Cryptocurrencies (often called “coins” or “tokens”, and collectively referred to in colloquial manner as “crypto”) and blockchain technology (certain blockchain technologies may also be referred to as “Distributed Ledger Technology” or “DLT” for short) have, in their short life span of the past decade, created a new economy which opened a market of new opportunities.
The first cryptocurrency to enter the market was Bitcoin, and it has introduced an effective way to transfer value over the internet by relying on peer-to-peer and distributed verification. Ever since Bitcoin there have been other blockchain-based projects that have introduced new innovations to blockchain technology (these cryptocurrencies are often referred to as “Altcoins”), one of the most noteworthy being Ethereum, which allows for the deployment and execution of software on the blockchain called smart contracts. As a result of this growth, many private and public enterprises have formed in Hong Kong to take advantage of the opportunities offered by this new technology, and to leverage Hong Kong’s unique position in business, technology and law.
Hong Kong is a unique jurisdiction, as it leverages the “one country, two systems” principle, which gives it a high degree of autonomy. The Basic Law of Hong Kong enshrines various free market principles safeguarding its position as an international financial centre. Thus, given its free market foundations, the legislative council in Hong Kong has yet to pass any new laws and regulations that specifically deal with cryptocurrencies or cryptocurrencies business. However, the rapidly expanding cryptocurrencies or cryptocurrencies businesses market caught the Hong Kong government’s attention, resulting in enforcement actions being taken under the existing legislation and new regulatory regimes being introduced with the goal of better protecting investors’ interests.
As there is no new primary legislation to directly regulate cryptocurrencies in Hong Kong, there is a certain degree of uncertainty on the legal definition within the statutory law. Nevertheless, there are secondary sources of law, including the designation set by the Secretary for the Financial Services and Treasury Bureau (“FSTB”), Professor K C Chan, who designated Bitcoin (specifically) as a “virtual commodity”. In a press release, the Hong Kong Monetary Authority (“HKMA”) stated in 2015 that Bitcoin and other similar currencies were not legal tender but “virtual commodities”, and as Bitcoin has no backing – either in physical form or by the issuers – it cannot be qualified as a means of payment or electronic money. The HKMA, which acts as Hong Kong’s de facto central bank, has also stated that it has no plans to issue any central bank-backed cryptocurrency. On the other hand, the Hong Kong Securities and Futures Commission (“SFC”) had issued a number of statements in 2018 and 2019 in an attempt to monitor the activities involving cryptocurrency, including a statement dated 1 November 2018 titled “Statement on Regulatory Framework for Virtual Asset Portfolios Managers, Fund Distributors and Trading Platform Operators” (the “2018 SFC Statement”) and a statement dated 28 March 2019 titled “Statement on Security Token Offerings” (the “2019 SFC Statement”), both of which gradually show the Hong Kong government’s stance towards cryptocurrency and cryptocurrency businesses. Interestingly, in the 2018 SFC Statement, the concept of a new asset class called “virtual assets” was introduced, which refers to “a digital representation of value (the “Virtual Assets”), and examples include ‘cryptocurrencies’, ‘crypto-assets’, ‘digital tokens’ and ‘digital tokens (such as digital currencies, utility tokens or security or asset-backed tokens) and any other virtual commodities, crypto assets and other assets of essentially the same nature’. This seems, to a certain extent, to expand on the HKMA’s categorisation of “virtual commodities”.
The most observable attitude made by the government and the various regulatory authorities is to warn the public against the uncertainties in the cryptocurrency marketplace. The earliest observable public warning was made by the Hong Kong Police Force in 2014 which highlighted that bitcoins are not money and are not regulated by the HKMA; the volatility of the prices of Bitcoin; the cybersecurity risks associated with dealing with Bitcoin; and any potential fraud especially with “Bitcoin Mining Contracts”. Any suspected proceeds of crime should be reported to the Joint Financial Intelligence Unit (“JFIU”), a joint unit composed of the Hong Kong Police Force and the Hong Kong Customs and Excise Department (“CED”). The press release issued by the HKMA, as referred to above, contained a similar warning about the volatile nature of bitcoins.
With the advent of Ethereum and other smart contract blockchain platforms, new applications of cryptocurrency such as initial coin offerings, or token sale (collectively “ICO(s)”) become more widely popular in Hong Kong and globally. As many ICO issuers have established their base of operations in Hong Kong and have opened their campaigns to Hong Kong residents, the SFC, the local securities regulator, has issued a statement on ICO on 5 September 2017 warning the public about: (i) the risk of participating in ICO campaigns; (ii) that ICO tokens that possess features of “securities” as defined under the Securities and Futures Ordinance (Cap.
571) (the “SFO”) would require to be authorised by the SFC, unless an exemption applies; and (iii) that dealing and advising on “securities”-based ICOs would be a “regulated activity” under the SFO and therefore such activity should only be carried out by licensed corporations.
In subsequent public communications, the SFC has stated that it is monitoring the cryptocurrency space and will enforce any relevant provision under the SFO if necessary. Aside from the statements given by the SFC, in early 2018 the Investor Education Centre and the FSTB launched an education campaign on ICOs and cryptocurrencies. The campaign’s key message is not to buy something you do not understand. We can therefore see that, the Hong Kong government’s view towards cryptocurrencies, that do not possess features of securities, can be described as relatively passive. The regulatory authorities have not called for new legislation to regulate cryptocurrencies, as current laws are still applicable. For now, it is observable that the government and the regulatory authorities aim to educate the public about the risks involved in the cryptocurrency economy and still assessing the suitability of the currently available legislation in regulating cryptocurrencies and protecting the public.
Notwithstanding the above, in 2018, the cryptocurrency economy saw the introduction of security tokens offering (“STO”), an alternative to ICOs whereby the tokens being sold to participants are of securities nature (commonly referred to as “Security Tokens”). STO has also introduced the cryptocurrency economy to other new business opportunities including cryptocurrency exchanges that wish to provide trading services to these Security Tokens and technical issuance platforms. Such market trend initiated a range of new regulatory approaches and initiatives to promote fintech development from the SFC and several agencies, given that the Security Tokens would seemingly fall under the jurisdiction of the SFC as bestowed to them through the SFO, including the additional licensing conditions on licensed corporation and the expansion of the regulatory “sandboxes” (as discussed below) as initiated in the 2018 SFC Statement. Hong Kong now appears to take a more proactive approach in exploring the regulation over virtual assets, in particular Security Tokens.
As mentioned above, the HKMA and the SFC have recognised bitcoins and other currencies like it as a “virtual commodity” (it is not clear if and how this extends to other Altcoins), which is a sub-category of “virtual assets” and Hong Kong has not created new legislation or regulations to define those terms. The SFC has not made further clarification on which tokens or coins would fall under the new asset class of “virtual asset” but has admitted that many virtual assets do not necessarily constitute “securities” or “futures contracts” for the purpose of the SFO (which the SFC has now specifically confirmed Bitcoins and Ether as examples), which may be referred to as “Non-SF Virtual Assets”.
Certain businesses which are common in the cryptocurrency economy are ordinarily regulated in Hong Kong, and thus a cryptocurrency company that wishes to participate in such market must abide by such specific legislation.
Hong Kong does not regulate private possession or transfer of cryptocurrencies between private individuals, on the assumption that the cryptocurrency in question was obtained and is transferred in good faith (cryptocurrencies are subject to anti-money laundering laws which are discussed below).
One of the most noteworthy regulated industries that is quite pervasive in the cryptocurrency economy is the ICO space. ICOs are campaigns where issuers sell blockchain-based tokens to potential participants in exchange for other cryptocurrencies such as Ether or Bitcoin. The purpose of conducting an ICO is to crowdsource funds for a specific project that the issuer aims to develop, and the tokens have certain “utility” within such project; therefore the tokens sold in ICOs are commonly referred to as “Utility Tokens”. One example is the OAX project ((Hyperlink)), which was considered the first ICO in Hong Kong. The conventional ICO follows the ERC-20 Ethereum standard and the sale is conducted through a web portal. Aside from the technical elements, the issuers also circulate several documents to the public during the ICO period such as the white paper (or even technical white paper) and the token sale agreement, if any.
Another type of campaign that is similar to ICOs is STOs, which has risen to attention in recent years. The issuance process of a STO is similar to an ICO save that the tokens being exchanged in return would be Security Tokens, i.e.
it possesses the characteristics of equity, debt, structured products or collective investment scheme (the common types of securities under SFO), therefore would be subject to the provisions of the SFO. The offering of the Security Tokens would therefore need to be conducted in compliance with the SFO and in a similar manner as the offering of traditional securities products, including but not limited to the requirement of dealing through intermediaries that are licensed with the SFC and the requirement of publishing an offering memorandum (or “prospectus” depending on the type of offering being made or whether certain exemptions under the SFO have been relied on). As an industrial practice, the documents commonly found in an ICO, i.e.
Tax Haven Bitcoin Countries
the White Paper, would also be published.
In general, Hong Kong does not prohibit the possession or trading of Non-SF Virtual Assets, as Bitcoins and currencies similar to it are considered to be virtual commodities and not electronic money, provided the cryptocurrencies are possessed and traded in good faith. There are other regulatory considerations depending on the use of cryptocurrencies, such as the running of ICO campaigns or trading Bitcoin futures contracts.
As remarked in the paragraph above, the government has a duty to safeguard the free flow of capital as enshrined under Article 112 of the Hong Kong Basic Law. Trade controls and consumer protection are predominantly controlled by the CED, and the basic trading of cryptocurrencies is subject to oversight by CED. The applicable legislation and regulations on the trading of cryptocurrencies will depend on the actual features of each particular cryptocurrency; for example, some tokens commonly known as “ICO tokens” may actually be Security Tokens instead by nature, i.e.
it takes the form of or possesses features that are common in other financial products such as shares, debts, loan notes, interests in a fund or securitisation of another asset or asset class, if not correctly structured. These tokens will therefore be regulated by the applicable legislation such as the SFO.
Trading of Bitcoin in Hong Kong is commonly done on cryptocurrency exchanges, on over-the-counter (“OTC”) desks and peer-to-peer (“P2P”) platforms with both consumers and institutional participants; depending on the nature of the transaction, different legislation will apply. In most business-to-consumer transactions conducted on exchanges and OTC desks, general consumer protection laws such as the Sales of Goods Ordinance (Cap.
26) and the Trade Descriptions Ordinance (Cap.
362) apply, with the former specifying the procedures and rights of parties in the transaction, and the latter setting out rules on the prevention of unfair trade practices. Business-to-business transactions are not covered per se by the above statutes which are mostly aimed at protecting individual consumers.
Certain commodity exchanges are prohibited from establishing in Hong Kong, under the Commodity Exchanges (Prohibition) Ordinance (Cap.
82) with the list of prohibited commodities being specified in the Schedule of the above Ordinance (“Schedule”), e.g.
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barley, cocoa, coffee, copper, cotton, gold, lead, maize, oats, platinum, rice, rubber, silver, oil seeds and vegetable oils, sugar, timber, tin, wheat, zinc, jute, frozen meat, poultry and fish and soybeans. To date, cryptocurrency (or “virtual commodity”) has not been added to the Schedule, and therefore there are no statutory prohibitions on operating exchange in Hong Kong for trading of cryptocurrencies, which are classified as virtual commodities.
Cryptocurrency exchanges and OTC desks do also observe other legal requirements such as anti-money laundering and counter-terrorist financing and customer due diligence checks (further discussed below). There are certain cryptocurrencies that will be restricted in trading on the abovementioned platforms; the first type of restricted cryptocurrencies is Security Tokens.
In the 2019 SFC Statement, the SFC stated that Security Tokens are normally digital representations of ownership of assets (e.g.
gold or real estate) or economic rights (e.g.
9. Hong Kong Tax (2017)
a share of profits or revenue) utilising blockchain technology. The SFC considers that Security Tokens are likely to be “securities” as defined under the SFO and as such are subject to the securities laws of Hong Kong. Under Schedule 1 of the SFO, there are different categories of “securities”, mainly:
Shares – shares are defined under the Companies Ordinance (Cap.
622) and in the common law relate to an equitable ownership interest of a company; such interest gives the shareholders certain rights, as stipulated in the company’s articles of association. A cryptocurrency token can form a blockchain-based share certificate, if each token unit represents, inter alia, legal or beneficial ownership in the company, a right to vote in shareholders’ meetings, and a right to receive dividend or some kind of distribution. Public offerings of such cryptocurrencies would be restricted on the basis that in Hong Kong, under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.
The state of play
32)(“CWUMPO”), a person shall not issue any form of application for shares in (or debentures) of a company to the public unless the form is issued with a prospectus which complies with the requirements under the same ordinance, unless one of the exemptions is applicable.
• Debentures – encompasses various debt-based instruments issued by a company. This category is quite broad as it is not necessary for a debenture to be expressly described as one; all that is required is that the instrument evidences a debt obligation by the company, whether or not the debt is charged against the company. Cryptocurrencies that share such features could be considered as debentures and, as mentioned above under the CWUMPO, should be distributed subject to similar restrictions.
• Structured Products – mainly include products and investment agreements such as equity-linked deposits or equity-linked investments (sometimes a hybrid of securities and regulated investment agreements). “Structured product” is defined under the SFO to instruments which return or amount due or the method of settlement is determined by the references to other price, value, level, securities, commodity, index, property, interest, rate, currency exchange rate or futures contracts. On a prima facie basis, this would appear to cover most derivatives products surrounding cryptocurrencies that are surfacing in the market over the last couple of years, but subject to further clarification from the SFC.
• Regulated Investment Products – as broadly defined in Schedule 1 of the SFO to include any contract that requires an investor to enter into with a profit calculated by changes in the value of any property. This would appear to be a catch-all product to cover most investment contracts whereby the investors are paying for the expectation of profit, in particular applicable to some cryptocurrencies projects where the elements of profits are heavily focused on, in contrast to focusing on the utility functions of the cryptocurrencies.
• Collective Investment Schemes (“CIS”) – the provisions concerning CIS products aim to regulate investment products that are collective in nature; examples of such products include unit trusts and mutual funds. Unlike the definition of “shares” above, a CIS may form if the definition under Schedule 1 of the SFO, which includes four components, is satisfied:
• there must be an “arrangement of property”;
• the participating persons do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management;
• the property is managed in whole or on behalf of the person operating the arrangements; and/or contributions and profits or income are pooled; and
• the purpose or effect, or the pretended purpose or effect, is to enable the participating persons to receive: (a) profits, income or other returns represented to arise; or (b) payments from the acquisition or disposal of the property.
Any person or intermediary (“Intermediary”) who carries out business involving Security Tokens in Hong Kong (or targeting Hong Kong investors) is required to be licensed or registered for regulated activities. Any person who markets and distributes Security Tokens (whether in Hong Kong or targeting Hong Kong investors) is required to be licensed or registered for type 1 regulated activity (dealing in securities) under the SFO. Intermediaries being involved in STOs are reminded to comply with all existing legal and regulatory requirements in Hong Kong, in particular:
• Professional investors only. Under the current market, Security Tokens are normally offered to professional investors only. The 2019 SFC Statement confirms that Type 1 Intermediaries should only target clients who are professional investors as defined under the SFO.
• Suitability obligations. When the Intermediary makes recommendation or solicitation of a Security Token, it shall ensure the suitability of its recommendation or solicitation for that client is reasonable in all the circumstances having regard to information about the client of which the Intermediary is or should be aware through the exercise of due diligence.
• Complex products. The SFC considers that Security Tokens would be regarded as “complex product”, which is defined as “an investment product whose, terms, features and risks are not reasonably likely to be understood by a retail investor because of its complex structure”. Nevertheless, it is generally the Intermediary’s (in particular those that operates through an online platform) duty to assess whether a product is a “complex product” or not. If the Intermediary comes to the conclusion that any Security Token it intends to distribute is a “complex product”, it should adopt additional investor protection measures to better protect clients’ interests by ensuring that clients are well informed about the key nature, risks and features of such Security Token and such Security Token is suitable for them.
• Product due diligence. Intermediaries distributing Security Tokens should conduct proper due diligence for the purpose of developing an in-depth understanding of the STOs and also ascertaining the risk return profile of such STOs.
• Information for clients. In order to help clients make an informed investment decisions, Intermediaries should make clear and adequate disclosure of the material information relating to the STOs in an easily comprehensible manner in order to help clients making an informed investment decision, including but not limited to: providing clients with access to up-to-date STO offering documents and other information; providing clients with material information as soon as reasonably practicable to enable clients to appraise the position of their investments, etc. Intermediaries should also provide prominent and clear warning statements to clients prior to and reasonably proximate to the point of sale or advice.
Should there be any failure to comply with the legal and regulatory requirements during the distribution of STOs, the fitness and properness of the Intermediary may be affected and SFC disciplinary action may follow.
Furthermore, in compliance with the “Circular to Intermediaries on compliance with Notification Requirements” issued by the SFC on 1 June 2018, the SFC has confirmed that any service involving trading of crypto-assets would be considered as a significant change in the nature of business of the Intermediary and would be subject to the notification requirements under the Securities and Futures (Licensing and Registration) (Information) Rules (the “Information Rules”), and the 2019 SFC Statement urges the Intermediary to notify the SFC should they wish to be engaged in cryptocurrency-related businesses.
Given the broad nature of the CIS definition (as discussed above), it could be argued that many ICO campaigns could fall within the parameters of the CIS definition, thus being a Security Token. If this is the case, the issuer may not make the ICO open to the public without prior authorisation from the SFC and be in compliance with the SFO as mentioned above. In March 2018, the SFC halted the ICO operated by a company called Black Cell Technology Limited (“Black Cell”), which allowed token-holders to redeem their tokens into equity shares in Black Cell. The SFC has considered this arrangement to be a CIS under the circumstances. In the above case, Black Cell has undertaken not to proceed with the ICO. It is important to note that in light of the SFC’s numerous statements to date, the regulators are closely observing the ICO and broader cryptocurrency economy to ensure that the relevant securities legislation is complied with, thus cryptocurrency exchange must conduct sufficient legal due diligence to ensure the cryptocurrencies they allow on their marketplace are not considered “securities” otherwise they will also be subject to the provisions under SFO.
Aside from securities, other types of financial instrument markets have also developed in the cryptocurrency economy. Bitcoin-based derivatives products have enjoyed considerable popularity, trading on exchanges such as Bitmex. Bitcoin futures gained even more popularity in late 2017 when CBOE and CME started offering Bitcoin futures contracts. The SFC stated in its announcement on 11 December 2017 that any intermediary in Hong Kong that offers brokerage services for the above Bitcoin futures will be required to obtain the appropriate licences from the SFC (namely “Type 2” when dealing with such futures contracts, and “Type 5” when advising on such futures contracts).
In the broad sense, trading of cryptocurrencies is not restricted in Hong Kong so long as they are classified as “virtual commodities” (and not Security Tokens) and do not infringe on any applicable securities and futures legislation. Cryptocurrency exchanges are not subject to legislation that prohibits the operation of commodity exchanges (but are subject to the laws on commodity exchange as mentioned above).
Along with the 2018 SFC Statement, the SFC issued an appendix titled “Regulatory Standards for Licensed Corporations Managing Virtual Asset Portfolios” (the “Regulatory Standards”) and a “Circular to intermediaries: Distribution of virtual asset funds” (the “Circular”), which focused on the SFC’s stance and the regulatory standards to be imposed on: (i) Intermediaries that are licensed to manage portfolios or intend to manage portfolios that invest in virtual assets (the “Type 9 Intermediaries”); and (ii) Intermediaries that are licensed to distribute funds or intend to distribute virtual asset funds in Hong Kong (the “Type 1 Intermediaries”).
Interestingly, the SFC has confirmed that, where a firm only manages a “portfolio” (which covers collective investment schemes and discretionary accounts in the form of an investment mandate or a pre-defined model portfolio) which invests solely in Non-SF Virtual Assets, it is not required to be licensed or registered for Type 9 regulated activities (asset management) (the “Type 9 Licence”), but where a firm manages a fund of funds (even with the underlying fund investing solely in the Non-SF Virtual Assets), the firm is required to be registered for Type 9 Licence (asset management).
Pursuant to the 2018 SFC Statement and the Regulatory Standards, the SFC has developed a set of principles-based standard terms and conditions which would be imposed as licensing conditions (the “VA Licensing Conditions”) on the Type 9 licensed intermediaries (the “Type 9 VA Licensed Intermediary ”) which manage or plan to manage portfolios with: (i) a stated investment objective to invest in Virtual Assets; or (ii) an intention to invest 10% or more of the gross asset value (the “GAV”) of the portfolio (the “De Minimus Threshold”) in Virtual Assets (collectively, the “Virtual Asset Portfolio(s)”). The key VA Licensing Conditions to be imposed include but are not limited to (i) only professional investors are allowed, with proper risk disclosure, (ii) no less than HK$3 million liquid capital, (iii) appropriate portfolio valuation principles must be adopted, (iv) an independent, experienced and capable auditor must be appointed, and (v) an appropriate custodial arrangement must be in place. In particular in relation to condition (ii), a Type 9 VA Intermediary which holds Non-SF Virtual Assets (which, strictly speaking, does not constitute “client assets” under the SFO) for portfolios under its management shall be required to maintain a required liquid capital of not less than HK$3 million (or its variable required liquid capital, whichever is higher).
In addition, the SFC has also confirmed in the Regulatory Standards and the Circular that if a firm distributes a fund under its management that solely invests in Non-SF Virtual Assets in Hong Kong (i.e.
the management of such fund’s portfolio does not require a Type 9 Licence), it is still required to be licensed or registered for Type 1 regulated activities (dealing in securities) (“Type 1 VA Licensed Intermediary”) and depending on whether it is authorised by the SFC, the Type 1 VA Licensed Intermediary is required to comply with certain requirements.
Such regulatory approach from the SFC has indicated its acceptance of virtual asset funds being distributed and managed in Hong Kong provided the requirements imposed are fulfilled. As a result, the Hong Kong market has seen a surge of Type 9 Intermediaries making application to the SFC to notify the SFC of its intention to change the nature of its business, in the view of providing services to virtual asset funds. Consequently, Hong Kong may be a good alternative jurisdiction for many fund managers to consider should they wish to launch virtual asset funds, in light of the increasing difficulties in other offshore jurisdictions when dealing with virtual assets.
In general, there is no capital gains tax payable from the sale of financial instruments in Hong Kong. That being said, any Hong Kong-sourced income from frequent cryptocurrency trading in the ordinary course of business may be treated as income in case of individual clients, and profits in case of a corporation, and subject to income tax and profits tax respectively, regardless of whether the trading is made in exclusive cryptocurrency or fiat-to-cryptocurrency exchanges. Pursuant to a press release dated 3 April 2019, the government confirmed that the Inland Revenue Department does not maintain statistics specifically on tax payable by persons carrying on virtual asset-related activities and each case should be assessed on the basis of its own individual facts and circumstances. The Inland Revenue Department would also, if necessary, seek relevant information from other tax authorities through the exchange of information mechanism under tax treaties to assess the situation. Regardless, to date, the Inland Revenue Department has not issued specific guidelines on how it would treat cryptocurrencies for the purposes of tax assessment.
Many jurisdictions have implemented stringent anti-money laundering and counter-terrorist financing (“AML/CTF”) laws and regulations, with the majority implementing recommendations set out by the Financial Action Task Force (“FATF”), an international inter-governmental organisation that aims to standardise AML/CTF systems around the world.
In Hong Kong, the principal AML/CTF legislation is the Anti Money Laundering and Counter Terrorist Financing Ordinance (Cap.
615) (“AMLO”) which applies to financial institutions (including HKMA-authorised institutions, i.e.
banks, SFC-licensed corporations, licensed insurance companies, stored value facility issuers and money service operators) and “designated non-financial business and professions” (“DNFBP”) (professions such as being lawyers, public accountants, estate agents, and trust and company services agents), and also creates a licensing regime for money service operators, and trust and company services providers. Businesses that principally deal with cryptocurrencies such as exchanges and OTC desks are not directly subject to the provisions of AMLO, as such businesses do not fall within the definition of a financial institution or DNFBP unless the cryptocurrency business partially operates in a regulated business, for example, providing money services such as money changing and remittance services. Further to the rules set out in AMLO, each regulatory authority has formulated its own guidelines on dealing with AML/CTF issues.
As mentioned in the section on “Government attitude and definition” above, the regulatory authorities in Hong Kong have maintained a cautious approach to cryptocurrencies. In 2014, both the HKMA and the SFC issued circulars to their respective supervised institutions warning of the anonymous nature of cryptocurrency transactions and their inherent money-laundering and terrorist-financing risks. These statements came around the same time as the most noteworthy cryptocurrency money-laundering case stemming from the apprehension and conviction of Ross Ulbricht, the operator of the deep-web marketplace, “Silk Road”. Both regulators have clearly indicated the requirement for increased vigilance when dealing with cryptocurrency business, including inquiring into the internal controls on AML/CTF policies and procedures of the cryptocurrency businesses. In light of these requirements, many cryptocurrency businesses voluntarily apply the customer due diligence measures set out in the Schedule 2 of AMLO as part of their AML/CFT policies.
While AMLO sets out specific guidelines applicable to financial institutions and DNFBPs, other businesses and individuals have a statutory duty to report any suspicious transactions under various criminal statutes, namely the Drug Tracking (Recovery of Proceeds) Ordinance (Cap.
405) (“DTRPO”), Organised and Serious Crimes Ordinance (Cap. 455) (“OSCO”), and the United Nations (Anti-Terrorism Measures) Ordinance (Cap. 575) (“UNATMO”). Any suspected transactions involving money laundering, terrorist financing or receipts of crime must be reported to the JFIU by submitting a suspicious transaction report (“STR”); failure to file a STR is a criminal offence which is liable to a fine of HK$50,000 and a three-month imprisonment. As highlighted above, many cryptocurrency businesses implement AML/CTF measures to comply with the relevant suspicious transaction reporting provisions under the DTRPO, OSCO and UNATMO, and also the likely requests from their banks in Hong Kong.
Various regulatory bodies in Hong Kong embrace the government’s plan to promote fintech and financial innovation in the city. Currently the HKMA, SFC and the Insurance Authority are operating “sandbox” programmes that allow innovative financial products to be tested in a limited regulatory environment.
The first regulatory sandbox was introduced by the HKMA on 6 September 2016 (the “HKMA Sandbox”). The HKMA Sandbox provides HKMA-authorised institutions (“AIs”), e.g.
banks, to allow for live testing of financial technologies before their formal launch. AIs must set applicable boundaries to conduct the trials on the client base and must offer appropriate customer-protection measures to resolve customer losses. On 28 November 2017, the HKMA introduced the Fintech Supervisory Sandbox 2.0 Chatroom that allows AIs to receive supervisory feedback through emails, video conferences and face-to-face meetings from the HKMA’s Fintech Facilitation Office and Banking Department during the early stages when the new technological application is being contemplated by the AIs. As of July 2018, the HKMA reported that it had supervised four distributed technology projects; this means that banks in Hong Kong are actively looking at rolling out blockchain technologies as part of their services. One of the visible disadvantages of the HKMA sandbox is that it is only available to AIs or technology companies that are associated with an AI. Technology start-up companies who do not meet the above criteria are not permitted to access the HKMA sandbox.
The SFC sandbox was announced on 29 September 2017 (the “SFC Sandbox”). The objective of the SFC Sandbox is to allow firms to utilise innovative technologies and demonstrate a genuine commitment to carry out SFC-authorised activities through the use of financial technology that may increase the quality of products and services for investorsin Hong Kong. The SFC Sandbox will be opened to qualified firms who are “fit and proper” and hold applicable SFC licences and comply with the licensing requirements such as Financial Resources Rules. The SFC will impose licensing conditions on firms in the SFC Sandbox, which can be removed upon the firms’ exit from the SFC Sandbox when the firm satisfies the requirements to operate outside of the SFC Sandbox. The guidelines from the SFC do not specify what technologies are permitted in the SFC Sandbox as they only require a genuine commitment to use financial technology in carrying out regulated activity, i.e.
a cryptocurrency-based service that falls within the preview of regulated activity. Similar to the HKMA Sandbox, access to the SFC Sandbox is also limited to firms that hold SFC licences or people who qualify for SFC licences, which may also limit the access to the SFC sandbox for start-up companies.
Along with the 2018 SFC Statement, the SFC issued an appendix titled “Conceptual Framework for the Potential Regulation of Virtual Asset Trading Platform Operators” (the “Conceptual Framework”), setting out the potential regulations over “virtual asset trading platform operators” (commonly known as the “cryptocurrency exchanges”) (the “Platform Operators”). The Conceptual Framework expanded the existing SFC Sandbox to cover the operation of cryptocurrency exchange (referred to as the Virtual Asset Trading Platform in the 2018 SFC Statement). If the SFC considers a Platform Operator is demonstrating commitment adhering to the high standards of the SFC, the Platform Operator may be placed in the SFC Sandbox where it will work closely with the SFC for the exploration of any prospect in the SFC granting licences to it, subject to licensing conditions. If, at the end of the initial stage of the SFC Sandbox, the SFC concludes that it is appropriate to grant a licence to and to regulate the Platform Operators, the SFC has indicated that it will consider granting a licence to a qualified Platform Operator and impose certain licensing conditions as set out in the Conceptual Framework.
Some of the key proposed licensing conditions include (i) restricting services to “professional investors” only who have passed the suitability test, (ii) AML/CFT requirements on customers, (iii) limitations on trading of ICO tokens within the initial 12 months, (iv) prevention of market manipulative and abusive activities, (v) ongoing reporting obligations, (vi) insurance requirements, and (vii) segregation and custody of customers’ money and virtual assets. In relation to “professional investors”, they should have shown sufficient knowledge in virtual assets (including the relevant associated risks) before being offered the trading services of virtual assets. The required level of knowledge in virtual assets is still subject to clarification. Platform Operators may also be subject to licensing principles where they must establish and disclose their virtual assets admission criteria, set up a committee responsible for decision-making to admitting virtual assets and also adopt a fee structure to avoid any potential, perceived or actual conflict of interest when receiving payment for admitting virtual assets. Another condition worthy of further mention relates to the insurance requirements. The Platform Operators may be required to take out an insurance policy for risks associated with the custody of virtual assets, such as theft or hacking. The SFC indicates that the insurance policy would be expected to provide full coverage for virtual assets held by a Platform Operator in hot storage and a substantial coverage (for instance, 95%) for those held in cold storage. There are currently very limited insurance options on the market and, even if available, given the relatively short history and the significant value fluctuation of virtual assets, it is possible that the insurance products would require a higher premium and thus increase the operation costs of the Platform Operators.
As a result of the 2018 SFC Statement, Hong Kong has witnessed a surge of Platform Operators expanding their business to cover the Hong Kong market with the hope of participating in the SFC Sandbox and eventually be granted a licence to trade Security Tokens. As of the date of this publication, it is yet to be seen how the SFC will finalise its licensing regime for cryptocurrency exchanges, as the SFC Sandbox is currently being conducted in closed-door discussions with the SFC and there are already comments from the industry on how the proposed licensing direction would impose an uncommercial burden on the business.
Ownership of cryptocurrencies is currently not subject to any restrictions or regulations in Hong Kong, provided that they are obtained in good faith. Possession of cryptocurrencies may be illegal when their sources originate, amongst others, from computer crime, which under Hong Kong laws are proscribed in section 161 of the Crimes Ordinance (Cap.
200), and section 27A of the Telecommunications Ordinance (Cap. 171) and other applicable Hong Kong legislations including the DTRPO and the OSCO which establish offences for handling the proceeds of crime.
There are no requirements to date to obtain any licence to own or trade cryptocurrencies which are classified as “virtual commodities”. On the other hand, this statement is subject to exceptions when dealing with securities and futures involving cryptocurrencies, such as Bitcoin futures: a broker who wishes to offer such contract to their clients will require the appropriate SFC licences.
Mining is the process of creating new blocks on the blockchain; this process includes verifying transactions and collecting “block rewards” of cryptocurrencies. This type of activity is common to blockchain platforms that use the “proof-of-work” consensus algorithm, where the transaction is proved by the computing power used to process it. There are other consensus models such as “proof of stake”, where the block producers stake their cryptocurrencies to gain the rights to process the transaction.
Assuming that “mining” is considered as mining of “proof of work”-based cryptocurrencies (such as Bitcoin) to date, there are no specific regulations governing mining of cryptocurrencies in Hong Kong. Moreover, to date no Hong Kong governmental body has issued any guidance that discourages, restricts or prohibits Bitcoin mining activities. Whether cryptocurrency mining is legally permitted in Hong Kong is subject to other regulations in Hong Kong under certain circumstances, will be discussed below.
Mining operations (especially for cryptocurrencies such as Bitcoin) can be highly industrialised operations, usually involving the use of hundreds of ASIC (application-specific integrated circuit) computers to mine cryptocurrencies. Such operations closely resemble large-scale data centre operations. Any regulations that apply to other similar applications such as data centres may also be applicable to cryptocurrency mining sites. In Hong Kong, data centre facilitation is overseen by the Office of the Government Chief Information Officer.
Businesses that intend to operate large-scale data centres should be aware of the relevant land-use rights stipulated under the laws of Hong Kong. Under the statutory Outline Zoning Plans (“OZP”) prepared by the Town Planning Board under the Town Planning Ordinance (“TPO”), such data centres belong to “Information Technology and Telecommunications Industries” for cryptocurrency mining purposes and would therefore require application for amendment to the OZP under Section 12A of TPO. Apart from zoning permission, it should be noted that development of a site is subject to, inter alia: the terms and conditions of the land lease governing the site; the usage set out in the occupation permit; and the deed of mutual covenants, if any.
The operation of a data centre involves mechanical and electrical installations which may be subject to statutory requirements in Hong Kong. The key statute in question is the Buildings Energy Efficiency Ordinance (Cap.
610) and, in order to comply with the ordinance, the owner or operator of a data centre in a prescribed building should engage a Registered Energy Assessor to certify that its building services installations have complied with the requirements under the above ordinance. The above rules would only be applicable to large-scale cryptocurrency mining operations and would not likely apply to domestic or small-scale mining operations.
Prior to recent legislative changes, there were no statutory declaration requirements on the import and export of large quantities of money in Hong Kong as advised by FATF Recommendation 32. As of 16 July 2018, with the commencement of the Cross-boundary Movement of Physical Currency and Bearer Negotiable Instruments Ordinance (Cap.
629) (“CMPCBNIO”), a person who physically imports or exports large amounts of currency or bearer-negotiable instruments (“CBNIs”) through the designated checkpoints stated in the CMPCBNIO must now disclose and declare such movement to CED. The disclosure threshold is set at HK$120,000 (Schedule 4 of the CMPCBNIO).
The new CMPCBNIO is only applicable to CBNIs, which are defined as cash or negotiable instruments such as bearer cheques, promissory notes, bearer bonds, traveller’s cheques, money orders or postal orders. As Bitcoin has so far been classified by the HKMA as a “virtual commodity”, it should not fall within the definition of CBNI, but it is unclear how this would apply to other Altcoins. There would also be considerable difficulties in enforcing this provision, as CMPCBNIO requires the physical movement of CBNIs; thus to enforce the declaration requirements, the CED would have to prove that Bitcoins were physically moved across the border.
In Hong Kong, there is no requirement to report cryptocurrency transactions of any amount. Profits generated through cryptocurrency trading may be subject to declaration in a tax return under the applicable tax legislation, as discussed above. As cryptocurrencies are not defined as CBNIs, there is no obligation to declare them to CED when importing them to Hong Kong.
In essence, any cryptocurrencies or cryptocurrency accounts would be treated as personal property and would fall into the estate of the deceased, which can be administered by the Executor named in the will of the deceased or an Administrator appointed by the Probate Court. The Executor or the Administrator could apply for a “Grant of Probate” or a “Letter of Administration” before he is allowed to handle the cryptocurrencies or exchange accounts.
Ordinary access to cryptocurrencies requires the user to have access to the private key to make transactions on the blockchain, and if the private key is lost then the cryptocurrencies are irrecoverable. Thus when conducting estate planning, arrangements should be made to preserve the private key beyond the death of its owner, such as recording the recovery seed and storing in a safe environment (i.e.
a bank safe deposit box). Cryptocurrency exchange accounts may be accessed by the Executor or the Administrator in accordance with the procedures of each exchange; like with many internet-based services, this may require the Executor or the Administrator to submit the certificate of death, the Grant of Probate and/or the Letter of Administration to the exchange.