supplemented by the Suitability FAQs, including:

(a) ensuring that any recommendations or solicitations made are suitable for or are otherwise in the best interests of the client in all circumstances, taking into account, among other things, the nature and features of the VA-related product, the client’s risk tolerance and financial situation;

(b) where the VA-related product is a derivative product, ensuring that the client understands the nature and risks of the product and has sufficient net worth to be able to assume the risks and bear potential losses of trading in such product; and

(c) conducting proper due diligence on the products, including, among other things, understanding the products’ risks and features and regulatory status, and the targeted investors.

Providing financial accommodation – Before intermediaries provide any financial accommodation to the client, it should ensure that the client has the financial capacity to meet the obligations arising from leveraged or margin trading in VAs and VA-related products.

Warning statements – Apart from Exempt Investors, intermediaries should provide to clients (a) information and warning statements in relation to VA-related products, and information on the underlying VA investments, in a clear and easily comprehensible manner; and (b) risk disclosure statements specific to VAs.

B. VA Dealing Services

Intermediaries must be licensed or registered for Type 1 (dealing in securities) regulated activity to provide VA dealing services, and may only partner with SFC licensed VA trading platforms (“SFC-licensed platforms“) to provide such services, either by (i) introducing clients to the SFC-licensed platforms for direct trading; or (ii) establishing an omnibus account with the SFC-licensed platforms.

For intermediaries providing VA dealing services under an omnibus account, as a licensing or registration condition, such intermediaries must comply with the terms and conditions prescribed by the SFC, which include, among other things, that:

(a) before providing VA dealing services to retail investors, intermediaries should: (i) assess each retail investor’s knowledge of VAs and risk tolerance level; (ii) set a reasonable exposure limit for each retail investor, with reference to such retail investor’s financial situation (including net worth) and personal circumstances; (iii) ensure that the VA dealing services are conducted through an omnibus account established and maintained with an SFC-licensed platform that is not subject to the licensing condition that it can only serve professional investors; and (iv) implement adequate controls to ensure that retail investors can only trade in VAs that are made available for trading by retail investors by the SFC-licensed platforms; and

(b) any deposit of VAs by a client, or any withdrawal of VAs by a client, must be dealt with through the intermediary’s segregated account(s) established and maintained with (i) the intermediary’s partnered SFC-licensed platforms; or (ii) authorised financial institutions (or their local subsidiaries) which meet the expected standards of VA custody issued by the HKMA. Intermediaries should also comply with the relevant anti-money laundering and counter-terrorist financing requirements with respect to VAs when handling these VA deposits and withdrawals.

There are also additional requirements and licensing or registration conditions for intermediaries who provide VA dealing services when acting as introducing agents of a SFC-licensed platform.

C. VA Asset Management Services

Intermediaries must be licensed or registered for Type 9 (asset management) regulated activity to provide asset management activities relating to VAs which meet the de minimis threshold (that is, a stated investment objective of a portfolio to invest in VAs or an intention to invest 10% or more of the gross asset value of a portfolio in VAs). As a licensing or registration condition, such intermediaries must comply with additional requirements under the terms and conditions prescribed by the SFC relating to the management of such asset portfolios.

If a Type 1 (dealing in securities) intermediary is authorised by its clients to provide ancillary VA dealing services on a discretionary basis, the intermediary should only invest less than 10% of the gross asset value of the client’s portfolio in VAs (that is, below the “de minimis threshold”).

D. VA Advisory Services

Intermediaries must be licensed or registered for Type 1 (dealing in securities) or Type 4 (advising on securities) regulated activity to provide VA advisory services, and are expected to comply with all the regulatory requirements (including to observe the suitability obligations) imposed by the SFC and the HKMA when providing advisory services, irrespective of the nature of the VAs.

When recommending any VAs to retail investors, intermediaries should take all reasonable steps to ensure that (a) the VA is of high liquidity and is an eligible large-cap VA (that is, it is included in a minimum of two acceptable indices issued by at least two different index providers), and (b) the VA is made available for trading by retail investors by the SFC-licensed platforms.

Implementation

There will be a 3-month transition period before the full implementation of the updated requirements under the Joint Circular. Hence, intermediaries may continue to provide VA-related services to their existing clients who have been assessed to possess knowledge of VAs based on the results of the VA knowledge tests conducted before 20 October 2023.

If intermediaries intend to further expand their VA-related services, particularly to retail investors, or make any changes to their existing activities, they should notify the SFC and the HKMA (where applicable) in advance.

Takeaway

The Joint Circular has introduced additional investor protection measures and other updates to the policies in light of the latest market developments, and has clarified the standard of conduct expected from intermediaries’ conducting VA-related activities, which demonstrates the Hong Kong Government and the regulators’ joint commitment to enhance the level of responsibility and accountability of key players in the VA industry in Hong Kong. We look forward to the SFC and the HKMA issuing further regulatory guidelines and updates as the VA industry continues to expand and develop in the future.

For the full text, please refer to the Joint Circular and Appendices.

[1] “VA-related products” refer to investment products which (a) have a principal investment objective or strategy to invest in virtual assets; (b) derive their value principally from the value and characteristics of virtual assets; or (c) track or replicate the investment results or returns which closely match or correspond to virtual assets.

[2] The complex product regime refers to the requirements in paragraph 5.5 of the Code of Conduct for Persons Licensed by or Registered with the SFC (“Code of Conduct“) and Chapter 6 of the Guidelines on Online Distribution and Advisory Platforms.

[3] “Institutional professional investors” is defined under paragraph 15.2 of the Code of Conduct as persons falling under paragraphs (a) to (i) of the definition of “professional investor” in section 1 of Part 1 of Schedule 1 to the SFO.

[4] “Qualified corporate professional investors” refers to corporate professional investors which have passed the assessment requirements under paragraph 15.3A and gone through the procedures under paragraph 15.3B of the Code of Conduct.