New guidelines for ‘Digital Asset Buying and selling Platform Operators’, aka crypto exchanges, kick in on June 1, 2023 in Hong Kong. The rules will permit licensed exchanges to promote extremely liquid cryptocurrencies to retail traders.
This development continues a practice of Hong Kong, a Particular Administrative Area of China, being a sandbox of kinds and a gateway to the mainland and its markets. Nevertheless, Beijing has banned cryptocurrency trading in addition to mining of Bitcoin, whereas additionally being an enthusiastic adopter of blockchain know-how and its potential to streamline and reduce prices in a large assortment of industries.
With Hong Kong’s Securities and Futures Commision (SFC) laying out the foundations that outline what cryptocurrency exchanges must do to be licensed within the metropolis and function legally, might this be an indication of China softening its place on digital currencies?
Forkast’s Megha Chaddah spoke with Angelina Kwan, chief govt officer of Hong Kong-based regulation marketing consultant Stratford Finance, concerning the new guidelines, what they get proper and the gaps that also should be stuffed. As a director of the SFC’s Supervision of Markets division from 1999 until 2006, Kwan helped form early Hong Kong rules on automated and web buying and selling companies.
The next Q&A has been edited for readability and size.
Megha Chaddah: In distinction to regional neighbors, Hong Kong appears to be setting in place digital asset enterprise tips to make sure that these companies can function in an orderly style. Broadly talking, would you say the federal government seems to be setting up guardrails for buyer security whereas giving digital asset companies room to innovate?
Angelina Kwan: I wouldn’t say there’s particular guardrails. I might say that we’re transferring ahead in a really coordinated style by way of full licensing. This can be a 380-page session conclusion that displays the market truly writing into the primary set of session guidelines that the SFC put up.
They put up an excellent algorithm. The market commented and now they’ve come again with tempered and excellent choices by way of what the following part of digital belongings goes to be. And it’s going to be very coordinated.
It’s very clear you’re going to get a license should you adjust to all the foundations and rules, and retail traders will have the ability to purchase digital belongings so long as they cross sure necessities by way of understanding what they’re moving into, understanding and opening accounts with licensed, digital asset service suppliers.
I might say this can be a regime that’s very clear who does what, what protections traders get and the way can we innovate and transfer ahead for digital belongings. I made a forecast in 2018 the place I mentioned that the market on the time shouldn’t be regulated, however in 3-5 years, the market is unquestionably going to be increasingly more regulated. And other people simply must be on board and perceive this.
As digital belongings turn out to be increasingly more like an actual asset, you’re going to get institutional and retail adoption of such belongings.
Chaddah: You talked about retail clients being allowed to commerce cryptocurrencies, that are massive and extremely liquid. However the burden to make sure that these clients perceive the dangers concerned rests on the exchanges themselves. How sensible is that this requirement and the way does it evaluate to the burden that’s positioned on exchanges that deal in conventional monetary merchandise?
Kwan: I used to work for HKEX (Hong Kong Trade) and HKEX has this wonderful web site the place it discusses every of its merchandise.
Guidelines and rules are printed and brokers are the folks that promote the merchandise on Hong Kong exchanges. These are the registered folks that have licenses, who take possession of the consumer relationship and are those speaking to and advising purchasers.
They might have investor training coaching, and the regulator additionally shares investor training coaching. So should you go to quite a lot of brokers, they’ll have few seminars. They may have your account govt speak to you about totally different merchandise. However should you actually aren’t the kind of particular person that may commerce, it’s possible you’ll not get your account opened by a dealer since you is probably not the best danger profile. For instance, should you’re an 80-year-old retiree with a small pension, you’re not going to be shopping for derivatives, particularly derivatives on very dangerous belongings.
On the flip facet, if the identical retiree is shopping for an annuity or placing it right into a financial savings account, which may be one thing that an 80-year-old [could access] and that’s the half known as suitability. That’s dealt with by the dealer and the change. The dealer places the commerce on the change that gives the interface.
And that’s the place we are actually with these licensed exchanges. They’ve to supply account opening, make sure that their purchasers know what they’re moving into and what the merchandise are. Some digital asset exchanges are excellent at explaining every product. They might not inform you the chance, however they positively inform you concerning the product. They most likely must do extra about speaking about danger.
Chaddah: Accepted tokens for funding must endure a stringent due diligence course of, which incorporates having a year-long observe report and inclusion into acceptable indices. In order that minimizes the possibilities of fly-by-night operators or cash profiting from gullible traders. We now have seen cases in South Korea the place one of many managers of a crypto change who was answerable for token itemizing was accused of taking bribes for listings. Do you suppose that Hong Kong regulators are maintaining with all that’s taking place across the area and shutting potential loopholes?
Kwan: They’re, positively. However this session paper was drafted manner earlier than this [South Korea] bribery case got here out. Within the session draft, it mentioned that should you’re an change that desires to supply tokens, your administration has to know precisely what they’re providing. So should you’re providing Bitcoin, administration might want to know and do due diligence on Bitcoin. It’s worthwhile to know the place it got here from, the place it’s traded, be listed on not less than two indices. It’s worthwhile to know that it’s not a rip-off that you simply’re going to offer to your purchasers. In order that’s the requirement that was written virtually six months in the past.
Within the South Korea bribery case, if it was a agency with a administration crew that was very critical about following the foundations, that one man wouldn’t have the ability to get this token listed except he was capable of persuade the complete administration crew. In order that [bribery] wouldn’t have occurred if Korea had that kind of rule. Administration groups now should be satisfied that corporations and exchanges should be satisfied that these are the best tokens earlier than they provide them to their purchasers. So due diligence is required.
On the New York Inventory Trade, it’s FINRa that approves an inventory. In Hong Kong, It’s SFC and HKEX that approve the itemizing. However if you have a look at digital asset tokens, you’ve received Satoshi Nakamoto and a gaggle of folks that got here up with this [Bitcoin] product. That’s it. However there have been no guardrails after they listed the token and the token simply type of developed. And plenty of of those tokens have been simply developed and there’s no background nor documentation, there’s nothing on them. In order that’s why companies which might be going to be regulated in Hong Kong must do the due diligence earlier than unleashing these tokens.
Chaddah: The foundations for digital buying and selling platforms additionally discuss secure custody of belongings, segregation of consumer funds. How a lot of it’s because of the collapse of the FTX change and the alleged co-mingling of funds? And do you suppose there’s sufficient that’s put down by way of licensing necessities there?
Kwan: The present SFC guidelines would not have laws to have outsourced custodians at the moment. In order that’s one thing I feel they’re going to positively work on. They’re going to require that the change getting a license has to have a custodial operate, both as an related entity or inside that change.
So should you’re getting the license, you’re answerable for the buying and selling, the safekeeping of your scorching wallets, your chilly wallets, your change mechanisms, your individuals. On the opposite facet, you’ve folks that don’t have a licensed change background. And it’s a free-for-all since you don’t know what’s behind all of this, as a result of it’s not licensed.
We didn’t know SBF [Sam Bankman-Fried, the founder of FTX] didn’t examine sure issues or we didn’t know some exchanges didn’t have correct custody. However when you get a license, it’s a must to have sure programs in place. You’ve been checked, signed off on and doubtless have an auditor. Such good housekeeping for a growing asset goes to convey the following part ahead to develop digital belongings.
Chaddah: The SFC is saying stablecoins are a no-go for retail buying and selling till we’ve got rules for this particular kind of crypto asset. Do you suppose Hong Kong’s improvement of the state CBDC aka the e-HKD has one thing to do with this resolution?
Kwan: The HKMA (Hong Kong Financial Authority) drafting rules for stablecoins is among the causes the SFC has mentioned what it has mentioned. The HKMA goes to draft a complete regime of how stablecoins ought to work and the way they need to be backed. And there have been stablecoin issuers very all for it. The straightforward ones are US$1 to 1 USDT.
Those that aren’t straightforward are those that you simply noticed with Terra and Luna, who known as themselves [an algorithmic] stablecoin. And that’s what the SFC is most nervous about.
If it’s a one-for-one like USDC and USDT, it’s very straightforward to know. As this begins transferring alongside, I feel the SFC and the market can have discussions over cash like that. However for the following iteration of Terra and Luna, that’s positively not on the desk.
My crew within the Hong Kong Securities Institute has to ascertain the questions for this. Will probably be one of the clear. I feel it’s very clear and a reasonably great way of getting your license. It could take you some time nevertheless it’s positively going to return, whereas [the processes] in different international locations have slowed as a result of they’re overwhelmed or rethinking what they’re going to do subsequent by way of licensing.
All the things that I mentioned is now codified and in writing so there’s no extra excuse of not placing in correct inner controls, safety measures and having workers which might be educated and have the best background for digital belongings. So it’s a great step ahead for Hong Kong to be the regulatory sandbox for China, for digital belongings. With that, I feel we are going to see a number of curiosity within the license as a result of it’s going to be very clear.
Chaddah: We’re already listening to so many companies speaking about making use of for the licenses, equivalent to Okex and ZA Financial institution. How quickly do you suppose we might see the primary of those licenses and the place would possibly we be by the tip of this 12 months?
Kwan: The primary two [firms] – Hashkey and OSL – simply must reapply. So that you’ll see two [licenses] out the door possibly inside 6 to eight months. However they’re already licensed and fall below the ‘choose in’. Then you definitely’ve received the businesses which might be being ‘grandfathered’, these already working in Hong Kong.
Firms are actually placing in licensing functions and it’ll take them a while to determine the appliance, so this might take six months to a 12 months due to the processing time, with simply 4 individuals on the SFC crew doing [processing at present].
There are about 10 exchanges within the first batch which have indicated curiosity in acquiring licenses, which can take about eight months to a 12 months or a 12 months and a half. It took Hashkey virtually two years [together approved]. It takes time as a result of there’s a lot data and also you’ve set to work on totally different licenses on the similar time.
By this time subsequent 12 months, we’ll positively have a few licensed companies. Within the letter that went out with the session paper, it requested companies to go away Hong Kong if they don’t adjust to the license utility. We’re hoping that individuals do get the license and we get a really energetic digital asset business right here, identical to securities.