Joint circular on intermediaries’ virtual asset-related activities

The Hong Kong Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) have issued a joint circular addressed at financial market intermediaries engaged in virtual asset-related activities. The circular thereby provides guidance and updates on the regulatory approach for distributing virtual asset-related products (VA-related products) and providing virtual asset dealing services to investors.
#### The key issues addressed in the circular include the following:
(1) Distribution of VA-related products: Both regulators acknowledge that the global regulatory landscape for virtual assets is uneven and highlight the risks associated with investing in virtual assets. Therefore, intermediaries need to conduct proper due diligence on VA-related products and ensure that they are suitable for clients. As most VA-related products are likely to be considered complex products, intermediaries distributing them must comply with SFC’s requirements for selling complex products, ensuring their suitability for clients, regardless of whether or not a client has been advised to purchase a VA-related product. Such due diligence measures include a knowledge test and a suitability test to ensure that clients can assess and deal with VA-related product risks. And although there are fewer restrictions as to the sale of VA-related products for those products traded on regulated exchanges, the knowledge test is still required.
Furthermore, the two regulators caution intermediaries when providing financial accommodations for VA-related products, ensuring clients have the financial capacity to handle leveraged or margin trading or when offering their products and services outside of Hong Kong. Finally, intermediaries are reminded to provide clear and comprehensible information and warning statements should be provided to clients regarding VA-related products and their underlying virtual asset investments.
(2) Conduct requirements for VA dealing services: Both regulators are highly concerned about the lack of regulatory standards on overseas virtual asset trading platforms. These platforms may not provide adequate investor protection and security for clients, such as client asset protection, hot and cold wallet management, and insurance in case of hacking or fraud. To address these concerns, the SFC and HKMA propose that intermediaries only partner with SFC-licensed VA trading platforms for VA dealing services.
While VA dealing services don’t constitute „dealing in securities“, providing such services to clients still requires intermediaries to meet adequate fitness and properness criteria to conduct such dealing activities. Furthermore, intermediaries dealing in VA-related securities are expected to
1. assess retail clients‘ knowledge of virtual assets and risk tolerance;
2. set limits on each client’s exposure to virtual assets based on their financial situation;
3. ensure VA dealing activities occur through an omnibus account with an SFC-licensed platform that serves retail investors; and
4. implement controls to limit trading to virtual assets available on SFC-licensed platforms.
Finally, when intermediaries allow clients to deposit or withdraw virtual assets, they should use segregated accounts with their partnered SFC-licensed platforms or authorized financial institutions that meet HKMA’s custody standards. They should also comply with anti-money laundering and counter-financing of terrorism guidelines.
(3) Conduct requirements for VA-asset management or advisory services: Intermediaries providing virtual asset portfolio management or virtual asset discretionary account management services are subject to additional requirements if they meet the de minimis threshold of investing or having a policy to invest 10% or more of the gross asset value of a portfolio in virtual assets. For discretionary account management services (those conducting investment services on behalf of clients), Type 1 intermediaries should only invest less than 10% of the gross asset value of the client’s portfolio in virtual assets. Furthermore, the regulators remind intermediaries providing asset management services in tokenized securities to comply with existing requirements and guidance issued by the SFC applying to asset managers.
As far as the provision of VA advisory services are concerned, the SFC and HKMA remind intermediaries that VA-advisory services should only be provided to clients for whom intermediaries offer Type 1 (dealing) or Type 4 (advising on securities) regulated activities. The expected conduct requirements for VA-advisory services are outlined in the prescribed terms and conditions for each license; nevertheless it is imperative that VA advisors conduct proper suitability and knowledge tests. When recommending virtual assets to retail clients, intermediaries should further ensure that the assets are of high liquidity, typically large-cap virtual assets available on SFC-licensed platforms for trading by retail investors.
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To conclude, the two regulators note that intermediaries are reminded to notify the SFC and the HKMA in advance if they intend to engage in activities involving tokenized securities and virtual assets or make any changes to these activities. Also, they are reminded to take all actions necessary to ensure compliance with the outlined requirements for existing clients, for which these requirements previously did not apply.