Recession gatecrashes Hong Kong’s fintech party | SFC outlines VATP regulatory framework and China’s digital currency

Reuters | Sharon Lam | Nov 8, 2019

HK - Recession gatecrashes Hong Kong’s fintech party | SFC outlines VATP regulatory framework and China's digital currency

Recession gatecrashes Hong Kong’s fintech party

HONG KONG (Reuters Breakingviews) - Hong Kong’s economic travails are an unwelcome guest in the city’s fintech party. Enthusiasm for online-only banks was palpable at the Fintech Week conference. Yet months of political unrest have hit small businesses, and the added risks may delay local launches by the likes of Standard Chartered and Tencent.

Attendees this week descended on Hong Kong’s Lantau Island for the financial hub’s fourth annual gathering. With appearances from top officials like Financial Secretary Paul Chan to executives at Singapore’s $14 billion Grab and other rising stars, there was plenty of buzz. Hot topics included central bank digital currencies and cross-border payments.

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Virtual banks, as these branchless outfits are known in Hong Kong, took centre stage. Earlier this year, Hong Kong authorities granted eight licenses for such firms to offer payments, deposits and other services, in a long overdue shakeup. HSBC, Bank of China Hong Kong, Hang Seng Bank and Standard Chartered account for some three-quarters of the city’s mortgages and two-thirds of retail loans. Online challengers, including a joint venture between Chinese handset maker Xiaomi and AMTD, as well as insurance giant Ping An, are ready to muscle in. About 30% of total banking revenue, or $15 billion, is up for grabs, analysts at Goldman Sachs reckon.

Yet just 40 kilometres away from sunny Lantau, Hong Kong’s central business districts and elsewhere are reeling from broader malaise. The financial centre’s economy shrank by 3.2% in the third quarter, plunging it into recession for the first time in a decade, as increasingly violent anti-government protests took hold. Lenders now face lower profitability as risks of loan losses and higher credit costs rise, Morgan Stanley analysts warned in a recent note. The protest-battered city’s 340,000 small and medium-sized businesses, prime customers for online-only banks, have been hit the hardest. Virtual banks say they remain fully committed to Hong Kong.

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Latham and Watkins LLP | Simon Hawkins and Kenneth Y.F. Hui

SFC outlines new regulatory framework for virtual asset trading platforms, HKMA highlights recent FinTech initiatives, and PBOC discusses China’s forthcoming central bank digital currency.

The fourth annual Hong Kong FinTech Week conference kicked off with a major announcement from Mr. Ashley Alder, Chief Executive Officer of the Securities and Futures Commission (SFC), who introduced a new, formalized regulatory framework for virtual asset trading platforms (VATPs). A panel of central bankers also discussed stablecoins and central bank digital currencies, including the People’s Bank of China’s (PBoC) forthcoming central bank digital currency, referred to as the digital currency / electronic payment (DCEP) coin.

VATP Regulation

Last year, the SFC published its conceptual framework for the potential regulation of VATPs and, since then, the SFC has worked behind the scenes with some of Hong Kong’s existing VATPs to better understand their operations, and to explain the SFC’s regulatory expectations, while also assessing VATPs capability to comply with the SFC’s expected requirements.

Importantly, under Hong Kong’s securities laws, the SFC only has power to regulate a VATP that trades virtual assets or tokens that are legally “securities” or “futures contracts.” Bitcoin and other, more familiar, cryptoassets are not securities, and nothing in the SFC’s new framework alters this position. The new framework therefore only applies to VATPs, which include at least one security virtual asset or token for trading. Thereafter, the SFC’s new rules will apply to all of a VATP’s operations, even if the vast majority of other virtual assets or tokens traded on the platform are not securities.

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Essentially, the new regulatory framework allows a VATP to “opt in” to SFC regulation by electing to trade at least one security virtual asset. The SFC’s view is that the principal benefit of being regulated is that the VATP would be able to represent itself to clients as a supervised business. Once licenses are granted to the VATPs that choose to opt in, investors will then be able to distinguish easily between regulated platforms and platforms that are not regulated.

VATPs that wish to opt in under the new framework may apply to the SFC to be licensed for Type 1 (dealing in securities) and Type 7 (providing automated trading services) regulated activities. The SFC will only accept license applications from centralized VATPs that are based in Hong Kong, so decentralized and peer-to-peer VATPs will not be able to obtain licenses (for the time being, at least).

License applicants must demonstrate that they are willing and able to comply with the expected standards under the regulatory framework published by the SFC. Under the key licensing conditions that will be imposed on licensees, a VATP operator must:

  • Only offer its services to “professional investors” (i.e., the general public will not be able to trade on SFC-licensed VATPs)
  • Have stringent criteria for the inclusion of virtual assets to be traded on its platform
  • Obtain the SFC’s prior written approval for any plan or proposal to add any product to its trading platform
  • Submit monthly reports to the SFC on its business activities
  • Engage an independent professional firm acceptable to the SFC to conduct an annual review of its activities and operations and prepare a report confirming that it has complied with the licensing conditions and all relevant legal and regulatory requirements
  • Only provide services to clients who have sufficient knowledge of virtual assets
  • Not conduct any offering, trading, or dealing activities of virtual asset futures contracts or related derivatives
  • Adopt a reputable external market surveillance system to supplement its own market surveillance policies and controls
  • Ensure that an insurance policy covering the risks associated with custody of virtual assets is in effect at all times

Notably, SFC-licensed VATPs should only include security virtual assets that are (i) asset-backed; (ii) approved or qualified by, or registered with, regulators in comparable jurisdictions; and (iii) with a post-issuance track record of 12 months.

VATPs

In light of the intensive assessment process and to meet the expected regulatory standards, the time required for processing a licensing application from a VATP may be longer than the 16-week period that is typically expected for a standard securities licensing application.

If a platform operator is licensed, its infrastructure, core fitness and properness, and conduct of virtual asset trading activities should be viewed as a whole. Although trading activities in non-security virtual assets or tokens are not “regulated activities,” the SFC’s regulatory remit over all of these aspects of platform operations will be engaged once a platform involves trading activities in security virtual assets or tokens, even if these activities are a small part of its business.

The SFC has stated that it will continue to monitor the evolution of cryptoassets and work with the Hong Kong government to explore the need for legislative changes in the longer term.

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Other FinTech Initiatives in Hong Kong

Mr. Eddie Yue, Chief Executive of the HKMA, highlighted a series of recent initiatives aimed to foster the FinTech ecosystem in Hong Kong:

  • The subsidiaries of Hong Kong Interbank Clearing Limited and Institute of Digital Currency of the PBoC have signed a memorandum of understanding to connect the digital trade finance platforms of Hong Kong and the PRC.
  • The HKMA and the Bank of Thailand are conducting a joint research project to study the application of central bank digital currency to cross-border payments, with a view to facilitating HKD-THB payment-versus-payment among banks in Hong Kong and Thailand. A joint report is scheduled for release in the first quarter of 2020.
  • The first-ever innovation hub of the Bank of International Settlements (BIS) commenced operations in Hong Kong in November 2019. The mandate of the BIS innovation hub is to identify and develop in-depth insights into critical trends in financial technology of relevance to central banks, to explore the development of public goods to enhance the functioning of the global financial system, and to serve as a focal point for a network of central bank experts on innovation.
  • The HKMA is conducting a study on the application of artificial intelligence (AI) technology in the banking industry and will release a series of publications on this topic in the coming months. This announcement follows a circular issued by the HKMA earlier in November 2019, setting out high-level principles that banks should take into account when designing and adopting AI and big data analytics applications.
  • The HKMA has jointly launched the Fin+Tech Collaboration Platform with the Hong Kong Science and Technology Parks to support FinTech development. Industry players can use the platform to organize FinTech-related activities, such as hackathons.

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