Clifford Chance

Some of the key enforcement risks that a virtual asset trading platform needs to be aware of when seeking to be regulated under the new framework.

In November 2019, the Securities and Futures Commission (SFC) gave the green light to grant licences to virtual assets (VA) trading platform operators under the SFC's regulatory sandbox initiative announced more than a year ago (see the article of our Tech Team "To be, or not to be, a Hong Kong SFC licensed virtual asset trading platform" for the key features of the new framework). Many have since questioned how practicable it is for crypto exchanges to operate under the new framework. We highlight below a number of areas that may pose enforcement risks to aspiring platform operators:

Standard of regulation – Adopting a tech-neutral regulatory stance, while the SFC tailored the new regulatory framework considering the unique features of VA, the regulatory standards are benchmarked against, and comparable to (if not higher than), the existing requirements applicable to licensed ATS providers and securities brokers. In certain areas (such as AML/CFT), the SFC would require platform operators to apply the requirements of international bodies (e.g. FATF) in case they are more stringent that those of the SFC.

Scope of regulatory supervision – when considering a platform operator's fitness and properness, the SFC will also take into the trading activities of non-security tokens of the licensed entity or its group companies. Non-compliant conduct in such activities may also lead to enforcement/regulatory action against the licensed corporation.

No more anonymity – a platform operator needs to take all reasonable steps to establish the true and full identity of each of its clients. Where a client’s IP address is masked (for example, where access is via a virtual private network which is quite common), a platform operator should take reasonable steps to unmask the IP address or decline to provide services to that client where necessary.

Suitability – a platform operation needs to understand each client’s financial situation, investment experience and investment objectives, and ensure that the client has sufficient knowledge of virtual assets. It needs to set a trading limit, position limit or both with reference to a client’s financial situation with a view to ensuring that the client has sufficient net worth to be able to assume the risks and bear the potential trading losses.

The new SFC regime will change the unsolicited and anonymous nature of most of the trading which currently takes place on unregulated crypto exchanges. It is certainly exciting for crypto exchanges to be offered a path to regulation in Hong Kong but there are various operational and regulatory compliance challenges involved. Platform operations will need to put in place proper controls and systems to operationalise and comply with the new regulatory framework to manage enforcement risks.