However, three individuals familiar with but not allowed to speak publicly on the application process told CoinDesk that obtaining a new license could cost anywhere between $12 million and $20 million.
Their estimates took into account operating costs leading up to the license and payments for necessary vendors for the application itself, including consultants, lawyers and insurance providers.
OSL and HashKey are part of larger financial services groups and may have the funds to spare, but the cost of consideration under the new rules will be prohibitive for many firms.
Licensing consultants can charge up to $1 million to advise companies on the application, a person familiar with the matter said. Exchanges are required to maintain a paid-up share capital of 5 million Hong Kong dollars ($640,000), and liquid capital of at least $380,000. They must hold liquid assets equivalent to at least a year of operating expenses, not counting virtual assets.
Companies will have to invest in capabilities that ensure segregation of client funds, safe custody of assets, pay for smart contract audits and overall corporate governance. Before onboarding investors, firms will need to assess their knowledge of virtual assets.
Firms must also have a local presence with seed phrases and private keys (with backups) stored in Hong Kong. They must hire compliance officers known as licensed responsible officers (ROs), to make sure the business meets the regulatory requirements, and each applicant is required to have at least two ROs. ROs typically charge a premium for their services due to high demand.
“We will have this natural selection of players in the market,” Alessio Quaglini, CEO of Hex Trust, told CoinDesk. Hex Trust is planning to apply for a Hong Kong license for its own exchange HTX.
The announcement of a licensing regime has prompted a rush for applications but industry members know that not all will meet the regulator’s benchmark.
SOMA.finance Co-Founder Will Corkin said that small exchanges that might not have large trading volume or don’t have a track record of doing things the right way are “up for a pretty difficult battle” to get licensed.
Robert Zhan, KPMG China director of risk consulting, pointed out that only eight banks attained virtual bank licenses even though there were “a significant number of parties” interested.
Zhan explained that the Securities and Futures Commission has shared its “minimum criteria” for applicants. As well as meeting those requirements, applicants need to ensure they are “presenting the strongest possible case to support their application,” Zhan said.
China’s regulatory sandbox
Despite China’s ban on its own population trading virtual assets, Hong Kong’s residents have the implicit go-ahead. Conferences have started again in the city, with attendees flying in from Singapore and Dubai to see if Hong Kong is truly open.
“I’m sure that was not easy,” Stratford Finance CEO Angelina Kwan said, referring to Hong Kong getting approval to be China’s regulatory sandbox for digital assets. However, Hong Kong functions as a sort of testing ground for other forbidden activities on Mainland China. Hong Kong is home to international capital markets and allows betting on horse races (Chinese citizens cannot directly invest in overseas stocks and gambling is banned).
The hope is that once platforms begin to obtain licenses, investors can move fiat currency from banks onto trading platforms, trade in fairly liquid markets, and have exposure to virtual assets.
“People want to have the Securities and Futures Commission, regulatory bodies like that, behind them,” Corkin told CoinDesk.
“The 2017 days of opening up exchanges based out of small European countries doesn’t really hold the same as it did back then,” Corkin said.
Holding licenses issued by a globally respected financial regulator means that licensed platforms are far more likely to meet internal standards of investment firms, thereby allowing for more capital to enter.
The biggest fanfare has been made about the regime’s allowing platforms to serve retail investors. Retail trading has been going on in Hong Kong in a gray area with investors turning to global exchange Binance and buying NFTs on OpenSea (the latter remains unregulated).
But derivatives, the largest money-maker for exchanges, are still off the cards. The regime will only permit investors to trade large-cap coins.
Tokens will need to be listed in two acceptable indices, and go through due diligence. They will need to have a one-year track record. The background of developers will be checked, as will supply, demand and liquidity.
Under the regime, platforms cannot choose external custodians. They must handle custody themselves. One of the heaviest requirements on platforms is that they must have insurance or compensation which covers the potential loss of 50% of client virtual assets held in cold storage.
Quaglini said that this cost will be borne by loss-making companies, or the end user who has the option of using offshore exchanges.
In his view, there should be a few credible institutions specialized in custody that can bear insurance costs. A few specialized players would mean they can operate a profitable business.
“It’s going to be very hard to create competitive players,” he said.
Kwan, who used to work for the Security and Futures Commission, explained the regulator’s requirement on exchanges handling their own custody as needing to know who to hold accountable. “It’s one throat to choke,” Kwan said, also pointing to potential security risks with connectivity.
Since crypto exchanges are required to have ties to a bank in order to apply for the license, Hong Kong’s de facto central bank, the Hong Kong Monetary Authority, has been holding roundtables inviting banks and virtual asset players to attend, the first in April and another in June.
Companies have found it difficult to maintain reliable banking relationships, with some fearing that even if they manage to open accounts, they may be closed down. Consultancies have been giving presentations to compliance teams in banks to bring them up to speed on what risks to look for.
Finding the right insurance and even a provider has also been an issue for applicants. Kwan said that some companies wrongly end up buying specie insurance rather than comprehensive coverage or fiduciary liability insurance.
Like the banks, insurance companies are also unsure about working with crypto.
Annie Hui, co-founder of digital asset security firm Custonomy said that she hopes that, as the guidelines are refined, that proof of solvency will be integrated into the regime. This would mean that platforms have in place mechanisms to prove that the total amount of assets held in custody is larger than the total amount of liabilities.
Stablecoins are not permitted so far. OKX global’s Chief Commercial Officer Lennix Lai said their unavailability for retail trading was a “temporary arrangement” and added he is “cautiously optimistic” that they will be made available, once the HKMA issues its conclusions on stablecoins. Whatever happens, it is clear that algorithmic stablecoins like the now defunct terraUSD will not be allowed.
The two already have a financial asset link in the form of the Shanghai-Hong Kong Stock Connect program, which allows qualified investors in mainland China to access eligible shares listed on the Hong Kong Stock Exchange and vice versa.
Users can access spot trading, earn products, and an non-fungible token (NFT) marketplace. They will be able to trade 34 tokens, including the Binance Smart Chain’s native token BNB, which is available in Japan for the first time.
Hong Kong was once a crypto hot spot, home to initial coin offerings and exchanges galore, before regulators began knocking on doors and talking about banning retail investment, which scared most industry participants away to other jurisdictions.
Johnny Ng is working to bring them back, with inadvertent help from U.S. regulators.
Elected to LegCo last year, Ng has arguably become the de facto head of the legislature’s crypto caucus. He has lobbied Hong Kong chief executive John Lee to support digital assets in a high-profile way. This year, Lee gave a speech at the inauguration of the Institute of Web 3.0 Hong Kong. It was a big deal given Hong Kong’s former status as a crypto hub.
On the city’s Web3 push, Ng said, “I wouldn’t say it’s just me, but I am a part of it.”
I recently met Ng for lunch in the Admiralty district of Hong Kong. We went to what he called his canteen, an upscale dim sum place with a view of the harbor. The shrimp dumplings came each in its own little basket, with gold brushed onto their skin. The staff knew his favorite table, slightly secluded from the rest, and addressed him as Legislator Ng.
Ng said he first heard about Bitcoin around 2011 when he was working on facial recognition technology. A friend asked if he wanted to start mining. Ng said he wasn’t convinced then.
Six years later, when BTC was trading at a couple thousand dollars, he read the Bitcoin white paper and became interested. He started to look into why it was valued, attended local meetups and found true believers.
Now he’s one too. Since becoming part of LegCo last year, he’s been promoting Web3.
Being a member of Hong Kong’s LegCo isn’t a full-time job so Ng also co-founded an accelerator for Web3 startups called G-Rocket. He claimed there’s no conflict of interest because he declared his stake on a public registry and has recused himself from voting on Web3-related bills.
New licensing regulations
Exchanges have to get licenses under Hong Kong’s new regulations to provide virtual asset trading services, and they will be operating under defined and strict parameters. For prospects like Coinbase, this is potentially appealing because they now have a clear route to operate under regulation.
While a great deal has been made about allowing retail investors access to virtual assets, the coins Hong Kong residents will be able to access will be limited to those with large market capitalization that meet other criteria, including having a 12-month track record and being included in two indices that meet the regulator’s guidelines.
The most common question Ng has fielded from licensed players is whether they can list more types of coins, but he said there will need to be meaningful volume first and Hong Kong is taking it “step by step.”
So far, only OSL and HashKey Group have Type 1 and 7 licenses under the previous opt-in regime, which means their applications for a license under the new regime should be smooth. When I said to Ng that at least one of those two isn’t profitable, Ng said you can’t judge the licensing regime from the first two platforms that come under it. “To be honest,” he said, “no one knows what they’re doing. They’re not very into this, they just got the license first.”
Only larger players may be able to get licenses, he said, given the requirements for capital, hiring of responsible officers and experience.
“Bigger exchanges are more stable,” Ng said, though he hedged by saying there’s no certainty. “Even the biggest can fall.”
Ng is quick to say that “Hong Kong isn’t a country, it’s just an administrative region” of mainland China. But he said the “One Country Two Systems” model allows Hong Kong to do things which suit it.
“In the previous government [under former chief executive Carrie Lam], the opposition made passing laws a mess because they kept filibustering,” Ng said. (The opposition Democratic Party members resigned en masse after members were disqualified for supporting Hong Kong independence and refusing to recognize Beijing’s sovereignty over the city). “If you slow down government,” he said, “it doesn’t work.”
There is still the question of whether Hong Kong will fall in line with Beijing’s stance on crypto. Ng said Beijing was never against the tech, just the hype, which lured retail investors into bad investments. “China has 1.4 billion people with different levels of education,” he said.
Ng is part of a consultative body, the Chinese People’s Political Consultative Conference, which plays an advisory role to the mainland Chinese government. Wearing that hat, Ng submitted proposals to the Chinese government on blockchain in 2018 and Web3 earlier this year. He said he hasn’t received a response to either.
One reason Ng gave for advocating on behalf of Web3 is the technology’s potential to increase social mobility for young people. “Being born in the ’80s makes you a crypto elder,” he said.
The grandson of a migrant from Zhongshan in China, Ng said he grew up poor, born on the Kowloon peninsula. It’s a long held joke in this city that the richest don’t leave Hong Kong Island, across the harbor from Kowloon.
Looking back on his youth, he said the same families who were rich then in Hong Kong remain the richest now.
“Traditionally successful entrepreneurs may not be interested in this industry,” he said. “Even if they are, they might not know how to play it.”
I asked Ng whether he’s going to tweet an invite to Binance, the largest crypto exchange globally, which like Coinbase has been targeted by the U.S. SEC. Unlike Coinbase, which is unequivocally a U.S. company, Binance has at times been cagey about where it’s headquartered, and SEC charges against the exchange go beyond allegedly listing unregistered securities: Binance is also accused of allowing commingling of funds, inflation of trading volume, and actively skirting regulation.
“Binance?” Ng said with a laugh. “Yes, I didn’t mention that name.” He explained that he invited Coinbase because it’s publicly listed (unlike closely held Binance). If Coinbase were to come, it’d show Hong Kong policy is competitive.
No more named invitations are forthcoming, Ng said. “Everyone is welcome.”
Led by supporters of the ousted leader Aung San Suu Kyi, the Spring Development Bank (SDB), will target Suu Kyi supporters as customers, including the Burmese diaspora, the spokesperson said. The NUG’s stance is that it is the legitimate sovereign and government of Myanmar, not the military junta.
Under the new rules, companies will need to disclose information about the quantity, characteristics, business models and accounting policies regarding the sale of virtual currencies as well as profits, volume and market value of their crypto.
Stablecoin issuers will have to abide by tough rules. Stablecoins must be pegged to the yen or other legal tender and guarantee holders the right to redeem them at face value. Only licensed financial institutions like licensed banks, registered money transfer agents and trust companies will be able to issue stablecoins.
The legislation, which will take effect next year, is compiled from 19 proposals from lawmakers. It defines digital assets and sets out penalties for unfair transactions. Service providers must segregate user assets, have insurance, hold some reserves in cold wallets and maintain records of all transactions.
Under the rules, crypto exchanges are to maintain at all times no less than 5,000,000 Hong Kong dollars ($640,00) in capital, and at the end of each month, submit the platform’s available and required liquid capital, a summary of bank loans, advances, credit facilities as well as a profit and loss analysis to the SFC. Approved tokens on regulated exchanges need a 12 month “track record,” according to the rules.
The Securities Commission Malaysia (SC) ordered Huobi Global to stop operations in the country, including disabling its website and mobile applications, because it is operating a digital asset exchange without registration.
Ripple will show the use case for its platform under the e-HKD pilot, a program run by the Hong Kong Monetary Authority, the de facto central bank. It is also working with Taiwan’s Fubon Bank, to build a product for real estate asset tokenization and equity distribution, under the e-HKD pilot.
Amidone all the talk of licensing and regulations in Hong Kong, “not all crypto-related activities require a license,” Lee continued. “You may be operating in an unregulated space, but this does not mean it’s illegal,” he said.
The ruling People Power Party said that it would launch an internal task force to investigate Kim’s cryptocurrency transfers on Monday. Rep. Yun Chang-hyeon, who heads the special committee on digital assets will head the task force, along with Rep. Kim Sung-won.
Rep. Kim Nam-kuk of the Democratic Party of Korea allegedly withdrew 800,000 WEMIX tokens from late February to early March in 2022, and the transactions were reported to the Financial Services Commission’s Financial Intelligence Unit (FIU), according to CoinDesk Korea. Kim’s WEMIX holdings stood at six billion won ($4.5 million) between January and February 2022.
In November last year, Binance acquired regulated crypto exchange Sakura Exchange BitCoin (SEBC). Existing services on SEBC will be terminated on May 31 and a new service under the provisional name “Binance Japan” will launch after June 2023, the notice said.
Hong Kong is reminding banks that they can provide services to virtual asset companies amid complaints about the difficulty of opening bank accounts in the jurisdiction, its de facto central bank said on Thursday.
On a permissionless chain, while the authorities could require banks to freeze accounts, if the person in question withdraws assets to a self-custody wallet, the authorities cannot seize the assets. On a permissioned chain, the authorities could seize those assets.
The exchange, called HashKey PRO, will offer bitcoin (BTC), ether (ETH), USD coin (USDC) and fiat trading pairs, according to the statement. HashKey said it is preparing to offer services to retail investors “in the coming months.”
“Providing automated trading services is a regulated activity under the SFO,” Choy said. If a decentralized platform allows trading in virtual assets, which constitutes securities or futures as defined under the SFO, the platform and operators are required to have a Type 7 license, he added.
The white paper, reviewed by CoinDesk, notes that Japan should demonstrate leadership at the Group of Seven (G7) summit this year, where crypto will be discussed. It proposes the country should look ahead to the future potential of Web3 and clarify its leading position on technology-neutral and responsible innovation.
Crypto has come under more scrutiny from regulators following the collapse of the cryptocurrency exchange FTX last year, and the failures of Silicon Valley Bank (SVB), Signature Bank (SBNY) and Silvergate Bank.