SFC to Grant Licenses to Crypto-exchanges — A Positive Step Backwards?
While general interest in Blockchain and cryptocurrencies has been fading, Blockchain again became a central theme at Fintech Week, with about half of the main and future stage talks dedicated to things like stablecoins, Libra and Central Bank Digitual Currencies (CBDC).
While HKEX this year did not make a Blockchain announcement, and the HKMA’s release of a research paper around CBDCs seems to not be ready for presentation, the outgoing SFC Chief Executive Ashley Alder once again takes the opportunity of a global attentive audience to announce a new approach to regulating cryptocurrency exchanges in Hong Kong.
In November 2018 Alder introduced a ‘Sandbox regime.’ You can find the original announcement here and our commentary here. Its biggest criticism: You can only join the sandbox if your business does not require a license.
The November 2019 announcement rectifies this. Exchanges that deal in tokens deemed securities or futures now not only require a license, but have some reasonable expectation that they can obtain this license from the SFC.
As the Securities and Futures Ordinance (Cap 571) remains unchanged, pure Bitcoin exchanges, as well as those trading in tokens not deemed securities, continue to be regulated by the Customs & Excise Department (which does not yet issue or require licenses). But such exchanges may ‘opt in’ to becoming regulated by the SFC by listing at least one security token.
In detail, exchanges will at least require a Type 1 (dealing in securities) and Type 7 (providing ATS) license. Depending on the business, other licenses may be required. We note that while token exchanges often appear similar to stock exchanges, this does not make them stock exchanges, and does not affect HKEX’ statutory monopoly.
While some newer, inactive platforms may attempt to ‘try out’ this new licensing regime, we don’t expect much to change over the next year. The licensing regime continues to be highly restrictive, limiting trading to institutions and requiring hard to obtain insurance on all assets held. It is unknown how large the market for institutional investors is, especially since SFC regulated funds will continue to have difficulties putting cryptocurrencies into their portfolios, while U.S. and EU regulated exchanges provide fierce competition.
Conclusion
We don’t expect any of the popular cryptocurrency exchanges to risk their profitable retail business and join the SFC licensing regime. However, some new ventures, especially those few founded in the past two years that have not gained significant market share, may want to find out how large and profitable the ‘institutional market’ is in Hong Kong.
The term ‘Virtual Asset’ continues to be used by the SFC as if it had any legal or technical meaning. It does not. It confuses various legal concepts and represents a creeping overreach of its competencies. We understand the SFC has urged government to amend the SFO to give it power over all things digital, and we understand that Ashley Alder as Chairman of the IOSCO board has made efforts to pursue such efforts globally. We do not believe bringing commodities or currency trading under the supervision of securities regulators serves investors, traders, producers or the economy as a whole.
