Background
On 20 October 2023, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) issued an updated joint circular on intermediaries’ virtual asset-related activities (Joint Circular) with appendices. This Joint Circular supersedes the previous joint circular of 28 January 2022.
When the SFC formulated its regulatory approach to virtual assets (VAs) in 2018, it imposed an overarching “professional investors (PIs) only” restriction on various types of VA-related activity, including in respect of the distribution of VA funds. Since then, the VA landscape in Hong Kong has evolved rapidly and begun to expand into mainstream finance. For example, the SFC has allowed SFC-licensed VA trading platforms (SFC-licensed platforms) to serve retail investors and has authorized VA futures exchange traded funds for public offering in Hong Kong.
In light of these developments and calls from the industry to further expand retail access through intermediaries, the SFC and the HKMA have updated their guidance in relation to:
- distribution of VA-related products;
- provision of VA dealing services;
- provision of asset management services in respect of VAs; and
- provision of VA advisory services.
The main changes to the Joint Circular from the 2022 version reflect this policy change and updates the existing guidance, in particular in relation to dealing and advisory services, to cater for retail clients. This includes appropriate investor protection safeguards that come with permitting retail access, e.g. by restricting access to certain non-complex VA-related products only. The Joint Circular also brings the guidance to intermediaries in line with the new regime governing SFC-licensed platforms.
VAs and VA-related products
Under the Anti-Money Laundering and Counter Terrorist Financing Ordinance (AMLO), the term “virtual asset” is broadly defined to mean a digital representation of value that:
- is expressed as a unit of account or a store of economic value;
- either:
- functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes; or
- provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with any cryptographically secured digital representation of value; and
- can be transferred, stored or traded electronically.
Central bank digital currencies, investment assets regulated under the Securities and Futures Ordinance (the SFO) (e.g. securities or futures contracts), stored value facilities and digital representations of value similar to a customer loyalty or reward point are excluded from the definition of “virtual assets” under AMLO.
For the purpose of the Joint Circular, “VA-related products” refer to investment products which: (a) have a principal investment objective or strategy to invest in VAs; (b) derive their value principally from the value and characteristics of VAs; or (c) track or replicate the investment results or returns which closely match or correspond to VAs.
Key aspects of the Joint Circular
The key takeaways from the Joint Circular are set out below.
A. Distribution of VA-related products
Complex product regime requirements
The Joint Circular provides guidance to the industry on how the existing complex products regime applies to VA-related products. Appendix 3 contains a flowchart illustrating the factors that determine whether a VA-related product is a complex product. The SFC’s website also provides a non-exhaustive list of examples of complex products / non-complex products.
Intermediaries distributing VA-related products that are complex products must comply with the SFC’s requirements governing the sale of complex products, including complying with the suitability obligation and providing minimum information and warning statements to clients[1] in relation to such products,[2] Examples of VA-related products considered as complex products include unlisted VA-related derivative products and overseas VA non-derivative exchange-traded funds.
Certain types of VA-related products are not considered complex products and are exempt from the complex product regime requirements. These include VA-related derivative products traded on regulated exchanges specified by the SFC[3] and, in the case of exchange traded VA-derivative funds, are authorized for offering to retail investors by the SFC or the applicable regulator in a designated jurisdiction as set out in Appendix 2 to the Joint Circular (e.g. Australia, Luxembourg and the USA, etc.).
Additional investor protection measures
In addition to the complex product requirements, the SFC and HKMA have imposed the following investor protection measures covering specific risks associated with VA-related products:
- Selling restrictions – VA-related products which are considered complex products, except exchange traded derivatives referred to above, should only be offered to PIs. This means that retail access will largely be restricted to a limited suite of VA-related exchange-traded derivative products such as futures-based VA ETFs authorized for public offering by the SFC and traded on the Stock Exchange in Hong Kong.
- Virtual asset knowledge test – Except for institutional PIs and qualified corporate PIs, intermediaries should assess whether clients have knowledge of investing in VAs or VA-related products prior to effecting any VA-related transactions on their behalf. If a client does not possess the requisite knowledge, the intermediary may only proceed if it has provided adequate training to the client on the nature and risks of trading in VAs or VA-related products.
Appendix 1 to the Joint Circular sets out non-exhaustive criteria for assessing whether a client can be regarded as possessing VA knowledge. Such knowledge is present if the client has: (i) undergone training or attended courses on VAs or VA-related products; (ii) current or previous work experience related to VAs or VA-related products; or (iii) prior trading experience in VAs or VA-related products.
- Sufficient net worth – Intermediaries should also ensure that their clients (except institutional PIs and qualified corporate PIs) have sufficient net worth to be able to assume the risks and bear the potential losses of trading VA-related products.
Other existing investor protection measures
- Suitability– Where applicable, intermediaries should also comply with the suitability requirements, including:
– Ensuring that recommendations or solicitations made are suitable for clients in all circumstances, conducting proper product due diligence. Appendix 4 to the Joint Circular sets out additional due diligence requirements for unauthorized VA funds.
– Where the VA-related product is a derivative product, intermediaries must comply with paragraphs 5.1A and 5.3 of the Code of Conduct for Persons Licensed by or Registered with the SFC, such as ensuring that the client understands the nature and risks of derivative products, etc. Intermediaries should provide clients trading in VA-futures contracts with warning statements (which can be a one-off disclosure). Examples of such statements are set out in Appendix 5 of the Joint Circular.
- Selling restrictions – Intermediaries should also observe the selling restrictions that are applicable to VA-related products, such as the provisions in the SFO which prohibit the offering to the Hong Kong public of investments which have not been authorized by the SFC. Depending on the selling restrictions specific to a particular jurisdiction, exchange or product, a VA-related product may not be offered to retail investors.
- Online distribution – Where the VA-related products are distributed on an online platform, the platform must be properly designed and have appropriate access rights and controls to ensure compliance with the applicable selling restrictions.
- Financial accommodation – Before providing any financial accommodation to clients for investing in VA-related products, the intermediary should satisfy itself of the client’s ability to meet the obligations arising from leveraged or margin trading in VA-related products. Otherwise, the intermediary should not accept instructions from the client.
- Warning statements / product information – Except for institutional PIs and qualified corporate PIs, intermediaries distributing VA-related products should provide information and warning statements to clients in relation to the relevant VA investment in clear and easily comprehensible language. Please refer to Appendix 5 to the Joint Circular.
B. Provision of VA dealing services
Partnering with SFC-licensed VA trading platforms only
Intermediaries should only partner with SFC-licensed platforms for the provision of VA dealing services, whether by way of introducing clients to, or establishing an omnibus account with, such platforms.
Compliance with regulatory requirements imposed by the SFC and the HKMA
Intermediaries must comply with all regulatory requirements imposed by the SFC and the HKMA when providing VA dealing services, irrespective of whether the VAs involved are securities as defined under the SFO.
VA dealing services should only be provided to the intermediaries’ existing clients (including retail clients) to which they provide services in Type 1 (dealing in securities) regulated activity.
Conduct requirements for intermediaries providing VA dealing services under an omnibus account arrangement
Conduct requirements in relation to VA dealing services under an omnibus account arrangement will be imposed on intermediaries as licensing or registration conditions. Please refer to Appendix 6 to the Joint Circular.
One of the conditions requires intermediaries to comply with prescribed terms and conditions (T&Cs), which are aligned with the requirements of the regulatory framework for SFC-licensed platforms to the extent that they relate to the performance of the dealing function carried out by intermediaries. Under the T&Cs, intermediaries should, before providing VA dealing services to retail clients:
- assess each client’s VA knowledge and risk tolerance levels and set a reasonable trading / exposure limit for each client;
- ensure that its VA dealing activities are conducted through an SFC-licensed platform that is not subject to the licensing condition that such platform can only serve PIs;
- implement adequate controls to ensure that their retail clients can only trade in VAs that are made available by the SFC-licensed platform for retail trading; and
- for intermediaries that allow clients to deposit or withdraw VAs from their accounts, receive or withdraw such client VAs through segregated account(s) established and maintained with their partner SFC-licensed platforms or HKMA-licensed banks (or subsidiaries of locally incorporated licensed banks) which meet the HKMA’s expected standards on VA custody.
Conduct requirements for intermediaries providing VA dealing services as an introducing agent
Intermediaries providing VA dealing services as an introducing agent may introduce retail clients to SFC-licensed platforms, but they must not relay clients’ orders to such platforms or hold any client assets (including fiat currencies and VAs) for the introduction services.
These requirements will be imposed by the SFC (and in consultation with the HKMA, where applicable) as licensing/registration conditions (see Appendix 6 to the Joint Circular).
C. Provision of asset management services in respect of VAs
Only intermediaries licensed or registered for Type 9 (asset management) regulated activity are permitted to provide asset management activities in respect of VAs, which meet the de minimis threshold (i.e. a stated investment objective of a portfolio to invest in VAs or an intention to invest in 10% or more of the gross asset value of a portfolio in VAs). Intermediaries providing such services which meet the de minimis threshold are subject to additional requirements set out in the terms and conditions (please see Appendix 7 to the Joint Circular).
Where a Type 1 (dealing in securities) intermediary is authorized by its clients to provide VA dealing services on a discretionary basis as an ancillary service, it should only invest less than 10% of the gross asset value of the client’s portfolio in VAs.
D. Provision of VA advisory services
Intermediaries must comply with all regulatory requirements imposed by the SFC and HKMA when providing advisory services, irrespective of the nature of the VAs, and should only provide such service to existing clients (including retail clients) which they provide services in Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities.
The expected conduct requirements are set out in the terms and conditions in Appendix 6 to the Joint Circular. This includes complying with suitability obligations, and when recommending VAs to retail clients, intermediaries should take reasonable steps to ensure that the recommended VA is of high liquidity (at a minimum, it must be an eligible large-cap VA, i.e. it should have been included in a minimum of two acceptable indices issued by at least two different index providers) and is made available by SFC-licensed platforms for trading by retail investors.
E. Provision of dealing, advisory or asset management services in relation to tokenised securities
Intermediaries providing dealing, advisory or asset management services in tokenized securities should comply with the existing requirements governing dealing in securities or asset management regulated activity, and any further guidance the SFC may issue on tokenized securities.
Implementation
Intermediaries who already provide VA dealing services to non-qualified corporate PIs and individual PIs:
- You have a three-month transition period to comply with the Joint Circular. You will need to update your policies, procedures and systems to align with the new requirements.
Intermediaries who plan to provide VA dealing services to non-qualified corporate PIs, individual PIs and retail investors:
- Please ensure you are compliant with the new requirements before introducing these services.
Intermediaries should notify the SFC and the HKMA (where applicable) in advance if you intend to:
- engage in activities involving tokenised securities and VAs, which include the provision of dealing and advisory services in VA-related products, tokenised securities and VAs
- engage in VA asset management services, or
- make any changes to these activities (including changes in the type of clients served).
If you would like to discuss, please contact Etelka Bogardi (etelka.bogardi@nortonrosefulbright.com) or Conrad Lam (conrad.lam@nortonrosefulbright.com).
[1] Except for institutional PIs and qualified corporate PIs.
[2] The complex product regime requirements are set out in paragraph 5.5 of the Code of Conduct for Persons Licensed by or Registered with the SFC and Chapter 6 of the Guidelines on Online Distribution and Advisory Platforms.
[3] This refers to the list of specified exchanges set out in Schedule 3 to the Securities and Futures (Financial Resources) Rules (Cap. 571N).
