Revamped SFC and HKMA guidance applies to intermediaries that distribute products or provide dealing, advisory, and asset management services related to virtual assets.

On 20 October 2023, the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) issued a joint circular (Joint Circular) to provide updated guidance to intermediaries conducting virtual asset (VA) activities. The Joint Circular revises a previous joint circular issued on 28 January 2022 (see Latham’s Client Alert).

The need to update the 2022 joint circular emerged after a new regulatory regime for virtual asset trading platforms (VATP) was launched in June 2023, which allowed such platforms to onboard retail investors (see Latham’s Client Alert) for the first time.

The Joint Circular reflects a widening scope of investor access as the regulators move to allow intermediaries to provide more VA services to retail clients, as well as makes some housekeeping amendments to reflect developments in the VA sector. Many of the changes will reduce some compliance friction and should be welcomed by the industry. With the SFC expected to provide additional direction on its expected standards for tokenized securities in the near future, the Joint Circular has updated the definition of VA to exclude tokens constituting securities and futures contracts. 

With this updated guidance, financial services industry participants have a clear pathway to provide retail investors with access to VA-related services. As before, and as described in our previous blog posts, intermediaries providing VA services will have additional terms and conditions imposed on their licences to implement the VA regulatory framework.

This blog post sets out the key changes that the Joint Circular implemented to the previous VA regulatory framework.

VA-Related Product Distribution

• Knowledge Assessments: Intermediaries are required to assess whether clients have knowledge of investing in VA or VA-related products prior to effecting a transaction in VA-related products (other than for institutional professional investors and qualified corporate professional investors (Exempt Investors)).

Previously, a person could be regarded as having such knowledge if they executed five or more transactions in any VA or VA-related product within the past three years. This deeming provision has now been removed, meaning that intermediaries will need to consider the extent of the person’s trading experience and understanding, if any, when assessing if the client has such VA knowledge. This change also applies to intermediaries conducting VA knowledge tests for the activities mentioned below.

• Warning Statements: The Joint Circular also confirms that Exempt Investors do not need to be provided with warning statements and risk disclosure statements when intermediaries are distributing VA-related products to them.

VA Dealing Services

• Dealing with Retail Clients: As SFC-licensed VATPs are now permitted to onboard retail clients to trade VAs, intermediaries are allowed to provide VA dealing services on an introducing agent or omnibus basis to them.

When dealing with retail clients, intermediaries are expected to:

(i) assess each retail client’s knowledge of VAs and risk tolerance level;

(ii) set a limit for each retail client to ensure that the client’s exposure to VAs is reasonable, with reference to the client’s financial situation (including net worth) and personal circumstances;

(iii) when providing omnibus services, ensure that the VA dealing activities are conducted through an omnibus account established and maintained with an SFC-licensed platform that can serve retail clients; and

(iv) implement adequate controls to ensure that their retail clients can only trade VAs that VATPs make available for trading by retail investors (“eligible large-cap VA” i.e., the specific VA should have been included in a minimum of two acceptable indices issued by at least two different index providers).

• Segregated Accounts: Intermediaries can now allow clients to deposit or withdraw VAs from their accounts, but must ensure that such client VAs are held on trust in segregated account(s) established and maintained with: (i) their partnered VATPs; or (ii) Hong Kong banks (or their subsidiaries) which meet the expected standards of VA custody issued by the HKMA from time to time.
• Risk Assessment: Except for Exempt Investors, an intermediary should, before providing VA dealing services, evaluate a client’s risk tolerance level, determine the client’s risk profile, and assess whether it is suitable for the client to participate in the trading of VAs.
• No Staking, etc.: Intermediaries are also restricted from making any arrangements to use client VAs to generate returns, meaning that they are not permitted to offer staking, lending, and other forms of yield farming.
• No Suitability Assessment for Unsolicited Order Placement: For orders in VAs (including VAs classified as complex products) which a client places directly on the trading platform of an intermediary or directly to its staff for onward transmission to a VATP for execution, the intermediary does not need to ensure that the transaction is suitable for the client if the intermediary made no solicitation or recommendation.
• Solicitations/Recommendations in VAs: When making a solicitation or recommendation or providing ancillary VA advisory services to retail clients, the intermediary should take all reasonable steps to ensure that the VA is of high liquidity (and at minimum, an eligible large-cap VA) and made available by VATPs for trading by retail investors.

VA Advisory Services          

• Risk Assessments: Except for Exempt Investors, an intermediary should, before providing VA advisory services, evaluate a client’s risk tolerance level, determine the client’s risk profile, and assess whether it is suitable for the client to participate in VA trading.
• High Liquidity VAs: When providing VA advisory services to retail clients, the intermediary should take all reasonable steps to ensure that the VA is of high liquidity (and at minimum, an eligible large-cap VA) and made available by VATPs for trading by retail investors.

VA Asset Management Services

• High Liquidity VAs: Intermediaries are permitted to provide VA discretionary account management services to retail clients, and should take all reasonable steps to ensure that the VA is of high liquidity (and at minimum, an eligible large-cap VA) and made available by VATPs for trading by retail investors.
• Cap on Percentage of VAs in Client’s Portfolio: If a Type 1 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 (i.e., below the “de minimis threshold”) of the client’s portfolio in VAs.
• Opening to Retail Clients: The requirement for VA fund managers to only permit professional investors to invest in their VA fund has been removed.

Future Guidance and Next Steps

Tokenization is increasingly seen as the next frontier for VAs as regulators promote Hong Kong as a digital asset hub; the Hong Kong government recently issued tokenized green bonds to demonstrate and encourage market take up of tokenization. Market participants have been asking for additional guidance from the regulators on tokenization of SFC-authorised products (like retail funds) and other securities.

The Joint Circular repeatedly notes that intermediaries seeking to provide dealing, advisory, and asset management services in tokenized securities should comply with guidance that the SFC is expected to issue in the near future.

Intermediaries interested in providing VA services following the Joint Circular should notify the SFC (and the HKMA, if applicable) to start discussions on the services they intend to provide and how they can comply with the requirements in the Joint Circular.

Intermediaries already providing VA services should revise their systems and controls to align with the updated requirements. A three-month transition period will apply to intermediaries already providing VA dealing services before the full implementation of the expected requirements in the Joint Circular. Intermediaries looking to further expand their services to retail clients (or make any other changes to their activities) should also notify the SFC (and the HKMA, if applicable).

Hong Kong regulators are expected to issue more VA-related announcements during the forthcoming Hong Kong Fintech Week. We will track and report on those developments on our Global Fintech and Digital Assets Blog.