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The outgoing chairman of Hong Kong’s Securities and Futures Commission (the “SFC”), Carlson Tong Ka-shing, has reportedly stated that the SFC is looking to extend its regulatory reach to Hong Kong’s cryptocurrency exchanges, which have so far been operating in a largely unregulated sphere.

This move represents the next stage in the SFC’s steadily growing involvement in cryptocurrencies and other digital tokens, seeking to address the potential risks they pose to investors. That involvement began in September 2017, when the SFC issued a statement on initial coin offerings (“ICOs”) warning that certain digital tokens may be viewed as “shares”, “derivatives” or an interest in a “collective investment scheme”. This meant that transactions involving the tokens would be “regulated activities” under the Securities and Futures Ordinance. Only licensed and registered entities may engage in regulated activities, under the SFC’s watchful eye.

Further warnings followed in December 2017 and February 2018, when the SFC issued circulars highlighting the risks of becoming involved in cryptocurrency-related investment products, ICOs and cryptocurrency exchanges. These warnings culminated in March 2018 in the SFC taking action against an ICO issuer named “Black Cell” for allegedly offering digital tokens redeemable for equity shares. The SFC stated that this amounted to a regulated “collective investment scheme”, and Black Cell was forced to halt its token sale and reverse all Hong Kong transactions.

The fact that the SFC is now turning its attention to cryptocurrency exchanges should come as no surprise. Such exchanges often play a key role in the flow of “fiat” currencies into and out of the digital token economy, which makes them a prime target for regulation. Major concerns identified by regulators include protecting investors from extreme price volatility and market manipulation, and the potential use of exchanges to facilitate money laundering and other criminal activities. Perhaps, most troubling of all are the potential cybersecurity risks of trading on exchange platforms, which have been demonstrated by several high-profile events such as the US$500 million hack of Japanese exchange Coincheck in January 2018.

The SFC’s next move, under its new chairman, Tim Lui Tim-leung, will be watched closely by all those involved in this nascent industry. Hints at the likely direction regulation will take may be gleaned from other parts of the world. While certain jurisdictions, such as Mainland China, have taken a hard line on digital token issuers and exchanges, banning many of their activities outright, it is unlikely that the SFC will take this approach. It is more probable that Hong Kong will draw on the more positive models adopted in other major financial centres. For example, the US and Japan have introduced requirements for cryptocurrency exchanges to be registered with local regulators, although so far they do not have a comprehensive regulatory framework in place. More progressive frameworks are currently being constructed in smaller jurisdictions such as Gibraltar and Malta.

A key challenge facing the SFC will be to introduce regulation which adequately protects the investing public without establishing overly large financial and practical barriers to compliance. If this balancing act can be achieved, regulation should be a positive move – both for Hong Kong’s fintech sector, providing much-needed certainty to exchange platform operators and their customers, and for its economy as a whole, allowing Hong Kong to take full advantage of its position as one of the world’s leading financial centres when participating in this emerging market.

In the meantime, exchanges and other cryptocurrency-related businesses should do all they can to prepare for regulation, including implementing adequate KYC (client due diligence), AML, counter-terrorism and cybersecurity measures.

(Excerpt) Read more Here | 2018-10-26 15:01:55

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