Cryptocurrency firms that are looking to establish in Hong Kong need to act quickly as there may be a backlog in application reviews when the new licensing regime comes into play, Angelina Kwan, chief executive officer of financial services firm Stratford Finance and a former regulator of the Hong Kong Securities and Futures Commission (SFC), told Forkast.
Kwan, who helped write rules for the financial industry that are now a part of the new crypto licensing program set to take effect in June, said the regulations are almost identical to that for traditional financial institutions.
They include requiring firms to establish a listing committee to review tokens that the licensed Virtual Asset Service Provider (VASP) will be offering to their clients, requiring the appointment of an external advisor to review the VASP, specific security and internal controls as well as ensuring clients understand the virtual asset products, she said.
For the new licensing regime for virtual asset trading platforms, the SFC plans to require exchanges to apply for licenses that would allow retail investors to trade certain large-capitalization tokens. However, non-fungible tokens (NFTs) and tokens that are deemed as securities will not be included in this specific license and it was likely that the SFC would publish another consultation paper about tokenization in due course, according to Kwan.
The following Q&A has been edited for clarity and length.
Timmy Shen: The city’s official said earlier this week that over 80 foreign and mainland China companies have expressed their interest in establishing Web 3.0 companies in Hong Kong ahead of new crypto regulations. Is this something you’ve noticed in Hong Kong?
Angelina Kwan: Yes, that’s the statistic they’ve been given and It’s very exciting because now there’s even more clarity that Virtual assets are an accepted asset class I think we have one of the clearest licensing regimes [globally].
Singapore has a very clear regime but they have many applicants that are still waiting for regulatory approvals. The process has slowed due to the number of applications and partially because of manpower resources in the regulator to process all the licenses. In Hong Kong, it’s very clear it will take a little while [to get your license] but at least you’ll be told [if you don’t get it].
Shen: So there’s a growing demand now for licenses. Do you think there will be a backlog?
Kwan: Absolutely, there’ll be a backlog. But if you read the consultation paper, the SFC has actually done something that’s extremely smart.
That is to get potential licensees to use an external firm as a part of the licensing process. That external firm will have to sign off on controls and the different areas in the consultation paper. And the [external] firm will be doing a lot of the heavy lifting and it’ll be the company that will be responsible to ensure it complies with the rules. That should make it slightly easier for the SFC so that they don’t have to do it all themselves.
But in my experience as an ex-regulator, we can work with [external experts] and they can teach us these things. So these are all permutations that hopefully will expedite the licensing process.
Shen: Is it going to be expensive for crypto firms to be compliant? How much more budget do companies need to set aside to meet the new regulatory requirements for a license?
Kwan: I’ve talked to a number of those potential companies and it depends on how complex your operations are. The standard review can be X and then if you need your policies and procedures to be remediated, then it’s going to be X plus a summation of whatever else needs to be remediated. But for those that already have systems in place – like some are international firms coming to Hong Kong – if they’ve already got international standards and they’re regulated somewhere else, it may be easier for those firms to comply.
But what this will cut down is those firms that just rock up and go, “I want to get a license.” It’s going to cut that down because they’ll make sure that there are internal controls. They’ll make sure of their procedures and security.
Shen: What are the key things these crypto firms should pay attention to when they apply for the license?
Kwan: Internal controls are very important and by putting it in policies and procedures that they actually follow. Security is key, and so is the walleting system. They’re requiring digital asset firms to have their own walleting system in place. That has to be as a part of the whole process now instead of separating it, unless you have a really good system in place.
It’s very much exactly what a traditional financial services firm needs to do. If you’ve come from a traditional brokerage firm, none of this is a surprise. If you’re a crypto OG (original gangster, a reference to early-day crypto investors), then it may be more new areas to focus on as a part of the regulatory requirements for VASPs.
Now with the SFC poised to allow retail, it’s going to be very key for firms to understand how to protect customers’ assets. Nobody wants another FTX to happen again. The rules are in place to protect people from [another] FTX type of failure.
The most important thing is integrity of the people who run the firm. I don’t know what happened to Sam [Bankman-Fried]. But obviously the fact that [FTX] could take deposits and use them as their own is a major and grave concern in terms of integrity. That’s why all of these rules are in place, to avoid this happening.
Shen: What are the major concerns now from crypto firms looking to get a license?
Kwan: There is a concern in terms of how much is enough and what to be putting in place.
If you had to prioritize and had a limited budget, you’d do the main points – security, custody and things that would affect clients.
Do you need a beautiful office? No. But do you need really good security? Yes. If you’re going to take customer deposits, then do you have segregated accounts? You [need to] have protocols in place for encryption and moving funds around. Do you have a cold wallet or hot wallet? How is your wallet held? All of that stuff is very important and I would prioritize that as number one as opposed to a beautiful office.
The other thing that you would have to prioritize is minimum capital. It’s not a lot of money, but it protects the firm and it makes sure that they have liquid assets that they can handle themselves in a situation where there were runs or things like that. And by all means it doesn’t cover that, but at least it’s something.
Shen: Is the new licensing regime stricter than that for traditional financial services firms?
Kwan: It’s pretty identical but there are new requirements for virtual assets as they have specific characteristics that are different from, say, securities trading. There are only a few things that are new introductions. One, the requirement for a firm to put in place a listing committee who reported to the board of directors of the firm to review and decide on the tokens that the firm is going to offer to its clients. Two, the other different thing is the walleting system and the hot and cold wallets. Number three is the appointment of an external advisor to review the firm’s operations.
Shen: You hosted a webinar last week with Elizabeth Wong, Director of Licensing and Head of Fintech Unit, Intermediaries of the SFC. What are the main takeaways?
Kwan: I specifically asked her about what the SFC would do with people just coming in to Hong Kong and operating without a license trying to market in here. Ms. Wong said that the SFC will publish a list on their website of what firms are not licensed and what firms are licensed. So it will be very clear to investors who they should be trading with and who not.
There was also a question about how the listing committee for tokens would work. Every potential VASP will be required to have a listing or token admissions committee that will approve all the coins and tokens that will be traded on that exchange.
Ms. Wong also explained why the SFC has required the formation of a token listing committee by a VASP. The reason was that the SFC would not know where these coins came from as they didn’t approve them for sale (shares, funds and financial services products are usually approved by regulators before they may be sold to the investing public). It was important that the VASP must be satisfied with, say, a particular virtual asset and that its founders and its white paper or other coins were proper virtual assets and the VASP had performed due diligence on products before they sold them.
Shen: One topic people are talking about is the influence from China, which banned crypto transactions. Do people need to worry about trading crypto in Hong Kong?
Kwan: No, potential licensed VASPs and their clients should not be worried about China in relation to digital assets in Hong Kong. The Hong Kong virtual asset service provider licensing regime has been approved by the Hong Kong Legislative Council, and is being promulgated by the SFC. There are measures being consulted on by the Hong Kong Monetary Authority in relation to the regulation of stablecoins. Finally, even virtual-assets-related ETFs have been listed on HKEX, making Hong Kong one of the first markets to do so. All of this has been put in place, which shows that China is aware and has allowed Hong Kong to develop virtual assets as a regulated asset class.
Shen: Do you have any advice for firms that want to relocate to Hong Kong? What do they need to act on right now?
Kwan: They will need to act now if they wish to get grandfathered into the licensing regime. They will have to properly set up operations in Hong Kong by the deadline.
The SFC requirement is that all potential licensees must have a presence in HK. This is why all brokerage firms have to be here and responsible officers who sign off on those brokerage firms’ trades have to be in Hong Kong. There are examples of exemptions, but largely at least, you must have operations domiciled in Hong Kong.
Shen: Could you share more about insurance for VASPs? You mentioned before our interview talking to people about insurance for firms.
Kwan: The most common complaint is “I can’t get insurance” and one of the requirements is insurance. So the Financial Services Development Council has been addressing the insurance side and working with the insurance industry to hopefully attract more insurance companies to offer insurance policies to VASPs.
The consultation paper also details the insurance issue. So the SFC has already addressed the issue.
The other hurdle is about banking and VASPs opening bank accounts. If you’re licensed, you can get bank accounts. But many of the firms, especially the ones setting up, are not licensed yet and they need bank accounts. This issue is also being worked on and with the virtual asset industry maturing with clear rules and regulations.
(Updates to clarify Kwan’s role as an SFC regulator in helping write rules for financial industry.)