Hong Kong Regulator Calls for Tough Rules Despite Crypto Hub Ambitions

Crypto service providers are moving from the fringe to provide a full range of financial services, making a "light touch" regulatory approach “far from adequate,” a Hong Kong regulator said on Thursday.

Julia Leung, deputy CEO and executive director of Intermediaries for Hong Kong’s Securities and Futures Commission (SFC), said that recent turmoil in crypto markets highlighted not only intrinsic volatility and structural vulnerabilities, but also its increasing interconnectedness with the traditional financial system.

Leung was speaking at the Institutional Digital Assets and Crypto Regulation Symposium organized by City & Financial Global in London.

International cryptocurrency exchange FTX, which filed for bankruptcy last Friday, was once headquartered in Hong Kong, and sources told CoinDesk that the exchange still has staff in the city.

Leung noted that Hong Kong’s opt-in regulatory framework requires segregation of client assets from house assets. To address conflicts of interest, it prohibits virtual asset platforms from trading on their own account, and there is no lending or pledging of client assets.

Centralized virtual asset trading platforms operate in ways similar to stock exchanges and broker-dealers, Leung said, adding that the SFC will hold these platforms to standards similar to those applicable to stock exchanges and broker-dealers.

She noted that the SFC had announced its opt-in framework for centralized trading platforms in 2018 but that the authorities could only apply the full force of their legal power to platforms willing to trade at least one security token.

Currently, only two companies in Hong Kong, OSL and HashKey, are licensed under the opt-in regime. Most retail investors in the city are using unlicensed platforms.

A bill is currently going through Hong Kong’s Legislative Assembly which expands the existing regulatory regime to platforms that do not trade security tokens. Once that bill is passed, all centralized platforms will need to be licensed by the SFC, whether or not they trade security tokens, though there will be a grace period.

Leung said that given recognition of the growing investor demand for virtual assets, particularly among private banks and hedge fund customers, it was important for regulators to provide clarity on obligations on banks, brokers and fund managers.

Adopting a comprehensive regulatory approach was supportive of crypto's underlying distributed ledger technology, NFTs, the metaverse and Web3, according to Leung.

“Many financial institutions are now exploring how to tokenize financial assets or develop their own tokens on private blockchains,” Leung said.

The SFC plans to issue a circular to clarify that tokenized debt securities as digital representations of traditional securities on the blockchain should be treated in a similar way as existing conventional securities instruments, she said.

Leung also spoke about decentralized finance, saying that “most DeFi activities operate outside any regulatory system”.

According to Leung, some operators are intentionally elusive to minimize liability and regulatory scrutiny. She said that regulators worldwide had reached consensus on a coordinated approach and that they would be “relentless” in pursuing a regulatory solution to DeFi.