Stablecoins, NFTs, VATP Licence and Type 9 Licence Uplift: Recent Developments in Cryptocurrencies and Virtual Assets in Hong Kong

Cryptocurrencies are extremely volatile, where fortunes could be made and lost in the blink of an eye. The collapse of the LUNA token, de-peg of stablecoin TerraUSD (UST) and bankruptcy of FTX led to a series of defaults and liquidity crisis in the crypto world. Cryptos have also been the subject of romance and investment scams. But none of these incidents will prevent Hong Kong from developing into a virtual asset hub.

Increasingly, overseas market players and crypto firms are seeking to enter the Hong Kong market to offer their services and products. In order to do so, they will need the blessing from the Hong Kong Monetary Authority (HKMA) and/or the Securities and Futures Commission (SFC) – the two main financial regulators in Hong Kong – with respect to their licensing applications and crypto activities.

This article looks at the following four main areas: (i) stablecoins; (ii) non-fungible tokens (NFTs); (iii) virtual asset trading platform (VATP) licence; and (iv) SFC Type 9 licence uplift for virtual assets.

Stablecoins

The term stablecoin could be misleading because the value of a stablecoin may not be stable. The majority of stablecoins are supposed to be pegged to fiat currencies which in theory means that their values should be stable. But in practice this may not be the case. This could be seen in the collapse of UST and the LUNA token, which reportedly wiped out almost US$45 billion within a week.

The HKMA has proposed to regulate stablecoins. As a matter of priority, stablecoins that purport to reference one or more fiat currencies will be in-scope of the initial proposed regulatory regime. Other forms of stablecoins may also become in-scope as the regime continues to develop. Anyone seeking to conduct or actively market a regulated activity in Hong Kong that involves stablecoin should consider whether a licence is required.

Non-fungible Tokens (NFTs)

NFT has become a quick and easy way to raise funds, but it is not always straightforward. Anyone seeking to raise funds by way of NFT should consider whether the proposed NFT would fall within the definition of “securities” or “collective investment scheme” under the Securities and Futures Ordinance. The SFC has published a reminder that where an NFT is a “genuine digital representation of a collectible”, it does not fall within the SFC’s regulatory remit. This would include NFTs that “represent a unique copy of an underlying asset such as a digital image, artwork, music or video.”

NFTs with a more complex structure, such as one that pays out a dividend or interest, or one that entitles the holders to certain rewards over a period of time, could be more problematic under Hong Kong law. If an NFT represents a transferable share of an underlying asset such that each NFT represents the same value and is interchangeable, it may no longer be “unique”. Despite the term “non-fungible”, it may be deemed as “fungible” and subject to regulations. NFT structuring requires detailed planning to avoid breaching regulations.

Virtual asset trading platform (VATP) licence

Crypto firms that operate as a crypto exchange in Hong Kong will need to obtain the Virtual Asset Trading Platform (VATP) licence from the SFC effective 1 June 2023. The licensing process is aimed at ensuring that licence applicants meet the regulatory requirements in Hong Kong, which include aspects such as custody of assets, know-your-client (KYC), anti-money laundering and counter-financing of terrorism (AML/CFT), conflicts of interest, admission of virtual assets for trading, prevention of market manipulative and abusive activities, accounting and auditing, and risk management. The split of client assets between cold wallet and hot wallet, together with the required insurance and compensation arrangements, often require some restructuring of existing crypto platforms.

Apart from the VATP licence, the Trust or Company Service Provider (TCSP) licence under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance is also relevant for the purpose of holding client assets through an associated entity of the virtual asset platform operator. The TCSP licence is administered by the Companies Registry and is required for anyone who carries out a trust or company service business in Hong Kong.

SFC Type 9 licence uplift for virtual assets

SFC Type 9 asset managers seeking to invest in virtual assets and cryptocurrencies will need to consider whether a Type 9 licence uplift is required. If an asset manager invests in 10% or more of the gross asset value (GAV) of the portfolio in virtual assets, a Type 9 licence uplift would be required. An application for a licence uplift will subject the asset manager to additional terms and conditions relating to virtual assets. Asset managers who seek to invest in virtual assets below the 10% threshold should also consider whether their existing fund documents require amendments.

Looking forward

Running a crypto business can be extremely lucrative but it is also subject to scrutiny by regulators. Crypto platforms seeking to establish a presence in Hong Kong should work with their legal advisors to prepare for the licensing process and structuring of products. A breach of regulatory obligations could potentially subject the responsible persons to fines and imprisonment.