Hong Kong, rule of law and the free market
Updated: 2020-08-23 version history
In general, Hong Kong has a reputation as a reliable and predictable non-interventionist regulator. Most rules are clearly laid out and easy to comprehend and follow for people with little legal training (like me).
Rules rarely contradict each other and while government agencies do not closely coordinate with each other or share common goals, there are few power plays and power grabs between different agencies and departments.
However, some license regimes are restrictive and tied to control over real estate, which makes them only accessible to an oligopolistic cartel of property developers. Other licenses are no longer given out and have to be bought from existing license holders.
The result of this means that while Rule of Law and Free Market Principles prevail in Hong Kong, markets are highly duopolized and uncompetitive.
While Bitcoin in general is not specifically regulated other existing regulations might apply and the above mentioned realities shape Bitcoin markets and businesses in Hong Kong. It is important to understand the political and economical limitations and obscurities of Hong Kong to understand how Bitcoin fits in. Sadly this greatly exceeds the scope of this article.
Hong Kong Bitcoin Regulation
Bitcoin did not get onto the radar of the Hong Kong regulators until late 2013. Until then there was little Bitcoin activity in Hong Kong. Bitfinex was likely the first exchange to open bank accounts in Hong Kong and offering exchange and trading services largely to international customers in 2012.
ANX and Bitcashout followed in 2013, and Bitcoin prices continued to rally throughout November 2013, reaching a high of US$1153.27 on European exchange Bitstamp on December 4, 2013.
The then Financial Secretary John Tsang 曾俊華 mentioned Bitcoin for the first time in a blog post, (Archived) on December 1, 2013 (referenced here). In this article Tsang gives a good summary of how Bitcoin works and warns about its volatile nature and the lack of support from a state or issuer. He warns of a bubble bursting and sees many opportunities for software developers.
On December 4, 2013 the issue was picked up by Hong Kong’s parliament, the Legislative Council.
Legislator Christopher Cheung 張華峰, representing the financial services asks: “Will the Government state its position on the Bitcoin clearly and openly, so that the industry can have something to go by?”
John Tsang ultimately defines Bitcoin as “a commodity generated in the cyber world” and “neither electronic money nor a stored value payment facility.”
This policy, likely developed in coordination with Hong Kong Monetary Authority (HKMA), Securities and Futures Commission (SFC), Financial Treasuries Bureau (FTB), the Customs and Excise Department (C&ED) in consultation with their Mainland Chinese counterparts, has become the cornerstone of Hong Kong’s Bitcoin regulation and is unlikely to change.
The stance was repeated in a meeting of the Legislative Council on January 2014 (Press Release from January 8, 2013), adding “We have branded bitcoins as a highly speculative product and we call upon the public to be very careful.”
Bitcoin as a Virtual Commodity
Being defined as a virtual commodity rather than a currency, Bitcoin is per se not regulated by any of the financial regulatory bodies, such as the HKMA or the SFC.
Trading activities are controlled by the Customs and Excise Department, including commodities trading. Being a “free port” Hong Kong places little restriction on imports and exports and does not charge tariffs.
Some financial regulatory principles such as “Know Your Customer” may still apply to commotities trading. What this means precisely for Bitcoin trading remains unknown.
The only guidance available is a document from the Customs and Excise Department from January 30, 2014. In short, people dealing with Bitcoin might have a duty to:
obtain information on the customer and keeping it up to date
obtain information on the business relationship,
the source of wealth and source of funds
monitor the business relationship
make reports to the Financial Intelligence Unit about suspicious activity
While not carrying legal status, the Joint Financial Intelligence Unit (JFIU) references a 2014 report by the Paris-based Financial Action Task Force (FATF) on cryptocurrencies. The document may be interesting as a reference point.
In March 2015 the Secretary for Financial Services & the Treasury, Prof KC Chan 陳家強 reiterated the government’s stance that Bitcoin regulation is “not needed”.
In September 2018 the HKMA reiterated their stance that Bitcoin is not money, but instead a type of commodity, in a speech given by its Chief Executive, Norman Chan. The speech mimicks that of Agustín Carstens of the Bank of International Settlements in February 2018.
Bitcoin as a Virtual Currency
Recently, various Hong Kong institutions departments have become less consistent in refering to Bitcoin as a virtual commodity, and instead mention the term ‘virtual currency’ more frequently.
Most notably, the Legislative Council refers to Bitcoin as a virtual currency in their research publication. Councillors frequently (e.g. June 2017, November 2017 & April 2019) refer to Bitcoin as a virtual currency or cryptocurrency, a terminology typically rejected by the government. In its “Money Laundering and Terrorist Financing Risk Assessment Report” the Financial Services and Treasury Bureay writes “Virtual currencies (“VCs”) are virtual commodities” and refers to Bitcoin primarily as a virtual currency. The HKMA refers to Bitcoin mainly as a “cryptocurrency” in their November 2016 “Whitepaper on Distributed Ledger Technology.” The same goes for the “Whitepaper 2.0” published October 2017.
This terminology puts it more in line with international organizations and in our opinion does not represent a policy shift.
Bitcoin as a Virtual Asset
On November 1, 2018, the Chief Executive Officer of the SFC, Ashley Alder, announced in a keynote speech at Fintech Week the strict enforcement and clarification of existing rules, as well as a sandboxing arrangement for cryptocurrency exchanges. He groups cryptocurrencies like Bitcoin, security and utility tokens together into the term ‘virtual assets or crypto-assets’.
The intention of these rules and publications are difficult to understand, as they appeared relatively abruptly and without a clear goal. They do not represent law or introduce new regulation.
The term virtual asset has been picked up by Councillor Wu Chi-wai and Secretary for Financial Services and the Treasury, James Lau in their Q&A in LegCo on April 3, 2019, for which we criticize them.
Whether a fund needs a license from the SFC is independent of whether it holds these ‘virtual assets.’
A fund that only invests in cryptocurrencies (and not in futures or securities) does not need a type 9 license (asset management). If it however distributes such a fund in Hong Kong it requires a type 1 license. The SFC however expects that a fund holding cryptocurrencies behaves as if it held securities or futures.
All licensed funds that hold more than 10% of their funds in cryptocurrencies are now subject to special Terms and Conditions which may differ from fund to fund.
Any fund that invests in ‘virtual assets’ may only be available to professional investors.
The SFC will also be interested in the security arrangements of such a fund, custodial arrangements or insurance.
The clarifications are trying to limit the cryptocurrency exposure of funds, and keep it off limits for retail investors. It is also trying to heavily disincentivize funds from holding too much cryptocurrency. For example, if due to appreciation the cryptocurrencies in a portfolio increase above 10%, the SFC requires a fund to divest or else see themselves tied to restrictive terms of conditions.
If you are running a fund, consult a lawyer about whether you need a license to operate in Hong Kong.
As explained above, trading activity is regulated by the Customs & Excise Department of the Hong Kong Police Force. The SFC only regulates those exchanges that give investment advice, trade futures or on margin.
Under the new interpretations, the SFC will allow certain cryptocurrency exchanges into a ‘sandbox’ regime, where the exchanges have to behave as if they were license holders without receiving a license.
Exempt from this sandbox are all currently viable business models, including spot exchanges, Bitcoin ATM providers, OTC exchanges that deal with non-professional investors, margin, derivatives and futures exchanges and those trading ICO tokens.
The only type of exchange qualifying for the sandbox is an OTC exchange serving institutional customers. Such an exchange doesn’t require a license, but whether or not it is a sustainable business model to enter the sandbox depends on how many licensed funds require access to the OTC markets.
If you are running a fund offering investment advice, futures, derivatives, margin or trading ICO tokens, consult a lawyer about whether you need a license to operate in Hong Kong. In August 2020 the SFC issued its first ‘approval-in-principle’ to cryptocurrency brokerage OSL.
Stablecoins are tokens which are in some way pegged to a traditional currency. In Hong Kong there is no specific framework for the regulation of stablecoins. Most stablecoins have a central issuer that sells and redeems the stablecoin for the currency backing it. This behavior likely falls under existing regulation administered by the Hong Kong Monetary Authority, in particular Stored Value Facility (SVF). Currently there is no indication that a company handling cryptocurrency has any chance of seeing their SVF license accepted.
Synthetic stablecoin without a physical backing of the underlying asset exist as well and are more difficult to define from a regulatory standpoint. Accepting such stablecoins as payment is legal, but exchanging them for other fiat currencies might be a regulated activity under the C&ED. Offering payment processing services for any stablecoin is likely regulated under the HKMA.
Hong Kong’s tax regime remains simple and taxes are generally low. There is no Value Added Tax (VAT) or Capital Gains tax, making many of the taxation nightmares around Bitcoin known from other countries non-existent.
Income tax needs to be paid independent of whether payments are made in cash, cheque or Bitcoin and it is generally up to a business if they want to do their accounting in Hong Kong Dollars or Bitcoin.
The Right to Exchange HKD
Article 112 of the Basic Law states:
“No foreign exchange control policies shall be applied in the Hong Kong Special Administrative Region. The Hong Kong dollar shall be freely convertible. Markets for foreign exchange, gold, securities, futures and the like shall continue.”
This relatively unusual constitutional provision makes it unlikely that we will ever see significant restrictions or even a “ban” on Bitcoin. The article however does not prevent the government from creating licensing regimes that favor monopolies and allow for significant rent seeking.
Bitcoin Exchanges, Forex and ATMS
As clarified by the Customs and Excise Department in January 2014, Bitcoin exchanges, forex booths or Bitcoin ATMs do not require a Money Service Operator License (MSO).
“Bitcoin is not “money” and does not fall within the regulatory regime administered by the C&ED”
The concern behind this is that Bitcoin exchanges might apply for MSO licenses and use them to create an illusion of legitimacy or government sanction.
However, there are strong concerns that do not require a MSO is interpreted as must not obtain a MSO. Regulated and licensed businesses have complained to us about being prevented from offering Bitcoin products, and Bitcoin ATMs have been removed from the premises of such businesses at the “suggestion” of the C&ED.
This puts police intimidation as the number one legal barrier to offering Bitcoin products. Note however that this only applies to companies under the C&ED licensing regime. Companies outside of that regime do not feel restricted or intimidated in offering Bitcoin products.
The HKMA and banks
The HKMA has no jurisdiction over Bitcoin. There is little information and no public documents that detail the HKMA’s position on Bitcoin outside of repeated warnings over its lack of state backing and volatile nature.
While it probably isn’t exactly a secret that the HKMA is highly skeptical and even dismissive of Bitcoin as a decentralized global currency, it’s guidence towards banks is publicly unknown.
It is likely that confidential notes, minutes and verbal instructions exist that limit the banks’ ability to engage with Bitcoin businesses.
In reality banks are highly hesitant to open accounts to financial services companies, and even more so cryptocurrency businesses. There are few reports of private banks accounts being shut down due to involvement with Bitcoin trading, but for company accounts this remains common.
Currently there is no dedicated Bitcoin payment processor active in Hong Kong. While some processors like Coingate, Globee, Bitpay and Coinbase are serving Hong Kong businesses, few are exchanging Bitcoins into Hong Kong or U.S. dollars for them. Hong Kong exchanges offer such services only on a limited on-demand basis.
While a payment processor’s services would be similar to that of an exchange or broker, it is possible the HKMA could attempt to claim jurisdiction over payment processors, for example as part of the Stored Value Facility (SVF) license.
Advertising money lending services requires a Money Lenders’ license issued by the Companies Registry. Whether Bitcoins are used or not is not relevant to the issuance of a license, and money lenders using Bitcoin have successfully obtained licenses.
Securities law is incredibly complicated and Blockchain-based product are not excempt. Whether a cryptocurrency is a commodity or security, and whether a security is a legal security requires very careful examination.
Some tokens, especially those derived from “Token Creation Events” or “Initial Coin Offerings” are very likely securities, and their offering to unqualified investors in Hong Kong is illegal. It however currently seems unlikely that the SFC will go after securities not specifically offered or advertised to Hong Kong investors.
On February 9, 2018 the SFC contacted Hong Kong exchanges urging them to delist tokens deemed securities. ICO issuers were also contacted. They either stopped their ICO or promised to comply with securities regulation.
Advising on token offerings, brokering tokens and letting customers trade them may require a license from the SFC.
Security Tokens derived from “STOs” are for obvious reasons securities. The SFC clarifies in their statement from March 28, 2019: “Any person who markets and distributes Security Tokens (whether in Hong Kong or targeting Hong Kong investors) is required to be licensed or registered for Type 1 regulated activity. All usual due diligence, information and investor warnings apply.
Bitcoin will likely become more regulated as it becomes more popular. I expect concern over Bitcoin to remain with the C&ED, either through the creation of a “Virtual Currencies/Cryptocurrencies Dealer” license (VCD)” or the inclusion of provisions for cryptocurrencies into the MSO license.
Cryptocurrencies brokers, exchanges and ATM operators and anybody engaging in or facilitating the exchange of cryptocurrencies will have to apply with the C&ED and prove residency, physical locations, sufficient capitalization and a clean criminal record.
The SFC will further relax its rules towards funds, and later also derivatives and futures trading and enable its existing license holders to offer these products based on cryptocurrencies. Possibly ETFs and other funds will become possible and even listed.
I expect it to take a long time until the Hong Kong government reclassifies Bitcoin as a currency, which will allow the HKMA to clarify its rules, allow banks to offer Bitcoin-based investment products as well as allow SVF license holders to include Bitcoin into their products.
This post was written by Leonhard Weese, and for obvious reasons does not constitute legal advise. For corrections, suggestions and inquiries contact the author via @LeoAW or leo (at) bitcoin (dot) org (dot) hk