Hong Kong treads fine line on regulating retail crypto trade

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HONG KONG: Retail investors in Hong Kong may soon be able to buy pop­u­lar cryp­tocur­ren­cies like bit­coin at gov­ern­ment-licensed exchanges, thanks to new rules meant to bol­ster the city’s stand­ing as a dig­i­tal asset hub.

Glob­al cryp­to mar­kets have yet to recov­er from a string of high-pro­file fail­ures in recent months, includ­ing the spec­tac­u­lar down­fall of trad­ing plat­form FTX and cryp­to-friend­ly US banks Sig­na­ture and Sil­ver­gate.

But the so-called “cryp­to win­ter” has not deterred Hong Kong author­i­ties from embrac­ing the sec­tor, a piv­ot that began last Octo­ber and cul­mi­nat­ed with new laws for cryp­to exchanges start­ing Jun 1.

Offi­cials are also hop­ing the shift will be a boon for the city’s econ­o­my, which con­tin­ues to strug­gle in the wake of the pan­dem­ic, social unrest and the impact on busi­ness con­fi­dence from a Bei­jing-imposed nation­al secu­ri­ty law.

Cru­cial­ly, observers say it will cement Hong Kong as a key route for main­land Chi­nese investors look­ing to trade cryp­to, which is out­lawed in the country.

Reg­u­la­tors are hop­ing to woo firms with favourable busi­ness con­di­tions, but must bal­ance that against the need for investor pro­tec­tions — a well-devel­oped area in tra­di­tion­al finance but less so in the vir­tu­al-asset space.

“There is an explic­it acknowl­edge­ment that these prod­ucts are becom­ing more and more part of our econ­o­my,” Giu­liano Castel­lano, a law pro­fes­sor at the Uni­ver­si­ty of Hong Kong, told AFP.

The city has had a vol­un­tary licens­ing sys­tem for cryp­to trad­ing plat­forms since 2019, but licensees could only ser­vice pro­fes­sion­al clients with port­fo­lios of at least HK$8 mil­lion (US$1 million).

With­out licensed local options, Hong Kong’s retail cryp­to traders are rel­e­gat­ed to off­shore web­sites such as Binance and Coin­base, or a raft of brick-and-mor­tar shops that buy and sell tokens for cash.

The client-base restric­tion was unpop­u­lar with Hong Kong’s cryp­to busi­ness­es, and offi­cials even­tu­al­ly dropped it when design­ing the incom­ing rules.

“The genie’s out of the bot­tle,” said Kristi Swartz, a fin­tech lawyer at DLA Piper, refer­ring to retail cryp­to trading.

“(They) just have to face real­i­ty … If it’s already there, let’s try to reg­u­late it.”

CHINA’S PETRI DISH

Hong Kong is rac­ing reg­u­la­tors around the world to fig­ure out ground rules for cryp­to, which despite its crash­es still has a glob­al mar­ket cap­i­tal­i­sa­tion of more than US$1 trillion.

The Euro­pean Union ear­li­er this month approved the world’s first com­pre­hen­sive rules on the sec­tor and inter­na­tion­al secu­ri­ties watch­dog IOSCO pro­posed its rec­om­men­da­tions short­ly afterwards.

In con­trast to evolv­ing atti­tudes on cryp­to world­wide, Chi­na has main­tained a strict ban since 2021.

Hong Kong — a Chi­nese city with finan­cial reg­u­la­tions sep­a­rate from the main­land — holds spe­cial appeal for Chi­na’s cryp­to busi­ness­es and investors, accord­ing to Leo Weese, co-founder of the Bit­coin Asso­ci­a­tion of Hong Kong.

“There is a huge appetite from … (Chi­nese) cryp­tocur­ren­cy ven­tures to have any kind of legal pres­ence on Chi­nese soil,” he said, adding that firms see it as a gate­way to the lucra­tive main­land market.

In both tra­di­tion­al finance and cryp­to, it is com­mon for main­land Chi­nese investors to be recog­nised as Hong Kong clients if they have a bank account and address in the city.

“Once you have a Hong Kong licence, you are going to be able to con­vince a lot of your main­land clients… that it’s safe for them to inter­act with you through their Hong Kong bank account,” Weese told AFP.

Major cryp­to exchanges like Huo­bi and OKX, both found­ed in Chi­na, have announced plans to apply for a Hong Kong licence.

While Bei­jing’s anti-cryp­to stance remains unchanged on paper, senior econ­o­my offi­cials have pub­licly backed Hong Kong’s ambitions.

“You can see that Chi­na says, ‘Look, if it hap­pens in Hong Kong, pop­u­la­tion cir­ca sev­en, eight mil­lion, that’s fine. We can use it as our petri dish,’ ” Swartz told AFP.

PROTECTING INVESTORS

Unlike the out­go­ing sys­tem, the retail-friend­ly rules tak­ing effect in June will be manda­to­ry, mean­ing all exchanges doing busi­ness in Hong Kong will even­tu­al­ly need to get licensed.

Hong Kong reg­u­la­tors said they hope to move quick­ly on issu­ing the first licences.

Some cryp­to busi­ness­es say the switch is not expect­ed to dis­rupt day-to-day oper­a­tions as author­i­ties allow a one-year tran­si­tion period.

HashKey and OSL, the two exist­ing licensees, told AFP they will apply for fresh licences and grow their retail presence.

“There’s a very sig­nif­i­cant need in the mar­ket to have plat­forms that are eas­i­ly acces­si­ble… but are also prop­er­ly man­aged and prop­er­ly reg­u­lat­ed,” said Michel Lee, HashKey Group’s exec­u­tive president.

“This new regime adds a lot more clar­i­ty as to what you’re get­ting, what’s the safe­ty stan­dard you will be pro­vid­ed with.”

With the mem­o­ry of FTX’s col­lapse still fresh, Hong Kong reg­u­la­tors said the new rules aim to “pro­vide robust investor pro­tec­tion and man­age key risks”.

One safe­guard is that exchanges can only pro­vide “large-cap vir­tu­al assets” — such as bit­coin and ethereum — to retail investors, and must set up inter­nal com­mit­tees to decide which cryp­tocur­ren­cies to offer.

Retail clients also have to under­go knowl­edge tests and risk pro­fil­ing before they can trade — though it remains unclear what lev­el of knowl­edge is deemed enough.

Mean­while, prod­ucts like sta­ble­coins and cryp­to deriv­a­tives are off-lim­its for retail investors for the time being.

“The new reg­u­la­tions are meant to pro­tect investors bet­ter,” said Castel­lano, the legal scholar.

“It’s wise to have a cau­tion­ary approach.”

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