Hong Kong Fintech Regulatory Update: From “A Leap of Faith” to “A Vote of Confidence” Part I Expanding Clientele (Retail Access)

The Securities and Futures Commission of Hong Kong (SFC) and Hong Kong Monetary Authority (HKMA), as the respective securities and banking authorities of Hong Kong (Regulators), have come a long way since 2016 in shaping the regulatory regime for intermediaries in the virtual assets (VA) space.

Undertaking the role as a pioneer in providing regulatory clarity and roadmap to market participants and creating an ecosystem conducive of market innovation, as well as, balancing investor protection have resulted in the SFC publishing a plethora of guidance.

Against the backdrop of technology innovation and increased technology adoption, the Regulators have recently published the following regulatory guidance below:

• Joint circular on intermediaries’ virtual asset-related activities published by the Regulators on 20 October 2023 (Joint Circular)¹ , superseding the version dated 28 January 2022 (2022 Joint Circular)
• Circular on intermediaries engaging in tokenized securities-related activities published by the SFC on 2 November 2023 (Tokenized Securities Circular)
• Circular on tokenization of SFC-authorized investment products issued by the SFC on 2 November 2023 (Tokenized Products Circular)

The effect of these circulars further expanded market accessibility of VA to retail investors through (a) permitting only Hong Kong–regulated financial intermediaries to participate, (b) imposing prescriptive guidance on the manner of conducting regulated activities relating to VA, and (c) imposing licensing conditions restricting the permissible scope of business activities.

Navigating the overwhelming volume of regulatory guidance is no easy task. However, this article will predominantly cover the impact on intermediaries’ business operations as it relates to the distribution, dealing, advising, and management of VA that may be offered to the public.

The expansion of market access dovetails with the introduction of a licensing regime applicable to VA trading platform operators that are now permitted to serve retail investors and to distribute certain VA funds (i.e., VA futures exchange traded funds) to retail investors in Hong Kong.

The tables below summarize the regulatory landscape that apply to regulated financial intermediaries engaged in different types of VA-related activities:

Distribution of VA-related products
Regulators	SFC & HKMA
Legislation/ Guidance	Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615, Laws of Hong Kong) (AMLO) Securities and Futures Ordinance (Cap. 571, Laws of Hong Kong) (SFO) Joint Circular2
In Scope Intermediaries	Type 1(Dealing in Securities)/ Type 9 (Asset Management)/ AMLO licensee3
Product Types	VA-related products4 that will be considered as complex products5. For example, overseas virtual asset-related non-derivative products other than those authorized/approved by a designated regulator on a regulated specified exchange (Exempted Complex Products); non-SFC-authorized VA funds; and VA-related derivative products	VA-related derivative products traded on regulated exchanges specified by the SFC (Regulated Specified Exchanges6) Exchange-traded VA derivative funds authorized/approved for retail offering by regulator in designated jurisdiction (Authorised/Approved by Designated Regulator7) public futures-based VA exchange-traded funds (VA ETF) authorized by the SFC and traded on the Stock Exchange of Hong Kong Limited or Exempted Complex Products Tokenized SFC-authorized investment products8
Target Investors	Professional investors9	Retail investors
Terms & Conditions (T&C)	No, but various SFC guidance apply	No, but various SFC guidance apply
SFC Conduct Guidance	suitability10 requirements irrespective of whether solicitation or recommendation exists full scope of complex product requirements11 additional due diligence requirements for non-SFC-authorized VA funds12 existing guidance governing derivative products VA knowledge test13 , information, warning statements, and risk disclosures14 applicable to non-qualified corporate professional investors15 and individual professional investors16	existing guidance on derivative products virtual asset knowledge test and risk disclosures
Selling Restrictions17	Compliance with prospectus regime under the Companies (Winding up and Miscellaneous Provisions) Ordinance (Cap. 32, Laws of Hong Kong) Part IV of the SFO	SFO — Product Authorization by the SFC if publicly offered in Hong Kong
Financial Accommodation	Only if assured that the client has the financial capacity to meet obligations arising from leveraged or margin trading in VA-related products
Advance Notification Obligation to the Regulators	Change of business activities (including changes of type of clientele served)

 

Dealing in Securities
Regulators	SFC & HKMA
Legislation/Guidance	SFO + Existing SFC & HKMA regulatory guidance + Joint Circular + AMLO
In Scope Intermediaries	Type 1 (Dealing in Securities)18 –provide VA dealing services to clients, regardless of the nature of the VA –must partner with SFC-licensed VA trading platforms (SFC-licensed platforms)
Account Types	Omnibus Account19	Introducing Agent
Service Offerings	Dealing services access client’s knowledge of VA and risk tolerance level set limit to ensure client’s exposure to VA is reasonable, with reference to client’s financial situation (including net worth) and personal circumstances account maintained with SFC-licensed platform that can serve retail investors (Retail Platforms) adequate control in place to ensure trading in VA made available by Retail Platforms	SHOULD NOT relay orders on behalf of clients or hold any client assets SHOULD enter into written agreement with SFC-licensed platforms outlining responsibilities under the introducing agent model20
	Deposit/Withdrawal21 only through segregated accounts established or maintained with partnered SFC-licensed platforms; or authorized financial institutions22 that meet the expected standards of VA custody issued by the HKMA
Target Investors	Retail clients23
Terms & Conditions24 (T&C)	October 2023 T&C apply	N/A
Conduct25 Requirements	Effected through imposing licensing or registration conditions	Effected through imposing licensing or registration conditions26
Compliance Deadline by 20 January 2024	Existing intermediaries to upgrade systems and controls to service “non-qualified corporate professional investors” and “individual professional investors”
Advance Notification Obligation to the Regulators	dealing in VA-related products, tokenized securities, and virtual assets (including digital securities) change of business activities (including changes of type of clientele served)

 

Asset Management Services
Regulators	SFC & HKMA
Legislation/Guidance	SFO + Existing SFC & HKMA regulatory guidance + Joint Circular
In Scope Intermediaries	Type 9 (Asset Management)27	Type 1 (Dealing in Securities)
Service Offerings	Portfolio Management Discretionary Account Services28	Dealing services on a discretionary basis as an ancillary service29
Prerequisite	De minimis threshold as stated in the investment objective of a portfolio: or an intention to invest 10% or more of the gross asset value (GAV) of a portfolio in VA	Only invest less than 10% of the GAV of the client’s portfolio in VA
Target Investors	Professional investors
RA9 Terms & conditions (RA9 T&C)30	October 2023 RA9 T&C apply	N/A
Conduct Requirements	Effected through imposing licensing or registration conditions31	N/A
Advance Notification Obligation to the Regulators	managing VA change of business activities (including changes of type of clientele served)

 

Advising on Securities
Regulators	SFC & HKMA
Legislation/Guidance	SFO + Existing SFC & HKMA regulatory guidance + Joint Circular
In Scope Intermediaries	Type 1 (Dealing in Securities)/Type 4 (Advising on Securities)32
Service Offerings	Providing VA advisory services, regardless of the nature of the VA (securities or otherwise)
SFC Conduct Guidance	Observe suitability obligations Take all reasonable steps to ensure VA recommended is of high liquidity (i.e., an eligible large-cap VA that has been included in at least two acceptable indices issued by two different index providers) and made available on Retail Platforms
Target Investors	Retail investors
RA4 Terms & Conditions33 (RA4 T&C)	October 2023 RA4 T&C apply
Advance Notification Obligation to the Regulators	advising on VA-related products, tokenized securities, and VA (including digital securities) change of business activities (including changes of type of clientele served)

In other words, applying the “same business, same risks, and same rules” standard, the Joint Circular clarifies that only intermediaries licensed with the SFC/registered with the HKMA may conduct business activities relating to VA, subject to compliance with conduct requirements set out in the Joint Circular and limited by conditions that may be imposed by the SFC on the intermediary’s license.

Sidley’s Insight

1. Level Playing Field

Compared with the 2022 Joint Circular, the Joint Circular amended the definition of VA to refer to only VA defined under section 53ZRA of the AMLO. Therefore, as the AMLO requires VA trading platform operators only to be licensed with the SFC, the Joint Circular, superseding the 2022 Joint Circular, provides guidance to all intermediaries with regard to their distribution, dealing, advisory, and management of VA that do not necessarily fall within the definition of “securities” and “futures contracts” as defined under the SFO.

The publication of the Joint Circular extended the Regulators’ governance regime applied to traditional financial instruments defined under the SFO to VA creating a “new world order” that may as yet be further disrupted as global regulatory landscape continues to evolve. Following the introduction of the licensing regime applicable to VA service providers, should/would the Regulators, in due course, legislate and require intermediaries to be separately licensed/registered under the AMLO as new categories of VA service providers? Further, would service providers for VA-related products, including custodians, administrators, or index providers, be required to be licensed under the AMLO?

2. Type 1 Versus Type 4 Regulated Activities

Notably, the Regulators stated that VA dealing services do not amount to “dealing in securities” as defined in the SFO, while the Regulators expressed the view that the performance of VA advisory services fall within the ambit of “advising on securities” under the SFO. This admission reflects the continuous dilemma that global regulators (including the Regulators) undergo in deciphering the appropriate taxonomy for the activity performed through technology adoption and categorizing VA as being in nature a traditional financial instrument within the current scope of the SFO or VA as currently defined under the AMLO or even otherwise.

As observed from the frequency of guidance published by the Regulators since 2018, it is inevitable and most likely recognized by VA industry players that the Regulators’ regulatory approach will evolve on par in light of latest market developments and feedback from the market. In particular, with the Regulators taking a bold move to enable increased retail access to VA through permitting the distribution of VA-related products, would and how would global events relating to FTX and/or JPEX falter the Regulators’ approach to regulating VA-related activities in practice? Would the expected conduct requirements set out in these circulars be regarded as stifling as opposed to welcoming by VA industry participants in light of increasing unevenness in the global regulatory landscape relating to VA?

3. Fit and Proper

The concept of fitness and properness applies to intermediaries licensed by the SFC and intermediaries are guided by the “Fit and Proper Guidelines” (Guidelines) in determining whether it remains “fit and proper” to be licensed/registered. Without indicating whether the Guidelines apply to intermediaries engaged in VA dealing services, the SFC indicated that it is empowered under Section 129 of the SFO to consider the state of affairs of any other business conducted by the intermediary conducting Type 1 regulated activities in determining its “fitness and properness.”

The reliance on this “catch-all” provision in the exercise of the SFC’s inspection power is not novel. However, it is questionable as to whether the Guidelines apply to intermediaries engaged in VA dealing activities given the SFC’s admission that VA dealing services do not equate to “dealing in securities” under the SFO. If otherwise, how would the SFC assess the “fitness and properness” of licensed/registered intermediaries that provide VA dealing services in reliance on the “catch-all” provision? Should intermediaries interested in engaging in VA dealing services demystify how this concept applies before embarking on extending its business domain into VA?

The next article of the series will discuss details of additional conduct requirements applicable to specific intermediaries engaged in activities relating to tokenized securities, digital securities, and primary dealing in SFC-authorized investment products.

---

¹ Link access to the appendices of the Joint Circular referenced throughout this article is set out herein for ease of reference: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://apps.sfc.hk/edistributionWeb/api/circular/openAppendix?lang=EN&refNo=23EC44&appendix=0.
² Joint circular on intermediaries’ virtual asset-related activities, 20 October 2023 (https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC47).
³ SFC-licensed platforms without any licensing condition imposed limiting its dealings with professional investors only when distributing products that can be offered to retail investors.
⁴ VA-related products refer to investment products that (a) have a principal investment objective or strategy to invest in VA, (b) derive their value principally from the value and characteristics of VA, or (c) track or replicate the investment results or returns that closely match or correspond to VA.
⁵ The non-exhaustive list of examples of non-complex and complex products can be found at https://www.sfc.hk/en/Rules-and-standards/Suitability-requirement/Non-complex-and-complex-products.
⁶ List of regulated specified exchanges is set out in Schedule 3 to the Securities and Futures (Financial Resources) Rules (Cap. 571N, Laws of Hong Kong).
⁷ List of designated jurisdictions is set out in Appendix 2 to the Joint Circular.
⁸ Subject to compliance with guidance set out in the Tokenised Products Circular: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=23EC53.
⁹ There are four types of professional investors: (a) “Institutional professional investor” is defined under paragraph 15.2 of the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) as persons falling under paragraphs (a) to (i) of the definition of “professional investor” in Section 1 of Part 1 of Schedule 1 to the SFO; (b) “qualified corporate professional investors” refers to corporate professional investors that have passed the assessment requirements under paragraph 15.3A and gone through the procedures under paragraph 15.3B of the Code of Conduct; (c) “non-qualified corporate professional investors” – please refer to footnote [15] below; and (d) “individual professional investors” – please refer to footnote [16] below.
¹⁰ (a) Paragraph 5.5 of the Code of Conduct; (b) for derivative products, compliance with Paragraphs 5.1A and 5.3 of the Code of Conduct; (c) Chapter 6 of the Guidelines on Online Distribution and Advisory Platforms; and (d) Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons and the Frequently Asked Questions on Triggering of Suitability Obligations.
¹¹ A flowchart illustrating the factors for determining whether a VA-related product is a complex product is set out in Appendix 3 of the Joint Circular.
¹² Applicable to non-SFC authorized VA funds and outlined in Appendix 4 of the Joint Circular.
¹³ Non-exhaustive criteria for assessing whether a client can be regarded as having knowledge of VA, set out in Appendix 1 of the Joint Circular.
¹⁴ Information for clients investing in VA-related products — a non-exhaustive list of risk disclosure statements is set out in Appendix 5 of the Joint Circular.
¹⁵ "Non-qualified corporate professional investors” refers to corporate professional investors that have not passed the assessment requirements under paragraph 15.3A or have gone through the procedures under paragraph 15.3B of the Code of Conduct.
¹⁶ "Individual professional investors” refers to individuals falling under Section 5 of the Securities and Futures (Professional Investor) Rules.
¹⁷ The People’s Republic of China (PRC) prohibits sale of VA-related products to Mainland investors. There may be future exchange rules that prohibit offering of VA futures contracts to retail investors. Proper design and appropriate access rights and controls must be implemented for distribution through online platform to ensure compliance with selling restrictions.
¹⁸ The Regulators recognize that VA dealing services do not amount to “dealing in securities” as defined in the SFO. However, they are only prepared to allow Type 1 licensed intermediaries to provide VA dealing services.
¹⁹ Schedule 1 of the October 2023 T&C as referred to in footnote 24.
²⁰ Clients will be onboarded by and will trade through the SFC-licensed platforms direct with trading accounts in the client’s name.
²¹ Compliance with Chapter 12 of the Guideline on Anti-Money Laundering and Counter-Financing of Terrorist (For Licensed Corporations and SFC-Licensed Virtual Asset Service Providers).
²² An authorized institution defined in section 2(1) of the Banking Ordinance.
²³ "Retail client” means any person other than a professional investor.
²⁴ Marked up revisions to the T&C applicable to intermediaries engaged in VA dealing services appear in Appendix 6a of the Joint Circular.
²⁵ The SFC may, under section 129 of the SFO, take into account the state of affairs of any other business of the corporation.
²⁶ Section 116(6) or 119(5) of the SFO.
²⁷ Only allow Type 9 licensed intermediaries that meet the de minimis threshold to engage in the provision of asset management services in respect of VA.
²⁸ An investment mandate or a pre-defined model investment portfolio for which a management or performance fee will be received in return.
²⁹ Activities performed wholly incidental to an intermediary’s provision of services in Type 1 RA.
³⁰ Marked up revisions to the RA9 T&C applicable to intermediaries engaged in asset management services in respect of VA which meet the de minimis threshold are set out in Appendix 7a of the Joint Circular.
³¹ Section 116(6) or 119(5) of the SFO.
³² Only allow intermediaries licensed or registered for Type 1 (dealing in securities) or Type 4 (advising on securities) RA to provide VA-advisory services. Such services form part of an intermediary’s advisory business and may therefore affect its fitness and properness.
³³ Expected conduct requirements for VA-advisory services are set out in RA4 T&C and extracted in Appendix 6 of the Joint Circular.