Today we are going to discuss the dual license regulation of virtual asset trading platforms and the requirements for applying to become a virtual asset Service provider (VASP). If you are interested in engaging in virtual asset trading in Hong Kong, you need to understand these application requirements and related procedures.

According to current Hong Kong laws and regulations, if virtual asset trading platforms intend to provide trading services for at least one security token, they can apply to the SFC for a license for regulated activities under Category 1 (securities trading) and Category 7 (providing automated trading services). So far, only two exchanges in Hong Kong have successfully obtained both licences. They are OSL Digital Securities Limited, owned by BC Technology Group, and Hash Blockchain Limited, owned by HashKey Group.

At present, there is some confusion in the industry about the relationship between the existing Class 1 and Class 7 licenses and the VASP license. Considering that the terms and characteristics of virtual assets may change over time, the classification of some virtual assets may change from non-security tokens to security tokens. In order to avoid violating the provisions of the licensing system and ensure the continuity of business, the SFC clearly requires in the consultation document that virtual asset trading platforms (including responsible personnel and licensed representatives) should simultaneously apply for Class 1, Class 7 and VASP licenses in accordance with the existing Securities and Futures Ordinance and Anti-Money Laundering Ordinance to obtain the authorization of dual licenses.

Simply put, if you want to establish a full cryptocurrency exchange in Hong Kong, you need to have a Class 1, Class 7 and VASP license at the same time.

So how to apply for a VASP license?

First of all, for the basic qualification requirements of a company, your company needs to be registered in Hong Kong or registered overseas under the Hong Kong Companies Ordinance. In addition, the paid-up capital of your company must be at least HK $5 million, and the future deposit in your bank account must not be less than HK $4 million. If you are a trust card, the paid-up capital requirement is HK $3 million, including HK $1.5 million to be held in custody with the Treasury. If your company is a wholly-owned subsidiary or affiliated company, then you also need to have a trust license in Hong Kong.

Regarding the requirements for company personnel, you need to appoint at least 2 responsible personnel to oversee the VASP's operations and ensure compliance with regulatory requirements such as anti-money laundering and anti-terrorist financing. At least one of the responsible persons must be the Executive Director of the VASP. If you have more than one executive Director, then they must all be appointed as responsible officers. In addition, at least one responsible person must ordinarily reside in Hong Kong and there must be a responsible person available to supervise the business of the virtual Asset Service at all times. At the same time, individuals providing virtual asset services on behalf of the VASP, including those who will be responsible personnel, will need to obtain approval from the SFC. In addition, an auditor with experience in virtual currency business is required.

In addition to the basic qualifications of the company and the requirements of the company personnel, some other documents and reports need to be provided. Examples include virtual asset trading business assessment reports, risk management policies and procedures, anti-money laundering and anti-terrorist financing policies and procedures, customer asset management, financial reporting and disclosure arrangements, virtual asset listing and trading policies, mechanisms to prevent market manipulation and irregularities, avoidance of conflicts of interest, and cybersecurity.

Finally, an applicant for a VASP license will also need to seek approval from the SFC to determine the premises used to keep records or documents required under the Anti-Money Laundering and Anti-Terrorist Financing Regulations. The premises must be a suitable non-residential place for the storage of relevant documents and records.

If you plan to become a VASP, be sure to meet these conditions and prepare the required documents and reports.

When applying for a VASP license, the following business restrictions and prohibitions need to be considered. If you only apply for a VASP license under the Virtual Asset Service Provider regime under the Anti-Money Laundering Ordinance, you can only conduct centralized non-security token trading, not securities token trading.

Therefore, when you only have VASP without Class I and Class VII licenses, you cannot engage in DeFi strategies, that is, decentralized financial strategies. In addition, you cannot act as a market maker, that is, you cannot provide market making services in the market. If you intend to operate a decentralized exchange (DEX), that is also not allowed. For matchmaking transactions involving security tokens, you will need to hold a Category 7 licence. In addition, proprietary trading is prohibited and you cannot trade in your own name. At the same time, margin and credit trading are not allowed. Licensed platform operators may not sell, trade or buy or sell virtual asset futures contracts or related derivatives. Nor can you offer programmatic trading services to clients. In addition, you may not enter into any arrangement with the customer's virtual assets for the purpose of obtaining a return from the customer or otherwise. This includes arrangements relating to customer virtual assets held by you or your affiliated entities. Finally, platform operators must not allow a single customer to open multiple accounts, except in the form of separate accounts.

However, if you have both Class 1 and Class 7 licences under the SFO, you can conduct centralized securities and non-securities token trading at the same time.

At present, according to the relevant requirements, the applicant is required to provide the Hong Kong registration number of the company, the relevant information of the company's principal, licensed representative, director and ultimate owner. In addition, it is necessary to provide the address of the non-domestic premises for the storage of documents and records, and external assessment reports may be required.

For simultaneous applications for dual licences, the SFC will arrange for simplified application procedures. Applicants only need to submit one consolidated application form online and indicate that they are applying for both licences. For platform operators who already hold a licence under the SFO, the application process will be simplified and they will only need to submit to the SFC the additional information required under the virtual asset service provider regime, such as the ultimate owner's information. The SFC will require these applicants to submit additional information required for the virtual asset service provider regime and process applications under both licensing regimes.

In order to simplify the application process, the SFC recommends that applicants for virtual asset trading platforms commission an external appraisal expert to evaluate their business and submit the appraisal expert's report to the SFC at a specific time.

The specific timing includes when the licence application is submitted (Phase 1 report) and after approval in principle from the SFC (Phase 2 report). The first phase report should cover the design effectiveness of the virtual asset trading platform's architecture, management, operation, systems and monitoring measures, and focus on key areas such as management and staffing, token inclusion, custody of virtual assets, customer awareness, anti-money laundering/anti-terrorist financing, market inspection, risk management and cybersecurity. Evaluation experts should examine and evaluate whether the platform operator's policies and procedures are clearly documented and in compliance with applicable laws and regulations. The second phase report should assess the implementation arrangements and actual effects of planned policies, procedures, systems and controls. The SFC will only give final approval if it trusts the results of the Phase 2 report. In other words, the second stage of the review will directly determine the outcome of the application.

So what about the original cryptocurrency exchange in Hong Kong?

The Hong Kong government has offered a transitional management approach.

According to the latest amended regulations, applications for VASP licenses will be open from June 1, 2023.

For platforms that already offer virtual asset services in Hong Kong before June 1, 2023, the Hong Kong government has put in place a transitional arrangement that will allow them to smoothly transition to the new regulatory requirements.

During the transition period, these platforms can continue to conduct business, but they need to meet the conditions of operating in Hong Kong and having a substantial business.

First of all, from April 1, 2023, the revised regulations officially entered into force, but the VASP licensing system has not yet entered into force.

Then, starting from June 1, 2023, the virtual asset service provider licensing system will be officially implemented.

In the next nine months, from June 1, 2023 to February 29, 2024, existing virtual asset trading platforms will need to submit license applications to ensure that they can operate in compliance with the new regulatory framework.

If the existing virtual asset trading platform does not intend to apply for a license, then they need to start preparing for the orderly closure of their business in Hong Kong, with the final deadline of May 31, 2024.

For another 12 months of the transition period, from June 1, 2023 to May 31, 2024, the existing virtual asset trading platforms will be allowed to continue to operate as normal in order to provide them with more time to prepare.

Finally, on June 1, 2024, the transition period ends, and only licensed virtual asset trading platforms can continue to operate virtual asset services.