Virtual assets regulatory developments in Hong Kong and Singapore

Hong Kong’s SFC has indicated that it is actively soft consulting on opening up access to virtual asset investments for the retail market. It has also issued a Circular on Virtual Asset Futures Exchange Traded Funds to introduce the additional requirements for seeking SFC authorization for public offering in Hong Kong of exchange traded funds (ETFs) with exposure to virtual assets (VAs) via futures contracts (VA Futures ETFs).

Meanwhile, Singapore’s MAS released a Consultation Paper on 26 October 2022 proposing a tightening of its regulatory requirements for licensees and exempt payment service providers that carry on a business of providing a digital payment token (DPT) service under the Payment Services Act 2019 of Singapore.

Overview of the VA Futures ETF Circular

The SFC has indicated that it is prepared to accept applications for authorization of VA Futures ETFs traded on traditional regulated futures exchanges. VA Futures ETFs should meet the applicable requirements in the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products. In addition, the VA Futures ETFs will be subject to additional requirements as set out in the Circular, namely:

• Management company – there must be a good track record of regulatory compliance and a three year proven track record in managing ETFs.
• Eligible futures – initially, the SFC has indicated that it is only prepared to accept exposure to Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange.
• Investment strategy – the ETF must be actively managed with flexibility in portfolio composition.
• Disclosure – upfront disclosure of the investment objective and key associated risks will be required.
• Distribution – intermediaries are required to comply with existing conduct requirements for derivative products, as well as comply with a VA-knowledge test requirement.
• Investor education – extensive investor education is required prior to launch.

More broadly, the SFC will also be conducting public consultations on how retail investors could be given more access to VA-related investments, following the implementation of a new licensing regime for VA Service Providers that is expected to come into place in early 2023.

Our take on Hong Kong’s approach to retail access to VA-related investments

Previously, the SFC’s regulatory approach was to only allow professional investors to invest in VA-related funds and securities offered in Hong Kong. However, the various announcements at this year’s Hong Kong Fintech Week and the Hong Kong Government’s Policy Statement signal that Hong Kong intends to make significant moves toward a more open and inclusive approach to VA-related investments, so as to foster the sustainable development of a vibrant ecosystem for VAs in Hong Kong.

The announcement of the Circular in relation to VA Futures ETFs represents a welcome and encouraging step change towards greater financial inclusion and democratization of access to VA-related investment products for the mass retail market in Hong Kong, However, as indicated by the initial set of VA-related investments that are eligible for authorization (currently limited to only Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange), we expect the SFC will continue to take a cautious approach in the coming months towards both VA Futures ETFs for retail investors and VA-related investments more generally for retail investors.

As always, the SFC’s top priority remains protecting the investing public in Hong Kong and it will be interesting to observe how the additional requirements for investor education and VA knowledge will be implemented in relation to VA Futures ETFs. This will no doubt form the litmus test for a further opening up of VA-related investments to the Hong Kong retail market. We expect that VA knowledge tests and VA education will form important pillars of retail investor protection.

For Hong Kong to remain competitive as an international financial centre, its regulatory framework needs to strike a balance between encouraging innovation, while still retaining suitable safeguards for investor protection and market integrity. A level of consensus with other international financial centres is also important. Hong Kong’s characteristically more cautious approach has given, and will continue to give, Hong Kong the benefit of hindsight. We expect that the ongoing VA developments in other international financial centres will be keenly observed in Hong Kong and will, at least in part, inform the approach Hong Kong eventually takes to broader retail access to VAs.

How does this compare with Singapore?

While Hong Kong has signaled a potential opening up of VA access to the retail investing public, Singapore is already further along in its journey of regulating retail access to virtual assets. Days before Hong Kong announced its change in tenor to retail exposure to virtual assets, Singapore’s MAS released a consultation paper on 26 October 2022 proposing a tightening of its regulatory requirements for licensees and exempt payment service providers that carry on a business of providing a digital payment token (DPT) service under the Payment Services Act 2019 of Singapore (DPTSPs). The MAS is consulting on 3 key areas, namely (1) consumer access; (2) business conduct; and (3) technology. See our brief summary of this in our previous crypto alert.

Consumer access

In terms of consumer access, the MAS is concerned that retail customers may not have the financial wherewithal to withstand large losses that are likely to ensue from speculative trading of markets that they do not fully understand. To address these concerns, the MAS proposes that DPTSPs put in place consumer access measures for retail customers that should minimally apply to consumers resident in Singapore. The MAS is still considering whether it is appropriate for the consumer access measures to be applied to consumers outside of Singapore.

As part of the proposal to introduce consumer access measures for retail clients, MAS is also seeking views on the criteria and thresholds to be applied for a customer to be eligible as an accredited investor (AI). In particular, options which MAS is considering includes the imposition of a suitably calibrated maximum cap on the value of DPT holdings that can be counted towards the AI threshold and/or fully excluding the value of DPT holdings from the value of a customer’s net personal assets. The MAS is also contemplating allowing MAS-regulated single-currency pegged stablecoins to count towards AI determination without being subject to any caps.

Other consumer access measures which are being considered for retail clients by the MAS includes:

• requiring DPTSPs to assess if a retail client has sufficient knowledge of DPT services before providing any DPT service to that customer; and
• prohibiting DPTSPs from:
  • offering any monetary or non-monetary incentives to retail customers to participate in a DPT service or to any person to refer a DPT service to retail customers;
  • providing to a retail customer any credit facility to facilitate the retail customer’s purchase or continued holding of DPTs;
  • entering into any leveraged DPT transaction with a retail customer or facilitating a retail customer’s entry into any leveraged DPT transaction with any other person; or
  • accepting any payments made by the retail customer using a credit card or charge card in connection with the provision of any DPT service.

Business conduct

The MAS recognizes that most jurisdictions that have proposed specific rules in the DPT sector have not fully operationalized the rules, including requirements on business conduct practices. In order to establish baseline conduct norms for DPTSPs, MAS proposes to introduce business conduct standards for DPTSPs in key areas of concerns and this is not limited to retail clients. These include the following:

• requiring DPTSPs to segregate customer assets;
• requiring DPTPs to identify, mitigate and disclose conflicts of interest; and
• requiring DPTSPs to have adequate policies and procedures to handle customer complaints.

The MAS is also seeking views on: (a) whether an independent custodian would be appropriate in the context of the DPT sector, and whether there are other more effective measures to address concerns over customers’ assets such as in the event of DPTSP’ insolvency; and (b) appropriate and effective measures to safeguard the private keys and storage of customers’ DPTs.

In the context of retail customers specifically, MAS is also contemplating restricting business models that involve “staking” of a retail customer’s DPTs to protect against the risks of unregulated borrowing and lending– a key event precipitating the current “crypto winter”.

Technology

The MAS is also suggesting that DPTSPs be required to meet the same stringent (and relatively prescriptive) technology risk management requirements currently imposed on other financial institutions such as banks. While this will, importantly, level the playing field between banks and newer fintech players and will no doubt set a high watermark for technology and cyber risk management, it remains to be seen whether this will push DPTSPs accustomed to a freewheeling regulatory environment to shift their focus to less stringent jurisdictions or whether this will have the opposite effect of filtering out cowboy operations and drive retail customers to invest in legitimate DPTSPs willing to commit to the higher watermark.