Blog: Regulatory Approach To Digital Assets In Hong Kong And Singapore – Fin Tech – Worldwide – Mondaq

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Overview

Due to the growing popularity of digital assets, governments and
regulators have had to examine their legal and regulatory
frameworks to develop new laws to regulate market activities
relating to this asset class, including and not limited to the
management of fraud, market manipulation and anti-money laundering
and counter-financing of terrorism (AML/CFT) risks presented by
anonymized digital asset activities.

Unsurprisingly, digital assets were the focus of various
announcements issued during Hong Kong’s and Singapore’s
respective Fintech Week events held in early November 2022. This
Legal Update provides an overview of the key developments in the
evolution of the current approach to the regulation of digital
assets in both jurisdictions, in particular:

  • the definition of digital assets;
  • evolution of the current regulatory framework in Hong
    Kong;
  • evolution of the current regulatory framework in Singapore;
    and
  • upcoming legislation and consultations in both
    jurisdictions.

Definition of Digital Assets

There is no universal definition of digital assets. Digital
assets are generally understood to refer to assets of value that
exist in digital form such as cryptocurrencies and non-fungible
tokens (NFTs). The definitions used in Hong Kong and Singapore are
explained below.

Hong Kong’s upcoming legislation to regulate digital assets
(covered in this Legal Update) contains a broad definition of the
term ‘virtual asset (VA)’. In summary, a VA is defined as a
cryptographically secured digital representation of value that:

i. is expressed as a unit of account or a store of economic
value;

ii. either –

  1. is used, or is intended to be used, as a medium of exchange
    accepted by the public, for any one or more of the following
    purposes: payment for goods or services; discharge of a debt;
    investment; or
  2. provides rights, eligibility or access to vote on the
    management, administration or governance of the affairs in
    connection with, or to vote on any change of the terms of any
    arrangement applicable to, any cryptographically secured digital
    representation of value;

iii. can be transferred, stored or traded electronically;
and

iv. satisfies other characteristics prescribed by the Securities
and Futures Commission (SFC).

The definition of a VA is further qualified by the
following:

  • The following digital representations of value are excluded
    from the definition of a VA:

    • issued by a central bank, or a government or an entity
      authorised by a government of a jurisdiction to issue currency in
      that jurisdiction;
    • limited purpose digital tokens;
    • constitutes a securities and futures contract;
    • constitutes any float or stored value deposit under the Payment
      Systems and Stored Value Facilities Ordinance (Cap. 584).
  • New characteristics necessary for a digital representation of
    value to be a VA, or which precludes a digital representation of
    value from being a VA, may be prescribed by the SFC in the
    Gazette.
  • The Secretary for Financial Services and the Treasury may
    prescribe any digital representation of value to be a VA, or to
    exclude it as a VA, by notice in the Gazette.1

In contrast, Singapore legislation uses the term ‘digital
payment token (DPT)’ and the broader term, ‘digital token
(DT)’.

  • A DPT is defined in the Payment Services Act 2019 (PSA 2019),
    section 2(1), as a digital representation of value (other than an
    excluded digital representation of value) that – (a) is
    expressed as a unit; (b) is not denominated in any currency, and is
    not pegged by its issuer to any currency; (c) is, or is intended to
    be, a medium of exchange accepted by the public, or a section of
    the public, as payment for goods or services or for the discharge
    of a debt; (d) can be transferred, stored or traded
    electronically.2
  • A DT is defined in the Financial Services and Markets Act 2022,
    section 136(1), as a DPT or a digital representation of a capital
    markets product which can be transferred, stored or traded
    electronically, and satisfies such other characteristics as the
    Monetary Authority of Singapore (MAS) may prescribe.

Evolution of the Current Regulatory Framework in Hong Kong

The regulators in Hong Kong for securities and banking
activities are the SFC and the Hong Kong Monetary Authority (HKMA)
respectively. Their regulatory philosophy is technology neutral,
and they aim to evolve their regulatory framework around the
products and usage in the market, and to meet international
standards. At Hong Kong Fintech Week 2022, the
SFC’s Deputy Chief Executive Officer, Ms Julia Leung
,
stressed that the SFC takes a ‘same business, same risk, same
rules’ approach.

The new regulatory framework for VAs in the upcoming amendments
to the Anti-Money Laundering and Counter-Terrorist Financing
Ordinance (Cap. 615) (AMLO) is outlined in this
Legal Update
. In summary, the new framework introduces a
licensing regime for VA service providers and requires them to
implement anti-money laundering and other risk management controls
that apply to traditional financial institutions. In addition, on
31 October 2022, the SFC issued a circular on VA futures exchange
traded funds. A summary of this circular is covered in this
Legal Update
.

WHAT WERE THE DEVELOPMENTS BEFORE 2022?

Hong Kong regulators tend to adopt a risk-based approach,
prioritizing regulation of products and activities which have
significant impacts on investors, the financial stability of the
entire market, and the status of Hong Kong as an international
financial centre. VAs have received regulatory attention in Hong
Kong since 2017, when the SFC first published a statement on the
use of initial coin offerings to raise funds.3 Since
then, there have been several key milestones leading to the current
regulatory framework:

  • 1 November 2018: The SFC published a circular to
    intermediaries on the distribution of VA funds, which introduced
    the opt-in regime for VA trading platforms and imposed selling
    restrictions of VAs strictly to professional investors (PI) (2018
    SFC Circular).4
  • 6 November 2019: The SFC published a position paper on
    the regulation of VA trading platforms, which implemented a
    regulatory framework for platforms trading at least one security
    token.5

A major update was issued by SFC and the HKMA on 28 January
2022, in a joint circular on intermediaries’ VA-related
activities (Joint Circular), which supersedes the 2018 SFC
Circular. The 2022 circular provides important updates in three
areas on the application of existing regimes and requirements on
financial institutions providing VA-related products or
services.6

  • Distribution of VA-related products: Financial
    institutions should comply with SFC requirements on the sale of
    complex products, including to ensure product suitability, provide
    sufficient key information, and provide clear and prominent warning
    statements. This is based on the SFC’s view that VA-related
    products are complex products (except for VA-related derivative
    exchange-traded funds), as the risks associated with such products
    are not reasonably likely to be understood by retail
    investors.
  • Provision of VA dealing services: Financial
    institutions should only provide such services to existing PI
    clients for which they have carried out Type 1 (dealing in
    securities) regulated activities, and must only partner with
    SFC-licensed VA trading platforms.
  • Provision of VA advisory services: Financial
    institutions should only provide such services to existing PI
    clients for which they have carried out Type 1 (dealing in
    securities) and Type 4 (advising on securities) regulated
    activities. Financial institutions must also adhere to the terms
    and conditions set out in Appendix 6 of the Joint Circular, in
    particular, to ensure product suitability.7

On 28 January 2022, the HKMA also published a circular on the
regulatory approaches to banks’ interface with VAs and VA
service providers (VASPs).8 The HKMA repeated its
risk-based approach to supervising VA activities in line with
applicable international standards, focusing on three areas:

  • Prudential supervision: banks are expected to conduct
    proper due diligence of the VAs to which they may incur financial
    exposures, critically evaluate their exposure to different types of
    risks, and implement corresponding risk-mitigation measures.
  • Anti-money laundering (AML), counter-terrorist financing
    (CFT) and financial crime risk
    : banks should implement
    effective AML and CFT policies, procedures and controls, in
    relation to both (i) client bank accounts, including to file
    suspicious transaction reports to the Joint Financial Intelligence
    Unit; and (ii) banking relationships with VASPs, including to
    conduct appropriate money-laundering or terrorist financing risk
    assessments.
  • Investor protection: banks should implement
    appropriate investor protection measures for VArelated products, as
    they are very likely to be considered as complex products.

From these measures, it can be seen that Hong Kong regulators
have deployed existing regulatory regimes and instruments to
address the regulatory gaps posed by VAs on an incremental basis as
the industry has developed. This approach is also evident in the
new regulatory framework for VAs which will allow the SFC to update
the definition of a VA, and allow the Hong Kong government to
include or exclude digital representations for value, either
generally or in a particular case, as a VA, through notices in the
Gazette. Finally, on 31 October 2022, the Hong Kong government
issued a Policy Statement on the Development of Virtual Assets in
Hong Kong, available here.

Evolution of the Current Regulatory Framework in Singapore

Similar to Hong Kong, the Monetary Authority of Singapore (MAS)
first cautioned the public about the risks of investments in
cryptocurrencies in 2017.9 In the early years, Singapore
was described by some in the market as a ‘crypto paradise’.
However, following stricter measures imposed in recent months on
the digital assets sector, it has been lamented that the MAS has
made a ‘u-turn’ in its policies.

Singapore’s approach to digital assets is succinctly
expressed in the title of a recent speech by MAS Managing Director,
Mr Ravi Menon: ‘Yes to Digital Asset Innovation, no to
Cryptocurrency Speculation’. In summary, the regulatory
approach of Singapore has evolved around the concept of DPTs as
part of the payment services landscape, and subsequently, DTs
broader uses. Strong investor protection requirements apply to DPT
services offered within Singapore. Companies based in Singapore
that offer services outside of Singapore are also subject to a
level of regulatory oversight by the MAS, particularly on AML/CFT
requirements.

These regulatory developments began with the Payment Services
Act (No. 2 of 2019) (PSA) which set up a new licensing framework
for payment service providers, including DPT services, and
introduced the legal definition for DPT (as mentioned
above).10 Two years later, the Payment Services
(Amendment) Act 2021 made a number of key amendments to the
PSA,11 including the following:

  • expanding the definition of DPT services to include the
    transfer of DPTs, the provision of custodial wallet services for
    DPTs, and the exchange of DPTs by DPT service providers without
    possession of money or DPTs;
  • regulating the provision of DPT services through a licensing
    regime and requiring DPT service providers to adhere to AML and CFT
    regulations in Singapore; and
  • empowering the MAS to impose user protection measures on DPT
    service providers, and measures on certain DPT service providers
    which are necessary or expedient in the interests of the public,
    the stability of the financial system in Singapore, or the monetary
    policy of the MAS.

Next, the Financial Services and Markets Act 2022 expanded the
scope of MAS regulatory powers over DT service providers and the
statute includes the following measures: 12

  • regulating all DT service providers with a place of business in
    Singapore that provide DT services outside Singapore as a new class
    of financial institutions, with independent licensing and ongoing
    requirements to ensure adequate supervision by the MAS; and
  • introducing MAS regulatory powers to conduct AML or CFT
    inspections on such service providers, and to render assistance to
    domestic authorities and foreign counterparts.

In addition, the MAS issued the following guidance to the
industry.

  • A Guide to Digital Token Offerings, last updated in May 2020,
    stating that the MAS may regulate any offer or issue of DPTs which
    constitute capital markets products under the Securities and
    Futures Act 2001. 13 In particular, if an offer of DPTs
    relates to a collective investment scheme, such offer must be
    accompanied by a prospectus, and must comply with the relevant
    investment restrictions and business conduct
    requirements.14 Further, this guide emphasizes that all
    persons have obligations to report suspicious transactions under
    AML regulations, and must not serve individuals and entities
    designated under CFT regulations.
  • Guidelines on Provision of Digital Payment Token Services to
    the Public, issued in January 2022. These guidelines prohibit DPT
    service providers from promoting their services in public areas,
    including putting up advertisements, and relying on third parties
    to promote their services to the general public. However, DPT
    services may be promoted through their own media
    platforms.15

In summary, Singapore has created a robust, standalone
regulatory framework for the provision of payment services in
Singapore of which DPTs form a part. Nonetheless, given the
cross-border nature of digital assets, Singapore has also imposed
basic regulatory requirements on DT service providers operating in
Singapore that provide services entirely outside of Singapore, to
protect Singapore’s reputation as a global financial
centre.

Upcoming Legislation and Consultations

In Hong Kong, the Anti-Money Laundering and Counter-Terrorist
Financing (Amendment) Bill 2022 (the “Bill”) is currently
going through the legislative process. As mentioned above, it will
introduce a new VASP licensing regime expected to take effect in
2023.16 The SFC is currently carrying out a soft
consultation on whether retail investors should be allowed to trade
VA. In addition, the SFC will consult the public on the detailed
requirements of the new regime after the passage of the amendment
bill.

In Singapore, the MAS issued two consultation papers related to
digital assets on 26 October 2022:

The DPT services consultation paper focuses on consumer access
measures, business conduct measures, managing technology and cyber
risks, and market integrity. On consumer access, it is worth noting
that the MAS is not proposing a ban against offering cryptocurrency
services to retail customers. Instead, the MAS is considering the
use of targeted regulatory measures, including limiting consumer
access and improving business conduct, to address the risks posed
to retail customers. The MAS has proposed issuing guidelines on
these topics with a six to nine month transition period as a first
step, before introducing more detailed regulatory requirements and
subsidiary legislation that will also receive public
consultation.

The stablecoin consultation paper builds upon an
earlier MAS consultation paper on the scope of e-money and DPT
dated 23 December 2019
. In the latest consultation paper, the
MAS noted that stablecoins have the potential to perform the role
of a credible digital medium of exchange if it is well-regulated
and backed by arrangements with a high degree of assurance of value
stability. As such, the MAS plans to develop a specific and more
comprehensive regime for stablecoins which are currently classified
as DPTs under the PSA.

Both MAS consultation papers are open for responses until 21
December 2022.

Conclusion

Hong Kong and Singapore have sought to balance the risks
associated with digital assets with their ambitions of becoming
responsible global fintech hubs. However, the two jurisdictions
have taken somewhat different approaches in their regulatory
architecture.

In Hong Kong, the regulators have relied on existing regulatory
frameworks to regulate VASPs as a whole, primarily through AMLO
(for VAs) and the Securities and Futures Ordinance (Cap. 571) (for
securities and futures contracts). In contrast, Singapore created a
new regulatory framework for payment services which include DPTs,
and is taking steps to create a new regulatory regime for
stablecoins. Singapore’s regulatory regimes are therefore more
closely linked to the intended purpose or use of digital assets.
Some commentators argue that this approach is more flexible as it
allows the regulator to introduce more targeted and comprehensive
regulations that are appropriate for the activity under regulation,
in line with the fact that digital assets and distributed ledger
technology can be used in a variety of contexts, even within a
single industry.

Discussions on retail investor access to VA-related products and
services in both jurisdictions have received significant attention
following the recent Hong Kong and Singapore Fintech Week events.
This is as it should be, given the personal impact of such
regulations on investors and the importance of financial inclusion
across different demographics. Instead of drawing the line at PI
versus retail investors which has been the norm in the financial
regulations of both jurisdictions, it may be time to consider
allowing retail investor access based on an assessment of the
individual’s knowledge of the risks of trading digital assets.
After all, the size of an individual’s net worth may not be
indicative of an individual’s financial literacy. In an
interesting development, the MAS’ latest DPT consultation paper
mentions this option and seeks the industry’s engagement to
develop a common assessment template.

Finally, while there has been a lot of hype over the recent
‘pro-crypto’ comments by Hong Kong authorities17
and the ‘anti-crypto’ comments by Singapore authorities,
this is ultimately still a developing area. It remains to be seen
whether and to what extent the position between the two
jurisdictions will diverge in this area in upcoming
legislation.

Footnotes

1 Anti-Money Laundering and Counter-Terrorist Financing
(Amendment) Bill 2022, section 53ZRA(4), available at
https://ift.tt/S7meMKv.

2 Payment Services Act 2019, section 2(1), available at
https://ift.tt/LZKhTy2
2019/Published/20190220?DocDate=20190220.

3 Securities and Futures Commission, Statement on Initial
Coin Offerings (5 September 2017), available at
https://ift.tt/cuX81zH.

4 Securities and Futures Commission, Circular to
Intermediaries: Distribution of Virtual Asset Funds (1 November
2018, available at
https://ift.tt/rKp4B9a.

5 Securities and Futures Commission, Position Paper:
Regulation of Virtual Asset Trading Platforms (6 November 2019),
available at
https://ift.tt/E9Sa1HN.

6 Securities and Futures Commission and Hong Kong
Monetary Authority, Joint Circular on Intermediaries’ Virtual
Asset-Related Activities (28 January 2022), available at
https://ift.tt/sP0XImx.

7 Appendix 6 to the Joint Circular on Intermediaries’
Virtual Asset-Related Activities, “Licensing or Registration
Conditions and Terms and Conditions for Licensed Corporations or
Registered Institutions Providing Virtual Asset Dealing Services
and Virtual Asset Advisory Services”, available at
https://ift.tt/UehEGvc.

8 Hong Kong Monetary Authority, Regulatory Approaches to
Authorized Institutions’ Interface with Virtual Assets and
Virtual Asset Service Providers (28 January 2022), available at
https://ift.tt/w3BfQOd.

9 Monetary Authority of Singapore, MAS Cautions against
Investments in Cryptocurrencies (19 December 2019), available at
https://ift.tt/JCRbT26.

10 Payment Services Act 2019, available at
https://ift.tt/Ly9AjkB.

11 Payment Services (Amendment) Act 2021, available at
https://ift.tt/xL3O8we
2021/Published/20210301?DocDate=20210301.

12 Financial Services and Markets Act 2022, available at
https://ift.tt/Ki9EHdS
2022/Published/20220511?DocDate=20220511.

13 Monetary Authority of Singapore, A Guide to Digital
Token Offerings (updated 26 May 2020), available at
https://ift.tt/YwUEZsu.

14 A Guide to Digital Token Offerings (updated 26 May
2020), paragraphs 2.5 and 2.6, available at
https://ift.tt/QXzLfig
/media/MAS/Sectors/Guidance/Guide-to-Digital-Token-Offerings-26-May-2020.pdf.

15 Monetary Authority of Singapore, Guidelines on
Provision of Digital Payment Token Services to the Public (17
January 2022), available at
https://ift.tt/D5y7JTc.

16 Anti-Money Laundering and Counter-Terrorist Financing
(Amendment) Bill 2022, available at
https://ift.tt/S7meMKv.

17 Notably, the SFC has, over the years, issued various
reminders to investors about the risks associated with digital
assets. The latest reminder concerns the risks associated with
non-fungible tokens issued on 6 June 2022, available at
https://ift.tt/UjgpKTr.

Co-authored by Angus Yuen, trainee solicitor

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This
Mayer Brown
article provides information and comments on legal
issues and developments of interest. The foregoing is not a
comprehensive treatment of the subject matter covered and is not
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