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The Monetary Authority of Singapore (MAS) has issued a consultation paper setting out proposed amendments to its anti-money laundering and countering the financing of terrorism (AML/CFT) Notices and Guidelines applicable to financial institutions and variable capital companies (VCCs).

The amendments aim to enhance AML/CFT measures, align with international standards and clarify existing supervisory expectations. The consultation period ends on 8 May 2025, with the amendments expected to take effect from 30 June 2025.

Proposed amendments

The proposed amendments—which apply across the financial sector to banks, merchant banks, finance companies, payment service providers, direct life insurers, capital markets intermediaries, financial advisers, the central depository, approved exchanges and recognised market operators, approved trustees, trust companies, non-bank credit and charge card licensees, digital token service providers (FIs) and VCCs—broadly cover the following areas:

Clarification of timelines for filing of suspicious transaction reports (STRs)

MAS proposes to amend the AML/CFT Guidelines to state that the filing of an STR should not exceed five business days after suspicion was first established, unless the circumstances are exceptional or extraordinary. In cases involving sanctioned parties and parties acting on behalf of or under the direction of sanctioned parties, FIs and VCCs should file the STRs as soon as possible and no later than one business day after suspicion was first established.

MAS also proposes to set out its supervisory expectations with respect to the controls and processes for timely review of suspicious transactions and mitigation of ML/TF concerns identified, such as the need for FIs and VCCs to identify, prioritise and promptly review concerns of higher ML/TF risks and escalate any such concerns to senior management where necessary.

MAS further intends to remove the requirement for FIs and VCCs to extend a copy of STRs filed to MAS for information and to replace it with a requirement for FIs and VCCs to extend a copy of STRs to MAS upon request.

Expanding the definition of money laundering (ML) to include proliferation financing (PF) and incorporating PF risk assessments in ML/TF risk assessments

MAS proposes to clarify that ML includes PF and that FIs and VCCs must include PF risk assessments in their ML/TF risk evaluations. This aligns with the latest Financial Action Task Force (FATF) Standards, which require FIs and designated non-financial businesses and professions to identify, assess, understand and mitigate PF risks. MAS further acknowledges that most FIs would likely already consider PF risks within their existing AML/CFT and sanctions compliance frameworks, in line with guidance issued by MAS over the years.

Updates to MAS Notice TCA-N03 for trust companies

MAS proposes to amend the wording of MAS Notice TCA-N03 to align with the Trustees Act 1967 and anticipated legislative changes, flowing from the revised FATF Recommendation 25. The amendments will broaden the definition of a trust relevant party and clarify the requirements for identifying all related parties to a legal arrangement and to collecting relevant information. Additionally, the amendments will mandate the collection of certain information about the legal arrangement, such as the full name, unique identifier, trust deed and the purpose for which the legal arrangement was established, in line with the FATF’s recommendations.

Other amendments to the AML/CFT Guidelines

MAS is also proposing further changes to clarify and reflect MAS’ supervisory expectations and guidance over the years. These amendments cover the areas of screening, source of wealth (SoW) and source of funds (SoF) establishment, as well as the characteristics of a higher-risk shell company. Key proposed amendments include:

Clarifying that ML/TF information sources for screening should include relevant search engines used in countries or jurisdictions closely associated with the person screened, and that screening should be conducted in the native language(s) of the person screened.
Ensuring processes are in place to share customer and related account information across business units, including customer due diligence and SoW information.
Providing staff with adequate guidance on identifying indicators of fraudulent or tampered data, documents, or information and ensuring timely application of appropriate ML/TF risk mitigation measures.
Various SoW and SoF-related clarifications, including the need for corroboration of SoW and SoF that are more material and/or present a higher risk for ML/TF and the assessment of the plausibility and legitimacy of SoW and SoF.
Clarifying the need to assess whether a further or supplementary STR is warranted when further suspicion is raised.
Including characteristics of a higher-risk shell company as examples of potentially higher-risk categories.
Including participation in a tax amnesty programme under examples of suspicious transactions related to tax crimes.
Replacing references to ‘settlors’ and ‘protectors’ with ‘trust relevant parties’ to reflect the expanded definition and replacing the term ‘trust’ with ‘legal arrangement’ in the Guidelines.

Concluding observations

The consultation paper underscores MAS’ ongoing efforts to maintain a robust and clear AML/CFT framework that meets international standards. The proposed amendments are also a significant step towards enhancing the effectiveness of AML/CFT measures across the financial sector. FIs and VCCs should thoroughly review these proposed amendments, evaluate their implications on current practices and provide feedback (if any) by 8 May 2025.

The following Gibson Dunn lawyers prepared this update: Hagen Rooke, Jun Qi Chin, QX Toh, and Nicholas Tok.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Financial Regulatory team, including the following:

Hagen H. Rooke – Singapore (+65 6507 3620, hhrooke@gibsondunn.com)
William R. Hallatt – Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202.887.3632, jsteiner@gibsondunn.com)
Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
Emily Rumble – Hong Kong (+852 2214 3839, erumble@gibsondunn.com)
Becky Chung – Hong Kong (+852 2214 3837, bchung@gibsondunn.com)
Jun Qi Chin – Singapore (+65 6507 3622, jqchin@gibsondunn.com)
QX Toh – Singapore (+65 6507 3610, qtoh@gibsondunn.com)
Nicholas Tok – Singapore (+65 6507 3621, ntok@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)
Jane Lu – Hong Kong (+852 2214 3735, jlu@gibsondunn.com)

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

In response to industry feedback, the SFC has refined the Guidelines, which now impose fewer regulatory obligations than the SFC originally proposed. Set out below is a key overview of the Guidelines.

On October 31, 2024, Hong Kong’ Securities and Futures Commission (SFC) published its conclusions[1] (the Consultation Conclusions) on Guidelines for Market Soundings[2] (the Guidelines). We previously published an alert[3] on SFC’s consultation in October 2023.

Implementation Timeline

The Guidelines are set to take effect on May 2, 2025. The SFC takes the view that a six-month transition should be sufficient as intermediaries should have existing controls in place to safeguard confidential information. Where an intermediary is not able to enhance its existing system, policies and procedures after the Guidelines take effect, the intermediary should, at a minimum, put in place interim measures to comply with the Guidelines.

Overview of the Guidelines

The Guidelines set out four Core Principles and prescriptive requirements applicable to a Disclosing Person (usually a sell-side broker in possession of the market sounding information) and a Recipient Person (usually a buy-side firm in receipt of the market sounding information) when they conduct market sounding activities, i.e., the communication or information flow from sell-side to buy-side for the purpose of gauging interests in a potential transaction. Market sounding is most seen in block trades and private placements.

In response to industry feedback, the SFC has refined the Guidelines which now impose fewer regulatory obligations than the SFC originally proposed. We set out below a key overview of the Guidelines.

Four core principles under the Guidelines

The four Core Principles under the Guidelines that apply to all intermediaries that conduct market sounding activities are:

Handling of Information: Safeguarding the confidentiality of market sounding information, and ensuring effective systems of functional barriers to prevent inappropriate disclosure, misuse and leakage of such information.
Governance: Putting in place robust governance and oversight arrangements to supervise market sounding activities.
Policies and Procedures: Establishing and maintaining effective policies and procedures with respect to market sounding activities.
Review and Monitoring Controls: Implementing controls to monitor and detect suspicious behaviors and potential misconduct, or potential unauthorized or inappropriate disclosure, misuse or leakage of market sounding information, or non-compliance with internal policies and procedures governing market sounding activities.

Key highlights of the requirements after considering industry feedback

Type of market sounding information: The Guidelines only apply to “confidential information in connection with possible transactions in listed securities regardless of the listing venue, or transactions involving other securities that are likely to materially affect the price of listed securities.” This means that the Guidelines do not automatically apply to all non-public information, as the information must be “confidential” in order to fall within scope of the Guidelines. In the FAQ[4] issued by the SFC, the SFC provided examples of market sounding information, including the name or specific information of the subject security, identity of the Market Sounding Beneficiary (i.e., the issuer, client or existing shareholding of the security in question), the Market Sounding Beneficiary’s intent to pursue a transaction or other specific terms relating to the transaction. The SFC made clear that routine discussions, such as speculative trade ideas or sourcing orders, remain outside the scope of the Guidelines.
In-scope “securities transactions”: The Guidelines only apply to market sounding in connection with transactions involving listed securities (regardless of whether listed in Hong Kong or elsewhere) and securities (e.g., debt securities) which is likely to have a material effect on the share price of listed securities. This is a narrower scope of “securities” than the SFC initially proposed in its consultation paper, although the SFC will keep in view the need to expand the type of transactions.
Removal of the proposed requirements around “cleansing”: Given the concerns of practical challenges to perform “cleansing” of market sounding information once it becomes public (e.g., the information may never become public if a transaction is cancelled), the SFC has removed this requirement from the Guidelines.
Record-keeping requirements only apply to the Disclosing Person: Under the Guidelines as refined, the Recipient Person is no longer required to keep records of the market sounding communications. Instead, only the Disclosing Person is required to keep such records through the use of authorized communication channels. The required retention period is also shortened to 2 years. Note that this is distinguished it from the shorter six-month retention period for regular telephone order instructions required under the SFC Code of Conduct.

Specific Requirements for Disclosing Persons

A Disclosing Person is required to obtain consent from the Market Sounding Beneficiary, determine in advance a standard set of information to be disclosed, and use standardized scripts to communicate market sounding information through authorized communication channels. At a minimum, the scripts should include a statement that the communication is for market sounding, and making a request for consent from the Recipient Persons (or potential investors) for receipt of the market sounding information, and agreeing to safeguard its confidentiality. Records of market sounding communications must be kept for not less than two years.

Specific Requirements for Recipient Persons

A Recipient Person should designate a person familiar with the internal polices on market sounding activities and inform the Disclosing Person who that person is upon being contacted by the Disclosing Person for market sounding. The Recipient Person should inform the Disclosing Person whether it wishes to, or not to, receive market soundings in relation to either all possible transactions or particular types of possible transactions from the Disclosing Person. Where the Disclosing Person does not specify whether the communication is a market sounding, the Recipient should use reasonable efforts to verify where it is in possession of market sounding information, for example, by making additional enquiries with the Disclosing Person and seek confirmation whether the information to be shared involves market sounding information.

Conclusions

The Guidelines only apply to intermediaries licensed by or registered with the SFC and do not have the force of law, However, the SFC highlighted that the Guidelines may be admissible in evidence in court proceedings under the Securities and Futures Ordinance (SFO) where relevant to questions that arise in the court proceedings. Failure to comply with the Guidelines may also call into question of fitness and properness of an intermediary or licensed/ registered individual, which may lead to investigations or disciplinary actions taken against the relevant persons by the SFC. Intermediaries should review and enhance their existing policies and procedures, and ensure that enhancements are implemented by May 2, 2025.

[1] https://apps.sfc.hk/edistributionWeb/api/consultation/conclusion?lang=EN&refNo=23CP6

[2] https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/Guidelines-for-Market-Soundings/Guidelines-for-Market-Soundings_ENG.pdf?rev=-1

[3] https://www.gibsondunn.com/hong-kong-sfc-consults-on-market-sounding-guidelines/.

[4] https://www.sfc.hk/en/faqs/intermediaries/supervision/Market-Soundings/Guidelines-for-Market-Soundings

The following Gibson Dunn lawyers prepared this update: William Hallatt, Becky Chung, and QX Toh.

William R. Hallatt (+852 2214 3836, whallatt@gibsondunn.com)
Emily Rumble (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun (+852 2214 3838, apun@gibsondunn.com)
Becky Chung (+852 2214 3837, bchung@gibsondunn.com)
Jane Lu (+852 2214 3735, jlu@gibsondunn.com)

This disciplinary action serves as a timely reminder regarding the importance of compliance with the Statutory Secrecy Prohibition and as an example of the SFC’s willingness to take decisive action against individuals who breach this provision.

On May 28, 2024, the Hong Kong Securities and Futures Commission (SFC) suspended Mr. Wong Ka Ching (Wong), the former responsible officer (RO) of China On Securities Limited (China On), for four years.[1] The SFC’s disciplinary action against Wong follows the SFC’s investigation into China On over its failures as placing agent in a share placement which took place in 2019. This resulted in a public reprimand and the imposition of a HK$ 6 million fine on China On.[2]

However, while Wong’s suspension is at least partially the result of the SFC’s conclusion that China On’s failures as a placing agent were attributable to Wong as an RO and member of senior management, the SFC also concluded that Wong acted contrary to section 378 of the Securities and Futures Ordinance (SFO) (the Statutory Secrecy Prohibition) by disclosing confidential information regarding the SFC’s investigation to a purported consultant of China On.[3] This disciplinary action serves as a timely reminder regarding the importance of compliance with the Statutory Secrecy Prohibition and as an example of the SFC’s willingness to take decisive action against individuals who breach this provision.

I. Summary of the Disciplinary Action

By way of background, China On acted as the placing agent in late 2019 for the then-majority shareholder (Vendor) of Hon Corporation Limited (Hon Corp) for the procurement of placees to subscribe for shares representing up to 45% of Hon Corp’s total issued share capital (Shares) (the Share Placement). China On and the Vendor agreed that the total placing price for the Shares would be HK$57.24 million (i.e. HK$0.265 per share.)

Following an investigation, the SFC found that China On had failed to a) act within the scope of the Vendor’s authority, and b) adequately safeguard the Vendor’s assets in the course of identifying potential placees for the Share Placement. The SFC found that China On’s failures in this regard occurred with Wong’s consent or connivance, or were attributable to neglect on Wong’s part as an RO and a member of the senior management of China On. The SFC also found that Wong acted negligently or recklessly in handling the Placement, and failed to ensure that China On adhered to appropriate standards of conduct.

However, the SFC also found that Wong had breached the Statutory Secrecy Prohibition by disclosing information about the SFC’s investigation to a ‘dubious consultant’, referred to by the SFC only as “X”.

In its Statement of Disciplinary Action, the SFC noted that Wong had alleged that he had been heavily reliant on X for China On’s compliance and operational matters, and had granted X full access to China On’s front office, back office and accounting systems for this purpose. This was despite the fact that X had no formal agreement with China On and was not a licensed representative or member of senior management of China On. Further, Wong admitted to the SFC that he did not know anything about X’s background or qualifications other than that X had apparently represented to him that he had been licensed by the SFC. According to Wong, X also insisted that his remuneration for his work for China On be paid in cash or through third parties, and switched his phone number and WeChat every one to three months so to avoid detection by regulators.

Despite this, the SFC found that Wong had provided copies of the SFC’s letters and investigation notices to China On to X, and had sought advice and assistance from X in responding to the SFC’s investigation of this matter. Wong did this even though the SFC’s letters and investigation notices include (as a matter of course) prominent warnings to recipients about the consequences of breaching the Statutory Secrecy Prohibition by disclosing this correspondence to others. The SFC concluded that as a result of this, Wong had contravened the Statutory Secrecy Prohibition under section 378(7) of the SFO.

The SFC also concluded that Wong had procured, or at least allowed, China On to represent to the SFC that X had no relationship with China On or its management, and that he had had no involvement in the Share Placement. This was information that was false or misleading in a material particular. As such, its provision to the SFC in the course of the SFC’s investigation was contrary to the requirements under section 384(1) of the SFO.

II. The Statutory Secrecy Prohibition

By way of reminder, the Statutory Secrecy Prohibition is the legal requirement that a person to whom the Statutory Secrecy Prohibition applies must not (unless an exception applies):

disclose any matter coming to their knowledge –
1. by virtue of the person’s appointment under certain specified provisions of the SFO and other related ordinances (Relevant Provisions);[4]
2. in performing any function or exercising any power under any of the Relevant Provisions;
3. in carrying into effect or doing anything required or authorized under any of the Relevant Provisions; or
4. in the course of assisting a person who falls within (b) or (c);
communicate any such matter referred to in 1) to any other person; and
allow any person to have access to any information or document in their possession as a result of 1)a), b), c) or d).

In addition, where information is disclosed under 1)b) or c) above to any person, that person and anyone who receives such information directly or indirectly from him will also be bound by the Statutory Secrecy Prohibition.

Importantly, the persons to whom the Statutory Secrecy Prohibition applies includes not only the SFC and its staff, but also any person assisting the SFC in performing its functions. In an investigations context, the latter category includes any person assisting the SFC in relation to its investigative functions, including by providing a record, document or information required to be produced to the SFC under sections 179 or 181, or providing information and/or attending an interview with the SFC under section 183 of the SFO.

In practice, what this means is that individuals who are the subject of an investigation by the SFC, or who are otherwise assisting the SFC in its investigations (e.g. by cooperating with SFC notices or other requests) must not disclose any information regarding the SFC’s investigation to any person unless an exception to the Statutory Secrecy Prohibition applies.

There are seven exceptions to the Statutory Secrecy Prohibition, which allow for the disclosure of information in the following circumstances:

Disclosure of information already made available to the public;
Disclosure for the purpose of any criminal proceedings in Hong Kong;
Disclosure for the purpose of seeking professional advice from, or giving advice by, a counsel or solicitor, or other professional adviser acting or proposing to act in a professional capacity in relation to any matter arising under any of the Relevant Provisions;
Disclosure in connection with court proceedings to which the person is a party;
Disclosure in accordance with a court order or a law or legal requirement;
Disclosure to the Hong Kong Deposit Protection Board for the purpose of assisting the Board to perform its functions; and
Disclosure by the auditors of a listed corporation to the SFC, the Hong Kong Monetary Authority or the Insurance Authority under section 381 of the SFO.[5]

A breach of the Statutory Secrecy Prohibition is a criminal offence. If convicted, the person who breached the secrecy obligation is liable for a maximum fine of HK$1 million and imprisonment for up to two years upon indictment, and a maximum fine of HK$100,000 and imprisonment for up to six months upon summary conviction. Further, as seen from this case, the SFC may well take into consideration breaches of the Statutory Secrecy Prohibition in imposing disciplinary action on licensed persons.

III. The Importance of Maintaining Secrecy

The Statutory Secrecy Prohibition is one of the key distinguishing factors of the Hong Kong regulatory landscape, and is a key aspect of the SFC’s investigative arsenal. The SFC has stated publicly that it views the Statutory Secrecy Obligation as a safeguard of, relevantly:

the public interest that the SFC should not be compromised in its operations and the pursuit of its regulatory objectives by the leakage of confidential information;
the right of all persons, whether individuals or corporations, to be presumed innocent until proven guilty; and
the reputation of individuals and the goodwill of firms investigated by the SFC or undergoing disciplinary proceedings.[6]

Given these matters, it is unsurprising that the SFC takes breaches and/or suspected breaches of the Statutory Secrecy Prohibition very seriously. The disciplinary action taken against Wong in this case serves as an important reminder of the importance of strictly adhering to the Statutory Secrecy Prohibition and of the SFC’s willingness to discipline individuals for failure to comply with the Statutory Secrecy Prohibition.

Given this, we recommend that SFC licensed firms review their policies and procedures in relation to the handling of information in relation to SFC investigations, and take care to ensure that information flows in relation to investigations comply with the Statutory Secrecy Prohibition. In particular, we recommend reviewing policies and procedures in relation to the reporting of information to parent companies and/or other offshore entities in relation to ongoing SFC investigations to protect against inadvertent breaches of the Statutory Secrecy Prohibition by individuals based in Hong Kong.

__________

[1] “SFC suspends Wong Ka Ching for four years”, published by the SFC on May 28, 2024, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=24PR94.

[2] “SFC reprimands and fines China On Securities Limited $6 million for failures as share placement agent”, published by the SFC on May 18, 2023, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=23PR50.

[3] Section 378, Securities and Futures Ordinance, available at: https://www.elegislation.gov.hk/hk/cap571?xpid=ID_1438403472414_002.

[4] The Relevant Provisions consist of (a) the provisions of the SFO; (b) Parts II and XII of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) dealing with the performance of functions relating to prospectuses; (c) Part 5 of the Companies Ordinance (Cap 622) dealing with the buy-back by a corporation of its own shares, or a corporation giving financial assistance for the acquisition of its own shares; and (d) Part 2 (except section 6) of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap 615).

[5] Under section 378(7) of the SFO, notwithstanding the seven exceptions listed above, a person can also disclose information subjected to the Statutory Secrecy Prohibition by seeking the SFC’s consent. Application for the SFC’s consent should be made in writing, stating the full extent of a) the information sought to be disclosed, b) the persons to whom it is proposed to be disclosed and c) the reasons for the proposed disclosure. In particular, the SFC has clarified that the following disclosures can be assumed as permissible, and therefore not a breach of the Statutory Secrecy Prohibition, without the need to make any formal application for the SFC’s consent: 1) the fact that a person is bound by the secrecy obligation; 2) the general nature of the matter which has given rise to the secrecy obligation; 3) the means by which the person came to be bound by the secrecy obligation (e.g., by virtue of receiving an investigator’s notice under section 183 of the SFO); and 4) the date, time and place at which the person is required to provide information or documents to the SFC, or to attend an interview by an SFC investigator. Note that the disclosure under 4) can only be made to an individual’s employer or spouse; or where the individual is a regulated person, his firm’s responsible officer, executive officer, compliance officer or in-house lawyer. Where the person is a corporation, disclosure under 4) is limited to the corporation’s board of directors, its holding company or indemnity insurers. See “Secrecy Provisions”, published by the SFC, available at: https://www.sfc.hk/en/Regulatory-functions/Enforcement/Secrecy-provisions.

[6] “Secrecy Provisions”, published by the SFC, available at: https://www.sfc.hk/en/Regulatory-functions/Enforcement/Secrecy-provisions.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:

This update provides an overview of China’s major antitrust developments during 2023.

In 2023, China introduced a flurry of new regulations to help implement and clarify the amended Anti-Monopoly Law (“AML”), which came into effect in 2022 (see our 2022 Review). These refreshed rules provide valuable insights and guidance on the interpretation and application of the amended AML. On the merger control side, we have seen lengthy reviews involving semiconductors and other sensitive technologies where geopolitical factors might come into play. Meanwhile, authorities are continuing their enforcement efforts in industries that are close to people’s livelihood, with a focus on pharmaceuticals and cartels organized by trade associations. Lastly, there have been a number of high-profile litigation cases, including the largest damage award ever issued in the history of private antitrust litigation in China.

I. Legislative and Regulatory Developments

Amendments to the implementing rules of the AML. Following the amended AML, the State Administration for Market Regulation (“SAMR”) finalized a series of implementing rules and guidelines in 2023 to better facilitate the interpretation and enforcement of the amended AML. SAMR also revised or introduced some regulations to further develop China’s antitrust framework. These include:

Provisions on Review of Concentration of Undertakings (the “Merger Provisions”)
Regulations on Filing Thresholds for Concentration of Undertakings (the “Merger Notification Thresholds Regulations”)
Guidelines for Anti-Monopoly Compliance for Concentration of Undertakings (the “Merger Control Compliance Guidelines”)
Provisions on Prohibition of Monopoly Agreements (the “Monopoly Agreements Provisions”)
Provisions on Prohibition of Abuse of Dominance (the “Abuse of Dominance Provisions”)
Provisions on Prohibition of Elimination and Restriction of Competition Through Abuse of Administrative Powers
Provisions on Prohibition of Elimination and Restriction of Competition Through Intellectual Property Rights (the “IP Provisions”)

Key regulatory highlights include the following.

The Merger Provisions. These provisions importantly provide more clarity on what constitutes “control” for the purposes of merger control, including factors such as historical shareholder or board meeting attendance and voting patterns. In addition, the provisions provide further guidance on turnover calculations, as well as the procedures for “stopping the clock” and reviewing below-threshold transactions, which are both issues that arose prominently in two conditional merger clearance cases in 2023 (discussed further below).

Revised merger notification thresholds. In addition, SAMR also issued the revised Regulations on Filing Thresholds for Concentrations of Undertakings, which came into effect on 26 January 2024. This is the first amendment to the turnover thresholds since the introduction of the AML in 2008. Specifically, the filing thresholds are increased to reflect economic growth, such that undertakings must obtain merger clearance from SAMR if:

The undertakings’ combined worldwide turnover is more than RMB 12 billion (~USD 1.7 billion) (an increase from RMB 10 billion (~USD 1.4 billion)) and the Chinese turnover of each of at least two of the undertakings involved is more than RMB 800 million (~USD 113.5 million) (an increase from RMB 400 million (~USD 57 million)); or
The undertakings’ combined Chinese turnover is more than RMB 4 billion (~USD 568 million) (an increase from RMB 2 billion (~USD 284 million)) and the Chinese turnover of each of at least two of the undertakings involved is more than RMB 800 million (an increase from RMB 400 million).

Note that the alternative threshold (aimed at capturing “killer acquisitions”) as suggested in the draft amendments in 2022 is not included in the final version of the revised thresholds.

The Merger Control Compliance Guidelines. SAMR introduced these guidelines predominantly to encourage undertakings to implement antitrust compliance systems, in particular, systems to prevent gun-jumping and other violations of China’s merger control regime. The guidelines clarify the sanctions for gun-jumping, which can be up to 10% of the undertaking’s revenue in the prior year for cases that have the effect of restricting competition (that can be multiplied by two to five times for particularly serious cases) or up to RMB 5 million (~ USD 700,000) for cases that do not restrict competition. The guidelines further provide detailed guidance on SAMR’s expectations in relation to antitrust compliance systems, and “strongly encourage” undertakings with more than RMB 400 million revenue in China (~ USD 66 million) to implement such systems. Most notably, the guidelines indicate that an anti-gun-jumping compliance system may be considered a mitigating factor for gun-jumping enforcement actions.

The Monopoly Agreements Provisions. In the draft version published in 2022, SAMR clarified that vertical agreements would come within the “safe harbour” in the amended AML if the parties could show, among other things, that they did not exceed a 15% market share threshold. Unfortunately, the welcome clarification was dropped in the final version. Nevertheless, SAMR introduced greater clarity in other areas by explaining that an undertaking may be in breach of the AML for coordinating/facilitating others to enter into monopoly agreements if it: (i) has “decisive influence” over the content of the agreement (even if it is not a party to the agreement); or (ii) acts as the conduit for others to communicate and reach a horizontal agreement (i.e., a hub-and-spoke arrangement). SAMR also clearly signaled its continued focus on the platform economy by adding a specific provision banning undertakings from using data, algorithms and technology to effectively exchange information or coordinate conduct in order to conclude a monopoly agreement. The provisions also provide for an ostensibly broad leniency regime that appears to apply to any undertaking that voluntarily reports the conclusion of a monopoly agreement to the authorities.

The Abuse of Dominance Provisions. In addition to providing general guidance on how to determine market dominance, SAMR added guidance indicating that a refusal to trade can be indirectly inferred from a dominant entity imposing unreasonable prices against trading counterparties, and included a new provision stipulating that a refusal to trade may be justified in the platform economy context if a dominant undertaking has refused to trade on the grounds that the counterparty has failed to comply with rules on fairness, reasonableness and non-discrimination in the platform economy (which appears to be a reference to SAMR’s 2021 platform economy regulations). Further, the final Abuse of Dominance Provisions (unlike the draft) expressly designate national security, cybersecurity and data security as factors to be considered when determining whether there are justifications for certain forms of abusive conduct (e.g. restrictions of trade), which aligns with the growing importance of those issues in China in general.

The IP Provisions. SAMR’s 2023 revisions to the IP Provisions confirmed that there will be a safe harbour for IP-related vertical agreements (e.g. an exclusive IP licensing agreement) where the parties have less than 30% share in any relevant markets and there are at least four substitutes to the relevant intellectual property. In addition, the revised provisions specifically prohibit “excessive pricing” in IP licensing transactions, and introduce a new rule that prohibits an IP licensor from unreasonably requiring an IP licensee to cross-license its own IP rights to the licensor without the licensor providing “reasonable consideration”.

Further Legislative Efforts. In addition to the various finalized regulations discussed above, SAMR introduced several draft regulations in 2023, including the Draft Anti-Monopoly Guidelines for Industry Associations and Draft Anti-Monopoly Guidelines for Standard Essential Patents. Indeed, it appears that sustained legislative efforts can be expected in 2024, given indications from the Ministry of Justice that it would accelerate efforts to revise the Anti-Unfair Competition Law, and announcements by SAMR that it would begin formulating antitrust guidelines for the pharmaceutical sector, as well as horizontal merger guidelines.

II. Merger Control

In 2023, SAMR closed 797 merger review cases in total. Of these, 782 (~98%) received unconditional approval, four received conditional clearance, and eleven were withdrawn by the filing parties after SAMR’s acceptance of their case.

Overall, SAMR took an average of just over 3 weeks to close a case, which is likely because around 90% of cases were reviewed under the simplified procedure, and the fact that SAMR is increasingly delegating simplified cases to its provincial branches for more efficient reviews. In the context of conditional clearances, SAMR took an average of 309 days to complete its review, which is a decrease from the average of over 450 days in 2022. Notably, in the latter three conditional clearances of the year, SAMR consistently exercised its new power to extend the review period by “stopping the clock”—which it did for an average of 131 days. Stop-the-clock is considered SAMR’s new tool to extend its review period, and is likely to gradually phase out the previous practice of “pull and refile”.

As noted, SAMR issued four conditional clearances in 2023, which are summarized below. Three decisions are worth highlighting: the Broadcom/VMware megamerger (where Gibson Dunn represented VMware as global counsel), MaxLinear/Silicon Motion and Simcere/Tobishi (SAMR’s first-ever “below threshold” conditional approval).

(1) Broadcom/VMware. On 6 September 2022, Broadcom and VMware submitted their notification to SAMR, but SAMR did not formally accept the case until 25 April 2023. On 25 September 2023, SAMR decided to stop the clock, and resumed the clock on 17 November 2023.

SAMR finally issued a conditional approval on 21 November 2023. As part of the conditional clearance, SAMR imposed a set of behavioural remedies on a 10-year basis to address its antitrust concerns. These include:

No tying or bundling of the merged entity’s relevant products, or any restriction or discrimination against customers that purchase those products separately;
Requirements to maintain interoperability between VMware’s virtualization software and third-party hardware products sold in China;
Requirements for Broadcom to maintain its certification practice to ensure interoperability with third-party virtualization software; and
Measures to protect confidential information of third-party hardware manufacturers.

(2) MaxLinear/Silicon Motion. The MaxLinear/Silicon Motion case was conditionally cleared by SAMR in July 2023. The case was officially accepted for review on 28 October 2022. SAMR then decided to stop the clock on 6 January 2023, and only restarted the clock on 14 July 2023, marking an approximately 6-month suspension.

Substantively, SAMR raised several concerns regarding the market for NAND flash controllers. Despite effectively finding that the parties had no horizontal or vertical overlaps, SAMR imposed (among others) the following commitments:

Continue supplying Chinese customers on FRAND terms;
Maintain existing business contracts and relationships with Chinese customers;
Keep Silicon Motion’s existing China field engineers as part of the merged entity’s R&D function, such that Chinese customers of Silicon Motion’s NAND flash controllers can continue to receive technical support; and
Keep Silicon Motion’s NAND flash controller R&D functions in Taiwan.

(3) Simcere/Tobishi. This case marked the first time that SAMR has imposed remedies on a deal that fell below the merger notification thresholds. By way of context, Simcere had a monopoly over Batroxobin, an active pharmaceutical ingredient (“API”), in China. Post-transaction, the merged entity will have 100% market share in the relevant upstream and downstream markets. In addition, SAMR has previously fined Simcere for abuse of dominance back in January 2021. These were suspected to be the reasons why Simcere voluntarily notified SAMR of its acquisition of Tobishi, despite the deal falling below the filing thresholds.

As part of the conditional clearance, SAMR imposed a series of behavioural remedies on Simcere, for a period of 6 years:

Terminate its exclusivity agreement with DSM, which is the only global manufacturer of Batroxobin;
Divest all its assets for developing its Batroxobin injection, and supply the divestiture buyer with the API and necessary assistance to establish a direct supply relationship with DSM;
Reduce the price of Batroxobin injections by at least 20% post-transaction (or 50% if the divestiture is not completed), and guarantee supply to meet domestic demand in China;

(4) Wanhua/Juli. This concerned the acquisition of Yantai Juli Fine Chemical by Wanhua Chemical Group. This was one of the first conditional clearances that SAMR issued on a domestic acquisition. The behavioural remedies include SAMR’s typical measures, such as, requiring the parties to: (i) sell to customers on fair, reasonable and non-discriminatory terms; (ii) maintain or increase their production volumes; (iii) continue their research and development efforts; and (iv) stay away from coercive exclusive dealing.

III. Non-Merger Enforcement

Like previous years, the enforcement decisions published by SAMR indicate that enforcement efforts in 2023 continued to focus on the usual suspects, including public utilities, pharmaceutical corporations, energy suppliers, construction material manufacturers, and industry associations.

The number of major actions and the size of the fines brought against pharmaceutical companies stood out (although these remain very modest compared to fines in other jurisdictions). In total, SAMR and local AMRs brought enforcement actions against over ten companies in six cases of anticompetitive conduct, and imposed an average fine of ~RMB 196 million (~USD 27 million). Half of the published pharmaceutical enforcement actions were focused on abusive price gouging, and the remaining cases were primarily focused on anticompetitive agreements related to cartel behavior or resale price maintenance.

The largest single fine against a pharmaceutical company, which also appears to have been the largest single fine among the published decisions of 2023, was ~RMB 689 million (~USD 97 million). The fine was imposed on one of the entities involved in the Sph No. 1 Biochemical & Pharmaceutical case, where four pharmaceutical companies were penalized for having abused their collective total dominance of the Chinese market for polymyxin B sulfate injections.

IV. Antitrust Litigation

In September 2023, the Supreme People’s Court (“SPC”) published ten representative cases concerning monopoly and unfair competition issues. There are two cases worth highlighting:

The General Motors case[1], in which the SPC held that, where a regulator / authority has issued an administrative decision against an undertaking for monopolistic or anti-competitive conduct, the claimant in the follow-on actions for civil damages will have a lower burden of proof. Specifically, the claimant will not need to prove that the defendant engaged in monopolistic conduct (as that had already been established in the administrative decision), and will only need to prove that: (i) the defendant is indeed the undertaking referred to in the administrative decision; and (ii) the claimant suffered loss because of the defendant’s monopolistic conduct.
The Tobishi/Simcere case[2], in which the SPC held that, the jurisdiction of a refusal to deal case should be where the effect of the conduct took place. For example, in this case, Simcere refused to supply APIs to Tobishi , which prevented Tobishi from producing the relevant downstream product. The SPC found that the effects of Simcere’s refusal to deal took place where Tobishi’s factory was (i.e. in Beijing). Therefore, the Beijing Intellectual Property Court should have jurisdiction over the case.

There are also a number of interesting cases which offer valuable insights into the legal issues and possible interpretations of the AML from an antitrust litigation perspective:

JD.com v. Alibaba – In December 2023, the High People’s Court of Beijing ruled that Alibaba had engaged in coercive exclusivity conduct (known as “choose one out of two) and was in breach of the AML. The lawsuit first started in 2018, when JD.com filed a complaint against Alibaba for abusing its dominance of its online marketplace and mandating online merchants to choose between Alibaba and JD.com, thereby forcing merchants into exclusivity agreements. In the decision, the Court ordered Alibaba to pay JD.com RMB 1 billion, which is the largest damage award in the history of private antitrust litigation in China.
Li Zhen v. Alibaba – This concerned a claim filed by an individual consumer against Alibaba for abuse of dominance. Specifically, the plaintiff alleged that Alibaba and its affiliates forced consumers to only use Alipay’s payment services on Taobao and Tmall. In October 2023, the Shanghai Intellectual Property Court ruled in favour of Alibaba, noting that:
1. Payment service is not a standalone service but an integral part of the overall online-retail platform service. There is no independent transactional relationship between consumers or merchants on one hand, and payment service providers on the other hand. Therefore, no exclusivity or restrictions on the transaction can be imposed by Alibaba in this respect;
2. Since Alipay’s payment service is part of the wider online retail platform service, there is no payment or non-payment service separately sold to consumers and merchants on Taobao and Tmall. As a result, there is no basis to claim that Taobao and Tmall tied payment and non-payment services together; and
3. There was no evidence that Taobao and Tmall refused the access of third-party payment services to their platforms.

The plaintiff is now appealing the case to the SPC.

Hitachi Metals – In December 2023, the SPC overruled the finding that Hitachi Metals’ refusal to license a non-standard essential patent to four Chinese manufacturers amounted to an abuse of dominance. This marked the end of a 9-year lawsuit, and was also the first decision in China touching on refusal to license non-standard essential patent. In particular, the SPC rejected the lower court’s analysis and determined that Hitachi Metals did not possess the alleged level of market dominance, and hence the SPC did not proceed to examine the alleged abusive practices. The SPC also took the view that the patents in dispute were neither essential nor critical, and there were many alternative options available in the market.

V. Conclusion

Since the amendment of the AML, we have seen continued efforts by SAMR to establish a more defined and comprehensive antitrust framework. Going forward, we expect to see further guidelines and directions from SAMR to refine the applications of the amended AML. Indeed, as noted above, both the Ministry of Justice and SAMR have announced that efforts to further develop and sophisticate China’s antitrust regulatory framework are continuing in earnest. Businesses are encouraged to self-assess regularly and introduce internal antitrust compliance protocols to minimize any risk of infringement. In addition, reviews of concentrations in sensitive sectors (e.g. semiconductors) will continue to be challenging in view of the geopolitical climate.

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[1] Supreme People’s Court (2020) Supreme Law of the People’s Republic of China No. 1137

[2] Beijing Intellectual Property Court (2022) No. 1136 of Beijing 73 Minchu

The following Gibson Dunn attorneys prepared this update: Sébastien Evrard, Katie Cheung, and Peter Chau*.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition practice group, or the following authors in the firm’s Hong Kong office:

Sébastien Evrard (+852 2214 3798, sevrard@gibsondunn.com)
Katie Cheung (+852 2214 3793, kcheung@gibsondunn.com)

*Peter Chau, a trainee solicitor in the Hong Kong office, is not admitted to practice law.

The case illustrates the Hong Kong Court’s commitment to upholding party autonomy in arbitration and its longstanding policy of minimal curial intervention.

On 27 February 2024, the Honourable Madam Justice Mimmie Chan delivered her reasons for dismissing an application to set aside an arbitral award in CNG v G & G [2024] HKCFI 575.[1] Mimmie Chan J reiterated that such applications under section 81 of the Arbitration Ordinance (“Ordinance”) are of an “exceptional nature” and should not be lightly made. Her Ladyship urged legal professionals to play a more vigilant role in upholding Hong Kong’s policy of being supportive of arbitration agreements and awards, and to refrain from facilitating issuance of unmeritorious setting aside applications by “massaging” a case to fall within s 81 of the Ordinance.

Gibson Dunn represented the “G Parties”.

Background

This case involved a dispute between shareholders of a company (“SIL”) which owned and operated a mining project. The arbitration claimants (“G Parties”) claimed that the arbitration respondents (“CNG”) were in breach of the shareholders’ agreement by (i) failing to honour a right of first refusal to purchase CNG’s shareholding in SIL (“Share Transfer Claim”) and (ii) failing to honour a contractual Notice of Default with respect to an unauthorised shutdown of operations at the mining project (“Defaulting Shareholder Claim”).

By a First Partial Award issued on 8 February 2023 (“Award”), the Tribunal found in favour of the G Parties on the Share Transfer Claim and held that CNG was bound to sell its SIL shares to the G Parties in accordance with the shareholders’ agreement. The Tribunal further stated that, as the Defaulting Shareholder Claim was an alternative to the Share Transfer Claim, it was not necessary to make operative orders on the Defaulting Shareholder Claim.

CNG applied to the Hong Kong Court to set aside the Award on numerous grounds, including that the Tribunal allegedly failed to deal with issues and give reasons in the Award and that there was procedural unfairness resulting in CNG’s inability to present its case in the arbitration.

Mimmie Chan J’s Decision

2.1 Failure to deal with issues or give reasons

Mimmie Chan J rejected CNG’s argument that the Tribunal had failed to deal with key issues arising in the arbitration or to give reasons for its decision. Her Ladyship emphasised the relevant principles:

The approach of the Court is to read an award generously, remedying only meaningful and readily apparent breaches of natural justice. The Court will only draw an inference that a tribunal had missed a pleaded issue if such inference is “clear and virtually inescapable”.
A tribunal is not required to answer every question that qualified as an issue, nor is the tribunal obliged to structure its award in accordance with parties’ submissions. It is sufficient for the tribunal to deal with the essential issues for it to come fairly to its decision on the dispute.
A list of issues submitted by the parties does not dictate how the Tribunal deals with issues raised in the award – it is not an exam paper with compulsory questions for the Tribunal to answer.
To argue (as CNG did) that the tribunal had placed undue reliance on any aspect of the evidence is impermissible, as it is not the function of the Court to review the evidence again to make its own findings.

2.2 Procedural unfairness

Mimmie Chan J also rejected CNG’s complaints regarding alleged procedural unfairness in the arbitration. Such complaints were directed against, inter alia, the tight procedural timetable in the arbitration, late applications by the G Parties to admit secret recordings and the attitude of the President of the tribunal when CNG’s witnesses were examined, all of which (CNG argued) deprived it of its ability to present its case. Her Ladyship explained that:

The tribunal is the master of its procedures, and is in the best position to decide on the most appropriate manner in which the arbitration should be conducted. The Court will not interfere with the tribunal’s case management decisions unless there was a serious denial of justice.
Section 46 of the Ordinance only requires the tribunal to give the parties “a reasonable opportunity” (as opposed to a “full opportunity”) to present their case. No party can claim to be entitled to all the time it requires to prepare for a hearing.
Despite CNG’s present complaints, it was able to comply with all procedural deadlines in the arbitration and never sought an adjournment. The case took 1.5 years to come to the evidential hearing with both sides supported by large and sophisticated legal teams. Her Ladyship found that there were no unusual features for an international arbitration of this scale, and there was nothing referred to by CNG which can constitute serious and egregious errors on the part of the tribunal.

Comments

CNG v G & G is a prime illustration of the Hong Kong Court’s commitment to upholding party autonomy in arbitration and its longstanding policy of minimal curial intervention. As Mimmie Chan J noted, arbitration is a consensual process of final dispute resolution with only limited avenues of appeal and challenge to the award. It is not for the Court to sit on appeal against the tribunal’s findings of fact or law, and it is impermissible for aggrieved parties to “ask the Court after the event to go through the award with a fine-tooth comb, to look for defects and imperfections” or to “rehearse once again before the Court arguments already made before the Tribunal, or to have different counsel reargue its case with a different focus”. The Hong Kong Court routinely grants costs on an indemnity basis for unsuccessful challenges to arbitral awards.

Parties should bear in mind the above when considering whether to agree to submit their contractual disputes to arbitration.

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[1] Available here.

The following Gibson Dunn lawyers assisted in preparing this alert: Penny Madden KC, Brian Gilchrist, Elaine Chen, Alex Wong, and Andrew Cheng.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the following authors in the firm’s Litigation and International Arbitration practice groups:

Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Brian W. Gilchrist OBE – Hong Kong (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen – Hong Kong (+852 2214 3821, echen@gibsondunn.com)
Alex Wong – Hong Kong (+852 2214 3822, awong@gibsondunn.com)
Andrew Cheng – Hong Kong (+852 2214 3826, aocheng@gibsondunn.com)

The proposed information sharing system will help to bring Hong Kong in line with global trends and enhance the effectiveness of its mechanisms to combat fraud, money laundering and terrorist financing.

On January 23, 2024, the Hong Kong Monetary Authority (“HKMA”) published the “Public Consultation on a Proposal for Information Sharing Among Authorized Institutions to Aid in Prevention or Detection of Crime” (“Consultation Paper”).[1] In short, the Consultation Paper proposes to facilitate information sharing among Authorized Institutions (“AIs”) in respect of personal bank accounts for the purpose of preventing or detecting fraud or money laundering and terrorist financing (“ML/TF”). The proposal also considers the introduction of legislative amendments to provide “safe harbor” protection to AIs which share information for the purposes of preventing or detecting fraud or ML/TF, provided the AIs comply with appropriate safeguards.

I. Why encouraging information sharing between AIs?

While information sharing among AIs and law enforcement agencies has been successful in combatting a wide range of financial crimes, the HKMA recognizes that such arrangements may not, by themselves, be sufficient to fully address the risk of ML/TF via networks of accounts maintained or controlled by criminals (commonly referred to as “mule account networks”), since information might not be shared quickly enough to intercept illicit funds. Delays in information sharing provides an opportunity for criminals to exploit information gaps between AIs to rapidly move and conceal illicit funds. For example, by the time one AI has frozen the accounts maintained or controlled by criminals, those responsible may have already succeeded in moving their illicit funds to their mule accounts in another AI, which the first AI may not be able to quickly alert.

Therefore there has been a global trend towards encouraging information sharing among financial institutions to combat crime and related ML/TF. In Hong Kong, participating AIs can share information on corporate accounts with one another through the Financial Intelligence Evaluation Sharing Tool (“FINEST”) launched in June 2023. However FINEST currently does not support information sharing on personal accounts due to concerns over data privacy. The Consultation Paper points out that FINEST’s ability to prevent and detect crime would be enhanced if information sharing were extended to personal accounts because a significant portion of mule account networks involve bank accounts held by individuals. As such, the importance of safeguarding data privacy and customer confidentiality should be balanced against the need for information sharing among AIs to detect or prevent crime and facilitate the interception of illicit funds.

II. What is the effect of the “safe harbor”?

The HKMA proposes to introduce legislative amendments to provide “safe harbor” protection to AIs which share information on personal accounts with other AIs solely for the purposes of preventing or detecting fraud or ML/TF. The “safe harbor” would provide AIs with legal protection from breach of legal, contractual or other restrictions on disclosure of information, and AIs also will not be held liable for claimed loss arising out of disclosures made. However the “safe harbor” will only apply if the AI complies with the safeguards discussed below.

III. What is the scope of information that could be shared between AIs?

While the scope of information to be shared will vary on a case-by-case basis, the Consultation Paper proposes that it could generally include:

Bank account numbers;
Personal data (e.g. name, date of birth, identity card number) of a customer or counterparty who is a natural person;
Personal data of any beneficial owners or connected party (e.g. a director, partner, or trustee, as applicable) of a customer who is a legal person, a trust, or a legal arrangement similar to a trust;
Personal data of any person purporting to act on behalf of a customer (e.g. acting under power of attorney, or an account signatory);
Details of relevant transactions including counterparties;
Reasons why the transactions or activity may be involved in fraud or ML/TF.

IV. Is information sharing mandatory or voluntary?

Under the proposed system, information sharing by AIs will be made by participating AIs on a voluntary basis.

V. Will changes be made to the STR regime?

The HKMA proposes to introduce a legislative provision that will make clear for the avoidance of doubt that information sharing among AIs under the proposed arrangements will not constitute the offence of “tipping off” under the Organized and Serious Crimes Ordinance (Cap. 455) (“OSCO”) and the Drug Trafficking (Recovery of Proceeds) Ordinance (Cap. 405) (“DTROP”).[2] The obligation to file STRs will remain unchanged.

VI. What safeguards will be implemented?

The HKMA recognizes the importance of protecting the data privacy and customer confidentiality of legitimate customers. The HKMA therefore proposes that the “safe harbor” should only apply where appropriate safeguards are complied with, as summarized below:

The information is shared solely for the purpose of detecting or preventing financial crime;
AIs receiving information are required to treat it in the same manner, and to the same standards of confidentiality, as other confirmation information;
Onward sharing of information received by an AI to another AI is only permitted if is for the purpose of detecting or preventing financial crime, and subject to the same requirements regarding confidentiality;
Information sharing will only be permitted via secure channels such as FINEST (and AIs will need to demonstrate that they are technically and operationally ready and have implemented appropriate systems and controls in order to be permitted to access such platforms);
An AI should only request for information from another AI where the requesting AI has reasonable grounds to believe that the other AI is able to provide information which will assist with preventing or detecting financial crime (including in deciding whether to file an STR);
To prevent “fishing expeditions,” requests for information must be specific and identify the subject of the request, relevant transactions and reasons for suspecting that an activity is connected with financial crime;
Sharing of information will be on a need-to-know basis, i.e. an AI will only be permitted to request or disclose information where they have observed suspicious activity that may indicate that a person, account or transaction may be involved in fraud or ML/TF;
AIs need to adopt a risk-based approach with respect to information shared under the “safe harbor”, e.g. AIs should not terminate a customer relationship merely because the customer is included in information shared or requested (instead, an AI should always conduct its own risk assessment before deciding on the appropriate action to take).

The HKMA proposes to set out the specific requirements in the legislative amendments and the HKMA will also issue statutory guidance setting out its expectations on complying with the relevant requirements. The information sharing mechanism would be supervised by the HKMA, and the HKMA proposes to have the power to impose penalties on AIs that fail to comply with the relevant requirements.

VII. Conclusion

The proposed information sharing system will help to bring Hong Kong in line with global trends and enhance the effectiveness of its mechanisms to combat fraud and ML/TF. The HKMA notes that the United States, United Kingdom and Singapore have already introduced legislation to allow financial institutions to share information concerning individuals and entities where financial crime is suspected. While the specific requirements under each jurisdiction differs, they all provide a safe harbor for financial institutions which disclose information where financial crime is suspected.

The HKMA aims to issue its consultation conclusions and prepare the necessary legislative amendments in the second half of 2024. Interested parties are encouraged to provide feedback by March 29, 2024.

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[1] Available at: https://www.hkma.gov.hk/media/eng/regulatory-resources/consultations/Consultation_on_AI-AI_info_sharing_en.pdf.

[2] Under section 25A(5) of OSCO and DTROP, a person commits an offence if, knowing or suspecting that an STR has been filed, the person discloses to another person any matter which is likely to prejudice any investigation which might be conducted following the filing of the STR.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Arnold Pun, and Jane Lu*.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong and Singapore:

William R. Hallatt – Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Grace Chong – Singapore (+65 6507 3608, gchong@gibsondunn.com)
Emily Rumble – Hong Kong (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)
Becky Chung – Hong Kong (+852 2214 3837, bchung@gibsondunn.com)

*Jane Lu is a paralegal (pending admission) in the firm’s Hong Kong office who is not yet admitted to practice law.

As commercial transactions become more complex, arbitration agreements deserve attention and scrutiny by parties, because they can greatly influence how a dispute could unfold.

International transactions with Asian parties using arbitration as their preferred mode of dispute resolution continue to rise. In recent years, U.S. and European counterparties feature among the most frequent users of Singapore and Hong Kong as seats of arbitration.

Singapore and Hong Kong are regarded as two leading, pro-arbitration seats for international arbitration. As commercial transactions become more complex, parties have been seeking variations to the standard model arbitration clause to fit the specifics of their transactional requirements. No longer ‘midnight clauses’, arbitration agreements deserve attention and scrutiny by parties because they can greatly influence how a dispute could unfold.

This update considers the top 10 issues regarding arbitration clauses that we commonly advise on nowadays, and the extent to which the courts of Singapore or Hong Kong have dealt with them.

#	ISSUE	SUMMARY	EXPLANATION
1.	Are optional or asymmetrical clauses enforceable?	Yes	Both Singapore and Hong Kong have confirmed that optional arbitration clauses (giving parties the option, not obligation, to arbitrate their disputes), and asymmetrical arbitration clauses (entitling only one party the right to refer the dispute to arbitration) are enforceable. A lack of mutuality in obligations per se does not render the clause unenforceable. In an optional clause, it is advisable to stipulate whether the other party is bound by the other party’s choice (i.e., whether the first mover dictates the forum). In an asymmetrical clause, it is advisable to stipulate a process (e.g., written notice of a dispute arising) that would trigger a longstop date by which the party holding the right to refer the dispute to arbitration has to exercise or forfeit it.
2.	Are pre-arbitration requirements (e.g., mediation or negotiations): a. Enforceable? b. A question of admissibility or jurisdiction?	Yes Singapore and Hong Kong take different positions	Pre-arbitration requirements or arb-med-arb protocols or multi-tiered dispute resolution clauses are enforceable. The stringency with which such clauses will be enforced depends on the language used. Where clear obligations are imposed and expressed as mandatory, the court will require full and not merely substantial compliance. A party’s failure to adhere to conditions precedent to the arbitration is currently viewed as a matter going to admissibility under Hong Kong law such that it is only for the tribunal to decide if the preconditions are met, and if not, to decide whether to stay proceedings pending satisfaction of those conditions. Singapore law is not settled on this but there is authority suggesting that the tribunal lacks jurisdiction to proceed if the preconditions are not met. A party that disagrees whether the preconditions are satisfied may challenge jurisdiction before the tribunal and ultimately in court.
3.	Can parties mix and match institutions and arbitral rules?	Possible; not advisable	Only Singapore law has confirmed that a clause mixing institutions (e.g., ICC rules administered by the SIAC) and their arbitral rules can be enforced. However, this is not advisable and institutions like the ICC have now stipulated in their rules that only they can administer their own rules.
4	Are there presumptions relating to parties’ choice of the law governing the arbitration agreement?	Yes; recommend stating the law governing the arbitration agreement	The law governing the main contractual obligations of the parties is, in principle, distinct from the law governing the arbitration, which in turn need not follow the law of the seat (i.e., the procedural law). Most contracts will at least stipulate the law governing the contract, and by the choice of the seat, they will have chosen the procedural law. However, many contracts remain silent on the law governing the arbitration agreement itself (possibly on the assumption that the law governing the contract governs the arbitration agreement as well). This has spawned a series of cases. It is advisable to specifically stipulate the law that parties desire to govern the arbitration agreement (which affects validity and interpretation). In the absence of an express choice, the court will examine whether there is an implied choice of law. There is a presumption that the law governing the main contract governs the arbitration agreement. That presumption can be displaced by (a) the terms of the arbitration agreement, or (b) whether the effectiveness and validity of the arbitration agreement would be impacted by applying the presumption. In the absence of an express or implied choice, the system of law that has the closest and most real connection to the arbitration agreement will govern. It should be noted that this test follows the English position, which is about to be changed by statutory reform such that the law of the arbitration agreement will be presumed to follow the law of the seat. It remains to be seen whether the Singapore or Hong Kong courts adopt the new English position.
5.	Can the allocation of costs and interest be dealt with by agreement, including the costs of third party funding?	Yes	The allocation of costs and interest is a matter for the tribunal and the courts would not generally interfere in their award. The default rule in both jurisdictions is that costs follow the event. Parties may agree for each party to bear their own costs. Unlike in England, there is no statutory prohibition in Singapore and Hong Kong against allocating all the costs to one party regardless the outcome. Tribunals tend to award pre-award interest on a compounded basis to compensate the claimant for being out of the money, and post-award interest based on the prevailing statutory rate. Parties may also wish to stipulate whether and at what rate interest should apply. Third party funding is permitted in Singapore and Hong Kong for international arbitrations. There is no reason in principle why the costs of third party funding cannot be awarded to the successful claimant and tribunals have allowed this. To avoid any dispute, parties may stipulate the tribunal may award such costs.
6.	Can parties carve out issues for judicial determination? By extension, may parties appeal questions of law?	Yes No	The scope of the arbitration clause is a matter for agreement by parties, and it can be as wide or narrow as parties deem appropriate. This means it is possible to carve out certain issues for judicial determination. This could be useful to obtain a ruling on a certain definition or clause that parties might be using across multiple contracts, or a standard term. However, neither Hong Kong nor Singapore permits appeals on issues of law if otherwise those questions are referable to arbitration. It is unclear whether parties can agree to refer certain issues to an ‘appellate tribunal’, which some industry arbitration rules provide for. How such agreements square with the legislation in Singapore and Hong Kong remains untested.
7.	Can parties address multiparty or consolidation issues by agreement?	With great caution	Depending on the arbitral rules adopted, there may be default provisions as to the process to be undertaken in a multiparty or consolidated arbitration. The most important of which is that the original parties may not be able to appoint their own arbitrators. It could be possible for parties to stipulate that the ‘anchor’ parties get their choice of arbitrator. But this could raise issues of due process and equality. This explains why most institutional rules provide (e.g.) that where a party is joined, the tribunal is then appointed only by the institution and not the parties, or that if there are multiple claimants or respondents, they have to agree on their arbitrator or the institution will appoint the arbitrators. What can be useful is an express provision stipulating that parties agree that disputes arising out of a defined group of contracts are to be capable of consolidation and/or that parties to the defined group of contracts agree to be joined in any such proceedings.
8.	Can parties agree on expedition?	Yes	It is possible for parties to stipulate that their arbitration should be conducted in accordance with the expedited rules of the institution, or simply that the arbitration is conducted and completed within a defined period of time. Conversely, parties may stipulate that their arbitration will not be expedited even if it may qualify for expedition under the relevant rules.
9.	Should parties pay attention to questions of arbitrability?	Yes; ensure the disputed subject-matter is arbitrable under laws of the arbitration agreement and the seat	Typically, the law governing the arbitration agreement determines whether the dispute is arbitrable. This could be a trap for the unwary, and makes the choice of the law governing the arbitration agreement important (see above). The Singapore courts have recently ruled that at the pre-award stage, a dispute cannot be referred to arbitration if it is not arbitrable by both the law of the arbitration agreement and the law of the seat. Thus, while the choice of a ‘safe’ seat like Singapore or Hong Kong should avoid most arbitrability issues, advice should be taken in relation to whether the governing law of the contract would regard any potential dispute as not being arbitrable. In the commercial context, the question of arbitrability often arises when the dispute involves the validity of intellectual property rights and minority oppression claims.
10.	Can parties choose their supervisory court?	Yes, in Singapore	In Singapore, the default supervisory court is the General Division of the High Court. However, parties may choose the Singapore International Commercial Court as their supervisory court. The advantages of doing so have been summarised in a previous update. In Hong Kong-seated arbitrations, the Hong Kong courts (specifically the Court of First Instance) will be the court of supervisory jurisdiction.

Notwithstanding the permutations open to parties to create bespoke arbitration agreements, one must be careful not to add unnecessary complexity. While some variations can be useful (e.g., provisions on costs and interest), one counterpoint to balance is that the further an agreement deviates from the standard model clause, the more opportunities a recalcitrant respondent may have to raise arguments challenging jurisdiction or admissibility.

The following Gibson Dunn lawyers prepared this update: Paul Tan, Alex Wong, Jonathan Lai, and Viraen Vaswani.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders or members of the firm’s International Arbitration practice group:

Cyrus Benson – London (+44 20 7071 4239, cbenson@gibsondunn.com)
Brian W. Gilchrist OBE – Hong Kong (+852 2214 3820, bgilchrist@gibsondunn.com)
Penny Madden KC – London (+44 20 7071 4226, pmadden@gibsondunn.com)
Rahim Moloo – New York (+1 212.351.2413, rmoloo@gibsondunn.com)
Philip Rocher – London (+44 20 7071 4202, procher@gibsondunn.com)
Paul Tan – Singapore (+65 6507 3677, ptan@gibsondunn.com)
Alex Wong – Hong Kong (+852 2214 3822, awong@gibsondunn.com)

This briefing examines in depth the circulars and consultation paper issued by the SFC and HKMA in December 2023.

Throughout the course of 2023, the Hong Kong Securities and Futures Commission (“SFC”) and the Hong Kong Monetary Authority (“HKMA”) showed clear indications of their increased openness to virtual assets (“VA”), including through the implementation of the SFC’s Hong Kong virtual asset trading platform (“VATP”) regime,[1] and the release of multiple circulars liberalising the regulatory approach to this area.[2] This trend continued through until the very end of 2023, with the SFC and HKMA being very active in this space in late December. In particular, the SFC on December 22, 2023 issued a circular significantly relaxing the approach to virtual asset exchange traded funds (“VA ETFS”) and other funds with exposure to VA, followed by a joint SFC-HKMA circular in relation to intermediaries’ virtual asset-related activities and an HKMA consultation paper setting out a proposed legislative regime for the issuance of stablecoins. This client briefing examines the two circulars and consultation paper in further depth.

I. SFC Circular on SFC-Authorised Funds With Exposure to Virtual Assets

On December 22, 2023, the SFC published a circular on SFC-authorised funds with exposure to virtual assets (“SFC Circular”), and sets out the requirements under which the SFC will consider authorising funds with exposure to VA of more than 10% of their net asset value (“NAV”) (“SFC-authorised VA Funds”).[3] The SFC Circular supersedes an earlier circular on VA futures ETFs issued on October 31, 2022 (“October 2022 Circular”).[4] The key practical effect of the replacement of the October 2022 Circular is to expand the scope of VA ETFs that may be authorised by the SFC, as the October 2022 Circular only provided for the authorisation of VA ETFs with Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange (“CME”) as the underlying assets. The SFC Circular removes this requirement.

However, all funds with either direct (i.e. as a result of purchasing of tokens directly by the fund) or indirect investment exposure to VA seeking SFC authorisation must comply with a range of requirements, as summarised in the table below.[5] Further, (i) funds having or intending to have VA exposure of more than 10% of NAV that wish to seek the SFC’s authorisation or (ii) existing SFC-authorised funds that plan to obtain VA exposure of more than 10% of their NAV should consult and seek prior approval from the SFC by contacting the relevant case officer of the Investment Products Division.

Area	Key changes from the October 2022 Circular and/or key requirements
Eligible underlying VA	SFC-authorised VA Funds should only invest (indirectly or directly) in VA tokens that are accessible to Hong Kong public for trading on SFC-licensed VATPs.
Investment strategy	As noted above, the SFC Circular has removed the requirement under the October 2022 Circular that VA ETFs must only have as their underlying Bitcoin futures and Ether futures traded on Chicago Mercantile Exchange. However, the SFC Circular does allow SFC-authorised VA Funds to only have exposure to VA futures traded on conventional regulated futures exchanges. Further, the management company of such funds must be able to demonstrate that: (i) the relevant VA futures have adequate liquidity and (ii) the roll costs of the relevant VA futures are manageable and how such roll costs will be managed. Indirect exposures to eligible VA via other exchange-traded products are subject to applicable requirements in the UT Code and other requirements which may be imposed by the SFC. SFC-authorised VA Funds must not have leveraged exposure to VA at the fund level. SFC-authorised VA Funds that primarily adopt a futures-based investment strategy are expected to adopt an active investment strategy to allow flexibility in portfolio composition, rolling strategy and handling of any market disruption events.
Transactions and direct acquisitions of spot VA	Transactions and acquisitions of spot VA by SFC-authorised VA Funds should be conducted through SFC-licensed VATPs or authorised institutions (“AIs”) or their subsidiaries in accordance with any applicable HKMA requirements. For in-cash subscriptions and redemptions, SFC-authorised spot VA ETFs should acquire and dispose of spot VA through SFC-licensed VATPs, either on or off platform. For in-kind subscriptions, participating dealers (“PDs”) should transfer spot VA to SFC-authorised spot VA ETFs’ custody accounts with SFC-licensed VATPs or AIs (and vice versa where in-kind redemptions are concerned). Both in-cash and in-kind subscription and redemption are permitted for SFC-authorised spot VA ETFs. For ETFs that invest in spot VA, PDs should be SFC-licensed corporations or registered institutions.
Custody	The trustee/custodian of an SFC-authorised VA Fund should only delegate its VA custody function to an SFC-licensed VATP or an AI (or a subsidiary of a locally incorporated AI) which meets the expected standards for VA custody issued by the HKMA from time to time. The trustee/custodian and any delegate responsible for taking custody of VA holdings of an SFC-authorised VA Fund should comply with additional requirements: (i) it should ensure segregation between the VA holdings and its own assets as well as the assets it holds for other clients; (ii) it should store most of the VA holdings in a cold wallet, and minimise the amount and duration of VA held in a hot wallet; (iii) it should ensure the seeds and private keys are securely stored in Hong Kong, tightly restricted to authorised personnel, and sufficiently resistant to speculation or collusion, and properly backed up to mitigate any single point of failure.
Management companies	Management companies of SFC-authorised VA Funds should have a good track record of regulatory compliance, and at least one competent staff member with relevant experience in the management of VA or related products. The SFC’s Licensing Department may also impose additional terms and conditions on such management companies.
Valuation	When valuing spot VA, the management companies of SFC-authorised VA Funds should adopt an indexing approach based on VA trade volume across major VA trading platforms (i.e. a benchmark index published by a reputable provider that reflects a significant share of trading activities in the underlying spot VA).
Service providers	Management companies should confirm that all necessary service providers (such as fund administrators, participating dealers, market makers and index providers) are competent, available and ready to support the SFC-authorised VA Funds.
Disclosure and investor education	The offering documents (including the product key facts statements (“KFS”)) of SFC-authorised VA Funds should disclose the investment limits and key risks related to the funds’ VA exposures. Product KFSs for SFC-authorised VA Funds should contain upfront disclosure of the investment objectives and the key risks associated with the underlying VA exposures, such as: (i) price risk, custody risk, cybersecurity risk and fork risk for investments in spot VA; and (ii) potentially large roll costs and operational risks for investments in VA futures.
Distribution	Please refer to Section II below.

II. SFC and HKMA Joint Circular on Intermediaries’ Virtual Asset-Related Activities

On December 22, 2023, the SFC and HKMA issued a joint circular on intermediaries’ virtual asset-related activities (“Joint Circular”) which provides updated guidance to intermediaries carrying on VA-related activities, in respect of (i) the distribution of investment products with exposure to VAs; (ii) the provision of VA dealing services; (iii) the provision of VA advisory services; and (iv) the management of portfolios investing into VAs.[6] The Joint Circular supersedes an earlier joint circular published on October 20, 2023.[7]

The Joint Circular emphasises that VA-related products[8] will very likely be considered complex products and that intermediaries distributing VA-related products considered to be complex products will generally be required to comply with the SFC’s requirements on the sale of complex products (including most notably ensuring suitability of VA-related products, regardless of whether the intermediary has solicited or recommended that its clients invest in the product in question).

However, the SFC and HKMA have also imposed two additional investor protection measures on the distribution of VA-related products to address specific risks related to these products:

Restrictions on sale: Subject to certain exceptions (as discussed further below), the SFC and HKMA have indicated that VA-related complex products should only be offered to professional investors (“PIs”); and
VA knowledge test: Intermediaries must assess whether clients (other than institutional PIs and qualified corporate PIs) have knowledge of investing in virtual assets or VA-related products prior to effecting a transaction in VA-related products on their behalf. Where a client does not have the requisite knowledge, the intermediary may only proceed if it has provided sufficient training to the client on the nature and risks of VAs and the clients have sufficient net worth to bear potential losses from trading VA-related products.[9]

However, while the above investor protection measures appeared in the earlier joint circular dated October 20, 2023, the SFC and HKMA have in the Joint Circular stated that the selling restrictions above will not apply to SFC-authorised VA Funds (i.e. funds approved for public offering), subject to intermediaries complying with the following additional safeguards:

For SFC-authorised VA Funds listed and traded on the Hong Kong Stock Exchange (“SEHK”), client orders can be executed on exchange without the need to comply with the suitability requirement or minimum information and warning statements requirements,[10] providing there has been no solicitation or recommendation by the intermediary.
For SFC-authorised VA Funds that are not listed, or for listed funds where trading occurs off exchange, intermediaries will still have to comply with the abovementioned requirements, as well as undertaking the VA knowledge test set out above on the clients concerned.

Further, the SFC and HKMA have also reminded intermediaries that where these SFC-authorised VA funds are also VA derivative funds, intermediaries also need to comply with the requirements for derivative products set out in the Joint Circular.

To assist intermediaries in determining whether an investment product with exposure to VA is complex and the corresponding selling requirements that may apply to the product, the Joint Circular also includes a flowchart which sets out the relevant factors and the corresponding selling requirements.[11]

III. Legislative Proposal on Issuance of Stablecoins

On December 27, 2023, the Financial Services and the Treasury Bureau (“FSTB”) and the HKMA jointly issued a public consultation paper regarding their proposed legislative regime for the regulation of stablecoins (“Legislative Proposal”).[12] This followed the HKMA’s January 2022 discussion paper inviting feedback on its proposed regulatory approach towards crypto-assets and stablecoins (“Discussion Paper”) (as covered in our previous client alert)[13] and its January 2023 consultation conclusions (“Consultation Conclusions”)[14] (as covered in a subsequent client alert).

The introduction of the Legislative Proposal is driven by the potential interconnectedness between the virtual assets (“VA”) market and the traditional financial system. Specifically, the FSTB and HKMA view stablecoins, especially fiat-referenced stablecoin (“FRS”) as a key monetary and financial stability risk area which could lead to a spill-over from the VA sector to the traditional financial system, and vice versa.

A. Legislative Scope and Approach

The FSTB and HKMA have proposed that, rather than amending existing legislation (including the Payment Systems and Stored Value Facilities Ordinance (“PSSVFO”)), their intention is to introduce a new piece of legislation which will address specific features of stablecoins and could more readily serve as the foundation for the extension of the regulatory regime to other forms of VAs down the track. The FSTB and HKMA have also proposed that the issuance of an FRS by an FRS licensee would be excluded from the scope of existing regulatory regimes, including those applicable to securities (e.g. collective investment schemes) and SVFs.

The FSTB and HKMA have proposed that initially, the licensing regime will apply only to issuers of fiat-referenced stablecoins (“FRS”) – that is, stablecoins which have as their specified asset one or more fiat currencies.[15] The FSTB and HKMA have noted that while a FRS which derives value from arbitrage or algorithm will be caught by the regulatory regime, it is highly unlikely (as explained further below) that such FRS will be able to meet the HKMA’s licensing requirements.

That said, the FSTB and HKMA have left the door open to extend the regulatory regime to other forms of VAs (presumably including other types of stablecoins) by describing the proposed FRS issuance regime as a “first step” in the regulation of virtual assets. Notably, the FSTSB and HKMA have proposed that the legislative regime should empower the “authorities” to modify the parameters of in-scope stablecoins and activities, but have not specified if this power would be reserved to the HKMA specifically or to the HKMA in consultation with the FSTB (for example). In exercising any such power to modify the regime, the “authorities” would be required to consider a number of factors (such as the risks posed to the monetary and financial stability of Hong Kong), and the materiality of the case (such as the market share and the value in circulation) before exercising this power.

B. Licensing Requirements for FRS Issuers

Under the Legislative Proposal, an FRS issuer will have to be licensed with the HKMA before it can:

Issue, or hold itself out as issuing, an FRS in Hong Kong;

Issue, or hold itself out as, issuing a stablecoin that purports to maintain a stable value with reference to the value of the Hong Kong dollar; or
Actively market its issuance of FRS to the Hong Kong public.

In order to be licensed, the FRS issuer must demonstrate that it could meet the following licensing requirements, as summarised below:

Licensing Requirements		Description
Management of reserves and stabilisation mechanism	Full backing	The value of the reserve assets backing an FRS must be at least equal to the par value of the FRS (at a minimum) at all times. Issuers of FRS which derive value from arbitrage or algorithms will not be granted a license, given the inherent difficulties of maintaining a stabilisation mechanism in the absence of any backing assets.
	Investment limitations	The reserve assets must be of high quality and high liquidity with minimal market, credit and concentration risk. Reserve assets must be held in the referenced currency, although flexibility may be allowed on a case-by-case basis subject to the HKMA’s approval. The composition of the reserved assets should be determined with reference to the FRS’s liquidity requirements, including how liquidity requirements will be met through the management and investment of reserve assets. The HKMA will need to be satisfied of the appropriateness of the types of assets held by the FRS issuer, and expects that each issuer will have a regularly reviewed investment policy regarding assets that are suitable for holding as reserve assets.
	Segregation and safekeeping of reserve assets	FRS issuers will be expected have effective trust arrangements to ensure that reserve assets are appropriately segregated and available to satisfy FRS holders’ redemption, as well as their legal right and priority claim in the event of insolvency. Reserve assets must be stored in segregated accounts with licensed banks or with other asset custodians (subject to the HKMA’s approval of the proposed arrangements). FRS issuers must maintain effective internal controls to protect the reserve assets from operational risks, including risks of theft, fraud and misappropriation.
	Risk management and controls	FRS issuers must put in place adequate policies, guidelines and controls for the proper management of all investment activities associated with the management of the reserve assets. This includes having comprehensive liquidity risk management practices which address the approach to large scale redemptions – i.e. run scenarios or other scenarios of liquidity stress. FRS issuers must also conduct periodic stress tests to monitor the adequacy and the liquidity of the reserve assets.
	Disclosure and reporting	FRS issuers must regularly publish the total amount of FRS in circulation, the mark-to-market value of reserve assets and the composition of reserve assets. FRS issuers will also be expected to (in consultation with the HKMA) engage a qualified and independent auditor to perform regular attestations in relation to their FRS, including the (i) composition and market value of the reserve assets; (ii) the par value of FRS in circulation; (iii) whether the reserve assets are adequate to fully back the value of FRS in circulation and are sufficient liquid (as of the last business day of the period covered by the attestation); and (iv) whether the conditions on the reserves management as imposed by the HKMA have all been fulfilled. The Legislative Proposal recommends that the total amount of FRS in circulation and the value of reserve assets be disclosed at least daily, the composition of reserve assets be disclosed at least weekly, and attestation by the independent auditor be performed at least monthly.
	Prohibition on paying interest	FRS issuers must not pay interest to FRS users. Any income or loss from the reserve assets, including but not limited to interest payments, dividends or capital gains or losses are attributable to the FRS issuer.
	Effective stabilisation	The FRS issuer is ultimately responsible for ensuring the effective functioning of the stabilisation mechanism of its FRS, notwithstanding any engagement of third parties to carry out the stabilisation activity.
Redemption requirements		The HKMA expects for FRS users to have the right to redeem their FRS at par value with the FRS issuer to have a claim on the reserve assets (or the issuer if the issuer is not able to meet redemption obligations). An FRS issuer is expected to process redemption requests without undue costs and on a timely basis. The issuer must not impose unreasonable conditions on redemption, such as a very high minimum threshold amount. In the event that fees for redemption are charged, such fees must be clearly communicated to FRS users and must be proportionate, at a level that do not deter redemption. The FRS issuer must meet the redemption request at par value by paying in the fiat currency underlying the relevant FRS. Where channels for FRS users to exchange their FRS into fiat currency become unavailable (e.g. due to disruption to infrastructure), the FRS issuer must nevertheless still be able to ensure direct redemption for all FRS users at part in a reasonably timely manner. The FRS issuer is expected to draw up and maintain a contingency plan to enable orderly redemption of FRS by FRS users in the event that the FRS issuer is unable to meet redemption requests (including in the case of suspension or revocation of the issuer’s licence).
Restrictions on business activities[16]		The HKMA’s approval must be sought before an FRS issuer can commence any new lines of business. To this end, the FRS issuer must conduct a risk assessment and demonstrate to the HKMA that adequate resources are allocated to the issuance and maintenance of the FRS, that the new business will not introduce significant risks, and that proper risk controls are in place to ensure that the new line of business will not impair its functions as an FRS issuer. However, provided that the FRS issuer have adequate systems for the segregation and safekeep of FRS and handling of deposit and withdrawal requests for FRS, the FRS issuer will be allowed to conduct activities ancillary or incidental to its issuance of FRS, such as providing wallet services for the FRS it issues. The FRS issuer is prohibited from carrying on lending and financial intermediation or other regulated activities (e.g. regulated activities under the SFO).
Physical presence in Hong Kong[17]		The FRS issuer must be a company incorporated in Hong Kong with a registered office in Hong Kong. Its key personnel and senior management must be based in Hong Kong, and must be empowered with effective management and control of FRS issuance and related activities.
Financial resources requirements[18]		The FRS issuer is expected to maintain a minimum paid-up share capital to be HKD 25,000,000 or 2% of the par value of FRS in circulation, whichever is higher.
Disclosure requirements		The FRS issuer is expected to disclose general information about the issuer itself, the rights and obligations of its FRS users, the FRS stabilisation mechanism, reserves management arrangements, the underlying technology and the risks through a published white paper. The FRS issuer must also disclose their redemption policies, including the timeframe for the redemption process, the applicable fees and the right of FRS users to redemption.
Governance, knowledge and experience		Controllers, chief executives and directors of an FRS issuer must be fit and proper. Their appointment and any changes to the ownership and management of the FRS issuer are subject to HKMA approval. The FRS issuer is expected to have an adequate system of control for the appointment of the senior management team and suitable staff under a robust corporate governance structure.
Risk management requirements		An FRS issuer is expected to implement appropriate risk management processes and measures, such as adequate security and internal controls, effective fraud monitoring and detection measures; technological risk management measures; and contingency arrangements to address operational disruptions. The FRS issuer must also perform risk assessments on a sufficiently frequent basis and at a minimum, on an annual basis, to ensure adequacy of its internal controls.
Audit requirements		The FRS issuer are required to submit audited financial statements to the HKMA annually. Where required by the HKMA, the FRS issuer must submit reports prepared by external independent auditors and assessors to validate the management and operational soundness of the FRS issuance, such as whether the FRS issuer has adequate systems of control for the management of reserve assets, cybersecurity and the integrity of smart contracts.
Anti-money laundering and counter-financing of terrorism requirements		The FRS issuer must ensure that the design and implementation of its issuance business has adequate and appropriate systems of control for preventing or combating possible money laundering and terrorism financing, and for ensuring compliance with the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (“AMLO”) and any other related rules or regulations issued by the HKMA. This includes ensuring that the FRS issuer has adequate customer due diligence measures in relation to FRS issuance, redemption, transaction monitoring and travel rule requirements.

Notwithstanding the above, the HKMA will have the power to impose, amend and cancel ongoing licensing conditions on an FRS issuer, where necessary. These additional conditions can include requirements on reserve assets and restrictions on the types of services that could be undertaken by the FRS issuer.

Licenses granted under the FRS issuer licensing regime will be open-ended, i.e. licences will remain valid until or unless revoked by the HKMA or the FRS issuer ceases to operate. However, the issue of any new FRS (i.e. other than that which the FRS issuer received a licence to issue) will require the consent of the HKMA before it can issue any new FRS under its license. Further, all licensed FRS issuers must display their licence number on any advertising materials and consumer facing materials or software applications.

C. Custody and offering of FRS

With regard to offering of FRS, the FSTB and HKMA have indicated that they consider that FRS issued by unlicensed entities are unsuitable for use by the public. As a result, their intention is that only licensed FRS issuers, authorized institutions, licensed corporations and licensed VATPs can offer FRS in Hong Kong or actively market such offerings in Hong Kong. Meanwhile, authorized institutions, licensed corporations and licensed VATPs can offer FRS issued by unlicensed entities to professional investors only.

With regard to custody, we understand that the FSTB, HKMA and the SFC are continuing to examine the appropriate regulatory approach for such activities. Further regulatory guidance on this topic (including guidance from the HKMA on the provision of VA custodial services by authorised institutions) is expected in the short to medium term.

D. Supervisory Powers of the HKMA

Mirroring similar provisions under the Banking Ordinance, the Legislative Proposal confers supervisory powers on the HKMA to act in the event that a licensee (i) has become or is likely to become insolvent or unable to meet its obligations; (ii) is carrying on its business in a manner detrimental to the interests of its users or its creditors; or (iii) has contravened any of its licensing conditions or provisions of the proposed regulatory regime. In these circumstances, the HKMA will have the power to:

Require a licensee to implement any action relating to the licensee’s affairs, business or property that the HKMA considers as necessary, including restricting the licensee’s business of FRS issuance;
Direct a licensee to seek advice on the management of its affairs, business and property from an advisor appointed by the HKMA; and
Require a licensee’s affairs, business and property to be managed by a HKMA-appointed manager.

The HKMA’s consent will also be required for changes in ownership or management of FRS issuers, including with regard to any proposed amalgamation, sale or disposal of all or part of the business of an FRS issuer, change of control (including change of majority or minority shareholder controller, or indirect controller) and the appointment of chief executives and directors.

Additionally, the HKMA will also have the power to gather information, including request information or documents from licensees, or to conduct on-site examinations at the licensee’s premises. Where the HKMA has reasonable cause to suspect non-compliance, the HKMA will have the power to conduct investigations into the licensee and persons relevant to the suspected contravention. The HKMA will also have the power to give directions to bring an FRS issuer into compliance with its statutory obligation to ensure the protection of the FRS issuer. Finally, the HKMA will also have the power to make regulations to operationalise the FRS regulatory regime and issue guidelines regarding the way in which it expects to perform its functions with regards to this new regime.

E. Disciplinary Framework

The Legislative Proposal contemplates the creation of both a criminal and a civil framework. It will be a criminal offence to:

Issue an FRS in Hong Kong without a licence;
Advertise the issuance of FRS by an unlicensed issuer;
Fail to produce documents or information as required by the HKMA;
Provide false information to the HKMA; and
Contravene other conditions imposed by the HKMA in connection with the FRS licensing regime.

Separately, the HKMA will also have the power to impose civil and supervisory sanctions, including:

Issuing a caution, warning, reprimand or order to take specified action(s);
Issuing a temporary suspension, suspension or revocation of an FRS issuer’s license;
A pecuniary penalty not exceeding HK$10,000,000 or 3 times the amount of profit gained or loss avoided as a result of the contravention, whichever is higher; and
Any combination of the above.

As a check and balance, an appeal tribunal mechanism will be set up to address appeals against the HKMA’s disciplinary decisions. A person dissatisfied with the decision of the appeal tribunal will be able to appeal to the Court of Appeal against the determination on a point of law.

F. Transitional Arrangements

The FRS Issuer Licensing Regime is proposed to commence one month upon gazettal of the proposed new ordinance. However, the FSTB and HKMA have proposed a transitional arrangement to ensure the smooth transition into the new regime. Under this transitional regime, pre-existing FRS issuers conducting FRS issuance with a meaningful and substantial presence in Hong Kong prior to the commencement of the regime can continue to operate under a non-contravention period of six months, subject to submitting a licence application to the HKMA within the first three months of the commencement of the regime. This comparatively short transitional period (if not extended in the final version of the legislative regime) means that stablecoin issuers will need to take steps to quickly prepare licence applications (and establish a meaningful and substantial presence in Hong Kong if they do not already have one) following the gazettal of the new ordinance. Those pre-existing FRS issuers which fail to submit a licence application to the HKMA within the first three months will need to wind down its business by the end of the fourth month of the commencement of the regime.

__________

[1] See “Hong Kong SFC Consults On Licensing Regime For Virtual Asset Trading Platform Operators”, published by Gibson, Dunn & Crutcher (March 2, 2023), available at https://www.gibsondunn.com/hong-kong-sfc-consults-on-licensing-regime-for-virtual-asset-trading-platform-operators/; and “New Hong Kong Regulatory Requirements and Licensing Regime for Virtual Asset Trading Platforms Finalised as Legislation Takes Effect”, published by Gibson, Dunn & Crutcher (June 7, 2023), available at https://www.gibsondunn.com/new-hong-kong-regulatory-requirements-and-licensing-regime-for-virtual-asset-trading-platforms-finalised-as-legislation-takes-effect/.

[2] “Hong Kong’s SFC Updates Guidance on Tokenised Securities-Related Activities”, published by Gibson, Dunn & Crutcher (November 10, 2023), available at https://www.gibsondunn.com/hong-kong-sfc-updates-guidance-on-tokenised-securities-related-activities/.

[3] “Circular on SFC-Authorised Funds With Exposure to Virtual Assets”, published by the Securities and Futures Commission (December 22, 2023), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/products/product-authorization/doc?refNo=23EC65.

[4] “Circular on Virtual Asset Futures Exchange Traded Funds”, published by the Securities and Futures Commission (October 31, 2023), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=22EC60.

[5] These requirements are in addition to meeting the applicable requirements in the Overarching Principles Section and the Code on Unit Trusts and Mutual Funds in the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products.

[6] “Joint Circular on Intermediaries’ Virtual Asset-Related Activities”, jointly published by the Securities and Futures Commission and the Hong Kong Monetary Authority (December 22, 2023), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC67.

[7] “Joint Circular on Intermediaries’ Virtual Asset-Related Activities”, jointly published by the Securities and Futures Commission and the Hong Kong Monetary Authority (October 20, 2023), available here.

[8] “VA-related products” are defined as products which (a) have a principal investment objective or strategy to invest in virtual assets; (b) derive their value principally from the value and characteristics of virtual assets; or (c) track or replicate the investment results or returns which closely match or correspond to virtual assets.

[9] See Appendix 1 of the Joint Circular for the non-exhaustive criteria for assessing whether a client can be regarded as having knowledge of virtual assets.

[10] The minimum information and warning statements requirements require intermediaries to provide clear and easily comprehensible information and warning statements to clients in relation to VA-related products and information on the underlying VA investments; and provide to clients risk disclosure statements (which can be a one-off disclosure) specific to VAs.

[11] See Appendix 3 of the Joint Circular.

[12] “Legislative Proposal to Implement the Regulatory Regime for Stablecoin Issuers in Hong Kong Consultation Paper”, jointly published by the Financial Services and the Treasury Bureau and the Hong Kong Monetary Authority (December 27, 2023), available at https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2023/20231227e4a1.pdf.

[13] “Another Step Towards the Regulation of Cryptocurrency in Hong Kong: HKMA Releases Discussion Paper on Stablecoins”, published by Gibson, Dunn & Crutcher (September 19, 2022), available at https://www.gibsondunn.com/another-step-towards-the-regulation-of-cryptocurrency-in-hong-kong-hkma-releases-discussion-paper-on-stablecoins/.

[14] “Hong Kong Monetary Authority Introduces Plans To Regulate Stablecoins”, published by Gibson, Dunn & Crutcher (February 7, 2023), available at https://www.gibsondunn.com/hong-kong-monetary-authority-introduces-plans-to-regulate-stablecoins/.

[15] For completeness, the Legislative Proposal defines “stablecoin” to mean “a cryptographically secured digital representation of value that, among other things – (a) is expressed as a unit of account or a store of economic value; (b) is used, or is intended to be used, as a medium of exchange accepted by the public, for the purpose of payment for goods or services; discharge of a debt; and/or investment; (c) can be transferred, stored or traded electronically; (d) uses a distributed ledger or similar technology that is not controlled solely by the issuer; and (e) purports to maintain a stable value with reference to a specified asset, or a pool or basket of assets.” To avoid overlap with the SVF regulatory regime, the FSTB and HKMA have expressly carved out “deposits, including its tokenized or digitally represented form; certain securities or future contracts (mainly authorized collective investment schemes and authorized structured products); float stored in SVFs or SVF banks; and certain digital representations of fiat currencies issued by or on behalf of central banks; and certain digital representation of value that has a limited purpose” from the definition of “stablecoins”.

[16] This licensing requirement will not apply to FRS issuers which are authorized institutions, considering that these authorized institutions are already subject to relevant requirements under banking regulation.

[17] This licensing requirement will not apply to FRS issuers which are authorized institutions, considering that these authorized institutions are already subject to relevant requirements under banking regulation.

[18] This licensing requirement will not apply to FRS issuers which are authorized institutions, considering that these authorized institutions are already subject to relevant requirements under banking regulation.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong and Singapore:

The Proposed Guidelines set out for the first time the specific regulatory requirements and the SFC’s regulatory expectations in respect of market soundings in Hong Kong.

On October 11, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published a consultation paper (the “Consultation Paper”) on the proposed guidelines for market soundings (the “Proposed Guidelines”).[1] The Proposed Guidelines are noteworthy since it sets out for the first time the specific regulatory requirements and the SFC’s regulatory expectations in respect of market soundings in Hong Kong. This client alert will explore the SFC’s proposals in greater detail.

I. Why introduce the Proposed Guidelines?

To understand the rationale of the requirements in the Proposed Guidelines, it is helpful to understand why the SFC has decided that it is the appropriate time to introduce the Proposed Guidelines.

Firstly, the SFC observed an increasing number of persons trading ahead of placings and block trades, which suggested that some intermediaries may have unfairly taken advantage of non-public information received during market soundings to make unjustified profits. This led the SFC’s thematic review of market sounding practices and controls adopted by intermediaries in 2022, where the SFC noted a divergence of practices among intermediaries in designing their risk controls over market soundings, which suggested that more clarity on the SFC’s regulatory expectations was required to deter substandard conduct and to assist intermediaries in upholding market integrity during market soundings.

Secondly, in light of the determination of the Securities and Futures Appeals Tribunal (“SFAT”) on September 27, 2022 (the “SFAT Determination”) in the Aarons case,[2] the SFC considered it appropriate to provide both sell-side and buy-side market participants with additional clarity on complying with the general principles in the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”) during market soundings. In summary, the case involved a hedge fund manager who entered into short swaps (which can be used for short selling) after the manager received non-public information about an intended block sale (a large, privately negotiated sale of securities) of shares in a listed Korean company from one of the underwriters of the block sale. The communication was made by the underwriter (a sell-side broker) to the hedge fund manager (a buy-side participant) as part of a market sounding to see if the manager would be interested in participating as a buyer on the block sale. After news of the block sale became public, there was a material drop in the share price of the listed Korean company, and the short swaps entered into by the hedge fund manager generated a profit for the fund he managed.

The SFAT upheld the finding by the SFC that the hedge fund manager’s conduct was such that he was not a fit and proper person to continue to be licensed, having regard to General Principles 1 (Honesty and fairness) and 7 (Compliance) of the Code of Conduct. In doing so, the SFAT determined that a two years suspension of the hedge fund manager’s licence was the most appropriate sanction.

It is relevant to note that the hedge fund manager was not charged with the offence of insider dealing under the Securities and Futures Ordinance (Cap. 571) (“SFO”). The reason is likely because the civil and criminal insider dealing regimes[3] under the SFO have a regulatory lacuna with respect to insider dealing committed in Hong Kong with respect to overseas listed securities. This regulatory lacuna will be addressed when amendments to the insider dealing provisions under the SFO are introduced (please see our earlier client alert [4] for further details). As such, in hearing the appeal, it was not necessary for the SFAT to determine whether or not the communication made to the hedge fund manager constituted “inside information” as defined in the SFO. Rather, the issue to be determined by the SFAT was whether the hedge fund manager’s conduct breached the Code of Conduct (namely, General Principles 1 and 7).[5] The SFAT ultimately agreed with the SFC’s findings that the hedge fund manager’s deceitful conduct after receiving “material non-public information” about an impending block sale meant that he failed to adhere to principles of honest and fair conduct, and hence failed to act with the integrity that the market required, and in conclusion failed to comply with General Principles 1 and 7 of the Code of Conduct.

II. What communications are subject to the Proposed Guidelines?

The Proposed Guidelines would apply to the communication of non-public information – irrespective of whether or not it is price-sensitive “inside information”[6] – with potential investors prior to the announcement of a securities transaction, to gauge their interest in a potential transaction or assist in determining the specifications related to a potential transaction (such as private placements and large block trades) (“Market Sounding”), by intermediaries who:

Disclose non-public information during the course of a Market Sounding (“Disclosing Person”), such as a sell-side broker acting on behalf of an issuer or an existing shareholder selling in the secondary market (“Market Sounding Beneficiary”) in a potential securities transaction; and
Receive non-public information during the course of a Market Sounding, such as a buy-side firm that is sounded out by a Disclosing Person as a potential investor in a potential securities transaction(collectively, a “Market Sounding Intermediary”).[7]

It is important to highlight that the Proposed Guidelines apply to communications on all “non-public information”, irrespective of whether the same information constitutes “inside information” under the SFO. It is also noticeable that, despite referring to the SFAT Determination, the Proposed Guidelines do not use the potentially narrower term “material” non-public information, as found in the SFAT Determination, and instead adopt the much broader term “non-public information”. This appears to be intentional, as the Consultation Paper explains that one of the SFC’s concerns was that intermediaries may run the risk of potential misconduct from an inaccurate determination of what constitutes “inside information”, as it often involved complex judgment and interpretations and that it was not uncommon for parties to arrive at different conclusions)[8] – and presumably similar concerns apply to the determination of whether or not non-public information is “material” or not. Adopting the broader term “non-public information” therefore reduces the risk of inaccurate determinations.

III. What communications are not subject to the Proposed Guidelines?

According to the Consultation Paper, the Proposed Guidelines will not apply to communications regarding:

Speculative transactions or trade ideas shared by a Disclosing Person without consulting with the potential Market Sounding Beneficiary or without any “level of certainty” of such transactions materialising. The Proposed Guidelines provides guidance on the factors to consider in determining whether there is some “level of certainty”, such as the extent to which the Market Sounding Beneficiary has expressed an interest with the Disclosing Person in proceeding with a possible transaction, among other factors[9];
Transaction in such size, value, structure or selling method, that are commensurate with “ordinary day-to-day trade execution”, such as a sell-side broker sourcing potential buy-side participants to execute an ordinary size trade (in relation to the average trading volume or market capitalisation) after receiving an actual order instruction placed by the sell-side broker’s client with a genuine intention for execution; and
Public offering of securities.

The above carve-outs will be important in light of the wide range of Market Sounding communications that are likely to contain some form of “non-public information”. However, internal procedures and controls will need to be carefully designed and implemented, or else intermediaries run the risk of potential misconduct from an inaccurate determination of whether a particular communication falls within the above carve-outs, and therefore failing to comply with the regulatory requirements in the Proposed Guidelines.

The Proposed Guidelines also make clear that they may apply even before a formal mandate from the Market Sounding Beneficiary is received, i.e. as soon as the Disclosing Person starts to conduct any form of market sounding (soft or otherwise) on behalf of a Market Sounding Beneficiary.

IV. Core Principles of Market Sounding

The Proposed Guidelines contain a set of Core Principles (“CP”), which all Market Sounding Intermediaries should comply with in conducting Market Soundings. The CPs are briefly summarised below[10]:

CP 1. Market Integrity: Market Sounding Intermediaries should maintain confidentiality and not trade on or use non-public information passed or received during Market Soundings for the benefit of themselves or others until the information ceases to be non-public.
CP 2. Governance: Market Sounding Intermediaries should implement robust governance and oversight arrangements over its Market Sounding activities. This includes: (i) senior management are responsible for oversight of Market Soundings; (ii) establish governance arrangements for Marketing Soundings; (iii) designate a committee or person(s) independent from the “front-office” to monitor Market Soundings in support of senior management oversight; and (iv) develop and implement appropriate reporting lines and escalation processes to ensure any Market Sounding issues are promptly reported to senior management and the designated committee or person(s) for review and follow-up action.
CP 3. Policies and Procedures: Market Sounding Intermediaries should establish and maintain effective policies and procedures specifying the manner and expectations in which its Market Soundings should be conducted. The written polices and procedures should cover, among other matters: (i) when they become applicable and the timing and procedures of Market Soundings; (ii) allocation of roles and responsibilities among staff involved in Market Soundings, taking into account the “three lines of defence” and ensuring proper staff training; (iii) personal dealing restrictions; (iv) escalation protocols; (v) consequences for non-compliance with the Market Sounding requirements; (vi) categorisation, identification and handling of information during the course of Market Soundings; and (vii) record-keeping requirements.
CP 4. Information Barrier Controls: Market Sounding Intermediaries should implement adequate and effective physical and electronic information barrier controls to prevent inappropriate disclosure, misuse or leakage of non-public information during the course of Market Soundings. This includes, but is not limited to: (i) physical segregation; (ii) system user access controls; (iii) information sharing policies and procedures (e.g. Market Sounding information should be restricted to authorised personnel on a “need-to-know” basis and disclosed only through authorised communication channels); and (iv) maintaining a list of internal and external recipients of non-public information as well as “Restricted List” to prohibit trading on non-public information.
CP 5. Review and Monitoring Controls: Market Sounding Intermediaries should establish effective procedures and controls to monitor and detect suspicious behaviour, unauthorised disclosure, or misuse of information from Market Soundings. This includes periodic reviews of trading and communication surveillance controls, voice and electronic communications, and unauthorised access to information.
CP 6. Authorised Communication Channels: Market Sounding Intermediaries should only use recorded and firm-authorised communication channels to conduct Market Soundings, until the information ceases to be non-public.

Market Sounding Intermediaries are expected to periodically review and update their governance and oversight arrangements, policies and procedures, and internal systems and controls, to ensure that they remain robust and effective.

V. Specific requirements for Disclosing Persons

As the party that initiates Market Soundings, Disclosing Persons bear the initial responsibility to ensure that any non-public information associated with Market Soundings is properly safeguarded and disclosed in accordance with the standards of conduct set out in the Proposed Guidelines. To this end, the specific requirements applicable to the Disclosing Persons are more extensive than for the Recipient Persons, and are summarised below.[11]

Stage of Market Sounding	Specific Requirements
Pre-Market Sounding procedures	Before the initial contact with Recipient Persons or other potential investors to conduct a Market Sounding, a Disclosing Person should: Conduct assessments to determine whether the information disclosed during the Market Sounding would constitute non-public information; Obtain consent from the Market Sounding Beneficiary to engage in the Market Sounding; and Determine in advance, on a case-by-case basis taking into account the requirements in the Proposed Guidelines: (i) a standard set of information to be disclosed to Recipient Persons, (ii) an appropriate timing to conduct the Market Soundings, and (iii) a suitable number of Recipient Persons to contact for the Market Sounding.
During the Market Sounding communications process	A Disclosing Persons should adopt a standardised pre-approved script that is reviewed by senior management or independent functions, such as Legal and Compliance, during initial and subsequent Marketing Sounding communications. In summary, the script should at a minimum include: A statement that the communication is for the purpose of a Market Sounding and that the Recipient Person shall keep confidential the non-public information, and not trade or use such information for its own or others’ benefit until the information ceases to be non-public; A statement that the conversation is recorded and to request the Recipient Person’s consent for recording; Confirm that the individual is the person designated by the Recipient Person to receive Market Soundings; A statement that the Recipient Person will receive information which the Disclosing Person considers to non-public and a request for their consent to receive such information; and An estimate of when the information will cease to be non-public, where possible. After obtaining the above consents, a Disclosing Person should provide a written confirmation to the Recipient Person as soon as possible, summarising the contents covered in its Market Sounding communications. Prior to receiving the Recipient Person’s consent (as explained above), a Disclosing Person should ensure that any preliminary information shared with the Recipient Person is sufficiently broad, limited, vague and anonymised to minimise the change of the Recipient Person guessing the name of the security involved. Greater caution should be exercised in determining the amount of non-public information to be shared where the subject security may be identified even with the provision of only limited information (e.g. for narrow industry sectors) – for example the situation in the SFAT Determination as discussed above.
Cleansing	After non-public information has been disclosed during a Market Sounding, a Disclosing Person should: (i) conduct assessments to determine whether the information has ceased to be non-public (e.g. following the announcement of the transaction, or if the transaction was called off); and (ii) inform the Recipient Person(s) as soon as possible in writing when the information ceases to be non-public according to the Disclosing Person’s assessment.
Record keeping	A Disclosing Person should keep the records in relation to its Market Soundings for a period of not less than seven years. These records must include: Consents obtained from Market Sounding Beneficiaries to engage in Market Soundings; A list of Recipient Persons who informed the Disclosing Person that they do not wish to receive any Market Soundings; Audio, video or text recordings of Market Soundings conducted; The Disclosing Person’s assessment considerations, rationales, and discussions with the Market Sounding Beneficiary (if any), in determining whether the information disclosed would constitute non-public information, and whether non-public information disclosed during Market Soundings has ceased to be non-public; A list of all internal and external persons(s) who possess non-public information as a result of Market Soundings, including details such as the date and time of the Marketing Sounds, information and materials disclosed, etc.; Notifications to inform Recipient Persons when the information ceases to be non-public.

VI. Specific requirements for Recipient Persons

The specific requirements for Recipient Persons are relatively lighter when compared with the Disclosing Person, and are summarised below.[12]

Stages of Market Sounding

Requirements

Handling of Market Sounding requests

A Recipient Person should:

Designate a properly trained specified person(s) to receive Market Soundings, and inform the Disclosing Persons of such arrangement upon being contacted by the Disclosing Persons for Market Soundings; and
Inform the Disclosing persons whether it wishes to, or not to, receive Market Soundings from the Disclosing Persons.

Record keeping

A Recipient Person should keep the records in relation to its Market Soundings for a period of not less than seven years. These records must include:

Any notifications given to the Disclosing Person of its wish to, or not to, receive Market Soundings;
Audio, video or text recordings of Market Sounding received; and
A list of all internal and external persons(s) who possess non-public information as a result of Market Soundings, including details such as the date and time of the Marketing Sounds, information and materials disclosed, etc.

VII. Conclusion

The Consultation Paper containing the Proposed Guidelines is currently undergoing a public consultation. The SFC has indicated that it currently plans to provide a six-month transition period for the industry to update their internal procedures and controls after the Proposed Guidelines are finalised. Even prior to the finalisation of the Proposed Guidelines, intermediaries may still find it helpful to compare their existing internal procedures and controls with the requirements in the Proposed Guidelines, as it provides useful guidance on the SFC’s regulatory expectations and areas which an intermediary may wish to consider updating. As demonstrated by the SFAT Determination, the SFC can still find an intermediary to be in breach of the General Principles in the existing Code of Conduct if the intermediary engages in substandard conduct in respect of market soundings.

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[1] “Consultation Paper on the Proposed Guidelines for Market Soundings”, published by the SFC on October 11, 2023, available at: https://apps.sfc.hk/edistributionWeb/api/consultation/openFile?lang=EN&refNo=23CP6

[2] Christopher James Aarons v. Securities and Futures Commission, SFAT Application No. 1 of 2021, Determination, September 27, 2022, available at: https://www.sfat.gov.hk/files/SFAT%202021-1%20determination.pdf

[3] SFO, sections 270 and 291.

[4] “Hong Kong SFC Places Key Reforms to SFO Enforcement Provisions on Hold Following Industry Feedback”, published by Gibson Dunn on August 11, 2023, available at: https://www.gibsondunn.com/hong-kong-sfc-places-key-reforms-to-sfo-enforcement-provisions-on-hold-following-industry-feedback/.

[5] SFAT Determination, paragraph 192.

[6] “Inside information” is defined in sections 245 and 285 of the Securities and Futures Ordinance as “specific information that (a) is about (i) the corporation; (ii) a shareholder or officer of the corporation; or (iii) the listed securities of the corporation or their derivatives; and (b) is not generally known to the persons who are accustomed or would be likely to deal in the listed securities of the corporation but would if generally known to them be likely to materially affect the price of the listed securities.

[7] The Consultation Paper, paragraph 24; and the Proposed Guidelines, paragraph 1.2.

[8] The Consultation Paper, paragraphs 20 to 21.

[9] According to the Proposed Guidelines, a case-by-case consideration of the facts and circumstances is needed to determine whether there is some “level of certainty” of a corresponding potential transaction materialising. The examples of factors to take into account when making such determination include the extent to which the Market Sounding Beneficiary has orally or in writing: (i) expressed an interested with the Disclosing Person in proceeding with a possible transaction; (ii) shared any particulars with the Disclosing Person in relation to the possible transaction (such as the timing, size, pricing or structure of the transaction); or (iii) mandated, requested or consented to the gauging of investor appetite by the Disclosing Person. It is important to note that these are only examples of some factors to take into account, and are not intended to be exhaustive.

[10] The Consultation Paper, paragraphs 27 to 41; the Proposed Guidelines, paragraph 2.

[11] The Proposed Guidelines, paragraph 3.

[12] The Proposed Guidelines, paragraph 4.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Arnold Pun, and Jane Lu*.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:

William R. Hallatt – Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Emily Rumble – Hong Kong (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)
Becky Chung – Hong Kong (+852 2214 3837, bchung@gibsondunn.com)

*Jane Lu is a paralegal (pending admission) working in the firm’s Hong Kong office who is not yet admitted to practice law.

A summary and commentary on the recent decision of the Hong Kong Court of Final Appeal regarding service of originating process by the Securities and Futures Commission

On 30 October 2023, the Hong Kong Court of Final Appeal (the “CFA”) handed down its reasons for dismissing the appeal in Securities and Futures Commission v Isidor Subotic and Others [2023] HKCFA 32[1]. The CFA confirmed that leave is not required for the Securities and Futures Commission (the “SFC”) to serve proceedings out of jurisdiction as the relevant provisions in the Securities and Futures Ordinance (the “SFO”) has empowered the Court of First Instance (the “CFI”) to hear and determine a claim made against persons who are not within the jurisdiction.

Background

In July 2019, the SFC commenced the present proceedings against various individuals and companies under sections 213 and 274 of the SFO. It was alleged that these parties were operating a false trading scheme involving artificially inflating the price of the share of a Hong Kong listed company before “dumping” them and causing loss to market participants and lenders. The SFC sought, amongst other relief, a restoration order in favour of the market participants involved and an injunction to freeze certain assets.

As six of the defendants in this case were located outside of Hong Kong (the “Foreign Defendants”), the SFC applied for and was granted leave to serve a concurrent writ on them outside of Hong Kong. The Foreign Defendants applied to set aside the order granting leave and sought a declaration that the CFI lacks jurisdiction over them, arguing that leave was wrongly granted as the SFC’s claims did not come within any of the “gateways” specified in Order 11, rule 1(1) of the Rules of the High Court (the “RHC”) (i.e., the types of claims for which leave to effect service outside of Hong Kong could be obtained).

The CFI[2] and the Court of Appeal[3] both upheld the decision granting leave to effect service out of the jurisdiction on the basis that claims of the SFC were either a claim founded on tort and damage was sustained or resulted from an act committed within the jurisdiction (“Gateway F”) or a claim for an injunction restraining a conduct within the jurisdiction. The Foreign Defendants then appealed to the CFA on grounds that the relief sought by the SFC under Section 213 of the SFO cannot be properly characterized as a claim and even if it is a claim, it is not founded on tort for the purpose of invoking Gateway F.

Before the CFA hearing, the CFA directed the parties to make submissions on whether leave was in fact necessary in the circumstances because under Order 11, rule 1(2) of the RHC, if a legislative provision already confers the CFI with jurisdiction in respect of a claim over a defendant outside of Hong Kong or in respect of a wrongful act committed outside Hong Kong, leave from the court is not required for effecting service of a writ out of the jurisdiction.

CFA’s Decision

The CFA unanimously dismissed the appeal and held that, according to Order 11, rule 1(2) of RHC, it was not necessary for the SFC to seek leave from the CFI to serve its claim on the Foreign Defendants.

In coming to such conclusion, the CFA looked into three questions in particular, namely (1) what are the claims that the SFC is making; (2) whether the CFI is empowered to hear and determine the claims made by the SFC by virtual of any written law; and (3) whether the CFI is so empowered notwithstanding that the person against whom the claim is made is not within the jurisdiction of the court or that the wrongful act giving rise to the claim did not take place within the jurisdiction.

On the first question, it was observed that the writ which the SFC served upon the Foreign Defendants seeks declarations that they are persons within section 213 of the SFO who have engaged in false trading activities in contravention of sections 274 and/or 295 of the SFO.

On the second question, having identified the claims of the SFC, the CFA then considered the effect of sections 213 and 274 of the SFO. The CFA held that these provisions are intended to operate in combination and must be read together. Whilst section 274 of the SFO defines the prohibited acts of false trading, section 213 of the SFO provides for the orders that the CFI may impose against the contraveners. It is clear that by virtue of the written law, CFI is empowered to hear and determine the claims put forwarded by the SFC under sections 213 and 274 of the SFO.

On the last question, the CFA found in the affirmative because upon contravention of section 274 of the SFO, the CFI is empowered under section 213 of the SFO to grant relief against a person “in Hong Kong or elsewhere” where such person does anything that constitutes false trading affecting the Hong Kong market. It was noted that the policy to confer the CFI with extraterritorial jurisdiction over persons outside of Hong Kong is justified considering that trading on the Hong Kong Stock Exchange is global and therefore it would be necessary to make sanctions legally available against overseas fraudulent parties who cause disruption to the local market and losses to other investors.

Notwithstanding the above, the CFA also made clear that the application of Order 11 rule 1(2) of the RHC is limited to cases where the written law in question clearly contemplates proceedings being brought against persons outside of jurisdiction or where the wrongful act did not take place within the jurisdiction. It is not sufficient if the written law is of general application and may be invoked against persons within or outside the jurisdiction.

Comment

This decision confirms that no leave is required for the SFC to serve a writ seeking reliefs such as restoration orders, damages and compensation orders or restraint orders under section 213 of the SFO on foreign defendants out of jurisdiction.

Such decision is consistent with the intent of the SFO to seek redress in relation to wrongful acts damaging to market participants whether such acts took place within or outside Hong Kong and to provide appropriate legal recourse against the wrongdoers. In light of the decision, it is expected that the SFC may take more aggressive enforcement actions against parties who have engaged in cross-border market misconduct and pursue them regardless of their physical location.

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[1] https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=155879

[2]https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=137397&currpage=T

[3]https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=149666

The following Gibson Dunn lawyers assisted in preparing this alert: Brian Gilchrist, Elaine Chen, Alex Wong, and Cleo Chau.

Brian W. Gilchrist OBE (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen (+852 2214 3821, echen@gibsondunn.com)
Alex Wong (+852 2214 3822, awong@gibsondunn.com)
Cleo Chau (+852 2214 3827, cchau@gibsondunn.com)

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On November 2, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published two circulars providing guidance to intermediaries engaging in tokenised securities-related activities (the “Tokenised Securities Circular”),[1] and on the tokenisation of SFC-authorised investment products (the “Investment Products Circular”) (collectively, the “Circulars”).[2]

As further explained below, the Circulars reflect a distinct evolution in the SFC’s views on tokenised securities, in particular by explicitly superseding the SFC’s previous March 2019 statement characterising security tokens as complex products requiring extra investment protection measures and restricting their offering to professional investors (the “March 2019 Statement”).[3] Instead, the SFC has made it clear in the Tokenised Securities Circular that it now considers tokenised securities to be traditional securities with a tokenisation wrapper, as discussed further below, and has noted that there is a growing interest in tokenising traditional financial instruments in the market, including the issuance and distribution of tokenised funds by fund managers and management of funds that invest in tokenised securities. The two Circulars aim to assist intermediaries interested in exploring tokenisation by providing more guidance on regulatory expectations with respect to tokenised securities-related activities and how to address the risks specific to tokenised securities.

I. The Tokenised Securities Circular represents an important evolution in the SFC’s views of Tokenised Securities

As a starting point, the SFC has indicated that for the purposes of the Tokenised Securities Circular, it considers tokenized securities to be traditional financial instruments (e.g. bonds or funds) that are securities (as defined in the Securities and Futures Ordinance (“SFO”)) which utilise distributed ledger technology (e.g. blockchain technology) (“DLT”) or a similar technology in their security lifecycle (“Tokenised Securities”).[4] In the SFC’s words, these securities are “fundamentally traditional securities with a tokenisation wrapper”. Given this, the SFC has emphasised in the Tokenised Securities Circular that the existing legal and regulatory requirements for securities will continue to apply to Tokenised Securities.

In taking this approach, the Tokenised Securities Circular represents an important step forward from the March 2019 Statement, which characterised Security Tokens as complex products and imposed a “professional investor-only” (“PI-only”) restriction on the distribution and marketing of these securities. However, the SFC has now made it clear that tokenisation should not alter the complexity of the underlying security. Therefore, instead of a blanket categorisation of Tokenised Security as a “complex product”, the SFC now instructs intermediaries to adopt a “see-through approach”. In other words, intermediaries should determine the complexity of a Tokenised Security by assessing the underlying traditional security against the factors set out in the Guidelines on Online Distribution and Advisory Platforms and the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”),[5] as well as guidance issued by the SFC from time to time.

Similarly, the SFC has indicated that as Tokenised Securities are fundamentally traditional securities with a tokenisation wrapper, there is no need to impose a mandatory PI-only restriction. However, the offerings of Tokenised Securities to the Hong Kong public will continue to be subject to the prospectus regime in the Companies (Winding Up and Miscellaneous Provisions) Ordinance and offers of investments regime under Part IV of the SFO (“Public Offering Regimes”). As such, Tokenised Securities that have not complied with the prospectus requirements or offers of investments regime can only be offered to PIs.

The SFC has also noted that existing conduct requirements for securities-related activities will apply to the distribution of or advising on Tokenised Securities, management of funds investing in Tokenised Securities and secondary market trading of Tokenised Securities on virtual asset trading platforms.

II. Key regulatory expectations when engaging in Tokenised Securities-related activities

The Tokenised Securities Circular goes on to set out guidance regarding the SFC’s expectations for intermediaries choosing to engage in Tokenised Securities related-activities, as summarised below.

Risk management considerations

The SFC has emphasised in the Tokenised Securities Circular that its approach remains “same business, same risks, same rules”. However, the SFC considers that tokenisation has created new risks for intermediaries in relation to ownership (e.g. in relation to how ownership interests are transferred and recorded) and technology risks (e.g. forking, network outages and cybersecurity risks).

These risks can vary depending on the type of the DLT network utilised for the Tokenised Securities, with the SFC flagging that intermediaries should apply particular caution in relation to Tokenised Securities in bearer form issued using permissionless tokens on open, public network that does not restrict access for privileges and offers decentralised, anonymous, and large-scale user base (“Public-Permissionless Network”). This is on the basis that these sorts of securities are exposed to increased cybersecurity risks due to the lack of restrictions for public access and the open nature of these networks. In the event of a cyberattack, theft or hacking, the SFC has flagged that investors may experience increased difficulties in recovering their assets or losses, and may face potentially substantive losses without recourse. Intermediaries should address such risks accordingly by adopting adequate safeguards and controls.

Considerations for intermediaries engaging in Tokenised Securities-related activities

In general, the SFC has noted that:

Intermediaries engaging in Tokenised Securities-related activities need to ensure that they have appropriate manpower and expertise to understand and manage the nature of these activities, especially the new risks posed by the underlying technology.
Intermediaries must also ensure that they act with due skill, care and diligence, and perform due diligence on both the underlying product (e.g. the underlying security such as a bond which is being tokenised) and the technology used for the tokenisation.

Issuance of Tokenised Securities

Where intermediaries issue or are substantially involved in the issuance of Tokenised Securities which they also intend to deal in or advise on (e.g. fund managers of tokenised funds), the SFC will consider that these intermediaries remain responsible for the overall operation of the tokenisation arrangement, even if they have entered into outsourcing arrangements with third party vendors or service providers. The SFC has set out a non-exhaustive list of considerations that intermediaries involving in issuance should consider in relation to technical and other risks (see Part A of the Appendix to the Tokenised Securities Circular).[6] These considerations include, for example, the experience of the third party vendors involved in the tokenisation process, the robustness of the DLT network, data privacy risks and enforceability of the Tokenised Security.

The SFC has also stated that for custodial arrangements, intermediaries should consider the features and risks of the Tokenised Securities when considering the most appropriate custodial arrangement in relation to such Tokenised Securities, and that it expects custodial arrangements for bearer form Tokenised Securities using permissionless tokens on Public-Permissionless Networks to take into consideration the factors set out at Part B of the Appendix.[7] These factors include, for example, the custodian’s management of conflicts of interest, its cybersecurity risk management measures and its experience in providing custodial services for Tokenised Securities.

Dealing in, advising on, or managing portfolios investing in Tokenised Securities

Intermediaries should conduct due diligence on the issuers and their third party vendors / service providers, as well as the features and risks arising from the tokenisation arrangement when dealing in, advising on, or managing portfolios investing in Tokenised Securities. Intermediaries should also ensure that they are satisfied that adequate controls have been put in place by the issuers and their third party vendors / service providers to manage ownership and technology risks posed by the Tokenised Security before engaging in any of these activities.

Disclosure obligations

The SFC expects intermediaries to make adequate disclosures to clients of relevant material information (including risks) specific to Tokenised Securities. Such material information should include, for example:

Whether off-chain or on-chain settlement is final;
Any limitations imposed on transfers of the Tokenised Securities;
Whether a smart contract audit was conducted before the smart contract was deployed;
Key administrative controls and business continuity plans for DLT-related events; and
The details of any custodial arrangement where applicable.

III. Other clarifications regarding Tokenised Securities

The Tokenised Securities Circular also includes three important clarifications regarding the SFC’s approach to Tokenised Securities going forward:

The SFC has previously stated that the “de minimis threshold” under the Proforma Terms and Conditions for Licensed Corporations which Manage Portfolios that Invest in Virtual Assets (“Terms and Conditions”) only applies to virtual assets, as defined under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance.[8] [9] Viewed in conjunction with the Circulars, fund managers managing portfolios investing in Tokenised Securities which meet the “de minimis threshold” would not be subjected to the Terms and Conditions unless these portfolios also invest in virtual assets meeting the “de minimis threshold”.
Virtual asset trading platforms (“VATPs”) licensed by the SFC are currently required to set up a SFC-approved compensation arrangement to cover potential loss of security tokens.[10] On application by the VATP, the SFC has indicated that it is willing to consider, on a case-by-case basis, excluding certain Tokenised Securities from the required coverage.
The SFC has also provided guidance in relation to digital securities other than Tokenised Securities – i.e. products which the SFC defines as securities as defined in the SFO which utilise DLT or other similar technology but which are not traditional financial instruments. The SFC has indicated that these sorts of digital securities which are not Tokenised Securities are likely to be complex products on the basis that they are likely to be bespoke in nature, terms and features, and not easily understood by a retail investor. Given this, intermediaries distributing such digital securities would be required to comply with the requirements for sale of complex products. Further, the SFC has reminded intermediaries not to offer these sorts of digital securities to retail investors in breach of the Public Offering Regimes. The SFC has also emphasised that intermediaries should exercise their professional judgment to assess each digital security which they deal with, including whether the security is a Tokenised Security, and should ensure that additional internal controls are implemented to address the specific risks and nature of such digital securities.

IV. Key considerations for the tokenisation of SFC-authorised investment products

The Investment Products Circular separately sets out the SFC’s requirements for considering allowing tokenisation of investment products authorised by the SFC for offering to the Hong Kong public. It must be emphasised that the SFC requirements for Tokenised Securities (as set out in Section II above) will also apply to the tokenisation of SFC-authorised investment products.

Echoing the approach taken by the SFC in the Tokenised Securities Circular, the SFC has indicated in the Investment Products Circular that it will take a “see through” approach to tokenised SFC-authorised investment products, and will allow primary dealing of tokenised SFC-authorised investment products provided that the underlying product meets certain specified product authorisation requirements and safeguards, as summarised below.

Tokenisation arrangement	Product providers of tokenised SFC-authorised investment products (“Product Providers”) should: Remain and ultimately be responsible for the management and operational soundness of the tokenisation arrangement and record keeping in relation to ownership, regardless of any outsourcing arrangement; Ensure that proper records of token holders’ ownership interests are maintained; Ensure that the tokenisation arrangement is operationally compatible with involved service providers; Impose additional and proper controls before adopting Public-Permissionless Networks (e.g. use of a permissioned token); Confirm and, where requested by the SFC, demonstrate that the tokenisation arrangement, record keeping of ownership information and integrity of the smart contract is properly managed and operated, and (where requested by the SFC) obtain third party audit or verification of the same; and Where requested by the SFC, obtain a satisfactory legal opinion to support the application for primary dealing of a tokenised SFC-authorised investment product.
Disclosure obligations	The following disclosures must be made clearly and comprehensively in offering documents of a tokenised SFC-authorised investment product: The nature of the tokenisation arrangement, including whether off-chain or on-chain settlement is final; The ownership representation of the tokens, including legal and beneficial title of the tokens, and ownership of or interests in the product; and The associated risks of the tokenisation arrangement, including cybersecurity, system outages, the possibility of undiscovered technical flaws, evolving regulatory landscape and potential challenges in the application of existing laws.
Distribution of tokenised SFC-authorised investment products	Only regulated intermediaries (e.g. licensed corporations or registered institutions) can distribute tokenised SFC-authorised investment products. This requirement extends to Product Providers who wish to distribute their own products. These regulated intermediaries must comply with existing requirements (e.g. client onboarding requirements and suitability assessments) as applicable.
Staff competence	Product Providers must ensure that they have at least one competent staff member with the relevant experience and expertise to operate and/or supervise the tokenisation arrangement and to manage the ownership and technology risks of the arrangement.
Prior SFC consultation or approval	Prior consultation with the SFC will be required for tokenisation of existing SFC-authorised investments and the introduction of new investment products with tokenisation features. Changes made to the tokenisation of existing SFC-authorised investments must also be approved by the SFC. For example, the SFC has noted that its prior approval must be sought before adding the disclosure of new tokenised unit or share class of an SFC-authorised fund to the offering documents for offering to the Hong Kong public, unless the tokenisation arrangement is substantially the same as the existing arrangement.

Meanwhile, driven by investor protection concerns, the SFC has adopted a more cautious attitude towards secondary trading of tokenised SFC-authorised investment products, on the basis that further careful consideration is required in order to provide a substantially similar level of investor protection to investors to that afforded to those investing in a non-tokenised product. The considerations flagged by the SFC include maintenance of proper and instant token ownership record, readiness of trading infrastructure and market participants to support liquidity, and fair pricing of tokenised products. The SFC has indicated that it will continue to engage with the market on proper measures to address risks involved in secondary trading.

V. Conclusion

While the Circulars provide welcome guidance to intermediaries in relation to tokenisation of traditional financial instruments, it is clear that the SFC will expect intermediaries to closely engage with them prior to embarking on any activities in relation to tokenised products. Given the fast-changing nature of the cryptocurrency space, the SFC may provide further guidance or impose additional requirements for Tokenised Securities and/or tokenised SFC-authorised investment products from time to time. In particular, it appears that the SFC may well release further guidance in relation to secondary trading of SFC-authorised investment products following further engagement with market participants. Interested intermediaries should closely monitor such developments and ensure continuous compliance.

____________________________

[1] “Circular on intermediaries engaging in tokenised securities-related activities”, published by the SFC on November 2, 2023, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC52

[2] “Circular on tokenisation of SFC-authorised investment products”, published by the SFC on November 2, 2023, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC53

[3] “Statement on Security Token Offerings” published by the SFC on March 28, 2019, available at: https://www.sfc.hk/en/News-and-announcements/Policy-statements-and-announcements/Statement-on-Security-Token-Offerings

[4] “Securities” is defined under section 1 of Part 1 of Schedule 1 to the SFO, available at: https://www.elegislation.gov.hk/hk/cap571

[5] See Chapter 6 of the Guidelines on Online Distribution and Advisory Platforms, published by the SFC in July 2019, available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/guidelines-on-online-distribution-and-advisory-platforms/guidelines-on-online-distribution-and-advisory-platforms.pdf?rev=689af636b3ad4077929d46a94631e458. See also paragraph 5.5 of the Code of Conduct, published by the SFC, available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Sep-2023_Eng-Final-with-Bookmark.pdf?rev=209e9f3b717e4d70b45bfe45a0bb6288

[6] See Part A of Appendix to the “Circular on intermediaries engaging in tokenised securities-related activities” published by the SFC on November 2, 2023, available here: https://apps.sfc.hk/edistributionWeb/api/circular/openAppendix?lang=EN&refNo=23EC52&appendix=0

[7] See Part A of Appendix to the “Circular on intermediaries engaging in tokenised securities-related activities” published by the SFC on November 2, 2023, available here: https://apps.sfc.hk/edistributionWeb/api/circular/openAppendix?lang=EN&refNo=23EC52&appendix=0

[8] The Terms and Conditions are imposed on licensed corporations 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 of the portfolio in virtual assets (i.e. the “de minimis threshold”). See the Terms and Conditions, published by the SFC in October 2019, available at: https://www.sfc.hk/web/files/IS/publications/VA_Portfolio_Managers_Terms_and_Conditions_(EN).pdf

[9] “Joint Circular on Intermediaries’ Virtual Asset-Related Activities”, jointly published by the SFC and Hong Kong Monetary Authority on October 20, 2023, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/suitability/doc?refNo=23EC44

[10] See paragraph 10.22 of the “Guidelines for Virtual Asset Trading Platform Operators”, published by the SFC in June 2023, available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/Guidelines-for-Virtual-Asset-Trading-Platform-Operators/Guidelines-for-Virtual-Asset-Trading-Platform-Operators.pdf?rev=f6152ff73d2b4e8a8ce9dc025030c3b8

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.*

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong and Singapore:

*Jane Lu is a paralegal in the firm’s Hong Kong office who is not yet admitted to practice law.

On July 27, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published a “Circular on Licensing and Registration of Depositaries of SFC-authorised Collective Investment Schemes and Related Transitional Arrangements” (the “Circular”).[1] Trustees and custodians of SFC-authorised collective investment schemes (the “relevant CIS”) will have to be licensed or registered with the SFC for the new Type 13 regulated activity (“RA 13”) from October 2, 2024.

The Circular should be read in tandem with the soon to be enacted Schedule 11 to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Schedule 11”).[2] Together, the Circular and Schedule 11 provide guidance on the SFC’s expectations regarding RA 13 licensing arrangements.

The new RA 13 regulatory regime intends to remedy what the SFC has previously described as a “patchy” approach to the regulation of depositories, whereby the SFC was unable to directly supervise depositaries. Instead, the SFC could only exercise indirect oversight through the requirements under the Product Codes.[3] The RA 13 regulatory framework was proposed by the SFC in September 2019 to fill this void left by a lack of specific, direct supervision mechanism over trustees and custodians of public funds.[4] In doing so, the new RA 13 regulatory regime will also align Hong Kong’s fund custody framework with international standards; most major jurisdictions (such as the United Kingdom and Singapore) have some form of direct regulatory powers over entities providing trustee, custodian or depositary services for public funds (at a minimum). Viewed broadly, the introduction of RA 13 is also consistent with the SFC’s focus on regulating entities providing custody services – for instance, its recent decision to regulate virtual assets custody under its new virtual assets trading platform (“VATP”) regime by requiring custody be undertaken by a wholly owned subsidiary of a licensed VATP operator.

I. Who needs a RA 13 license?

The amendments made to the Securities and Futures Ordinance (“SFO”) to introduce RA 13 define it as “providing depositary services for relevant CISs”.[5] In essence, what this means is that trustees and custodians (i.e. depositaries as defined under the amendments to the SFO) of a relevant CIS at the “top level” of the custodian chain will be required to be licensed or registered for RA 13 in order to provide the following services:

the custody and safekeeping of the CIS property, including property held on trust by the relevant CIS (“CIS Property”); and
the oversight of the CIS to ensure that it is operated according to scheme documents.[6]

In practice, many of these depositaries were not previously supervised by the SFC until the introduction of the new RA 13 regime. This suggests that individuals who will now be required to be licensed to undertake RA 13 activities will be subjected to direct SFC supervision for the first time, and may not be accustomed to being licensed.

II. What are the RA 13 regulatory requirements?

In the table below, we highlight the key regulatory requirements applicable to depositaries licensed for RA 13 (“RA 13 Depositaries”):

Capital thresholds	RA 13 Depositaries are required to maintain a paid-up share capital of not less than $10,000,000 and a liquid capital of not less than $3,000,000.[7]
Treatment of Scheme Money	RA 13 Depositaries that hold or receive scheme money under a relevant CIS (“Scheme Money”) must deposit such Scheme Money into segregated and designated trust accounts or client accounts within three business days after receipt. Each segregated account must be established and maintained for one relevant CIS only.[8] RA 13 Depositaries must not pay Scheme Money out of the segregated account unless such payment is (i) instructed in writing, or (ii) for the purpose of meeting payment, distribution, redemption settlement, or margin requirements, or (iii) to settle any charges or liabilities on behalf of the relevant CIS, as per the scheme documents.[9]
Treatment of Scheme Securities	Similarly, an RA 13 Depositary must deposit client securities which it holds or receives when providing depositary services (“Scheme Securities”) into a segregated and designated trust account or client account. Alternatively, the RA 13 Depositary can register the Scheme Securities in the name of the relevant CIS.[10] An RA 13 Depositary can only deal with Scheme Securities in accordance with written instructions or scheme documents. It must take reasonable steps to ensure that Scheme Securities are not otherwise deposited, transferred, lent or pledged.[11]
Record keeping obligations	In line with the record keeping requirements generally applicable to licensed intermediaries, RA 13 Depositaries are required to keep accounting, custody and other records to sufficiently explain and reflect the financial position and operation of the business, and support accurate profits and loss or income statements. Specifically, RA 13 Depositaries must also account for all relevant CIS Property, and make sure that its accounting systems can trace all movements of relevant CIS Property.[12]
OTCD reporting	RA 13 Depositaries are exempted from reporting specified over-the-counter (“OTC”) derivative transactions to the Hong Kong Monetary Authority (“HKMA”) when acting as a counterparty to the OTC derivative transaction.[13] Similarly, authorized institutions need not report the OTC derivative transaction to the HKMA if the counterparty of the transaction is an RA 13 Depositary acting in its capacity as a trustee of the relevant CIS.[14]

Further, the SFC has previously clarified that the Managers-In-Charge (“MIC”) requirements under the current licensing framework extend to RA 13 licensees.[15]

III. Are there any additional requirements applicable to specific classes of RA 13 Depositaries?

Schedule 11 sets out additional requirements applicable to specific classes of RA 13 Depositaries. In the table below, we summarize the key requirements applicable to RA 13 Depositaries authorized under the Code on Unit Trusts and Mutual Funds[16] and Code on Pooled Retirement Funds (“UT/RF RA 13 Depositaries”).[17] These are mostly RA 13 Depositaries operating Chapter 7 Funds (i.e. plain vanilla funds investing in equity and/or bunds), specialized schemes (such as hedge funds, listed open-ended funds), and pooled retirement funds.

Appointment and oversight of delegates or third parties	UT/RF RA 13 Depositaries should establish internal control policies and procedures to oversee appointed delegates or third parties. These internal control policies and procedures should cover the following: the selection of a delegate or third party, including assessment procedures and criteria on the delegate or third party’s competence, regulatory and financial status, capabilities and the effectiveness of their internal controls and systems; ongoing and regular monitoring of the delegate or third party to ensure compliance with regulatory requirements and maintenance of effective internal controls and systems; and management of actual or potential conflicts of interests arising from the appointment and oversight of delegates or third parties (where applicable). UT/RF RA 13 Depositaries should also establish appropriate contingency plans to cater for instances of breaches or insolvency of these delegates or third parties.[18]
Oversight of the relevant CIS	UT/RF RA 13 Depositaries should have oversight over the operations of the relevant CIS, and ensure that the CIS is operated or administered in accordance with the relevant constitutive documents.[19]
Subscription and redemption	UT/RF RA 13 Depositaries should monitor the relevant operators of each CIS to ensure (among other things): timely processing of subscription and redemption transactions; execution of subscription and redemption orders in accordance with the constitutive documents of the relevant CIS; timely deposits of subscription and redemption proceeds into a segregated bank account designated as a trust account or client account holding relevant CIS Property; reconciliation of subscription and redemption, and that the frequency of such reconciliation is consistent across subscription and redemption; and proper documentation of reasons for (i) suspension of dealing of unit or shares of the relevant CIS, and (ii) suspension of valuation, price or net asset value calculations of the relevant CIS.[20]
Distribution payments	UT/RF RA 13 Depositaries should supervise the relevant operators of each CIS to ensure that: distributions are calculated in accordance with the constitutive documents of the relevant CIS; and complete and accurate distribution payments are made on a timely basis. With respect to each relevant CIS, UT/RF RA 13 Depositaries should ensure that distribution proceeds are transferred according to the operator’s instruction on a timely basis into a designated and segregated or omnibus bank account.[21]
Custody and safekeeping of CIS Property	UT/RF RA 13 Depositaries can adopt the safeguards to ensure the safekeeping of CIS Property: assess and manage custody risk by making adequate organisational arrangements to minimise the risks of loss of the CIS Property; register the CIS Property in the name of the UT/RF RA 13 Depositary; verify ownership of the CIS Property using reliable sources; maintain updated and comprehensive records of the CIS Property; and ensure reconciliation is carried out daily for CIS Property in cash form.[22]

Notwithstanding the above, there are specific requirements applicable to RA 13 Depositaries authorized under the Code on Real Estate Investment Trusts (“REIT RA 13 Depositaries”).[23] These are RA 13 Depositaries operating closed-ended funds primarily investing in real estate. REIT RA 13 Depositaries are under a fiduciary duty to hold assets of Real Estate Investment Trusts (“REIT”) on trust for the benefit of the unitholders of the REIT. While the requirements applicable to UT/RF RA 13 Depositaries summarized above are generally applicable to REIT RA 13 Depositaries, Schedule 11 tailors some of these requirements to account for the unique features and product structure of REITs. The key modifications are summarized as follows:

Cash flow monitoring and cash reconciliation

Under the Code on Real Estate Investment Trusts (“REIT Code”), the management company of a REIT bears the obligation to manage cash flows. Schedule 11 modifies the custody requirements – which require UT/RF RA 13 Depositaries to carry out cash reconciliation of CIS Property daily – to instead require REIT RA 13 Depositaries to ensure that the management company has put in place proper cash flow management policies and controls, and supervise the implementation of such policies and controls.

Custody and safekeeping of CIS Property

REIT RA 13 Depositaries should ensure that all REIT assets (including the title documents of REIT-owned real estate) are properly segregated and held for the benefit of the unitholders in accordance with the REIT Code and the constitutive document of the REIT.

Where the REIT RA 13 Depositary considers it in the interests of the REIT for certain assets of the REIT to be held by the management company on behalf of the REIT, the REIT RA 13 Depositary should make sure that the management company has established proper safeguards and controls to properly segregate REIT assets. Additionally, the REIT RA 13 Depositary must maintain on-going oversight and control over the relevant assets.

IV. What are the next steps?

The SFC has begun accepting licensing applications for RA 13 since July 27, 2023. Depositaries are reminded to submit RA 13 applications on or before November 30, 2023. The RA 13 regime will take effect on October 2, 2024.

_____________________________

[1] “Circular on Licensing and Registration of Depositaries of SFC-authorised Collective Investment Schemes and Related Transitional Arrangements” (July 27, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC32

[2] The final text of Schedule 11 can currently be found at Appendix C, “Consultation Conclusions on Proposed Amendments to Subsidiary Legislation and SFC Codes and Guidelines to Implement the Regulatory Regime for Depositaries of SFC-authorised Collective Investment Schemes” (March 24, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/api/consultation/conclusion?lang=EN&refNo=22CP1

[3] Namely, the Code on Unit Trusts and Mutual Funds, the Code on Open-Ended Fund Companies, the Code on Real Estate Investment Trusts, and the Code on Pooled Retirement Funds.

[4] “Consultation Paper on the Proposed Regulatory Regime for Depositaries of SFC-authorised Collective Investment Schemes” (September 27, 2019) (“2019 Consultation Paper”), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/api/consultation/openFile?lang=EN&refNo=19CP3

[5] Section 3, “Securities and Futures Ordinance (Amendment of Schedule 5) Notice 2023” (March 20, 2023), available at https://www.gld.gov.hk/egazette/pdf/20232712/es22023271262.pdf

[6] “Scheme document” refers to (i) the trust deed constituting or governing the relevant CIS if the CIS is constituted in the form of a trust, (ii) the documents governing the formation or constitution of the relevant CIS if the CIS is constituted in any other form other than a trust, or (iii) other documents setting out the requirements relating to (a) the custody and safekeeping of any CIS Property, or (b) the oversight of the operations of the relevant CIS.

[7] Amended Schedule 1 of the Securities and Futures (Financial Resources) Rules, set out under section 10 of the “Securities and Futures (Financial Resources) (Amendment) Rules 2023” (March 20, 2023), available at https://www.gld.gov.hk/egazette/pdf/20232712/es22023271256.pdf

[8] Amended rule 10B of the Securities and Futures (Client Money) Rules, set out under section 7 of the “Securities and Futures (Client Money) (Amendment) Rules 2023” (“CMR Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln055-e.pdf

[9] Amended rule 10C of the of the Securities and Futures (Client Money) Rules, set out under section 7 of the CMR Amendment Rules

[10] Amended rule 9B of the Securities and Futures (Client Securities) Rules, set out under section 6 of the “Securities and Futures (Client Securities) (Amendment) Rules 2023” (“CSR Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln054-e.pdf

[11] Amended rules 9C and 10A of the Securities and Futures (Client Securities) Rules, set out under sections 6 and 7 of the CSR Amendment Rules respectively

[12] Amended rule 3A of the Securities and Futures (Keeping of Records) Rules, set out under section 5 of the “Securities and Futures (Keeping of Records) (Amendment) Rules 2023” (“KKR Amendment Rules) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln057-e.pdf

[13] Amended rule 10 of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules, set out under section 4 of the “Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) (Amendment) Rules 2023” (“OTCD Amendment Rules”) (March 20, 2023), available at https://www.legco.gov.hk/yr2023/english/subleg/negative/2023ln061-e.pdf

[14] Amended rule 11 of the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules, set out under section 5 of the OTCD Amendment Rules

[15] Paragraph 26, 2019 Consultation Paper. The SFC’s MIC requirements are listed in the “Circular to Licensed Corporations Regarding Measures for Augmenting the Accountability of Senior Management” (December 16, 2016), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=16EC68, and the related Frequently Asked Questions published by the SFC (last updated on January 26, 2022), available at https://www.sfc.hk/en/faqs/intermediaries/licensing/Measures-for-augmenting-senior-management-accountability-in-licensed-corporations

[16] “Code on Unit Trusts and Mutual Funds” (January 1, 2019), published by the SFC, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/section-ii-code-on-unit-trusts-and-mutual-funds/section-ii-code-on-unit-trusts-and-mutual-funds.pdf

[17] “Code on Pooled Retirement Funds” (December 2021), published by the SFC, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-on-pooled-retirement-funds/code-on-pooled-retirement-funds.pdf?rev=9badf81950734ee08c799832be6ff92b

[18] Section 6, Schedule 11

[19] Section 8, Schedule 11

[20] Section 9, Schedule 11

[21] Section 11, Schedule 11

[22] See section 14, Schedule 11 for the full list of safeguards.

[23] “Code on Real Estate Investment Trusts” (August 2022), published by the SFC, available at https://www.sfc.hk/-/media/EN/files/COM/Reports-and-surveys/REIT-Code_Aug2022_en.pdf?rev=572cff969fc344fe8c375bcaab427f3b

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:

On August 8, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published its consultation conclusions on proposed amendments to enforcement-related provisions of the Securities and Futures Ordinance (“SFO”) (the “Consultation Conclusions”).[1] We previously covered the SFC’s consultation paper regarding the same (“Consultation Paper”) in a client alert.[2]

By way of refresher, the SFC had previously proposed in its Consultation Paper to make three key significant reforms to the SFO: (i) to amend the scope of section 213 to allow it to seek orders under this provision where the SFC has exercised its disciplinary powers under sections 194(1), 194(2), 196(1) or 196(2) against a regulated person, including an order that would allow the Court of First Instance (“CFI”) to restore parties to any transaction to the pre-transaction position; (ii) to amend section 103(3)(k) to focus on the point in time when the advertising materials are issued; and (iii) to extend the scope of the insider dealing provisions in Hong Kong to address insider dealing in Hong Kong with regard to overseas-listed securities or their derivatives, and to address conduct outside of Hong Kong in respect of Hong Kong listed securities or their derivatives.

In light of significant concerns raised by the industry, the SFC has eventually decided to only proceed at this stage with the amendments to the insider dealing provisions. However, the SFC has stressed that it remains committed to investor protection despite deciding not to proceed with the other amendments at this stage, as discussed further below. In this client alert, we provide some colour to the SFC’s responses and policy rationale under the Consultation Conclusions.

I. Expansion of section 213 of the SFO

The SFC had proposed to:

introduce an additional ground in section 213(1) which would allow the SFC to apply for orders under section 213 where it has exercised any of its powers under sections 194(1), 194(2), 196(1) or 196(2) of the SFO against a regulated person (i.e. wherever it finds that a regulated person has engaged in misconduct or is no longer fit and proper);
introduce an additional order in section 213(2) that would allow an order to be made by the CFI to restore the parties to any transaction to the position in which they were before the transaction was entered into, where the SFC has exercised any of its powers under sections 194 or 196 in respect of the regulated person; and
enable the CFI to make an order under section 213(8) against a regulated person to pay damages where the SFC has exercised any of its disciplinary powers against a regulated person (collectively, the “Section 213 Amendments”).

The concerns raised by respondents in relation to the Section 213 Amendments can be grouped into five key themes, as summarised below alongside the SFC’s responses to each of these concerns:

Concerns raised by respondents

The SFC’s responses

Legal and jurisprudence concerns

A number of respondents questioned whether it would be appropriate from a jurisprudential perspective to allow the SFC to seek court orders for a breach of codes and guidelines (e.g. the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”)) which do not themselves have the force of law and are not subject to the same scrutiny and oversight in their formulation. Respondents also considered this to be a concern given that the SFC’s codes and guidelines are broad and principles based and as such the Section 213 Amendments could create significant legal and regulatory uncertainty to intermediaries. Respondents also noted that the proposed amendments were likely contrary to section 399(6) of the SFO, which provides that any failure to comply with the provisions of codes and guidelines does not give rise to a right of action.

The SFC did not agree that allowing legal consequences to stem from a breach of the SFC’s codes and guidelines would fundamentally alter the status of these codes and guidelines. The SFC pointed out that the current law already allows the SFC to seek section 213 orders for breaches of licensing conditions, which also do not have the force of law.

The SFC further stated that the legislative intent of section 213 has always been “to allow the court to exercise its discretion and order relief as it considers necessary to protect investors adversely affected by others’ misconduct (in a general sense of the word), whether in the form of a breach of a statutory provision or a condition of a licence.”

Further, while reiterating that it did not consider these amendments would have changed the legal status of codes and guidelines, the SFC acknowledged that it would have needed to amend section 399(6) to align the two provisions if it had proceeded with these changes to section 213 in order to avoid inconsistencies.

Implementation difficulties

Some respondents pointed to a risk of parallel proceedings and conflicting outcomes, namely, where an appeal to disciplinary proceedings to the Securities and Futures Appeals Tribunal (“SFAT”) and the Court of Appeal could lead to a different outcome from the CFI’s decision in relation to section 213 proceedings.

The SFC acknowledged that the Section 213 Amendments would have created a new link between the disciplinary regime and section 213 where currently none exists. While noting that it was aware of the possibility of parallel proceedings prior to the release of the Consultation Paper, the SFC noted that this issue could be “administratively mitigated” by the SFC not commencing section 213 proceedings until the appeal process in relation to disciplinary proceedings had been exhausted.

Fairness and proportionality concerns

Some respondents raised concerns that the Section 213 Amendments would result in all forms of disciplinary action potentially triggering an action under section 213, including where the misconduct in question was minor. Other respondents noted that intermediaries could face both disciplinary sanctions and section 213 orders (including significant monetary penalties) stemming from the same misconduct, which they considered could lead to an unduly harsh burden on intermediaries.

Other respondents pointed out that the Section 213 Amendments could lead to a potential extension of the limitation period. At present, the statutory limitation period starts from the date of the loss or the date of the breach. Under the SFC’s proposal, the SFC’s power to apply for section 213 orders would be triggered after a disciplinary action is made. Effectively, this could mean that the statutory limitation period commences from the date of the disciplinary action as opposed to the date of the loss or breach. This extension could significantly increase the potential liability of intermediaries.

The SFC acknowledged the industry’s concerns regarding the impact of the Section 213 Amendments, and indicated that it would consider these concerns in further detail. In particular, the SFC noted that while it was not its intention to extend the statutory limitation period, that would have been the “natural result” of the proposed amendments in their initial form.

They noted that while the industry may perceive section 213 compensation orders as “punitive in nature” due to their size, the fundamental nature of these orders is to restore aggrieved investors to the position that would have been in had the intermediary’s misconduct not taken place. This is distinct from the purpose of regulatory fines which are to deter future non-compliance.

Concerns regarding Hong Kong’s competitiveness and status as an international financial centre

Many respondents raised concerns regarding the Section 213 Amendments’ impact on Hong Kong’s competitiveness and status as an international financial centre. In particular, respondents argued that the lack of predictability about the total financial impact of SFC enforcement actions, coupled with the combined financial burden of compensation orders under section 213 and disciplinary sanctions, could dissuade companies from participating in high risk regulated activities (e.g. sponsoring of IPOs), or even drive businesses away from Hong Kong.

The SFC strongly rejected these concerns. Instead, the SFC emphasised that:

it considered an effective regulatory regime should aim to strike a balance between “providing a proportionate degree of protection for investors and enabling the industry to conduct business in an environment which is not hampered by unnecessary regulatory barriers to innovation and competition”; and
higher regulatory standards and active enforcement of such standards would in fact strengthen investor confidence in the market, thereby making Hong Kong an attractive and competitive market for international investors.

Concerns regarding adequacy of current investor compensation regime

Several respondents stated that the current laws already provide adequate legal protection and safeguards for investors, and questioned whether there was a need for the Section 213 Amendments. These respondents pointed to existing frameworks under consumer protection laws, the option of civil litigation, the Financial Dispute Resolution Scheme, as well as intermediaries’ own complaint handling procedures.

The SFC strongly rejected these concerns, and expressly stated that it did not consider that the current regime ensured investors (especially retail investors) were appropriately compensated when they suffer loss as a result of intermediaries’ misconduct. The SFC noted that this was due to the limited resources often available to retail investors to pursue civil actions and the lack of a class action mechanism in Hong Kong. Given these factors, the SFC stated that it considered it to be appropriate for the SFC to obtain compensation on behalf of investors.

While ultimately stating that it would place the Section 213 Amendments “on hold” for the time being, the SFC was at pains to emphasise that it considers its inability to require intermediaries to compensate aggrieved clients or investors for losses as a result of breach of SFC codes or guidelines to be a “clear regulatory gap” which these amendments were intended to fix. However, the SFC has acknowledged that respondents raised a number of complex concerns which warrant further study, and noted that it may need to consider a broader range of options for remedying this gap, including strengthening the existing disciplinary regime.

Given this, we consider the key takeaway from the Consultation Conclusions in relation to the Section 213 Amendments to be that the SFC remains determined to protect investors by improving their ability to receive fair compensation in intermediary misconduct cases. As such, we expect to see future proposals from the SFC in this space in the short to medium term which will be intended to either overcome or avoid the concerns raised by the industry in relation to the Section 213 Amendments.

II. Amendments to exemptions in section 103 of the SFO

The second change proposed by the SFC was to amend section 103(3) of the SFO. Section 103(1) makes it a criminal offence to issue or be in possession for the purposes of issue of an advertisement, invitation or document which, to the person’s knowledge, contains an invitation to the public to enter into an agreement to deal in securities or any other structured products, to enter into regulated investment agreements, or to participate in a collective investment scheme, unless authorized by the SFC to do so. Section 103(3) further contains a list of exemptions to the marketing restrictions under section 103, including section 103(3)(k), which provides an exemption from the authorization requirement for advertisements of offers of investments that are disposed of, or intended to be disposed of, only to professional investors (the “PI Exemption”).

In the Consultation Paper, the SFC proposed the amendment of section 103(3)(k) (and consequential amendments to section 103(3)(j)) to focus on the point in time when the advertising materials are issued, by exempting from the authorisation requirement those advertisements which are issued only to PIs (the “Section 103 Amendments”).

The respondents’ comments centred on the necessity of the Section 103 Amendments and the operational difficulties and impact on business development and marketing processes. In light of the feedback received, the SFC has decided not to proceed with the Section 103 Amendments, as summarized below:

Concerns raised by respondents

The SFC’s responses

Necessity of the Section 103 Amendments

Many respondents questioned whether the amendments are necessary on the basis that they viewed there to be no material risk to retail investors from merely being exposed to unauthorised advertisements of investment products given that these investors are not allowed to invest in these products.

Respondents raising these concerns emphasised that the existing framework, current suitability requirements,[3] risk disclosures and know-your-client (“KYC”) procedures already provide sufficient safeguards to investors. As such, respondents argued that the SFC has not identified a specific harm posed to investors by general distribution of advertisements concerning investment products.

Operational difficulties and impact on business

Many respondents also argued that the Section 103 Amendments are detached from commercial realities, and would have unnecessarily disrupted common marketing activities. These respondents pointed out that PIs are usually reluctant to provide KYC information upfront at the preliminary marketing stage. By limiting marketing efforts to PIs who have already been identified through intermediaries’ KYC procedures, the Section 103 Amendments would significantly reduce intermediaries’ ability to market to prospective investors. Furthermore, the Section 103 Amendments would also disproportionately restrict online marketing efforts, which could jeopardise Hong Kong’s competitiveness and status. For example, many intermediaries currently make marketing materials freely available on their website to users, or allow only self-certification of PI status to access certain marketing materials. If the Section 103 Amendments were made, many forms of online marketing would likely be in contravention.

The SFC reasoned that the original legislative intent of section 103 of the SFO is to protect investors at the point when marketing materials are issued. The proposed amendments to section 103(3)(k) aim to reflect this original legislative intent.

The SFC noted that it was also motivated by multiple instances of intermediaries selling products intended for PI to retail investors (e.g. Chapter 37 bonds) in breach of suitability requirements.[4] That being said, it acknowledged that the upside of investor protection must be balanced against the practical impact any such amendments have on existing marketing processes. In particular, it acknowledged two practical difficulties (see table at left) highlighted by respondents in relation to i) PIs’ reluctance to provide detailed KYC information in the pre-marketing stage and ii) impact on online distribution of investment products.

The SFC’s decision not to pursue the Section 103 Amendments should not be seen as an abandonment of the issue, as the SFC emphasised that it would monitor the need for amendments in this area in the longer term and would consult again if necessary. However, it also noted that it would take a strong view against anyone misusing the PI Exemption to attempt to sell unsuitable products to retail investors. Instead, the SFC stated in the Consultation Conclusions that any person seeking to rely on section 103(3)(k) must be able to demonstrate a clear intention to dispose of investment products only to PIs, and that in order to do so, it should be “plainly apparent” from the face of the advertisement that the underlying investment product is intended only for disposal to professional investors.

Importantly, the SFC noted that it considers the “clear display of an appropriate message or warning on all advertising materials would go a long way” in helping an issuer in establishing this intention, and that intermediaries should consider how best to present this message or warning and put in place appropriate safeguards. Notably, it has indicated that it is considering providing further guidance to the market on this point.

III. Amendment to territorial scope of insider dealing provisions

The final change proposed by the SFC concerns the civil and criminal regimes under sections 270 and 291 of the SFO in respect of insider dealing. The SFC’s proposed amendments will extend the scope of the insider dealing provisions in Hong Kong to address insider dealing in Hong Kong with regard to overseas-listed securities or their derivatives, and to address conduct outside of Hong Kong in respect of Hong Kong listed securities or their derivatives (the “Insider Dealing Amendments”).

Most respondents supported the Insider Dealing Amendments on the basis that it would strengthen investor protection, protect the integrity and reputation of Hong Kong’s markets, and align the SFC’s insider dealing regime with other major common law jurisdictions. In light of this support, the SFC will proceed with the Insider Dealing Amendments.

During the consultation, several respondents requested clarifications on the scope and application of the Insider Dealing Amendments. These requests and the SFC’s corresponding responses are summarized as follows:

Clarifications requested by respondents	The SFC’s responses
Whether insider dealing would be determined by reference to Hong Kong or the laws of the overseas jurisdiction when assessing insider dealing of overseas-listed securities or their derivatives	The SFC stated that the amended insider dealing provisions will stipulate that the misconduct would also need to be unlawful in the relevant overseas jurisdiction. However, the SFC will not prescribe a list of selected overseas markets to which the amended insider dealing provisions will apply, as this would counterintuitively narrow the scope of enforcement against cross-border insider dealing.
Whether the Insider Dealing Amendments would apply to over-the-counter (“OTC”) transactions in overseas-listed securities	The SFC clarified that the Insider Dealing Amendments change the territorial scope, and not the applicability, of the insider dealing regime. This means that once the Insider Dealing Amendments are enacted, the insider dealing regime would apply to OTC transactions in overseas-listed securities, just as how existing insider dealing laws apply to OTC transactions in Hong Kong-listed debt securities.
Whether the SFC will provide a transition period to enable firms to update their internal compliance policies and manuals to reflect the Insider Dealing Amendments	The SFC will not be introducing any transitional period. From the SFC’s standpoint, firms will have sufficient time to update their internal procedures and manuals once the legislative amendments are published.
Whether a regulated person is required to report breaches with respect to overseas-listed securities and how such reports should be made, especially considering data transfer restrictions in different jurisdictions	The SFC clarified that reporting obligations set out under the Code of Conduct would apply to breaches of the Insider Dealing Amendments, once enacted.[5]

The SFC’s responses make clear that its intention is to expand its ability to take action in relation to cross-border insider dealing to better protect the reputation of Hong Kong’s markets. In explaining its decision to proceed with these amendments, the SFC noted that while it is open to it to deal with cross-border insider dealing by providing intelligence to securities regulators in other jurisdictions under existing cross-border regulatory cooperation arrangements, this is not always the most effective means to tackle cross-border insider dealing.

IV. Next steps

The SFC indicated that it will now proceed with introducing the Insider Dealing Amendments, although it has not specified a timeframe for introducing the draft text of the amendments to the Legislative Council. It has indicated that the industry will have the opportunity to review the draft text of these amendments in the course of the legislative process.

We recommend that intermediaries continue to monitor this issue to ensure that they update their internal policies and procedures in relation to insider dealing in a timely fashion once the timeline for the enactment of the Insider Dealing Amendments becomes clearer.

We suggest that intermediaries also review their use of disclaimers in advertisements reliant on the PI Exemption to ensure that they are in line with the SFC’s guidance in the Consultation Conclusions. We recommend intermediaries also continue to monitor for any further guidance from the SFC with respect to best practices when relying on the PI Exemption.

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[1] “Consultation Conclusions on Proposed Amendments to Enforcement-related Provisions of the Securities and Futures Ordinance” (August 8, 2023), published by the SFC, available at: https://apps.sfc.hk/edistributionWeb/api/consultation/conclusion?lang=EN&refNo=21CP3.

[2] “Hong Kong SFC Consults on Significant Reforms to the SFO Enforcement Provisions” (June 14, 2022), published by Gibson, Dunn & Crutcher, available at: https://www.gibsondunn.com/hong-kong-sfc-consults-on-significant-reforms-to-the-sfo-enforcement-provisions/.

[3] See “Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons” (last updated on December 23, 2020), published by the SFC, available at: https://www.sfc.hk/en/faqs/intermediaries/supervision/Compliance-with-Suitability-Obligations/Compliance-with-Suitability-Obligations#759450F3651D4BBF8AAA2F39C9F2BE88.

[4] The SFC has previously clarified that bonds offered for subscription and listed under Chapter 37 of the Main Board Listing Rules (“Chapter 37 Bonds”) are unsuitable for sale to retail investors, and warned intermediaries against this practice. See “Circular to Licensed Corporations distribution of bonds listed under Chapter 37 of the Main Board Listing Rules and local unlisted private placement bonds” (March 31, 2016), published by the SFC, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/suitability/doc?refNo=16EC18.

[5] Under the Code of Conduct, a licensed or registered person should report to the SFC immediately upon (among other things) “any material breach, infringement of or non-compliance with any law, rules, regulations, and codes administered or issued by the [SFC], the rules of any exchange or clearing house of which it is a member or participant, and the requirements of any regulatory authority which apply to the licensed or registered person”. See paragraph 12.5 of the “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” (“Code of Conduct”) (March 2023 edition), published by the SFC, available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Mar-2023_Eng.pdf?rev=7b4576843262491cb40638b09441d89b.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following in Hong Kong:

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. Please note, prior results do not guarantee a similar outcome.

On July 28, 2023, the Securities and Futures Commission (“SFC”) and the Hong Kong Monetary Authority issued a joint circular that sets out their expectations regarding allowing a proportionate and risk-based streamlined approach (the “Streamlined Approach”) for complying with the suitability obligations when dealing with sophisticated professional investors (“SPIs”) (the “Joint Circular”).[1] The Joint Circular included two Annexes, an explanatory document outlining the Streamlined Approach and an FAQ to facilitate intermediaries’ application of the Streamlined Approach.

As explained below, the Streamlined Approach, when applicable, simplifies the point-of-sale procedures in eligible investment transactions executed by SPIs who exhibit a higher level of sophistication and loss absorption ability. The Streamlined Approach should be beneficial for intermediaries accustomed to dealing with clients who are likely to qualify as SPIs, such as private banks and multi-family offices.

I. Who qualifies as a Sophisticated Professional Investor (SPI)?

An SPI is an individual professional investor[2] who satisfies all of the following requirements:

Financial situation: the SPI has (i) a portfolio of at least HK$40 million (or its foreign currency equivalent), or (ii) net assets, excluding primary residence, of at least HK$80 million (or its foreign currency equivalent);[3]

Knowledge or experience: the investor is sufficiently sophisticated such that he/she understands the risks of being treated as an SPI and the application of the Streamlined Approach. The requisite level of sophistication should be ascertained based on the client’s academic[4] or professional qualifications,[5] or work experience,[6] or accumulated trading experience in the relevant categories of investment products (by having executed at least five transactions within the past three years in the same category of investment products based on their terms, features, characteristics, nature, and risks).[7]

Investment objectives: the client is not a conservative client, i.e. the client’s investment objective is not capital preservation and/or seeking regular income.[8]

A corporation can also qualify as an SPI if its principal business is the holding of investments and it is wholly owned by one or more SPIs. This will be relevant to wholly owned investment holding company that are often set up by very high net worth investors.

Intermediaries can rely on information obtained during the onboarding or know-you-client reviews to determine whether an investor qualifies as an SPI.

II. What are Eligible Investment Transactions?

The Streamlined Approach allows for a simplified point-of-sales procedure only when executing investment transactions for an SPI within the Product Category and Streamlining Threshold specified by the SPI (the “Eligible Investment Transactions”):

Project Category: intermediaries are required to devise product categories to categorise investment products based on their terms and features, characteristics, nature, and risks (each a “Product Category”). The SPI specifies the Product Categories within which investment transactions can be executed under the Streamlined Approach. Intermediaries are required to document the SPI’s choices and provide the SPI with a Product Category Information Statement which explains the terms, features, characteristics, nature and risks of investment products within the Product Category. Intermediaries must ensure that an SPI possesses the requisite knowledge or experience criteria (please refer to Section I above) before applying the Streamlined Approach to investment transactions within a Product Category for the SPI.[9]

Streamlining Threshold: the SPI should specify a maximum threshold of investment, either being (i) an absolute amount, or (ii) a percentage of the SPI’s assets under management (“AUM”) with the intermediary, that can be executed under the Streamlined Approach (the “Streamlining Threshold”). The SPI should specify a Streamlining Threshold appropriate to his/her circumstances, and intermediaries are required to maintain records of the setting of such thresholds, including the SPI’s rationale for supporting the threshold set. For example, a higher amount may still be suitable if the AUM maintained with the intermediary represents an insignificant portion of the SPI’s portfolio and/or net assets. Intermediaries are required to establish and maintain effective systems and controls to ensure continuous compliance with the Streamlining Threshold (please refer to Section VI below).[10]

III. What steps need to be completed before applying the Streamlined Approach?

Before an intermediary applies the Streamlined Approach, it must have completed all of the following procedures:

The intermediary has assessed that the SPI satisfies all of the qualifying criteria with respect to its financial situation, knowledge or experience, and investment objectives (please refer to Section I above). This assessment must be in writing, and records of the assessment and all relevant information and documents obtained for the assessment must be kept by the intermediary.[11]
The SPI has specified the Product Categories and the Streamlining Threshold, and the intermediary has maintained records to support the choices made by the SPI.[12]
The intermediary is required to enter into a written agreement with the SPI, for the SPI to acknowledge and give consent to being treated as an SPI.[13] The intermediary is also required to (i) specify in writing the assessment criteria under which the client qualified as an SPI, and (ii) the Product Categories and the Streamlining Threshold under which Eligible Investment Transactions can be executed under the Streamlined Approach.[14]
The intermediary is required to fully explain to the SPI the consequences of being treated as an SPI, and the SPI’s right to withdraw from being treated as an SPI at any time. When explaining the consequences of being treated as an SPI, the intermediary shall at a minimum cover the points set out in paragraph 13.2 of Annex 1 of the Joint Circular.[15]

IV. How does the Streamlined Approach simplify the regulatory obligations when dealing with SPIs in Eligible Investment Transactions?

After an intermediary has completed the procedures referred to in Section III above, the intermediary can then apply the Streamlined Approach when dealing with the SPI in Eligible Investment Transactions. Under the Streamlined Approach, an SPI sets aside an amount (i.e. the Streamlining Threshold) to invest in a portfolio of investment products within the specified Product Categories. For these Eligible Investment Transactions, the intermediary is no longer required to match the SPI’s risk tolerance level, investment objectives and investment horizon, or to assess the SPI’s knowledge, experience and concentration risk. The explanation of product characteristics, nature and extent of risks can also be provided to the SPI upfront.

Therefore, when applicable, the Streamlined Approach simplifies the point-of-sale processes that are normally required when dealing with retail clients or individual professional investor clients.

The table below summarises the key differences between the normal, non-streamlined approach, and the Streamlined Approach when dealing with an SPI in Eligible Investment Transactions. Please be aware that the table below is not a summary of all the regulatory obligations applicable to intermediaries when executing transactions with clients, it is only intended to highlight the key differences under the Streamlined Approach.

Note that there are some differences in the application of the Streamlined Approach: (a) when executing transactions in an investment product with a recommendation or solicitation, and (b) when executing transactions in a complex product[16] without recommendation or solicitation. These differences are also shown in the table below.

Regulatory requirement	Normal approach	Streamlined Approach
Applicable to transactions both (a) in an investment product with a recommendation or solicitation, and (b) in a complex product without recommendation or solicitation
Suitability assessment	Intermediaries are required to assess that each recommended investment product is suitable for, and in the best interests of, the client, taking into account the client’s investment objectives, investment horizon, investment knowledge and experience, risk tolerance, and financial situation, etc. Intermediaries are also required to assess concentration risk when assessing the suitability of a recommended investment product for the client, taking into account the risk profile and nature of a product, the client’s risk tolerance level and financial situation, etc.[17]	Intermediaries are not required to match an SPI’s risk tolerance level, investment objectives and investment horizon with Eligible Investment Transactions.[18] Intermediaries are not required to assess an SPI’s knowledge and experience, and concentration risk in Eligible Investment Transactions.[19]
Product disclosure and product explanation	Intermediaries are required to provide each client with up-to-date prospectuses or offering circulars of the recommended investment products, and other up-to-date documents relevant to the investments. Intermediaries are also required to help each client make informed decisions by giving the client proper explanations of why recommended investment products are suitable for the client and the nature and extent of risks the investment products bear.[20]	Intermediaries are required to provide an SPI with up-to-date product offering documents for Eligible Investment Transactions, which could be done by sending a hyperlink to the offering documents or as attachments via electronic means (e.g., email). Intermediaries are not required to provide product explanation for Eligible Investment Transactions, except upon request and/or any material queries being raised by an SPI.[21]
Applicable to transactions in an investment product with a recommendation or solicitation
Record keeping	Intermediaries are required to maintain records documenting the rationale underlying investment recommendations made to the client and provide a copy of the rationale for the recommendations to the client upon his/her request.[22]	Intermediaries are not required to maintain records documenting the rationale underlying investment recommendations made to an SPI in Eligible Investment Transactions.[23]
Applicable to transactions in a complex product without recommendation or solicitation
Product due diligence on complex products[24]	Intermediaries are required to perform product due diligence on a complex product even where the sale of the complex product was without solicitation or recommendation (i.e. on an unsolicited basis).[25]	Subject to the provision of offering documents to the SPI, intermediaries are not required to perform product due diligence for investment products (that are complex products) which fall within the Product Categories specified by the SPI. For bonds (that are complex products), where offering documents are not provided to the SPI, intermediaries should prepare and provide their own summaries of the key terms and features of the investment product; or provide to the SPI sufficient information on the key terms and features of the investment product based on information available from reliable public domain or data providers.[26]
Warning statements for complex products	Intermediaries are required to provide the complex products warning statements on a transaction-by-transaction basis prior to and reasonably proximate to the point of sale.[27]	Intermediaries can provide warning statements in relation to the distribution of a complex product on an annual basis instead of a transaction-by-transaction basis.[28]

V. Is there an annual review requirement?

Intermediaries are required to carry out annual reviews to ensure that each SPI continues to satisfy the requirements to qualify as an SPI, and continues to agree for the intermediary to deal with the SPI in Eligible Investment Transactions under a Streamlined Approach. As part of the annual review, intermediaries are required to remind the client in writing of the following:

the consequences of being treated as an SPI;[29]
the Product Categories specified by the SPI, including information on the Product Categories as per the Product Category Information Statement;
the Streamlining Threshold specified by the SPI and an alert to the SPI where there was any incidents of breach; and
the client’s right to withdraw from being treated as an SPI, right to add or remove a Product Category, and/or right to revise the Streamlining Threshold at any time.[30]

VI. How to prepare for the implementation of the Streamlined Approach?

For intermediaries interested in applying the Streamlined Approach, they should consider taking the following steps:

Devise product categories	Intermediaries will need to devise Product Categories (see Section II above) to categorise their offered investment products based on their terms and features, characteristics, nature and risks. As a non-exhaustive example, the SFC notes that the following types of products should fall into separate Product Categories in order to differentiate them from other products with different characteristics, nature, risks and/or product-specific regulatory requirements:[31] accumulators and decumulators; collective investment schemes whose investment objective or principal investment strategy is investing in insurance-linked schemes; debt instruments with loss-absorption features and related products; and virtual assets and virtual asset-related products.[32]
Prepare the Product Category Information Statements	Intermediaries will need to prepare the Product Category Information Statements to provide to SPIs to explain the terms and features, characteristics, nature, and risks of investment products within each Product Category that the SPI may choose from (see Section II above). The Product Category Information Statements can be distributed in the form of an information booklet or hyperlinks.[33] Where the Product Category concerns complex products, intermediaries should also include the required warning statements for complex products in the Product Category Information Statement.[34]
Update existing client agreements and acknowledgments	Intermediaries will need to update its written agreements and client documents to specify the following: the SPI’s acknowledgment and consent to being treated as an SPI; the assessment criteria under which the client is assessed to qualify as an SPI; the SPI’s specified Product Categories and the Streamlining Threshold under which an Eligible Investment Transactions can be executed using the Streamlined Approach; an explanation of the consequences of being treated as an SPI;[35] and the SPI’s right to withdraw from being treated as an SPI at any time.[36]
Update internal policies and controls	Intermediaries are responsible for ensuring the proper application of the Streamlined Approach, including ensuring compliance with the regulatory requirements described above. In this regard, one of the requirements that intermediaries must comply with is to establish and maintain effective systems and controls to ensure continuous compliance with the Streamlining Threshold for each SPI. To achieve this, intermediaries can either: ensure the gross exposure arising from investment transactions executed under the Streamlined Approach remains at or below the Streamlining Threshold upon execution; or devise designated accounts (or sub-accounts) to consolidate Eligible Investment Transactions of the SPI executed under the Streamlined Approach, and ensure that the gross exposure arising from all positions maintained in the designated account remains at or below the Streamlining Threshold after receiving top-up or deposit of new funds into such designated account. The amount or percentage of the SPI’s AUM held with the intermediary to be allocated to the designated account should be discussed with the SPI at least annually, or whenever new funds are deposited into the designated account. Intermediaries are also required to implement measures to detect outsize or material transactions and issue warning statements to SPIs for these transactions. Intermediaries will need to review compliance with the Streamlining Threshold at least annually. If the gross exposure in the designated account exceeds the Streamlining Threshold, intermediaries are not expected to reduce/unwind the gross exposure to comply with the Streamlining Threshold. Rather, intermediaries may continue to operate and execute transactions in such designated account while restricting any top-up or deposit, or alternatively, intermediaries can execute investment transactions without applying the Streamlined Approach (e.g., outside of the designated account).[37] Intermediaries should update its internal policies, and systems and controls, to ensure ongoing compliance with the regulatory requirements when applying the Streamlined Approach, including keeping necessary records of all relevant information and documents from the application of the Streamlined Approach.

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[1] “Joint circular to intermediaries – Streamlined approach for compliance with suitability obligations when dealing with sophisticated professional investors” (July 28, 2023), published by the SFC, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/suitability/doc?refNo=23EC35

[2] An “individual professional investor” is an individual having a portfolio of not less than HK$8 million as ascertained according to the Securities and Futures (Professional Investor) Rules (Cap. 571D).

[3] Paragraph 3.1, Annex 1 of the Joint Circular

[4] By holding a degree or post-graduate diploma in accounting, economics or finance, or a related discipline.

[5] By having attained a professional qualification in finance (such as Chartered Financial Analyst (CFA), Certified International Investment Analyst (CIIA), Certified Private Wealth Professional (CPWP), Chartered Financial Planner (CFP) or other comparable qualifications).

[6] By having at least one-year relevant work experience in a professional position in the financial sector in Hong Kong or elsewhere (e.g., licensed for conducting relevant regulated activities).

[7] Paragraph 4.1, Annex 1 of the Joint Circular.

[8] Paragraph 5.1, Annex 1 of the Joint Circular.

[9] Paragraphs 7.1 to 7.3, Annex 1 of the Joint Circular.

[10] Paragraphs 8.1 and 8.2, Annex 1 of the Joint Circular.

[11] Paragraphs 12.1 and 12.2, Annex 1 of the Joint Circular.

[12] Paragraph 12.3, Annex 1 of the Joint Circular.

[13] Paragraph 13.1(a), Annex 1 of the Joint Circular.

[14] Paragraph 13.1(b) and (c), Annex 1 of the Joint Circular.

[15] See paragraphs 13.1(d) and 13.2, Annex 1 of the Joint Circular.

[16] “Complex product” refers to an investment product whose, terms, features and risks are not reasonably likely to be understood by a retail investor because of its complex structure. See the definition of a “complex product” in the “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” (the “Code of Conduct”). See also the non-exhaustive list of examples of non-complex and complex products, published by the Securities and Futures Commission, available at https://www.sfc.hk/en/Rules-and-standards/Suitability-requirement/Non-complex-and-complex-products.

[17] Questions 5A and 5B of the “Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons” (the “Suitability FAQ”), last updated by the SFC on December 23, 2020 and available at: https://www.sfc.hk/en/faqs/intermediaries/supervision/Compliance-with-Suitability-Obligations/Compliance-with-Suitability-Obligations#759450F3651D4BBF8AAA2F39C9F2BE88.

[18] Paragraphs 10.1 and 11.2, Annex 1 of the Joint Circular.

[19] Paragraphs 10.2 and 11.3, Annex 1 of the Joint Circular.

[20] Questions 6A and 6B, the Suitability FAQ.

[21] Paragraphs 10.3 and 11.4, Annex 1 of the Joint Circular.

[22] Question 7, the Suitability FAQ.

[23] Paragraph 10.4, Annex 1 of the Joint Circular.

[24] For the avoidance of doubt, product due diligence is required when an intermediary recommends an investment product, irrespective of whether the investment product is a complex product or not, see Question 4, Suitability FAQ. This row in the table concerns transactions in complex products where there is no recommendation or solicitation.

[25] Paragraph 5.5(a) of the Code of Conduct, which provides that the suitability requirements (including product due diligence), applies to the sale of complex products without a solicitation or recommendation.

[26] Paragraph 11.1, Annex 1 of the Joint Circular.

[27] Paragraph 5.5(a)(iii) of the Code of Conduct. See also the “Minimum information to be provided and warning statements” (June 12, 2019), published by the SFC, available at: https://www.sfc.hk/en/Rules-and-standards/Suitability-requirement/Non-complex-and-complex-products/Minimum-information-to-be-provided-and-warning-statements.

[28] Paragraph 11.5, Annex 1 of the Joint Circular.

[29] The consequences of being treated as an SPI are listed under paragraph 13.2, Annex 1 of the Joint Circular.

[30] Paragraph 14, Annex 1 of the Joint Circular.

[31] Question 3, Annex 2 of the Joint Circular.

[32] “virtual asset-related products” are investment products which: (a) have a principal investment objective or strategy to invest in virtual assets; (b) derive their value principally from the value and characteristics of virtual assets; or (c) track or replicate the investment results or returns which closely match or correspond to virtual assets.

[33] Paragraph 7.2, Annex 1 of the Joint Circular.

[34] Question 4, Annex 2 of the Joint Circular.

[35] The consequences of being treated as an SPI are listed under paragraph 13.2, Annex 1 of the Joint Circular.

[36] Paragraph 13.1, Annex 1 of the Joint Circular.

[37] Question 6, Annex 2 of the Joint Circular.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Arnold Pun, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:

On June 1, 2023, Hong Kong’s long-awaited licensing regime for virtual asset trading platforms (“VATPs”) went live, with the Hong Kong Securities and Futures Commission (“SFC”) marking the occasion by issuing a flurry of regulatory guidance for operators of VATPs (“Platform Operators”) in the form of guidelines, FAQs and handbooks.

This client alert discusses that regulatory guidance, with a particular focus on the key practical takeaways for prospective VATP licence applicants set out in the SFC’s Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission (the “Consultation Conclusions”). However, the guidance issued by the SFC spans a wide range of topics, including transitional arrangements, senior management accountability, onboarding of clients and cybersecurity. Prospective VATP licence applicants should ensure that they familiarise themselves with the SFC’s guidance and expectations for Platform Operators.

Consultation Conclusions Published on May 23, 2023

In February 2023, the SFC issued a highly-anticipated consultation paper inviting public comments on the proposed regulatory requirements applicable to Platform Operators.[1] We previously published a client alert on this topic.[2] Following a feedback period that concluded on March 31, 2023, the SFC published its Consultation Conclusions on May 23, 2023, which considered 152 submissions received by the SFC from industry associations, professional and consultancy firms, market participants, licensed corporations, individuals and other stakeholders.[3]

While the SFC found respondents generally supportive of the proposed regulatory requirements for Platform Operators in Hong Kong, a number of comments noted that the technical and implementation details may have been insufficiently clear. In response, the SFC has modified or clarified some of the regulatory requirements as set out in the Guidelines for Virtual Asset Trading Platform Operators (the “VATP Guidelines”), and also published additional circulars, FAQs and guidelines on May 31, 2023 and June 1, 2023.

The SFC maintains that providing clear regulatory expectations will be critical to fostering responsible development, especially within Hong Kong’s virtual assets (“VA”) landscape. Adopting the principle of ‘same business, same risks, same rules’, the SFC aims to support and develop the VA industry by ensuring robust investor protection and critical risk management.

Circular on Transitional Arrangements

On May 31, 2023, the SFC issued the Circular on Transitional Arrangements of the New Licensing Regime for Virtual Asset Trading Platforms (the “Transitional Arrangements Circular”) to provide additional guidance on the transitional arrangements for VATPs under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) licensing regime (the “AMLO VASP Regime”).[4] The guidance in this Circular is consistent with the transitional arrangements explained in the SFC’s consultation paper published in February 2023 but provides further detail that will be relevant to VATPs preparing to apply for a licence by no later than February 29, 2024.

An important point to note is that, upon reviewing a licence application, if the SFC considers that the VATP licence applicant does not meet any of the deeming conditions (which includes proving to the SFC’s satisfaction that the VATP is capable of complying with the regulatory requirements applicable to VATPs), then the SFC may issue a notice to the VATP (the “no-deeming notice”) to inform the VATP that the deeming arrangement will not apply to it. A VATP that receives a no-deeming notice will be subject to a deemed withdrawal procedure and must proceed to close down its business by May 31, 2024 or by the expiry of three months beginning on the day of the issuance of the no-deeming notice (whichever is the later), irrespective of whether it has objected to the deemed withdrawal of its licence application. It will therefore be crucial for a VATP licence applicant to submit a robust licence application that proves that it can meet all of the deeming conditions, or else it risks being ineligible for the deeming arrangement.

Other regulatory guidance applicable to VATPs

In addition to the recently published Consultation Conclusions, the VATP Guidelines, and the Transitional Arrangements Circular, operators of VATPs should also be aware of additional regulatory guidance contained in the following documents published between May 31 and June 1, 2023:

Licensing Handbook for Virtual Asset Trading Platform Operators;[5]
Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers);[6]
Prevention of Money Laundering and Terrorist Financing Guideline issued by the Securities and Futures Commission for Associated Entities of Licensed Corporations and SFC-licensed Virtual Asset Service Providers;[7]
Disciplinary Fining Guidelines;[8]
Scope of External Assessment Reports;[9]
Circular on implementation of new licensing regime for virtual asset trading platforms;[10]
Eight (8) FAQs on VATP licensing-related matters;[11] and
Nine (9) FAQs on VATP conduct-related matters.[12]

The regulatory guidance set out in the documents above, in addition to the VATP Guidelines, will be essential to VATP licence applicants, as applicants will need to ensure that its licence application provides to the SFC that it is capable to comply with these regulatory requirements – or else the applicant may be issued a non-deeming notice (as explained above).

VATP licence application forms

The licensing forms for the new AMLO VASP licensing regime (which includes making a simultaneous licence application under the Securities and Futures Ordinance (Cap. 571) (“SFO”) for Type 1 and Type 7 regulated activities) are also now available on the SFC’s licensing forms website.[13] Licensing forms will need to be submitted to the SFC electronically through the WINGS platform.

Some of the key aspects of the regulatory requirements highlighted in the Consultation Conclusions

Licensing requirement	The SFC has reiterated that Platform Operators should, as a matter of prudence, apply for approvals under both the existing SFC licensing regime and the AMLO licensing regime[14] to ensure business continuity, given that a VA’s classification may change from security to non-security, or vice versa. The SFC rejected the propositions that Platform Operators under the AMLO regime can withdraw a particular token which evolves into a security token and simply allow the client to sell down the token, as this will not be in the client’s best interests. This stance suggests that applicants seeking an AMLO only licence should expect to face tough questions from the SFC as to their rationale for not also seeking a licence under the SFC’s existing licence regime. The SFC has also stated that the AMLO regime will cover VA trading platforms which are centralised and function in a manner similar to the types of automated trading venues licensed under the SFO – i.e., they use automated trading engines which match client orders and provide custody services as an ancillary service to their trading services. Given this, the SFC has also clarified that the scope of the AMLO regime does not include over-the-counter VA trading activities and VA brokerage activities, as these do not involve providing VA services with an automated trading engine and ancillary custody services.
Retail access and onboarding requirements	Platform Operators will be allowed to provide their services to retail investors provided that they comply with a range of robust investor protection measures covering onboarding, governance, disclosure and token diligence and admission, before providing services to retail investors. The SFC notes that it is crucial for retail investors to understand the features and risks of investing in VAs, as well as the potential losses. As such, the SFC will require Platform Operators to conduct the full scope of the onboarding requirements, including assessing the investor’s risk tolerance, conducting an holistic assessment of the investor’s understanding of the nature and risks of VAs, etc. The assessment made during the onboarding process will also be relevant in order to comply with the suitability requirements. It is relevant to note that Platform Operators will be required to comply with the full scope of the onboarding requirements, even if the retail client is knowledgeable about VAs (e.g. as a result of trading VAs for a number of years) or the client is an individual professional investor. These requirements are broadly consistent with the regulatory requirements applied to traditional licensed corporations more generally. The SFC has also now issued FAQs providing further guidance on onboarding requirements, including matters such as how to assess an investor’s knowledge of VAs and risk tolerance levels.[15]
Governance	A Platform Operator will be required to set up a token admission and review committee that consists of senior management who are principally responsible for managing the Platform Operator’s key business line, compliance, risk management, and information technology functions (i.e., at a minimum the Manager in Charge (MICs) for these functions). The SFC has also now issued FAQs to augment the accountability of the senior management of Platform Operators through the imposition of a Manager in Charge regime for Platform Operators, which the SFC acknowledges is ‘substantially the same’ as that applicable to licensed corporations.[16]
Disclosure	The SFC notes that, although it understands the potential challenges of obtaining and verifying information provided by the issuer of a VA, it will still expect a Platform Operator to conduct due diligence on each virtual asset prior to admission for trading. As such, the Platform Operator is expected to obtain information for each VA which it can be reasonably satisfied is reliable and sufficient to base its token admission decision on. Accordingly, the SFC will require Platform Operators to take all reasonable steps to ensure that product specific information that they disclose is not false, biased, misleading or deceptive. The SFC has set out in the VATP Guidelines the minimum information that Platform Operators are required to disclose with regards to the risk disclosure statements, disclosures regarding the platform’s operations, and VA-specific disclosures.
Token admission	Similar to the SFC’s product due diligence requirements applicable to licensed corporations in respect of traditional financial products, the SFC will require a Platform Operator to conduct due diligence on each VA it plans to admit for trading on its platform to ensure that the VA complies with the admission criteria established by the token admission and review committee. These due diligence requirements apply even if the VAs are not intended to be made available to retail investors, although there will likely be material differences in the admission criteria applicable to VAs that are or are not available for trading by retail investors. Furthermore, there is no exemption from conducting due diligence even if the VA in question has already been admitted for trading on another licensed VATP. Relevantly, the SFC has decided that it will not relax the requirement for a non-security token to have at least a 12-month track record (as it is one of the factors which the token admission and review committee must consider). The result is that a newly or recently launched VA with less than a 12-month track record cannot be admitted for trading by a Platform Operator, even if it is not available for trading by retail investors. However, the SFC has relaxed one aspect of its token admission requirements, with Platform Operators no longer being required to submit to the SFC written legal advice confirming that each token made available for trading by retail clients would not amount to a security token. Nevertheless, Platform Operators will still need to take reasonable steps to ensure that security tokens are not made available for trading by retail clients, as this could be a breach of the prospectus regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32). The SFC has emphasised in the Consultation Conclusions the importance of having additional minimum criteria that need to be satisfied before a non-security token can be made available for trading by retail users. In this respect, the SFC has further tightened the eligible large-cap VA requirements to stipulate that at least one of the two acceptable indices must be issued by an independent index provider (that has experience publishing indices for conventional securities markets, and that is also compliant with the IOSCO Principles for Financial Benchmarks). Furthermore, in addition to being independent of the Platform Operator, the two index providers will also need to be independent of the issuer of the VA. Additionally, the SFC emphasised in the Consultation Conclusions that being included in two acceptable indices is merely the minimum criterion for admitting a VA for retail trading, and that Platform Operators will also need to ensure that tokens admitted satisfy the Platform Operator’s token admission criteria (and also ensure that such tokens have high liquidity for tokens available for retail trading).
Stablecoins	The SFC has also clarified in the Consultation Conclusions that, prior to stablecoins being subject to regulation by the Hong Kong Monetary Authority (“HKMA”), Platform Operators should not admit stablecoins for retail trading. The HKMA published the conclusions on its discussion paper on crypto-assets and stablecoins in January 2023, and the regulatory arrangements for stablecoins are expected to be implemented in 2023/24. We previously published a client alert on this consultation.[17]
Insurance and compensation arrangements	The SFC will now require Platform Operators to have in place a compensation arrangement approved by the SFC to cover potential loss of 50% of client VAs in cold storage and 100% of client VAs in hot or other storage held by its custodian (see below for further discussion on custody arrangements). The SFC has also noted that the arrangement should be made up of the following: Third-party insurance; Funds (held in a demand deposit or time deposit with less than 6 months maturity) or VAs of the Platform Operator or any corporation within the same group as the Platform Operator which are set aside on trust and designated for such a purpose; and/or A bank guarantee from an authorised financial institution in Hong Kong.
Custody and security requirements	In this aspect of the Consultation, the SFC had sought industry suggestions in relation to technical solutions that could mitigate risks associated with custody of client assets, particularly in hot storage. However, the SFC’s response in the Consultation Conclusions focused on reiterating the SFC’s view that, given the importance of safe custody of VAs, the SFC will require what it terms a ‘direct regulatory handle’ over a firm exercising control of client VAs, and as such will require custody to be undertaken by a wholly-owned subsidiary of a Platform Operator. For the same reason, the SFC will require all seeds and private keys holding customer VAs to be securely stored in Hong Kong, noting that if they were stored overseas, this would substantially hinder the SFC’s supervision and enforcement efforts. As a result, the SFC has reiterated in the Consultation Conclusions that the use of third-party custodians will not be allowed. The SFC also noted that it had received ‘many’ comments requesting that the SFC amend the requirement that 98% of client VAs must be stored in cold storage and only 2% could be stored in hot or other storage so to permit a lower cold to hot storage ratio to be adopted. However, the SFC has reiterated that it believes that this ratio should not be lowered and that the ‘bulk’ of client VAs should be held in cold storage given that it is generally free of hacking / other cybersecurity risks. Further, while many respondents had indicated that they believed that a lower cold to hot storage ratio was required in order to ensure more expedient asset withdrawals, the SFC appears to have had little sympathy for this position. Instead, the SFC has reminded Platform Operators of the requirement under the Guidelines for Platform Operators’ comprehensive trading and operational rules to cover withdrawal procedures, including the time required to transfer VAs to a client’s private wallet after receiving a withdrawal request on its website.
Virtual asset derivatives	This aspect of the Consultation had sought input in relation to business models that would be adopted by Platform Operators if allowed to provide trading services in VA derivatives and the types of investors that would be targeted. The SFC noted in the Consultation Conclusions that respondents expressed general support for allowing Platform Operators to provide trading services in VA derivatives, and that the SFC understood the importance of VA derivatives to institutional investors. However, the revised Guidelines maintain the prohibition on Platform Operators offering trading or dealing in VA derivatives, with the SFC instead indicating in the Consultation Conclusions that it will conduct a separate review of this issue ‘in due course’.
Proprietary trading and other services	The SFC has noted that it received submissions suggesting that proprietary trading, including proprietary market making by a Platform Operator’s affiliates, should be allowed in order to enhance liquidity. While maintaining the prohibition on proprietary trading, the SFC has amended the requirements in the Guidelines to allow trading by affiliates of a Platform Operator other than trading through the Platform Operator (regardless of whether such trading is on-platform or is off-platform). The SFC noted that this amendment has been made on the basis that the previous iteration of the draft Guidelines effectively prohibited group companies of a Platform Operator from having any positions in VAs. The SFC also noted that it received a number of responses in relation to whether Platform Operators could provide other VA services such as earning, deposit-taking, lending or borrowing. The SFC’s position, however, is that allowing such services could create potential conflicts of interest for Platform Operators (and would require additional safeguards) and as such Platform Operators will not be permitted to conduct these activities ‘at this stage’. The SFC has also clarified in the Consultation Conclusions that while Platform Operators are prohibited from providing algorithmic trading services to their clients, the platform’s clients can use their own algorithmic trading systems when trading on a licensed platform.
Disciplinary Fining Guidelines	The SFC has clarified that all Platform Operators will be subject to the same fining criteria[18] regardless of the regime under which the Platform Operator is licensed. In rejecting a submission proposing that fines should be determined with reference to the total annual turnover of the Platform Operator, the SFC has stated that it will continue to determine quantum based on the legislative requirement in the AMLO that a fine should not exceed the higher of HK$10 million or three times the profit gained or loss avoided. However, the SFC has also noted that it will closely monitor the implementation of the Fining Guidelines, and determine whether legislative change may be required. In response to a comment, the SFC specifically noted that the fact that a particular type of conduct is widespread in unregulated entities would not be considered a mitigating factor for any misconduct by licensed Platform Operators. In the context of submissions requesting greater clarity on factors relevant to the SFC’s decision to take enforcement action against Platform Operators and/or individuals, the SFC has stated that it will take a holistic approach to disciplinary action in order to ensure that all culpable parties are held accountable for their conduct. In this vein, the SFC has noted in the Consultation Conclusions that the VATP Guidelines already provide that senior management of a Platform Operator bear the primary responsibility for ensuring compliance with the rules and guidelines applicable to Platform Operators. Further, as noted above, the SFC has also issued an FAQ on the augmentation of the accountability of senior management for Platform Operators, which extends the SFC’s Manager in Charge regime to Platform Operators.[19]

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[1] “Consultation Paper on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission”, published by the SFC (February 20, 2023), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/consultation/doc?refNo=23CP1.

[2] “Hong Kong SFC Consults On Licensing Regime For Virtual Asset Trading Platform Operators”, published by Gibson, Dunn & Crutcher (March 2, 2023), available at https://www.gibsondunn.com/hong-kong-sfc-consults-on-licensing-regime-for-virtual-asset-trading-platform-operators/.

[3] “Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission”, published by the SFC (May 23, 2023), available at https://apps.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=23CP1.

[4] “Circular on transitional arrangements of the new licensing regime for virtual asset trading platforms” published by the SFC (May 31, 2023), available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC27.

[5] Published by the SFC on June 1, 2023, and available at: https://www.sfc.hk/-/media/EN/assets/components/Guidelines/File-current/Licensing-Handbook-for-VATPs-31-05-2023.pdf?rev=a94fa7324a964e328dd2415815611d76.

[6] Published by the SFC on June 1, 2023, and available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/guideline-on-anti-money-laundering-and-counter-financing-of-terrorism-for-licensed-corporations/AML-Guideline-for-LCs-and-SFC-licensed-VASPs_Eng_1-Jun-2023.pdf?rev=d250206851484229ab949a4698761cb7.

[7] Published by the SFC on June 1, 2023, and available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/prevention-of-money-laundering-and-terrorist-fi/AML-Guideline-for-AEs_Eng_1-Jun-2023.pdf?rev=243299fe5b11413495afee886891aa05.

[8] Published by the SFC on June 1, 2023, and available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/SFC-Disciplinary-Fining-Guidelines_Part-5B/230524–SFC-Disciplinary-Fining-Guidelines-Eng.pdf?rev=9a355f946ff74c7892a921ab73461314&hash=0A14F0BC24C3854FB909953BEA90FC2A.

[9] Published by the SFC on June 1, 2023, and available at: https://www.sfc.hk/-/media/EN/files/LIC/Fintech/Scope-of-External-Assessment-ReportsJune-2023-EN.pdf?rev=7faaba6cd7f84f96806588b03dc86cad&hash=C7C407B725E545E7637F80BD4B5BE4F1.

[10] Published by the SFC on May 31, 2023, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=23EC28.

[11] Published by the SFC on May 31, 2023, and available at: https://www.sfc.hk/en/Welcome-to-the-Fintech-Contact-Point/Virtual-assets/Virtual-asset-trading-platforms-operators/Regulatory-requirements/FAQs-on-licensing-related-matters.

[12] Published by the SFC on May 31, 2023, and available at: https://www.sfc.hk/en/Welcome-to-the-Fintech-Contact-Point/Virtual-assets/Virtual-asset-trading-platforms-operators/Regulatory-requirements/FAQs-on-conduct-related-matters.

[13] Available at: https://www.sfc.hk/en/Forms/Intermediaries/Licensing-forms.

[14] Licensing regime for Platform Operators under the Anti-Money Laundering Ordinance and Counter-Terrorist Financing Ordinance (Cap. 615).

[15] Published by the SFC on May 31, 2023 and available at: https://www.sfc.hk/en/Welcome-to-the-Fintech-Contact-Point/Virtual-assets/Virtual-asset-trading-platforms-operators/Regulatory-requirements/FAQs-on-conduct-related-matters/Dealing-with-clients/31-May-2023-Dealing-with-clients#F9658969756741BF96ED6ED786E29D98.

[16] Published by the SFC on May 31, 2023, and available at: https://www.sfc.hk/en/Welcome-to-the-Fintech-Contact-Point/Virtual-assets/Virtual-asset-trading-platforms-operators/Regulatory-requirements/FAQs-on-licensing-related-matters/Measures-for-augmenting-senior-management-accountability-in-Platform-Operators/Measures-for-augmenting-senior-management-accountability-in-Platform-Operators.

[17] “Hong Kong Monetary Authority Introduces Plans To Regulate Stablecoins” published on February 7, 2023, and available at: https://www.gibsondunn.com/hong-kong-monetary-authority-introduces-plans-to-regulate-stablecoins/.

[18] Published by the SFC on June 1, 2023, and available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/SFC-Disciplinary-Fining-Guidelines_Part-5B/230524–SFC-Disciplinary-Fining-Guidelines-Eng.pdf?rev=9a355f946ff74c7892a921ab73461314&hash=0A14F0BC24C3854FB909953BEA90FC2A.

[19] Published by the SFC on May 31, 2023, and available at: https://www.sfc.hk/en/Welcome-to-the-Fintech-Contact-Point/Virtual-assets/Virtual-asset-trading-platforms-operators/Regulatory-requirements/FAQs-on-licensing-related-matters/Measures-for-augmenting-senior-management-accountability-in-Platform-Operators/Measures-for-augmenting-senior-management-accountability-in-Platform-Operators.

The following Gibson Dunn lawyers prepared this client alert: Will Hallatt, Emily Rumble, Arnold Pun, Becky Chung, and Qingxiang Toh.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Digital Asset Taskforce or the Global Financial Regulatory team, including the following authors in Hong Kong and Singapore:

On 4 May 2023, the Hong Kong Court of Final Appeal (the “CFA”) handed down its judgment in Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2023] HKCFA 9[1], putting an end to the age-old debate on the effect of an exclusive jurisdiction clause (“EJC”) in the insolvency context.

The CFA upheld the Court of Appeal’s (the “CA”) decision (by majority) to dismiss the bankruptcy petition. The CFA endorsed the approach that in an ordinary case where the underlying dispute of the petition debt was subject to an EJC, the court should dismiss the petition unless there are strong reasons for the court to decide otherwise.

1. Background

The dispute concerned a loan advanced by Tor Asia Credit Master Fund LP (the “Petitioner”), pursuant to a Credit and Guaranty Agreement (the “Agreement”), to a company (the “Borrower”) controlled by Mr. Guy Kwok-Hung Lam (the “Debtor”), whereby the Debtor agreed to provide a guarantee, as primary obligor, to pay in full of all amounts due and owed without any demand or notice. The Agreement contained an EJC in favour of the New York courts in relation to “all proceedings arising out of or in relation to” the Agreement.

The Agreement was subsequently amended and the maturity of the loan was extended. Notwithstanding that, the Borrower was still unable to make repayment. The Petitioner then presented a bankruptcy petition in Hong Kong against the Debtor. The Debtor resisted the petition and argued that there was no event of default and that, pursuant to the EJC, the Petitioner was required to bring proceedings in the New York courts first to establish the Debtor’s liability.

The Court of First Instance (the “CFI”) granted the bankruptcy order, on the basis that the Debtor was unable to demonstrate a bona fide dispute on substantial grounds in relation to the petition debt[2]. The CA allowed the Debtor’s appeal and dismissed the bankruptcy petition[3]. The CA held that if the dispute concerning the underlying debt fell within the scope of an EJC, the bankruptcy petition should not be allowed to proceed without strong reasons.

The Petitioner appealed to the CFA on the proper approach that Hong Kong courts should adopt in a bankruptcy petition where the dispute concerning a debt is subject to an EJC.

2. The CFA’s decision

The CFA unanimously dismissed the appeal and affirmed the decision of the CA.

(i) Jurisdiction and powers of the CFI

The Petitioner contended that parties could not contract out of the insolvency legislation and in these proceedings different considerations were to be taken into account from those involving the upholding of EJCs in private actions. It was argued that to give presumptive weight to EJCs was to erode and undermine the domestic insolvency regime.

Whilst the CFA confirmed that the CFI’s jurisdiction in a bankruptcy matter was conferred by the Bankruptcy Ordinance (Cap. 6), and was not amenable to exclusion by contract, i.e. the parties’ agreement not to invoke the jurisdiction of the CFI had no effect on its jurisdiction, it held that the parties’ agreement to refer their disputes to a foreign court informed the CFI’s discretion as to whether to exercise its jurisdiction.

The CFA observed that the CFI might exercise its discretion to decline jurisdiction in certain classes of cases, such as where the issue of forum non conveniens was raised or where the dispute in a particular action was covered by an arbitration agreement or an EJC.

(ii) The discretion to decline jurisdiction in bankruptcy

Having found that the CFI had the power to decide whether to exercise its jurisdiction, the CFA further held that the determination of whether the debt was bona fide disputed on substantial grounds was a threshold question which might or might not be engaged when the court decided whether to exercise its bankruptcy jurisdiction.

The CFA noted that in the event that the parties had agreed to have all their disputes under an agreement giving rise to the debt determined exclusively in another forum, the CFI had total discretion to choose not to exercise its bankruptcy jurisdiction and refrain from determining such threshold question.

The CFA considered that it was at this stage that the public policy interest in holding parties to their agreements was engaged. Should the CFI proceed with the petition and make a ruling on the threshold question, it assumed jurisdiction to decide a question which the parties had otherwise agreed would be determined in another forum.

The CFA was of the view that parties’ agreement for certain disputes to be resolved in another forum would be highly relevant as to whether the CFI should exercise its bankruptcy jurisdiction at all. In the event that the underlying debt was subject to an EJC, unless the Petitioner could show that there were strong reasons, such as the risk of the debtor’s insolvency impacting third parties, the debtor’s reliance on a frivolous defence, or an occurrence of an abuse of process, the Court should normally dismiss the petition.

3. Comment

This decision crystalises the court’s position on the effect of an EJC in the context of bankruptcy and winding up proceedings. Absent strong reasons, the Hong Kong court will not proceed with the petition before the adjudication of the petition debt by the agreed forum. It also underscores the importance attached by the courts to party autonomy.

The case also serves as an important reminder to parties when entering into agreements with EJCs, they should be aware that such clauses will have significant impact on any insolvency proceedings to be commenced in Hong Kong and they may be required to first have the dispute over the underlying debt adjudicated in the agreed forum before commencing insolvency proceedings in Hong Kong.

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[1] https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=152321&currpage=T

[2] https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=137308

[3] https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=146843

In January 2022, the Hong Kong Monetary Authority (“HKMA”) issued a discussion paper inviting feedback on the regulatory approach towards crypto-assets and stablecoins (“Discussion Paper”).[1] We previously published an alert on this topic.[2] Following a feedback period that ended on 31 March 2022, on 31 January 2023, the HKMA issued its ‘Conclusions of the Discussion Paper on Crypto-assets and Stablecoins’ (“Consultation Conclusions”), which proposes the introduction of a stablecoin licensing regime.[3]

Recent events in the crypto market have highlighted the vulnerabilities of the crypto ecosystem, in particular, failures concerning the governance, stabilisation mechanisms, and transparency of crypto service providers. As a response to such failings, the HKMA’s proposals mirror international efforts to regulate stablecoin-related activities; for example, in October 2022, the Monetary Authority of Singapore proposed measures to regulate the issuance of stablecoins.[4]

Under the HKMA’s proposed licensing plans, the HKMA will give priority to regulating stablecoins that purport to reference one or more fiat currencies, irrespective of the intended use or underlying stabilisation mechanism of that stablecoin (“In-Scope Stablecoins”). This means that, in theory, stablecoins that reference fiat currencies through algorithms or arbitrage mechanisms fall under the scope of the HKMA’s proposals. However, for reasons explained in Section I below, such stablecoins are, in practice unlikely to meet the HKMA’s requirements for regulation and as such will most likely continue to be unregulated in the near term. That said, the HKMA has left the door open to expand its regime to allow for future regulation of other types of stablecoin structures.

To preserve flexibility in its regulatory scope, the HKMA will publish “guiding factors” in the future, setting out the factors the HKMA could have regard to in considering whether a particular structure should be declared as stablecoin subject to the HKMA’s regulatory oversight.

I. Key Features of the Proposed Stablecoin Licensing Regime

The HKMA’s proposals follow a risk-based “same risk, same regulation” approach. Rather than introducing a single type of license, the HKMA envisages introducing different licenses targeting different regulated activities. While the HKMA is still formulating the details to its requirements, the table below sets forth a summary of the proposed regulatory parameters of the proposed licensing regime:

Key activities to be regulated

The HKMA proposes to regulate the following critical functions:

Governance: establishment and maintenance of the rules governing an In-Scope Stablecoin arrangement;
Issuance: issuance, creation or destruction of In-Scope Stablecoins;
Stabilisation: stabilisation and reserve management arrangements of an In-Scope Stablecoin, regardless of whether such arrangements are provided by the issuer; and
Wallets: provision of services that allow the storage of users’ cryptographic keys, access to the users’ In-Scope Stablecoin holdings and the management of such stablecoins.

Entities that will require a licence

Entities that are involved in the following activities will require a licence under the proposed licensing regime:

Conducting a regulated activity concerning an In-Scope Stablecoin;
Actively marketing a regulated activity to the public of Hong Kong; or
Taking into account matters of significant public interest, the HKMA is of the opinion that the entity should be regulated.

Special attention should be paid to regulated activities concerning a stablecoin that purports to reference its value to the Hong Kong dollar (“HKD-backed Stablecoin”). Entities dealing with HKD-backed Stablecoins will be required to apply for a licence and abide by regulatory requirements under the proposed licensing regime, irrespective of whether that the regulated activity is carried out in Hong Kong or actively marketed to the Hong Kong public.

One of the suggestions made by the HKMA under the Discussion Paper is to impose a local incorporation requirement as one of the authorisation conditions. The HKMA’s reasoning is that a local incorporation requirement will enable effective supervision over licensed entities, and, where necessary, facilitate seizure of assets to protect users in the event of business failures. Feedback received from the consultation show mixed views towards this suggestion. In light of this, the HKMA has decided to evaluate the alternative suggestions raised by the respondents (for example, imposing the local incorporation requirement only on entities engaging in critical activities in a stablecoin arrangement, such as the management of reserve assets for stabilisation of the stablecoin’s value), and determine whether to go ahead with the local incorporation requirement.

The HKMA has also clarified that both Hong Kong authorised banks (“Authorised Institutions” or “AI”) and non-Authorised Institutions (“non-AI”) are eligible to apply for a licence to issue stablecoins. This direction is in line with international standards and will be beneficial to the competitiveness of Hong Kong’s crypto business environment. To ensure the fitness and properness of stablecoin issuers, the HKMA will calibrate the final regulatory requirements applicable to AI and non-AI based on the risks that each type of issuers present to the financial system. While it is acknowledged that AIs are already under stringent regulatory requirements compared to non-AIs, it remains to be seen whether requirements applicable to AI and non-AI stablecoin issuers will be similar or not.

Key regulatory principles

Although the HKMA has not released the details of its regulatory requirements in relation to each regulated activity, the HKMA has published some overarching guidelines which it considers to be the crucial elements of the proposed licensing regime:

Comprehensive regulatory framework: the regulatory requirements will cover a broad range of issues, such as ownership, governance and management, financial resources requirements, risk management, anti-money laundering / counter-terrorist financing (“AML/CFT”), user protection, and regular audits and disclosure requirements;
Full backing and redemption at par: the value of the reserve assets of a stablecoin arrangement will have to meet the value of the outstanding stablecoins at all times, and the reserve assets need to be of high quality and high liquidity, such that stablecoin holders should be able to redeem the stablecoins into the referenced fiat currency at par within a reasonable period;
Principal business restriction: regulated entities should not conduct activities that deviate from their principal business as permitted under their relevant licence (for example, a wallet operator should not engage in lending activities).

The significance of the requirement for a stablecoin arrangement to be asset-backed, effectively means that stablecoins which derive their value based on arbitrage or algorithms are unlikely to be accepted under the proposed licensing regime. In other words, although such stablecoins qualify as In-Scope Stablecoins, the HKMA is unlikely to grant a licence for entities providing these stablecoin arrangements.

Further, the HKMA has specifically highlighted an on-going concern over the concentration risks in the current crypto market – e.g. where multiple or bundled financial services are provided by the same entity or affiliated companies. This give rise to user protection and conflict of interest risks. While the HKMA is still exploring regulatory options to address this vulnerability at this juncture, this area is expected to become a core regulatory focus in the near future.

The HKMA stresses that it envisages a flexible approach which allows the HKMA to “scope in” regulated activities and entities not strictly captured above under the licensing regime. Therefore, the proposals above should be seen as a visualization of the initial phase of the licensing regime. The HKMA has stated that it will be publishing assessment criteria and guiding principles to support its flexible approach. As such, if unregulated stablecoin related activities and/or unlicensed entities prove to be pose a greater and more imminent threat to Hong Kong’s financial and monetary stability than currently anticipated, the HKMA is open to expanding the licensing regime to cover these activities and entities.

II. The Regulatory Position on Unbacked Crypto-Assets

In the Discussion Paper, the HKMA invited responses on whether it should regulate unbacked crypto assets, given their growing linkage with the mainstream financial system and risk to financial stability. Considering that responses on this point are varied, and in line with global regulatory trends, the HKMA has decided to put on hold any plans to regulated unbacked crypto-assets for the time being, and to instead focus on the regulation on stablecoins. That said, the HKMA will continue to monitor the risks posed by unbacked crypto-assets to Hong Kong’s monetary and financial stability.

III. Next Steps in the Stablecoin Regulations Roadmap

The HKMA aims to put in place the stablecoin regulatory regime by 2023/24. This timeline takes into account the need to align Hong Kong’s local regulatory regime with international recommendations and standards, which are expected to be released over the next one to two years.[5] In view of the cross-border nature of stablecoins, the HKMA has suggested possible cooperation and coordination among relevant financial regulators .

The proposed timeline will allow the HKMA to consider how the stablecoin licensing regime can fit into the broader virtual assets regulatory framework in Hong Kong and in particular, the licensing regime for virtual asset service providers (“VASPs”) administered by the Securities and Futures Commission (“SFC”). The SFC’s licensing regime for VASPs will come into effect on 1 June 2023. Please refer to our client alert on the particulars of the SFC’s licensing regime.[6]

It appears likely that the stablecoin regulations will be introduced either in the form of an amendment to the Payment Systems and Stored Value Facilities Ordinance or as new, standalone legislation. The HKMA has not committed to a transitional period in its Consultation Conclusions. However, in light of the substantial number of responses seeking a transitional period to provide sufficient time for existing service providers to make necessary adjustments to their internal policies, procedures and controls to comply with new regulations, it is possible that the HKMA may consider including a transitional period in the future.

In conclusion, the HKMA’s proposals represent a significant first step towards stablecoin regulation in Hong Kong. It is expected that the HKMA will be conducting further consultations to map out the particulars of the regulations. We will continue to closely monitoring this space and will provide further updates on future developments.

________________________

[1] “Discussion Paper on Crypto-assets and Stablecoins”, published by the Hong Kong Monetary Authority (12 January 2022), available at https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2022/20220112e3a1.pdf.

[2] “Another Step Towards the Regulation of Cryptocurrency in Hong Kong: HKMA Releases Discussion Paper on Stablecoins”, published by Gibson, Dunn & Crutcher (19 September 2022), available at https://www.gibsondunn.com/another-step-towards-the-regulation-of-cryptocurrency-in-hong-kong-hkma-releases-discussion-paper-on-stablecoins/.

[3] “Conclusion of Discussion Paper on Crypto-assets and Stablecoins”, published by the Hong Kong Monetary Authority (31 January 2022), available at https://www.hkma.gov.hk/media/chi/doc/key-information/press-release/2023/20230131e9a1.pdf.

[4] “MAS Proposes Measures to Reduce Risks to Consumers From Cryptocurrency Trading and Enhance Standards of Stablecoin-related Activities”, published by the Monetary Authority of Singapore (26 October 2022), available at https://www.mas.gov.sg/news/media-releases/2022/mas-proposes-measures-to-reduce-risks-to-consumers-from-cryptocurrency-trading-and-enhance-standards-of-stablecoin-related-activities.

[5] In particular, the Financial Stability Board published a proposed framework for international regulation of crypto-asset activities in October 2022, and has aimed to finalise the updated high-level recommendations by July 2023, with a view to implement the revised recommendations by end-2025.

[6] “Hong Kong Introduces Licensing Regime for Virtual Asset Service Providers”, Gibson, Dunn & Crutcher (30 June 2022), available at https://www.gibsondunn.com/hong-kong-introduces-licensing-regime-for-virtual-asset-services-providers/; “Hong Kong Licensing Regime for Virtual Asset Service Providers Passed with Three-Month Delay to Implementation Timelines”, Gibson, Dunn & Crutcher (8 December 2022), available at https://www.gibsondunn.com/hong-kong-licensing-regime-for-virtual-asset-service-providers-passed-with-three-month-delay-to-implementation-timelines/.

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Arnold Pun, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Digital Asset Taskforce or the Global Financial Regulatory team, including the following authors in Hong Kong:

William R. Hallatt (+852 2214 3836, whallatt@gibsondunn.com)
Grace Chong (+65 6507 3608, gchong@gibsondunn.com)
Emily Rumble (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun (+852 2214 3838, apun@gibsondunn.com)
Becky Chung (+852 2214 3837, bchung@gibsondunn.com)

On June 24, 2022, the Hong Kong Government gazetted the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (“Amendment Bill”)[1]. The Amendment Bill introduces changes to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”)[2], including the introduction of a licensing regime for virtual asset services providers (“VASPs”) and imposing statutory anti-money laundering and counter-terrorist financing (“AML/CTF”) obligations on VASPs in Hong Kong. A Legislative Council Brief on the Amendment Bill (“LegCo Brief”)[3] was also published on the same date, which provides valuable context for its introduction. The Amendment Bill follows the Consultation Conclusions[4] on this subject published by the Hong Kong government’s Financial Services and Treasury Bureau on May 21, 2021, as discussed in our previous alert.[5]

As noted by the LegCo Brief, the Hong Kong government considers its proposed VASP regime to be ‘more rigorous and comprehensive’ than the AML focused VASP regimes introduced in Singapore, the United Kingdom and Japan. To this end, and as discussed further below, the VASP regime is focused not only on AML related considerations but on ensuring adequate investor protection for virtual asset investors. As such, the VASP regime once implemented will not only impose a rigorous licensing regime on VASP operators, but will also criminalise a broad range of crypto-related misconduct, regardless of whether it takes place on a licensed VASP exchange. The regime also provides the SFC with an extensive range of supervisory powers.

I. Scope of proposed licensing regime for VASPs

As foreshadowed by the Consultation Conclusions last year, the Amendment Bill introduces a licensing regime for VASPs which provides that the business of operating a virtual asset (“VA”) service is a “regulated function” requiring a license when undertaken in Hong Kong.[6]

The Amendment Bill defines “VA service” as only including the operation of a VA exchange,[7] which is defined as the provision of services through means of electronic facilities whereby:

offers to sell or purchase VAs are regularly made or accepted in a way that forms or results in a binding transaction; or
persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VAs in a way that forms or results in a binding transaction; and
where client money or client VAs comes into direct or indirect possession of the person providing such a service.

While the scope of services covered by this definition is comparatively narrow in comparison to other crypto licensing regimes such as the Singapore Payment Services Act, we anticipate that this category of “VA service” may be expanded in the future to extend the VASP regime to other crypto-asset activities. This is particularly likely given that the Amendment Bill provides that the amendment of this definition would not require legislative change, but could instead be achieved by the publication of a notice in the Government Gazette by the Secretary for Financial Services and the Treasury.[8]

Further, we note that the above definition included in the Amendment Bill is broader than the definition proposed under the Consultation Conclusions, which contemplated licensing ‘any trading platform which is operated for the purpose of allowing an invitation to be made to buy or sell any VA in exchange for any money or any VA and which comes into custody, control, power or possession of, or over, any money or any VA at any time during the course of its business.’ As noted above, the Amendment Bill’s definition of “VA service” now also captures electronic facilities through which ‘persons are regularly introduced, or identified to other persons in order that they may negotiate or conclude, or with the reasonable expectation that they will negotiate or conclude sales or purchases of VAs in a way that forms or results in a binding transaction’. This is particularly significant to operators of peer-to-peer exchanges, given that this definition appears to capture at least some peer-to-peer platforms where those platforms constitute facilities through which parties are regularly introduced for the purpose of, or with the reasonable expectation of, negotiating or concluding sales of VAs. This is in contrast to the Consultation Conclusions’ statement that peer-to-peer trading platforms that only provide a forum where buyers and sellers of VAs can post their bids and offers “with or without automatic matching mechanisms” will not be covered under the definition of “VA exchange”. As such, it will be important for operators of peer-to-peer exchanges to review their Hong Kong activities and carefully consider whether they do fall within this additional limb of “VA exchange” as included in the Amendment Bill. We anticipate that it also may be necessary to seek further guidance from the SFC regarding their position on peer-to-peer platforms as part of the consultation process which is expected to take place regarding the SFC’s detailed regulatory requirements for the VASP regime. This consultation process is expected to take place during Q3-Q4 2022 once the Amendment Bill has been enacted and prior to the new regime taking effect.

The Amendment Bill has defined a “VA” as a digital representation of value that:

is expressed as a unit of account or a store of economic value;
either:
- functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of debt, or for investment purposes; or
- provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with any cryptographically secured digital representation of value; and
can be transferred, stored or traded electronically.[9]

Interestingly, the Consultation Conclusions did not contemplate the inclusion of the provision of rights, eligibility or access to vote as part of the definition of a “VA”. However, this addition means that governance tokens will likely be considered to be a VA. Further, while not referenced by name in the Amendment Bill or Legco Brief, we consider that, in line with the Consultation Conclusions, the definition of “VA” will capture stablecoins. Finally, while the definition of a VA does not currently cover non-fungible tokens, the Amendment Bill provides that the Secretary for Financial Services and the Treasury may expand the categories of tokens captured by the “VA” definition by publication of a notice in the Gazette.[10]

II. Licensing requirements for licensed VASPs

In order to be eligible for a VASP license, the VASP license applicant must be a locally incorporated company with a permanent place of business in Hong Kong or a company incorporated elsewhere but registered in Hong Kong under the Companies Ordinance (Cap. 622).[11]

An applicant wishing to be licensed as a VASP must demonstrate to the Securities and Futures Commission (“SFC”) that:

it is a fit and proper person to be licensed to provide the VA service;
it has at least 2 persons fit and proper to be responsible officers (“ROs”), each of whom are of sufficient authority within the applicant and at least one of whom must be an executive director;
each director of the applicant is fit and proper; and
the ultimate beneficial owner of the applicant is fit and proper to be the ultimate beneficial owner of a VASP licensee.[12]

The introduction of the fit and proper test is modelled on the fit and proper requirements for the licensing of regulated activities under the Securities and Futures Ordinance (Cap. 571) (“SFO”).[13] Given this, it is unsurprising that the factors that the SFC will consider in evaluating the fitness and properness of VASP applicants and associated individuals (e.g. ROs, directors and ultimate beneficial owners) are the same as those factors set out in the SFO in relation to licensed corporations and registered institutions. These factors include whether the applicant has been convicted of offences relating to money laundering / terrorist financing, fraud, corruption or dishonesty; the applicant’s financial status or solvency; its experience and qualifications; and its reputation, reliability and integrity.[14] Therefore, we recommend referring to the SFC’s Fit and Proper Guidelines[15] to understand the matters that the SFC will likely consider in evaluating whether a person is fit and proper in relation to a VASP licensee.

III. Licensing conditions and AML/CTF requirements

The Amendment Bill provides that the SFC may impose a range of licensing conditions on a VASP licensee, including, but not limited to, requirements in relation to:

Financial conditions (e.g. capital requirements);
Risk management policies and procedures;
Anti-money laundering and counter-terrorism financing policies and procedures;
Management of client assets;
Financial reporting and disclosure;
Virtual asset listing and trading policies;
Market abuse policies;
Cybersecurity; and
Avoidance of conflicts of interest.[16]

We anticipate further details regarding the nature of these licensing conditions will be provided by the SFC in its forthcoming consultation on the detailed regulatory requirements applicable to VASPs (as referred to above). However, it is interesting to note that the list of license conditions included in the Amendment Bill does not include categories of clients to whom the VASP licensee may provide services. This is in contrast to the LegCo Brief’s statement that, in order to promote investor protection, the licensing regime will, at the initial stage, stipulate that VASPs can only provide services to professional investors (“PIs”) and that this restriction would be imposed by the SFC as a license condition (which is in keeping with the approach taken by the SFC to imposing the same restriction on certain licensed corporations). We consider that the use of the phrase “initial stage” and taking this approach to the imposition of the PI only restriction (rather than enshrining it in the legislation itself) suggests that the SFC may possibly allow expansion of VASP services to retail investors down the track when VA markets become more mature and regulated. This would be a welcome development for the virtual asset industry and would bring the Hong Kong regime into line with comparable regimes globally, including the Singapore regime.

The Amendment Bill also provides that licensed VASPs must comply with the AMLO’s requirements such as customer due diligence and record keeping requirements (e.g. Schedule 2 of the AMLO).[17]

IV. Key offences under the new VASP regime

The Amendment Bill also creates a significant new enforcement regime applicable to those providing VA services in Hong Kong or to the Hong Kong public. In particular, the Amendment Bill proposes that carrying on a business of providing a VA service without a license would be an offence punishable on conviction on indictment to a fine of HK$5 million and 7 years imprisonment, and in the case of a continuing offence, a further fine of HK$100,000 for every day during which the offence continues.

The Amendment Bill also introduces the following range of other offences punishable by significant fines and/or imprisonment:

the offence of active marketing of a VA service by unlicensed persons, whether in Hong Kong or elsewhere, to the public of Hong Kong. This offence in particular is likely to have a significant impact on crypto exchanges based outside of Hong Kong and without a Hong Kong presence “on the ground” but which market their services to the Hong Kong public, including through, for example, Chinese language advertising;[18]
the offence of making false or misleading statements in connection with an application for the grant of a license;
the offence of making fraudulent or reckless misrepresentations with the intention to induce others to invest in VAs; and
the offence of employing any deceptive or fraudulent device, scheme or act, directly or indirectly, in a transaction involving VA. We anticipate that this offence in particular will have a broad remit, given that it appears likely to extend to market manipulation and/or insider dealing in relation to virtual assets on the basis that such activities involve fraudulent and/or deceptive conduct.

Importantly, the offences of making fraudulent or reckless misrepresentations or employing deceptive or fraudulent devices, schemes or acts are not limited to transactions on licensed VASPs and as such will capture all individuals and/or firms engaging in this type of conduct with a substantial nexus to Hong Kong.

Finally, in the case of non-compliance with the statutory AML/CFT requirements, the licensed VASP and its ROs commit offences and upon conviction, each is liable to a fine of HK$1 million and 2 years imprisonment. Further, licensed VASPs and ROs in contravention may also face disciplinary actions, including suspension or revocation of licenses.

V. Supervisory powers granted to the SFC over licensed VASPs

The Amendment Bill also provides the SFC with broad supervisory powers over licensed VASPs, these include the power to enter business premises of the licensed VASP and its associated entities for conducting routine inspections of business records;[19] to request the production of documents and other records;[20] to investigate non-compliances and impose disciplinary sanctions against licensed VASPs in contravention.[21]

The Amendment Bill also provides the SFC with a significant range of additional powers in relation to licensed VASPs, including:

the power to appoint an auditor to investigate into the affairs of a licensed VASP and its associated entities if it has reasons to believe that the licensed VASP, or any of its associated entities, has failed to comply with provisions of the AMLO, code or guideline published under AMLO, or any licensing conditions imposed by the SFC;[22] and
allowing the SFC to provide assistance to overseas regulators in investigations of any contraventions of VA requirements outside of Hong Kong. This is likely to be particularly significant given the global remit of many crypto businesses;[23] and
powers to impose prohibitions or restrictions on the operation of a licensed VASP in a range of circumstances, including where the SFC considers the VASP not be fit and proper, or where there is a risk of dissipation of client assets.[24]

The Amendment Bill also provides the SFC with the power to seek certain orders from the Court of First Instance (“CFI”) in relation to contraventions of the VASP regime, including contraventions of the AMLO, any notice given under the AMLO or any conditions of a license granted under the AMLO.[25] This includes, significantly, the power to apply to the CFI for an order compelling a person who has been, is or may become, involved in the commission of the aforementioned contraventions, to take any step that the CFI directs, including to restore parties to any transaction to the position in which they were before the transaction was entered into.[26] This could expose persons who are the subject of such orders to liability to provide significant investor compensation in relation to losses suffered as a result of contraventions of the AMLO. However, the Amendment Bill notably does not give the SFC the power to seek such orders in relation to contraventions of codes and guidelines issued under the AMLO, in contrast to the power being sought by the SFC at present in its current consultation on amendments to its power to seek certain orders from the CFI under section 213 of the SFO.

VI. Timing

The first reading of the Amendment Bill was due to take place on June 29, but that first reading has now been rescheduled to July 6, 2022, with the provisions relating to the VASP regime due to take effect on March 1, 2023.

While the Amendment Bill provides for transitional arrangements for providers of VA services, these transitional arrangements do not extend to the offences set out above in relation to fraudulent conduct in relation to transactions in VAs, which will take effect from March 1, 2023.

While the Consultation Conclusions had contemplated a transitional period of 180 days for providers of VA services, the Amendment Bill provides that:

there will be a transitional period for the first 12 months for any corporation carrying on a business of operating a VA exchange in Hong Kong prior to March 1, 2023 (i.e. regardless of whether they apply for a license); and
corporations carrying on a business of operating a VA exchange in Hong Kong immediately prior to March 1, 2023 that file an application for a VA in the first 9 months (i.e. license by December 1, 2023) will be deemed to be licensed from the day after the expiry of the 12 month transitional period (i.e. March 2, 2024) until the SFC has made a decision to either approve or reject their license application, or the license applicant withdraws their application.

As such, prospective license applicants should ensure that they are operating in Hong Kong prior to March 1, 2023 to ensure that they are entitled to these transitional arrangements.

_________________________

[1] Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022, available at: https://www.gld.gov.hk/egazette/pdf/20222625/es32022262516.pdf

[2] Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), available at: https://www.elegislation.gov.hk/hk/cap615

[3] Legislative Council Brief Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (June 22, 2022), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/legco/docs/AML(A)Bill%202022_legco%20brief_e%20(Issue).pdf

[4] Consultation Conclusions on Public Consultation on Legislative Proposal to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (May 2021), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf

[5] Licensing Regime for Virtual Asset Services Providers in Hong Kong, published by Gibson, Dunn and Crutcher (June 7, 2021), available at: https://www.gibsondunn.com/licensing-regime-for-virtual-asset-services-providers-in-hong-kong/#_ftn1

[6] Section 53ZRD(3), Amendment Bill

[7] Schedule B, Amendment Bill

[8] Section 53ZTL, Amendment Bill

[9] Section 53ZRA(1), Amendment Bill

[10] Section 53ZRA(4)(a), Amendment Bill

[11] Section 53ZRK(3)(a), Amendment Bill

[12] Section 53ZRK(3)(b), Amendment Bill

[13] See Section 129(1), Securities and Futures Ordinance (Cap. 571), available at: https://www.elegislation.gov.hk/hk/cap571

[14] Section 53ZRJ, Amendment Bill

[15] See SFC Fit and Proper Guidelines (January 2022), available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/fit-and-proper-guidelines/Fit-and-Proper-Guidelines.pdf

[16] Section 53ZRK(5), Amendment Bill

[17] Section 53ZRR, Part 3, Division 2, Paragraph 34, Amendment Bill

[18] We anticipate that the SFC will take a similar approach to “active marketing” in this context as it does to “active marketing” for the purposes of section 115 of the SFO. See, e.g., the SFC’s FAQ on this topic, available at: https://www.sfc.hk/en/faqs/intermediaries/licensing/Actively-markets-under-section-115-of-the-SFO#9CAC2C2643CF41458CEDA9882E56E25B

[19] Part 2, Division 2, Clause 11(1B), Amendment Bill

[20] Part 2, Division 2, Clause 11(3), Amendment Bill

[21] Section 53ZSO, Amendment Bill

[22] Section 53ZSG, Amendment Bill

[23] Part 2, Division 2, Clause 18(13B) and (13C), Amendment Bill

[24] Sections 53ZSX, 53ZSY, 53ZSZ and 53ZT, Amendment Bill

[25] See our previous alert on this topic – Hong Kong SFC Consults on Significant Reforms to the SFO Enforcement Provisions, published by Gibson, Dunn and Crutcher (June 14, 2022), available at: https://www.gibsondunn.com/hong-kong-sfc-consults-on-significant-reforms-to-the-sfo-enforcement-provisions/

[26] Section 53ZTG, Amendment Bill

The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, Arnold Pun, and Jane Lu.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact any member of Gibson Dunn’s Crypto Taskforce (cryptotaskforce@gibsondunn.com) or the Global Financial Regulatory team, including the following authors in Hong Kong:

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

The Hong Kong Court of Final Appeal (the “CFA”) [1] has recently confirmed that for the purpose of winding up foreign companies in Hong Kong, the requirement that the winding up must benefit the petitioner can include commercial pressure (in other words, leverage) to achieve the repayment of an undisputed debt.

The CFA’s reaffirmation of the threshold requirements for the court to exercise its jurisdictions, and in particular its clarification regarding the benefit requirement, is welcome. It demonstrates the court’s willingness in adopting a pragmatic approach in assessing whether it would be useful to entertain a winding-up petition in respect of a foreign company.

1. Factual Background and Procedural History in Hong Kong Courts

The Appellant was a PRC company listed in Hong Kong, and the Appellant and Respondent entered into a joint venture agreement. Following a dispute that led to an arbitral award against the Appellant, the Respondent served a statutory demand on the Appellant for the debt payable under the award. The Appellant failed to pay any part of the amounts demanded and sought an injunction to prevent the Respondent from presenting a winding-up petition as a creditor.

The Appellant’s case was that the Respondent could not satisfy the three core requirements for the court to exercise its jurisdiction to wind up a foreign-incorporated company when it is unable to pay its debts. The Appellant did not accept that the 2nd requirement was met, namely whether the winding-up order would benefit the petitioner. In particular, it did not accept that leverage (namely commercial pressure to achieve the repayment of an undisputed debt) could satisfy the 2nd requirement, as any benefit does not arise “as a consequence of the winding-up order being made”, but rather, would only be realised “if the winding-up order is either avoided or discharged”.

At the Court of First Instance, the Judge held that leverage created by the prospect of a winding-up petition constitutes sufficient benefit for the petitioner for the purposes of the 2nd requirement. The Court of Appeal upheld the Judge’s decision that there was a “real possibility of benefit” for the petitioner in making a winding-up order against the Appellant.

2. Nature of the Three Requirements for Winding Up Foreign-Incorporated Companies

The three “core requirements” previously approved by the CFA [2] which must be satisfied before a Hong Kong court will exercise its jurisdiction to wind up a foreign-incorporated company are that:

1. 1. 1. There must be a sufficient connection with Hong Kong;
    2. There must be a reasonable possibility that the winding-up order would benefit those applying for it; and
    3. The court must be able to exercise jurisdiction over one or more persons in the distribution of the company’s assets.

The CFA noted that the three requirements are not derived from statutory provisions and should not be approached through the ordinary rule of statutory construction. Rather, they are self-imposed judicial restraints on the exercise of the court’s jurisdiction (discretion) but not on the existence of the jurisdiction (which is entirely statutory). The CFA therefore considered that it would be more appropriate to characterise these requirements as “threshold requirements” rather than “core requirements”.

3. “Benefit” under the 2nd Threshold Requirement

3.1. General Nature of ‘Benefit’ under the 2nd Threshold Requirement

The CFA held that a “pragmatic approach” should be adopted in assessing whether it would be useful to entertain a winding-up petition in respect of a foreign company. Whilst the benefit the petitioning creditors can rely on will vary case-by-case, the CFA made the following observations:

There is no doctrinal justification for confining the relevant benefit narrowly to the distribution of assets by the liquidator in the winding up of the company;
It is sufficient that the benefit would be enjoyed solely by the petitioner;
There is also no doctrinal justification requiring the relevant benefit to come from the assets of the company;
There are cases where even though there was nothing for the liquidator to administer, the courts did not find any difficulty in finding benefit so long as some useful purpose serving the legitimate interest of the petitioner can be identified;
The benefit need not be monetary or tangible in nature; and
The fact that a similar result could be achieved by other means does not preclude a particular benefit from being relied upon.

3.2. Leverage as a Legitimate Benefit

With this “pragmatic approach” in finding benefit in mind, the CFA held that leverage is a relevant benefit as it is a proper purpose for a creditor’s winding-up petition. The benefit is derived from the invocation of the court’s winding-up procedures. In finding leverage as a legitimate benefit, the CFA also made a few observations:

Undisputed/Disputed Debt

The distinction between disputed and undisputed debt is important. The presentation of a winding-up petition, where the debt is disputed, may amount to an abuse of process of the court given that there is often a real and substantial dispute of facts.

Statutory Demand Mechanism

Additionally, the CFA observed that the statutory demand mechanism [3] provides a convenient method for creditors to seek repayment of an undisputed debt through presenting a winding-up petition. Non-compliance with the statutory demand operates as conclusive proof of the company’s inability to pay its debts (irrespective of whether the company is, in fact, insolvent) for the purpose of establishing the court’s jurisdiction to make a winding-up order, and the CFA observed that case law recognises the propriety of the use of a winding-up petition as a means of applying commercial pressure to seek payment of undisputed debt. Thus, there is no reason to exclude leverage as a relevant benefit under the 2nd requirement.

“Real” Leverage

The CFA also held that the leverage must be “real” and its significance depends on the potential impact of a winding-up order. Where the foreign company has no incentive to avoid a winding-up order, there is not much leverage. However, in this case, the leverage stemmed from the adverse consequences on the listing status of the foreign company which the court found to be real and significant.

4. Comity Argument: Forum Conveniens Only a Factor but Not a Requirement

The Appellant also raised a further comity argument arguing that winding up a foreign company is only justified when the jurisdiction of incorporation cannot fulfil its function making it necessary to “fill the lacuna”. The CFA observed that the Appellant was attempting to impose an additional requirement for the court to exercise its jurisdiction and held that if sufficient connection is established under the 1st requirement, any such forum conveniens issue should only be a factor (rather than an essential requirement) that the court can consider in deciding if a winding-up order should be made.

5. Conclusion

It is clear from the CFA’s judgment that for the purpose of winding up foreign companies in Hong Kong, the 2nd requirement that the winding up must benefit the petitioners can include commercial pressure to achieve the repayment of an undisputed debt.

On the other hand, the CFA also usefully clarifies that whilst the court is prepared to adopt a pragmatic approach, any such leverage must be real and significant and that contrary to the view of the Court of First Instance, any moderation of this 2nd requirement is not appropriate.

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[1] Shandong Chenming Paper Holdings Limited v Arjowiggins HKK 2 Limited [2022] CFA 11. A copy of the judgment of the Court of Final Appeal is available here. The judgment in the Court of Appeal ([2020] HKCA 670) is available here. The judgment in the Court of First Instance (HCMP 3060/2016) is available here.

[2] In Kam Leung Sui Kwan v Kam Kwan Lai (2015) 18 HKCFAR 501, more commonly referred to as the “Yung Kee” case.

[3] Section 327(4)(a) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.32). Under this section, a company is deemed unable to pay its debts if the company has failed to respond satisfactorily to a creditor’s written demand (by way of payment or otherwise) after 3 weeks of its service.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:

Brian Gilchrist (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen (+852 2214 3821, echen@gibsondunn.com)
Alex Wong (+852 2214 3822, awong@gibsondunn.com)
Rebecca Ho (+852 2214 3824, rho@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On 21 May 2021, the Hong Kong government published the Consultation Conclusions[1] on legislative proposals to enhance anti-money laundering and counter-terrorist financing (“AML/CTF”) regulations in Hong Kong, including a proposal to introduce a licensing regime for virtual asset services providers (“VASPs”). This client alert discusses the proposed scope of the licensing regime, the proposed regulatory requirements for licence holders, implications for cryptocurrency trading platforms, and opportunities for the future development of such trading platforms in Hong Kong.

Note that the discussions in this alert are based on the Consultation Conclusions. While unlikely, there could still be further changes in the drafting of the legislation before the laws are passed. Importantly there will be further public consultation before the detailed regulatory regime for licence holders, including applicable guidelines, are published, as discussed below.

I. Why introduce a licensing regime for VASPs?

In recent years, the world has seen tremendous growth in the trading of virtual assets (“VAs”) including cryptocurrencies like bitcoin. This drew the attention of the Financial Action Task Force (“FATF”), which expressed concern about the perceived money laundering and terrorist financing (“ML/TF”) risks arising from the growing use of VAs. To address these ML/TF risks, the FATF updated the FATF Standards in February 2019[2] to require jurisdictions to subject VASPs to the same range of AML/CTF obligations as financial institutions. To fulfil its obligations as a member of FATF, the Hong Kong government launched a public consultation on 3 November 2020.[3] Amongst other things, the consultation proposed amendments to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (“AMLO”) to introduce a licensing regime for VASPs. The public consultation period ended on 31 January 2021, and the Consultation Conclusions were published on 21 May 2021.

II. Scope of proposed licensing regime for VASPs

The proposed licensing regime for VASPs would designate the business of operating a VA exchange as a “regulated VA activity”. As such, any person seeking to operate a VA exchange in Hong Kong would be required to apply for a licence[4] from the Hong Kong Securities and Futures Commission (“SFC”) to become a licensed VASP under the AMLO. The granting of the licence would be subject to meeting the SFC’s fit-and-proper test and other regulatory requirements, which we discuss further below.

The proposed definition of a “VA exchange” is any trading platform which:

Is operated for the purpose of allowing an invitation to be made to buy or sell any VA in exchange for any money or any VA; and
Comes into custody, control, power or possession of, or over, any money or any VA at any time during the course of its business.

Accordingly, a peer-to-peer trading platform would not fall within the definition of a VA exchange provided that the actual transactions in VAs are conducted outside the platform and the platform is not involved in the underlying transaction by coming into possession of any money or any VA at any point in time (i.e. platforms that only provide a forum for buyers and sellers to post their bids and offers, where the parties themselves transact outside the platform). As such, on the basis of the current drafting, it is possible that decentralised exchanges (“DEXs”) that operate on the basis of non-custodial storage (as opposed to centralised exchanges where users give up custody of their assets to the exchange) and without a centralised entity in charge of the order book, may not ultimately be caught by the definition of a VA exchange.

The proposed definition of “VA” means a digital representation of value that:

Is expressed as a unit of account or a store of economic value;
Functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of debt, or for investment purposes; and
Can be transferred, stored or traded electronically.

The definition of “VA” is therefore likely to include cryptocurrencies such as bitcoin and VAs backed by another asset for the purpose of stabilising its value (i.e. stablecoins). On the other hand, the definition of VA would not cover:

Digital representations of fiat currencies (such as digital currencies issued by central banks);
Financial products already regulated under the Securities and Futures Ordinance (“SFO”);
Closed-loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible (e.g. air miles, credit card rewards, gift cards, customer loyalty points, gaming coins, etc.); and
Stored value facilities which are regulated under the Payment Systems and Stored Value Facilities Ordinance.

Depending on the final drafting of the legislative amendment to introduce the licensing regime for VASPs, it appears that non-fungible tokens (“NFTs”) may fall outside the definition of “VA”. In that scenario NFT trading platforms would also fall outside the scope of the licensing regime

III. Implications for non-Hong Kong cryptocurrency exchanges

The proposed licensing regime for VASPs would also extend to VA exchanges which operate outside of Hong Kong, but which actively market to the public of Hong Kong. This means that a cryptocurrency exchange that is based outside of Hong Kong will be prohibited from ‘actively marketing’ regulated VA activity (i.e. operating a VA exchange) to the public of Hong Kong unless they are a licensed VASP. This would be similar to existing prohibitions under the SFO[5] on actively marketing regulated activities to the public of Hong Kong (see below). In the context of the SFO, the meaning of actively markets is potentially broad, with some guidance available from the SFC[6] and in case law on its interpretation.

IV. Crypto assets which are securities or futures contracts are already regulated under the SFO

It is important to note that financial products which are already regulated under the SFO would not fall within the definition of “VA”, and therefore trading platforms which enable trading in such products would not fall within the licensing regime for VASPs. An example of such financial products is bitcoin futures which, depending on its terms and features, would likely either fall within the definition of “securities” or “futures contracts” under the SFO (and therefore would not be considered VAs).[7]

However, such trading platforms may already fall within the SFO regulatory regime for providing automated trading services, if it operates in or from Hong Kong, or actively markets to the public in Hong Kong (even if the platforms are based outside of Hong Kong). In this respect, in November 2019, the SFC published a position paper[8] which outlined the regulatory standards for the licensing of trading platforms that enable trading of crypto assets which have “securities” features.

V. Proposed licensing requirements for licensed VASPs

Eligibility: applicants must either be incorporated in Hong Kong, or non-Hong Kong incorporated companies which are registered in Hong Kong under the Companies Ordinance.
Fit-and-proper test: in considering whether or not an applicant is fit-and-proper to be granted a VASP licence, the SFC will take into account, among other matters, whether or not the applicant has been convicted of an ML/TF offence or other offence involving fraud, corruption or dishonesty, their experience and qualifications, their good standing and financial integrity, etc. This fit-and-proper test is likely to be very similar to, if not derived from, the well-established fit-and-proper test which applicants are required to satisfy to be granted a regulated activity licence under the SFO.
Two responsible officers: as with any firm currently licensed by the SFC, applicants will need to appoint at least two responsible officers to assume the responsibility of ensuring compliance with AML/CTF and other regulatory requirements, who may be held personally accountable in case of non-compliance.

VI. Regulatory requirements for licensed VASPs

Licensed VASPs will be subject to the AML/CTF requirements stipulated in Schedule 2 of the AMLO (i.e. the same as financial institutions), including customer due diligence and record-keeping requirements.

In addition to AML/CTF requirements, licensed VASPs will also be subject to regulatory requirements designed to protect market integrity and investor interests. These requirements will be set out in codes and guidelines to be published by the SFC. Licensed VASPs would be required to comply with these requirements under licensing conditions imposed by the SFC. These requirements are likely to be wide-ranging in scope, with prescribed requirements covering, among other things, financial resources, risk management, segregation and management of client assets, financial reporting, prevention of market manipulative and abusive activities, prevention of conflicts of interest, etc.

Notably, licensed VASPs will only be able to provide services to professional investors, i.e. high net worth and institutional investors. This means that after the commencement of the licensing regime for VASPs, licensed VASPs cannot provide services to retail investors.

VII. Supervisory powers of the SFC over licensed VASPs

The SFC will be given broad powers to supervise the AML/CTF and regulatory compliance of licensed VASPs. This will include powers to enter business premises, to request the production of documents and records, to investigate non-compliance and to impose sanctions (including orders for remedial actions, civil penalties and suspension or revocation licence) for non-compliances. The SFC will also have intervention powers to impose restrictions and prohibitions against the operations of licensed VASPs and their associated entities where the circumstances warrant, such as to prohibit further transactions or restrict the disposal of property. These powers enable the SFC to protect client assets in the event of emergency and to prevent the dissipation of client assets in the case of misconduct by a licensed VASP.

VIII. Timing

The Hong Kong government aims to introduce the AMLO amendment bill into the Legislative Council in the 2021-22 legislative session, which is due to commence in October 2021. The SFC will also prepare and publish for consultation the regulatory requirements for licensed VASPs, before commencement of the licensing regime for VASPs. Considering the above, the licensing regime is unlikely to commence before 2022. In any event there will be a 180-day transitional period from the commencement of the licensing regime to facilitate licence applications by interested parties.

IX. Conclusion

While the primary motivation for introducing the licensing regime for VASPs is to ensure that Hong Kong meets the latest FATF Standards, the Hong Kong authorities are also focused on promoting the protection of market integrity and investor interests, and the regulatory requirements for licensed VASPs extend beyond AML/CTF requirements by seeking to regulate matters including customer type (i.e. professional investors only), prevention of market manipulative and abusive activities, and prevention of conflicts of interest.

As Mr. Christopher Hui, Secretary for Financial Services and the Treasury, recently said in his remarks at a fintech forum,[9] the introduction of the licensing regime for VASPs is intended to facilitate the development of such an industry by providing a clear regulatory framework for the industry to operate within. Notably, the original proposal for the licensing regime has now been amended to allow non-Hong Kong companies to apply for a VASP licence[10] which may help to attract overseas crypto asset trading platforms that wish to develop their business within the Hong Kong regulatory framework.

For current VASPs contemplating applying for a VA licence when the licensing regime commences, we would recommend starting by reviewing their existing AML/CTF policies and systems and controls to identify gaps with the requirements under Schedule 2 of the AMLO. This is because these requirements are unlikely to be significantly modified during the legislative process, and it may take time and resources to design and implement. VASPs should also be alert to future consultations by the SFC on the codes and guidelines for licensed VASPs in order to identify the detailed regulatory requirements which licensed VASPs would need to comply with. Implementing these requirements will likely require preparing written policies and procedures, upgrading systems and controls, and potentially restructuring aspects of their business and operations to address potential conflicts of interest.

__________________________

[1] Consultation Conclusions on Public Consultation on Legislative Proposal to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (May 2021), published by the Financial Services and the Treasury Bureau, available at: https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf

[2] Public Statement – Mitigating Risks from Virtual Assets (22 February 2019), published by FATF, available at: https://www.fatf-gafi.org/publications/fatfrecommendations/documents/regulation-virtual-assets-interpretive-note.html

[3] Government launches consultation on legislative proposal to enhance anti-money laundering and counter-terrorist financing regulation (3 November 2020), Hong Kong government press release, available at: https://www.info.gov.hk/gia/general/202011/03/P2020110300338.htm

[4] There will be an exception for a VA exchange that is already regulated as a licensed corporation in the voluntary opt-in regime supervised by the SFC pursuant to the SFO.

[5] Section 115 of the SFO.

[6] “Actively markets” under section 115 of the SFO (last updated 17 March 2003), published by the SFC, available at: https://www.sfc.hk/en/faqs/intermediaries/licensing/Actively-markets-under-section-115-of-the-SFO#9CAC2C2643CF41458CEDA9882E56E25B

[7] Circular to Licensed Corporations and Registered Institutions on Bitcoin futures contracts and cryptocurrency-related investment products (11 December 2017), published by the SFC, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=17EC79

[8] Position paper: Regulation of virtual asset trading platforms (6 November 2019), published by the SFC, available at: https://www.sfc.hk/-/media/EN/files/ER/PDF/20191106-Position-Paper-and-Appendix-1-to-Position-Paper-Eng.pdf

[9] Secretary for Financial Services and the Treasury, Mr. Christopher Hui, remarks at StartmeupHK Festival – Virtual FinTech Forum on 27 May 2021, available at: https://www.news.gov.hk/eng/2021/05/20210527/20210527_131949_094.html

[10] The non-Hong Kong incorporated company would need to be registered in Hong Kong under the Companies Ordinance.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you would like to discuss further, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Financial Institutions practice group, or the following authors:

Connell O’Neill – Hong Kong (+852 2214 3812, coneill@gibsondunn.com)
Sébastien Evrard – Hong Kong (+852 2214 3798, sevrard@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)

Please also feel free to contact any of the following practice leaders and members:

Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Mylan L. Denerstein – New York (+1 212-351- 3850, mdenerstein@gibsondunn.com)
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Matthew Nunan – London (+44 (0) 20 7071 4201, mnunan@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.