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On February 20, 2023, the Hong Kong Securities and Futures Commission (SFC) published a consultation paper to solicit public views on allowing retail investors to participate in trading activities on virtual asset exchanges. Prior to that, the SFC specified that the scope of licensed virtual asset trading platforms was limited to institutional professional investors, corporate professional investors and individual professional investors. In this article, we will elaborate on the regulatory provisions on account opening, position limits and other risk control for retail investors, and interpret the good news for retail investors.
I. Change in the Hong Kong Securities and Futures Commission's attitude towards retail investors' entry
In 2018, the Hong Kong Securities and Futures Commission introduced the existing regime under the Securities and Futures Ordinance to regulate the virtual asset business. As the virtual asset market was still an emerging industry at that time, its highly speculative nature made it also more risky than the traditional financial market. For the sake of market stability and protection of investors' rights, the SFC limited the scope of licensed virtual asset trading platforms under the SFO to professional investors.
The so-called professional investors specifically include institutional professional investors, corporate professional investors and individual professional investors:
Ø Institutional professional investors refer to recognized exchanges, recognized clearing houses, intermediaries, recognized financial institutions, authorized insurers, recognized collective investment schemes, registered MPF schemes, occupational retirement schemes, the government, etc. as defined in the SFO.
Ø Corporate professional investor means a trust corporation within the meaning of the Securities and Futures (Professional Investor) Rules (a) holding total assets of HK$40 million (or its equivalent in foreign currency) or more; (b) a corporation or partnership holding a portfolio (cash, deposits, securities) of HK$8 million (or its equivalent in foreign currency) or more, or total assets of HK$40 million (or its equivalent in foreign currency) or more.
Ø Individual professional investor means an individual who holds a portfolio of more than HK$8 million (or its equivalent in foreign currency) within the meaning of the Securities and Futures (Professional Investor) Rules.
In November 2020, the HKSAR published a public consultation paper on the establishment of a licensing regime for virtual asset service providers under the Anti-Money Laundering and Terrorist Financing Ordinance. Forty percent of the submissions received by the SFC at that time argued that the authorities should allow retail investors to participate in the trading activities of virtual asset exchanges. It was pointed out that denying retail investors access to licensed virtual asset trading platforms may instead be detrimental to investors as it may drive them to trade on overseas virtual asset trading platforms that can be easily accessed online but are not regulated. If these unregulated virtual asset trading platforms fail, retail investors will not be able to withdraw their assets and will suffer significant losses.
On February 20, 2023, the Hong Kong Securities and Futures Commission (SFC) published a consultation paper to solicit public views on allowing retail investors to participate in trading activities on virtual asset exchanges. Prior to that, the SFC specified that the scope of licensed virtual asset trading platforms was limited to institutional professional investors, corporate professional investors and individual professional investors. In this article, we will elaborate on the regulatory provisions on account opening, position limits and other risk control for retail investors, and interpret the good news for retail investors.
I. Change in the Hong Kong Securities and Futures Commission's attitude towards retail investors' entry
In 2018, the Hong Kong Securities and Futures Commission introduced the existing regime under the Securities and Futures Ordinance to regulate the virtual asset business. As the virtual asset market was still an emerging industry at that time, its highly speculative nature made it also more risky than the traditional financial market. For the sake of market stability and protection of investors' rights, the SFC limited the scope of licensed virtual asset trading platforms under the SFO to professional investors.
The so-called professional investors specifically include institutional professional investors, corporate professional investors and individual professional investors:
Ø Institutional professional investors refer to recognized exchanges, recognized clearing houses, intermediaries, recognized financial institutions, authorized insurers, recognized collective investment schemes, registered MPF schemes, occupational retirement schemes, the government, etc. as defined in the SFO.
Ø Corporate professional investor means a trust corporation within the meaning of the Securities and Futures (Professional Investor) Rules (a) holding total assets of HK$40 million (or its equivalent in foreign currency) or more; (b) a corporation or partnership holding a portfolio (cash, deposits, securities) of HK$8 million (or its equivalent in foreign currency) or more, or total assets of HK$40 million (or its equivalent in foreign currency) or more.
Ø Individual professional investor means an individual who holds a portfolio of more than HK$8 million (or its equivalent in foreign currency) within the meaning of the Securities and Futures (Professional Investor) Rules.
In November 2020, the HKSAR published a public consultation paper on the establishment of a licensing regime for virtual asset service providers under the Anti-Money Laundering and Terrorist Financing Ordinance. Forty percent of the submissions received by the SFC at that time argued that the authorities should allow retail investors to participate in the trading activities of virtual asset exchanges. It was pointed out that denying retail investors access to licensed virtual asset trading platforms may instead be detrimental to investors as it may drive them to trade on overseas virtual asset trading platforms that can be easily accessed online but are not regulated. If these unregulated virtual asset trading platforms fail, retail investors will not be able to withdraw their assets and will suffer significant losses.
As the market for virtual asset business has matured, the SFC has developed a number of virtual asset policies to gradually allow retail investors to invest in virtual assets on a limited basis. In October 2022, the SFC established an authorization regime for virtual asset futures exchange traded funds (virtual asset futures ETFs), under which three virtual asset futures ETFs were authorized, giving retail investors indirect access to virtual assets in Hong Kong through regulated products.
On February 20, 2023, the SFC published a consultation paper to solicit public views on the Proposed Regulatory Requirements Applicable to Operators of Virtual Asset Trading Platforms Licensed by the SFC, proposing to allow retail investors to use trading services provided by licensed virtual asset trading platform operators, subject to the implementation of a series of measures by virtual asset exchanges to properly protect investors' rights and interests.
II. Account opening: expertise assessment
To ensure that retail investors receive adequate protection, the SFC follows the principle of investor suitability and requires licensed virtual asset platform operators to conduct an expertise assessment of retail investors when establishing business relationships with them. Only after a retail investor has passed the assessment can the platform operator open an account and provide services to the retail investor.
In assessing whether a retail investor has expertise in virtual assets and knowledge of the risks associated with them, the platform operator considers three main aspects: (a) whether the investor has received training or attended courses on virtual assets; (b) whether the investor's current or previous work experience is relevant to virtual assets; and (c) whether the investor has previous experience trading in virtual assets. .
In practice, an investor will be considered to have sufficient knowledge of virtual assets if he or she has made five or more transactions in any virtual asset within the past three years. For those retail investors who are assessed as not having the relevant knowledge, the platform operator should provide them with the necessary training before opening an account for the investor.
III. Risk tolerance: Position limit assessment
Considering the high risk of virtual asset investment, the SFC requires platform operators to conduct a comprehensive assessment of retail investors' potential trading losses and risk tolerance level, and does not set an overall position limit for each customer in virtual assets to ensure that retail investors can reasonably bear the relevant risks and losses in the event of market volatility.
In trade execution, the trading platform generally has automated pre-trade monitoring measures in place so that if a client enters any trade order that would exceed the limit specified for each client, the trade order will be prompted and cannot be executed. Of course, this position limit is also subject to change, and the platform operator will regularly review the risk profile of retail investors and adjust the position limit as appropriate.
The assessment method of the position limit and risk tolerance level is generally designed by the platform operator itself, which can be determined by the platform operator after obtaining the customer's identification information, financial status, investment experience and investment objectives, etc., but the platform operator must explain the assessment method and the assessment results to the customer. If the platform operator uses a risk scoring questionnaire to collect information, the platform operator shall pay special attention to the questions and the appropriateness of the design of the relevant scoring mechanism to ensure that the data in the scoring questionnaire can accurately reflect the true personal situation of the customer.
IV. Risk Alert: Disclosure Obligations of Platform Parties
Although retail investors who can participate in the trading activities of virtual asset exchanges have been evaluated by professional knowledge and risk tolerance level, they still need more protection than professional investors, therefore, the Hong Kong Securities and Futures Commission has imposed the obligation of risk indication and disclosure on platform exchanges.
At the legal level, when trading with retail investors, platform operators should inform retail investors that virtual assets are not legal tender, are not guaranteed by the government and relevant authorities, and that there is uncertainty as to whether virtual assets can be considered "property" under current law, which may affect the nature and enforceability of clients' interests in such virtual assets. This uncertainty may affect the nature and enforceability of the client's interest in the virtual asset. Second, policies in the area of virtual assets are subject to frequent change, and legislative and regulatory changes may adversely affect the use, transfer, trading and value of virtual assets.
With respect to investment risks, platform operators should fully advise retail investors that the protection provided by the Investor Compensation Fund does not apply to transactions in virtual assets by design, regardless of the nature of the token, and that transactions in virtual assets are irreversible and losses resulting from fraudulent or accidental transactions may not be recoverable.
With respect to trading, any advice provided by a platform operator to its clients should be made after thorough analysis and should be fair to all clients and without conflict of interest. For example, if a platform operator highlights a particular virtual asset to a client for commission rebates or other benefits, such conduct may be in breach of the relevant SFC regulations. Where a complex product is involved, the terms, features and risks of which are not reasonably likely to be understood by retail investors, the platform operator should provide a warning statement to investors about the complex product before selling or advising to ensure that the customer is suitable to trade in the complex product.
As the market for virtual asset business has matured, the SFC has developed a number of virtual asset policies to gradually allow retail investors to invest in virtual assets on a limited basis. In October 2022, the SFC established an authorization regime for virtual asset futures exchange traded funds (virtual asset futures ETFs), under which three virtual asset futures ETFs were authorized, giving retail investors indirect access to virtual assets in Hong Kong through regulated products.
On February 20, 2023, the SFC published a consultation paper to solicit public views on the Proposed Regulatory Requirements Applicable to Operators of Virtual Asset Trading Platforms Licensed by the SFC, proposing to allow retail investors to use trading services provided by licensed virtual asset trading platform operators, subject to the implementation of a series of measures by virtual asset exchanges to properly protect investors' rights and interests.
II. Account opening: expertise assessment
To ensure that retail investors receive adequate protection, the SFC follows the principle of investor suitability and requires licensed virtual asset platform operators to conduct an expertise assessment of retail investors when establishing business relationships with them. Only after a retail investor has passed the assessment can the platform operator open an account and provide services to the retail investor.
In assessing whether a retail investor has expertise in virtual assets and knowledge of the risks associated with them, the platform operator considers three main aspects: (a) whether the investor has received training or attended courses on virtual assets; (b) whether the investor's current or previous work experience is relevant to virtual assets; and (c) whether the investor has previous experience trading in virtual assets. .
In practice, an investor will be considered to have sufficient knowledge of virtual assets if he or she has made five or more transactions in any virtual asset within the past three years. For those retail investors who are assessed as not having the relevant knowledge, the platform operator should provide them with the necessary training before opening an account for the investor.
III. Risk tolerance: Position limit assessment
Considering the high risk of virtual asset investment, the SFC requires platform operators to conduct a comprehensive assessment of retail investors' potential trading losses and risk tolerance level, and does not set an overall position limit for each customer in virtual assets to ensure that retail investors can reasonably bear the relevant risks and losses in the event of market volatility.
In trade execution, the trading platform generally has automated pre-trade monitoring measures in place so that if a client enters any trade order that would exceed the limit specified for each client, the trade order will be prompted and cannot be executed. Of course, this position limit is also subject to change, and the platform operator will regularly review the risk profile of retail investors and adjust the position limit as appropriate.
The assessment method of the position limit and risk tolerance level is generally designed by the platform operator itself, which can be determined by the platform operator after obtaining the customer's identification information, financial status, investment experience and investment objectives, etc., but the platform operator must explain the assessment method and the assessment results to the customer. If the platform operator uses a risk scoring questionnaire to collect information, the platform operator shall pay special attention to the questions and the appropriateness of the design of the relevant scoring mechanism to ensure that the data in the scoring questionnaire can accurately reflect the true personal situation of the customer.
IV. Risk Alert: Disclosure Obligations of Platform Parties
Although retail investors who can participate in the trading activities of virtual asset exchanges have been evaluated by professional knowledge and risk tolerance level, they still need more protection than professional investors, therefore, the Hong Kong Securities and Futures Commission has imposed the obligation of risk indication and disclosure on platform exchanges.
At the legal level, when trading with retail investors, platform operators should inform retail investors that virtual assets are not legal tender, are not guaranteed by the government and relevant authorities, and that there is uncertainty as to whether virtual assets can be considered "property" under current law, which may affect the nature and enforceability of clients' interests in such virtual assets. This uncertainty may affect the nature and enforceability of the client's interest in the virtual asset. Second, policies in the area of virtual assets are subject to frequent change, and legislative and regulatory changes may adversely affect the use, transfer, trading and value of virtual assets.
With respect to investment risks, platform operators should fully advise retail investors that the protection provided by the Investor Compensation Fund does not apply to transactions in virtual assets by design, regardless of the nature of the token, and that transactions in virtual assets are irreversible and losses resulting from fraudulent or accidental transactions may not be recoverable.
With respect to trading, any advice provided by a platform operator to its clients should be made after thorough analysis and should be fair to all clients and without conflict of interest. For example, if a platform operator highlights a particular virtual asset to a client for commission rebates or other benefits, such conduct may be in breach of the relevant SFC regulations. Where a complex product is involved, the terms, features and risks of which are not reasonably likely to be understood by retail investors, the platform operator should provide a warning statement to investors about the complex product before selling or advising to ensure that the customer is suitable to trade in the complex product.
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