Is Cryptocurrency Legal In Hong Kong

Government attitude

Over the course of the last three years, Hong Kong’s regulators have been expanding their jurisdiction and remit over activities in relation to cryptocurrencies with a view to non simply offering ameliorate investor protection, but also building a harmonised regulatory framework across the entire ecosystem such that Hong Kong becomes a hub for cryptocurrency action in the region.

In 2018, the Securities and Futures Commission (the “SFC”) (Hong Kong’s securities regulator) introduced a compulsory licensing authorities for the management of portfolios of virtual assets (“VAs”) in circumstances where managers that were already licensed for traditional securities direction propose to include VAs in their portfolio in excess of 10% or more than of the gross value of their assets nether direction (“AUM”).

At the aforementioned time, recognising that the limit of its jurisdictional reach simply extended to assets that are divers equally “securities” nether the Securities and Futures Ordinance (Cap. 571) (the “SFO”) (and that many VAs do non fall into this category just are, instead, more likely to be “utility tokens”), the SFC also introduced an “opt-in” authorities for managers not previously licensed for traditional asset management, who now want to become VA managers and regulated by the SFC.

In 2019, the SFC further launched an opt-in licensing regime (the “Opt-in Authorities”) for virtual asset service providers (“VASPs”) looking to operate VA exchanges in Hong Kong.  And, most recently in June 2022, the SFC announced a mandatory licensing regime for VASPs who seek to (a) concur client avails, and (b) provide services (by electronic means) whereby (i) offers to sell or purchase VAs are regularly made or accustomed, or (ii) persons are regularly introduced to each other for the purpose of negotiating or final sales or purchases of VAs (in each case in the mode that results in a bounden transaction).  Such mandatory licensing authorities is expected to come into force in 2023 upon the passing of the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the “Subpoena Bill”).

In line with the expanding net of regulations over cryptocurrency activity and services, there has been an increasing number of participants (managers, traders, exchanges, etc.) applying for and receiving licences from the SFC.  To appointment, the SFC has issued seven Blazon ix VA licences (for direction of a portfolio of 100% VAs), and at least one hybrid licence for a Type 9 asset manager to manage a fund of crypto funds.

In January 2022, the SFC and the Hong Kong Monetary Authority (“HKMA”) (Hong Kong’south cardinal banking institution) issued a joint round (the “Articulation Circular”) expanding the accomplish of regulation to diverse other types of regulated action involving VAs, including distribution activities, dealing services and advisory services, and requiring these service providers to comply with additional requirements, such every bit ensuring suitability, providing adventure-related disclosures and conducting proper due diligence when providing services in relation to VAs.

From all of the above, it is fair to say that government mental attitude in Hong Kong to cryptocurrency action is certainly welcoming and inclusive, although information technology should exist noted, at this stage, that beyond all the different types of regulatory licences that accept been issued so far (and in respect of all the different regimes), the provision of services is restricted only to “professional person investors”.
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  Importantly, regulated participants are not allowed to provide cryptocurrency-related services in (or into) Hong Kong to the retail public, and to date at that place are no retail products that take been approved for retail consumption.  Nosotros expect this trend to continue at least in the curt to medium term.

Definition

Under Hong Kong police, cryptocurrencies are non legal tender regulated by the HKMA and do not qualify as coin.  There is currently no cryptocurrency that is backed by the Hong Kong government.  In the Joint Circular, the SFC and the HKMA adopted the definition in the SFC’s Position Paper published on 6 November 2019, referring broadly to “VAs” as digital representations of value that may be in the form of:

1. digital tokens (such as utility tokens, stablecoins or security- or asset-backed tokens); or
2. any other virtual commodities, crypto avails or other assets of essentially the same nature,

irrespective of whether or non they corporeality to “securities” or “futures contracts” as defined under the SFO.  However, digital representations of fiat currencies issued by central banks were expressly excluded from the definition of “VAs”.

In the Subpoena Bill, “VA” is defined in more item as a digital representation of value that:

1. is expressed as a unit of account or a store of economical value;
2. (i) functions (or is intended to part) equally a medium of commutation accepted by the public (one) as payment for goods or services, (ii) for the discharge of a debt, or (3) for investment purposes, or (ii) provides rights, eligibility or admission to vote on the direction, administration or governance of any cryptographically secured digital representation of value; and
3. can be transferred, stored or traded electronically (e.chiliad. Bitcoin or other stablecoins).

Such definition is consequent with the one adopted by the Financial Action Task Force (the “FATF”) and will include cryptocurrencies.

The Subpoena Bill has also explicitly carved out, from the definition of VA, a digital representation of value that (i) is issued by central banks, (two) constitutes securities or a futures contract that are already regulated under the SFO, (iii) constitutes a stored value facility, or (iv) is a express purpose digital token (“LPDT”).  In the Financial Services and the Treasury Agency’s (the “FSTB”) Consultation Conclusions, LPDTs are defined as assets that are non-transferable, non-exchangeable and non-fungible in nature.  In line with the FSTB’s interpretation, the Amendment Beak further provides that LPDTs include (i) customer loyalty or reward points, (two) in-game assets, and (iii) tokens like to (i) and (2) that are not intended to exist convertible into money or another medium of substitution accustomed by the public.

Importantly, in a round
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issued on 1 Nov 2018, the SFC drew the distinction betwixt utility and security tokens (see further below).

Stablecoins

Stablecoins are generally considered a subset of VAs, and are also currently not legal tender in Hong Kong.

In the Discussion Paper on Crypto-assets and Stablecoins
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published in January 2022, the HKMA expressed the need for stablecoins to be appropriately regulated before they are marketed to the public in Hong Kong, as their “pegging” characteristics may create the perception to investors that they have college potential for being incorporated into the mainstream financial system.  The HKMA intended to focus initially on activities related to payment-related stablecoins, peculiarly asset-linked stablecoins (e.g. to a single fiat currency).  As such, certain stablecoin-related activities carried out by an entity incorporated in Hong Kong (eastward.chiliad. facilitating the redemption of stablecoins and executing transactions in stablecoins) are likely to be considered regulated activities and may require a licence granted by the HKMA.

In Hong Kong, cryptocurrencies are considered a form of VA that are generally categorised either every bit security tokens or not-security tokens (e.g. utility tokens).  Currently, simply security tokens are regulated in Hong Kong by the SFC.

Security tokens

Security tokens are also known every bit “tokenised securities”.  Depending on the extent and blazon of activities, activities in relation to these security tokens may exist considered “regulated activities” that can only exist carried out with the relevant licence(southward) issued by the SFC (e.thou. dealing in and advising on security tokens).

Cryptocurrencies will be deemed security tokens if they fall within the definition of “securities” under the SFO.  In its Argument on initial coin offerings (5 September 2017),
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the SFC farther clarified that digital tokens (including any cryptocurrencies) may exist considered “securities” if they:

• stand for equity or buying interests in a corporation;
• create or acknowledge a debt or liability owed past the issuer;
• pay regular returns to investors that amount to dividend or interest; or
• requite their holders rights alike to that of a creditor or a shareholder (e.g. voting rights or the right to participate in the distribution of the corporation’s surplus assets upon winding up).

Therefore, most stablecoins and cryptocurrencies (eastward.g. Bitcoin and Ether) in the market are non regarded every bit securities by the definition under the SFO.

Non-security tokens

In dissimilarity, cryptocurrencies other than security tokens are considered “non-security tokens” or “virtual commodities” and are currently unregulated.

Opt-in Regime for VA trading platforms

In spite of this, the SFC does offer the Opt-in Regime for centralised VA trading platforms trading at least 1 security token to apply for Type 1 and Type 7 licences.  This Opt-in Government is voluntary, with the idea that participants who choose to submit themselves to SFC oversight can then say they are regulated by a reputable regulator in the APAC region.  Nonetheless, the Opt-in Regime is quite restrictive as, among other things, participants need to find at least one security token to list, and tin only offer their services to “professional investors” as defined nether the SFO.

Upcoming Mandatory VASP Licensing Government

On 24 June 2022, the Hong Kong government published the Amendment Pecker in the Gazette, which proposed a mandatory licensing regime for VA exchanges (the “Mandatory VASP Licensing Regime”).  Under the Mandatory VASP Licensing Regime, a person operating a VA exchange in (a) Hong Kong, or (b) elsewhere but actively markets to the Hong Kong public, volition be regarded as carrying out a “regulated activeness” for which a licence from the SFC is required.

Dissimilar the Opt-in Regime, which only regulates trading platforms trading security tokens, the Mandatory VASP Licensing Regime expands the SFC’s jurisdiction to comprehend the trading of non-security tokens.  Nether the Mandatory VASP Licensing Regime, a licence must be obtained insofar every bit it involves the trading of VAs (every bit defined in a higher place) even if they are non-security tokens.

Moreover, licensed VASPs can just provide services to “professional investors” and non retail investors.  According to the Securities and Futures (Professional Investor) Rules, VA holdings do non count towards the portfolio required for individual investors to qualify as a “professional investor”.  Therefore, licensed VASPs are prohibited from offering services to investors who only hold VAs in the equivalent amount that meet the portfolio threshold for “professional investors”.  Nevertheless, the regulators have emphasised that they will continue to review their position on the service offering brake on retail investors every bit the market becomes more mature.

In line with the existing licensing regime for carrying out regulated activity under the SFO, the Mandatory VASP Licensing Regime as well imposes certain baseline requirements on potential applicants.  For example, applicants must: (one) have sufficient presence in Hong Kong; (two) appoint at least 2 responsible officers (“ROs”) to ensure compliance with the anti-money laundering (“AML”) and counter-terrorist financing (“CTF”) requirements under Hong Kong’south Anti-Money Laundering and Counter-Terrorist Financing Ordinance (the “AMLO”), and appoint at to the lowest degree one of the ROs as an executive director of the applicant; and (3) see the fit-and-proper test.

On granting a VASP licence, the SFC may impose whatsoever weather condition on the licence, including simply not limited to (a) financial resources, (b) knowledge and experience, (c) chance direction policies and procedures, (d) AML/CTF policies and procedures, (e) management of customer assets, (f) soundness of business, (g) financial reporting and disclosure, (h) VA listing and trading policies, (i) prevention of market place manipulation and abusive activities, (j) avoidance of conflicts of interests, (k) keeping of records and accounts, and (50) cybersecurity.

Upon passing of the Amendment Bill, the Mandatory VASP Licensing Regime will take consequence on 1 March 2023 (the “Constructive Engagement”) with transitional arrangements bachelor.

VA management

In October 2019, the SFC introduced a new licensing regime for businesses directly managing a portfolio of VAs (the “Type nine VA Licensing Regime”).

Under the Blazon nine VA Licensing Regime, managers who currently hold a regular Blazon nine (Asset Management) licence (“Type 9 Licence”) (“Blazon 9 Managers”), and who seek to directly manage a portfolio of VAs that account for 10% or more of the portfolio’s gross asset value (“GAV”), must aggrandize their licences to a Type 9 VA licence with additional terms and conditions
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(the “
Pro Forma
T&Cs”) imposed on their existing Type ix Licences.  The
Pro Forma
T&Cs provide for, amongst other things, general principles relating to VA fund management, organization and management structure of VA fund managers, direction rules (due east.chiliad. best execution, prohibition on market place misconduct, order allocation, participation in initial offerings, cross trades, take a chance management, leverage, liquidity management), custody of portfolio assets and customer monies, record keeping, audits, portfolio valuation, marketing activities, fees and expenses, and reporting obligations to the SFC.

Still, Type 9 Managers managing a portfolio of VAs that account for less than 10% of the portfolio’s GAV volition only need to notify the SFC that they intend to manage such VAs (without requiring the SFC’s consent).

New managers who wish to manage a portfolio of pure VAs (regardless of whether their portfolios consist of any “securities”) may also choose, but are non required, to apply for a Type 9 VA licence and bailiwick themselves to the jurisdiction of the SFC.

Managers with a Type 9 VA licence (“Type 9 VA Managers”) are subject to different restrictions imposed by the SFC.  For instance, Type 9 VA Managers tin just manage VA portfolios for “professional investors”.  There is besides a minimum liquid upper-case letter requirement of HK$3 one thousand thousand and minimum paid-up capital requirement of HK$5 million for Type 9 VA Managers.  Post-obit the Effective Date of the Subpoena Bill, Type 9 VA Managers are expected to cull licensed VASPs if they wish to trade VAs through trading platforms.

In improver, Type 1 (Dealing in Securities) licensed corporations (“Type one Intermediaries”) who manage funds solely investing in VAs that are not “securities” or “futures contracts” and distribute the aforementioned in Hong Kong must also attach to the
Pro Forma
T&Cs
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on their licences.

Crypto fund of funds

For new managers who wish to manage a crypto fund of funds, the SFC has a “halfway house” regime, which does not require the incorporation of
Pro Forma
T&Cs simply imposes requirements in addition to that of a regular Type ix Licence, such equally restricting the provision of services to “professional person investors” only and prohibiting managers from belongings “client assets” as defined under the SFO.

Delight refer to “Cryptocurrency regulation” in a higher place for the current and hereafter regulatory framework on trading cryptocurrencies on exchanges and the licensing authorities for management of funds in relation to VAs.

Distribution of VAs

In the Articulation Round, the SFC and the HKMA confirmed that VA products are likely to be considered “complex products” under the SFO.  As such, distribution of whatever VA products must comply with the SFC’s guidelines, such as (a) ensuring suitability, (b) providing specific run a risk-related disclosures, and (c) conducting proper due diligence on the product (including their risks and features, the investor target and the regulatory status).  When distributing VA products, intermediaries must ensure their clients accept sufficient internet worth to be able to assume the risks and conduct the potential losses of trading VA products (the “Sufficient Cyberspace Worth Requirement”), and where VA products are offered on online platforms, there are appropriate access rights and controls to ensure compliance with selling restrictions.

For VA derivatives, intermediaries must comply with the boosted requirements under paragraphs five.1A and five.3 of the Lawmaking of Conduct for Persons Licensed by or Registered with the SFC (such as the Sufficient Net Worth Requirement and the client’s knowledge requirement, both in relation to “derivatives” specifically).

Overseas VA not-derivative exchange traded funds (“ETFs”) or other ETFs that invest directly in VAs are also considered complex products in the Joint Circular and must only be offered to “professional person investors” subject to suitability requirements.  However, a limited number of overseas VA-related derivative products that are traded on SFC-specified exchanges and have been approved for retail distribution by their relevant habitation regulators may be distributed to retail investors without the demand for complying with the suitability requirements.

Nevertheless, when intermediaries distribute VA products that are circuitous products to individual “professional investors”, they must (a) ensure that the clients have sufficient knowledge near VA investments (“VA Noesis Test”), and if the client does non, (b) proceed simply (i) when information technology is in the client’s best interests, and (ii) when the intermediary has provided relevant preparation to the client.

Finally, where an intermediary is providing financial accommodation in relation to VA products, information technology must ensure that the client has the financial capacity to meet obligations arising from leveraged or margin trading in such VA products.

Dealing in VAs

Dealing services in relation to VAs that are “securities” can but be provided by Blazon i Intermediaries.  Yet, the SFC has stated that the services of dealing in non-security VAs autumn outside the SFC’s jurisdiction, implying that such services may exist provided past non-intermediaries.

When providing VA dealing services, Type one Intermediaries must only partner with SFC-licensed VA trading platforms and must not allow clients to withdraw or eolith fiat currencies from their accounts held by the intermediaries.  Type 1 Intermediaries must besides only provide VA dealing services to “professional investors” who are existing clients to whom the Type 1 Intermediary is providing Type ane dealing services.  When they act as introducing agents to SFC-licensed platforms, Type 1 Intermediaries should only introduce “professional investors” and cannot relay club or hold client assets.

In addition, Type ane Intermediaries must comply with Role I of the terms and weather set out in Appendix vi to the Joint Circular,
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which impose some general requirements (such as tape keeping, audit, AML/CTF and ongoing reporting obligations) and some specific requirements in relation to VAs, which crave intermediaries to:

1. maintain excess liquid upper-case letter equal to 12 months of their actual operating expenses calculated on a rolling basis;
2. establish omnibus accounts for clients designated as trust or client accounts on SFC-licensed VA platforms;
3. accept client agreement with specific disclaimers and disclosures in place;
4. concur VAs on trust in segregated accounts on SFC-licensed platforms; and
5. hold client money in segregated bank accounts.

Hong Kong adopts a territorial principle of taxation, where only a person carrying on a concern in Hong Kong and deriving profits sourced in Hong Kong from that business are liable to Hong Kong profits tax (at a tax rate of xv% for unincorporated businesses and sixteen.5% for corporations).  It is characterised by cardinal features such as no turnover tax (eastward.g. value-added revenue enhancement, goods and services revenue enhancement), no majuscule gains taxation, generally no tax on dividend income, and no withholding tax on dividends and interest.  From 1 January 2023, four types of offshore passive income, namely dividends, interest, disposal gains in relation to shares or equity interest, and income from intellectual holding (“IP”), received in Hong Kong will continue to be not-taxable only if certain conditions (e.g. economic substance requirement for not-IP income, nexus approach for IP income) are met.

Tax of cryptocurrencies

While no specific laws are in place on the taxation of cryptocurrencies, the Inland Revenue Department (the “IRD”) issued the revised Departmental Interpretation and Practice Notes No. 39 (“DIPN 39”) in March 2020, which provides guidance on the digital economy, electronic commerce and digital avails.  The following are highlights of the section on the taxation of digital assets:

• The profits revenue enhancement treatment of digital assets depends on their categorisation (payment token, security token or utility token).
• The proceeds of an initial money offering are taxed by following the attributes of the token that is issued.  If security tokens are issued, gain would mostly be considered capital letter in nature.  If utility tokens are issued, proceeds would generally be taxable if found to exist sourced in Hong Kong.
• Digital assets held for long-term investment purposes may be considered capital in nature, in which case their disposal would result in capital gains (which are non taxable in Hong Kong).  Whether digital avails are held for long-term investment purposes or as trading stock depends on the facts and circumstances with reference to well-established principles such as the “badges of merchandise”, and the intention at the time of conquering is always relevant.
• New cryptocurrencies received in the course of a cryptocurrency business organisation (east.g. airdrops and blockchain forks) are to be regarded as receipts of the business and assessed accordingly.
• Cryptocurrency received by an employee as employment income should be reported at its market value and subject to the aforementioned salaries tax treatment every bit regular remuneration.

As the revised DIPN 39 was issued in 2020, it does not encompass bug arising from more than recent developments such equally decentralised finance (“DeFi”), staking and non-fungible tokens (“NFTs”).  As it more often than not takes longer for the IRD to update a DIPN, hereafter guidelines may potentially be provided in the form of frequently asked questions (“FAQs”) on the IRD’due south website.

VA funds and the Unified Fund Exemption

The list of qualifying avails included in the Unified Fund Exemption regime includes securities and other types of financial products.  Equally almost digital assets are non considered securities, these would not be qualifying assets for purposes of the exemption.

VA borrowing and lending

DIPN 39 does not address VA borrowing and lending.  As cryptocurrency is more often than not not “stock”, relief for stock borrowing and lending is not applicable.  Also, as cryptocurrency is not “money”, provisions in relation to “interest” that make reference to money are not applicable.

Money transmission laws

In that location is currently no specific legislation in Hong Kong on the transfer of cryptocurrencies between individual parties.  However, if the manual of cryptocurrencies includes the conversion into fiat currencies in substance, such transmission may be deemed a money remittance transaction, which will be subject to the AMLO.  According to Section 3(one) Schedule 2 of the AMLO, a fiscal institution must carry out customer due diligence (“CDD”) measures in relation to a customer for a wire transfer equal to or exceeding an aggregate value of HK$eight,000, whether carried out in a single performance or several operations that appear to the financial institution to be linked.  Records relating to CDD and transactions should be kept for at least 5 years from the date of transaction.

Anti-money laundering requirements

The AMLO in Hong Kong applies to financial institutions (including HKMA-authorised institutions (i.eastward. banks), SFC-licensed corporations, licensed insurance companies, stored value facility issuers and coin service operators) and designated non-financial businesses and professions (for example, lawyers, certified public accountants, licensed manor agents, and trust and company services agents).  Thus, all SFC-licensed entities conducting regulated activities are subject to the AML/CTF obligations of the AMLO, which also include licensed VASPs under the new government as mentioned above.  The regulated bodies should likewise ensure compliance with the FATF’south latest recommendation.

On the other hand, fund managers that manage funds investing only in cryptocurrencies that are not securities or futures contracts will non require a Type 9 Licence because this will not exist considered a regulated activity.  Since they are non licensed entities, they will not be subject to AMLO requirements.  This is likewise reinforced by the Argument
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in relation to “Bitcoin” and Money Service Operator Licence issued by the Money Service Supervision Bureau of the Customs and Excise Department (the “CED”) in Apr 2014, in which the CED stated that, for the purposes of the AMLO, Bitcoin or other similar virtual commodities are non “money” and autumn outside its jurisdiction.

On 29 September 2017, the SFC issued a round
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to announce the establishment of the SFC Regulatory Sandbox (the “Sandbox”).  The aim of the Sandbox was to provide licensed corporations and startup firms with a confined regulatory environs in which to operate regulated activities under the SFO before any fiscal technology (“Fintech”) is used on a fuller scale.

Initially, the SFC invited interested VASPs that had already obtained a Type 1 (Dealing in Securities) licence together with a Type 7 (Automatic Trading Services) licence to participate in the Sandbox.  The SFC so closely monitored the operation of the qualified platform operator for a minimum of 12 months, afterwards which they could apply to leave the Sandbox so as to be regulated in the aforementioned way as other licensed providers of automatic trading services operating outside of the Sandbox.  During the 12-month catamenia, the VASP also had to list at least ane VA token that had features of a “security” every bit defined under the SFO (that is, a “security token”).  OSL Digital Securities Express became the starting time participant to successfully have part in this sandbox regime and became the first SFC-licensed VA substitution in Hong Kong.

Similarly, the HKMA launched the Fintech Supervisory Sandbox on 6 September 2016 to facilitate the pilot trials of Fintech and other engineering initiatives of authorised institutions before they are launched on a fuller scale.

There is no reporting requirement for cryptocurrency payments in Hong Kong.

The CDD measures as required under the AMLO will only be triggered if in that location is an commutation of fiat currency of an amount equal to or in a higher place HK$eight,000.  Equally mentioned in “Money transmission laws” above, fiscal institutions should retain records relating to CDD and transactions for at least 5 years from the appointment of transaction and study any suspicious transactions.

Nether Hong Kong constabulary, all of a deceased’due south property volition laissez passer to the beneficiaries according to a valid will made pursuant to the Wills Ordinance (Cap. 30) or, in the absence of a will, be distributed in accord with the Intestates’ Estates Ordinance (Cap. 73).  Inheritance taxation was abolished in 2006.

In general, property can be categorised as (i) movable, (2) immovable, (3) tangible, or (4) intangible property.  The rules of determining the governing police of succession will differ depending on the category in which the relevant property falls.

The Hong Kong courts have recognised cryptocurrency as a form of holding since proprietary remedies were granted in a fraud case involving cryptocurrency.
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  Equally such, the treatment of cryptocurrency upon an possessor’s death is probable to follow the general succession rule in Hong Kong applicable to all other property as discussed to a higher place.

In line with the other common law jurisdictions, cryptocurrency, as a type of VA, is likely to be treated as intangible property due to its nature of beingness “an identifiable thing of value”,
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such that the law of the jurisdiction in which the cryptocurrency is located would not employ (in contrast with immovable property).

Nevertheless, thorough estate planning should be carried out to ensure that the value of cryptocurrency can be transferred upon the user’s expiry (since funds in the crypto wallet may be irrevocably lost when hard drives are misplaced or individual keys non safely kept).

Acknowledgments

Special thank you to the following for their contribution to this chapter: Esther Lee, Agnes Pang, Stephanie Chen and Karen Austin from Tiang & Partners; and Gwenda Ho, Ollie Roberts and Tommy Hui from PwC Hong Kong.