Hong Kong has decided to step up its game in the world of crypto assets and will be implementing regulations starting from June 1st. This is a significant development that will have an impact on token issuers, investors, and anyone who’s interested in the crypto industry.

Now, let’s talk about why understanding the due diligence process is crucial in this new regulatory landscape. When it comes to tokens, whether you’re issuing them, investing in them, or simply passionate about the industry, you need to be aware of certain things.

First and foremost, due diligence is all about doing your homework. It’s about thoroughly researching and investigating the tokens or projects you’re dealing with to ensure they are legitimate, transparent, and aligned with your goals and values. This process helps you assess the risks involved and make informed decisions. Even if you’re not directly involved in token issuance or investing, having a basic understanding of due diligence is still important as a crypto enthusiast. It allows you to navigate the industry more confidently, discern credible projects from scams, and contribute to the overall growth and development of the crypto ecosystem.

Hong Kong Crypto regulation framework

In this article, I will be breaking it all down for you. I’m going to share some key points about token due diligence that you should definitely know about. It’s all about making sure you understand what you’re getting into and protecting yourself in this fast-paced crypto world.

Brief Overview

Hong Kong is taking a proactive step in regulating crypto assets through the Securities and Futures Commission (SFC). The process began with the release of a consultation paper in February 2023, where invited parties were encouraged to provide their valuable input and comments. This collaborative approach aimed to ensure that the regulations address the needs and concerns of various stakeholders. Fast forward to the present month, and the regulations have been successfully passed.

It’s an exciting development that brings clarity and structure to the crypto asset landscape in Hong Kong. Now, the SFC has announced that starting from June 1, they will begin accepting applications for crypto trading platform licenses. This announcement signifies an important milestone in the journey towards a regulated crypto market in Hong Kong. By introducing licensing requirements, the SFC aims to enhance investor protection, promote market integrity, and establish a framework for the operation of crypto trading platforms within the region.

According to a report on the regulator’s consultation on policy recommendations, licensed virtual asset providers in Hong Kong will now be able to serve retail investors. However, there is a condition attached to this permission. Operators must assess the understanding of risks by retail investors before providing them with services. This requirement aims to ensure that retail investors are well-informed about the potential risks associated with virtual assets.

In addition, the regulator has proposed that stablecoins, which are cryptocurrencies pegged to the value of other assets, should not be allowed for retail trading until the planned regulations specifically designed for this asset class come into effect. This cautious approach reflects the regulator’s intention to have proper oversight and regulatory measures in place before retail investors engage in trading stablecoins.

It’s important to note that these proposed measures are part of ongoing efforts to refine and enhance the regulatory framework for virtual assets in Hong Kong. The regulator’s responsiveness to market developments and commitment to investor protection reflect the dynamic nature of the crypto industry and the jurisdiction’s dedication to fostering a responsible and sustainable virtual asset ecosystem.

Hong Kongs’ Guidelines for Crypto Exchanges

To provide virtual asset trading services on their platforms, crypto exchanges in Hong Kong will now be required to obtain a license. This regulatory step aims to ensure the integrity and security of virtual asset transactions. In order to obtain and maintain their licenses, exchanges will need to adhere to several key requirements.

First and foremost, exchanges must comply with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations. This means implementing robust processes to verify the identities of their users and conducting thorough checks to prevent illicit activities such as money laundering and terrorist financing.

Risk management is another crucial aspect that exchanges must address. They will need to establish effective systems and procedures to identify, assess, and mitigate potential risks associated with virtual asset trading.

Ensuring self-custody of assets is an added requirement for licensed exchanges. By maintaining control over the custody of assets, exchanges can enhance security and reduce the risk of unauthorized access or loss. They will also be expected to maintain accurate and transparent records of their financial transactions, ensuring compliance with auditing and reporting standards.

Moreover, exchanges have to follow a defined token onboarding process. Before offering tokens to retail investors, they must conduct thorough due diligence. Which will invariably help protect investors from potential scams or fraudulent projects. It’s important to note that tokens classified as “securities” under the Securities and Futures Ordinance (SFO) will not be permitted to trade on regulated exchanges in Hong Kong. This is in line with existing securities regulations and serves to ensure compliance with relevant laws and investor protection measures.

Eligibility Criteria for Tokens to List on Hong Kong Based Crypto Exchanges

When it comes to the eligibility criteria for tokens on regulated exchanges in Hong Kong, there are several important factors that will be thoroughly reviewed. These criteria aim to ensure investor protection, market integrity, and compliance with relevant regulations. Let’s take a closer look at each of these criteria:

  • Take a close look at the development and management team responsible for the token.
  • Examine the regulatory status of the token in different jurisdictions.
  • Evaluate the supply, demand, and liquidity of the token for a minimum of 12 months.
  • Assess the technical architecture of the blockchain, its security measures, and fault resistance.
  • Scrutinize the market materials to ensure they do not mislead potential investors.
  • Review the development milestones and roadmap of the token.
  • Analyze the token’s supply distribution.
  • Assess any potential legal risks associated with the token.
  • Explore the use cases of the token and its value capture model

Separate Indexes for Large Caps

Licensed exchanges in Hong Kong will be allowed to offer separate indexes specifically designed for large-cap crypto assets. These indexes serve as a way to track the performance of a group of major cryptocurrencies. To ensure the quality and reliability of these indexes, certain criteria and due diligence processes need to be met. Here are the key considerations:

  • Sufficient Liquidity: The selected tokens included in the index should have a sufficiently liquid market. Liquidity ensures that investors can easily buy and sell the tokens without significant price slippage.
  • Defined Calculation Rules: The index should be calculated based on clear and predefined rules. Through rules we can establish a consistent methodology for calculating the index value, ensuring transparency and reliability.
  • Well-Documented Methodology and Rules: The methodology and rules used to calculate the index should be thoroughly documented. What documentation does is that it provides clarity to investors and stakeholders, enabling them to understand how the index value is determined.
  • Experience of Index Providers: The indexes should be issued by reputable index providers who have prior experience in launching indexes, particularly in the field of stocks. The providers who have a strong track record possess the necessary expertise to create and manage reliable indexes.

In line with these requirements, the Hong Kong Securities and Futures Commission (SFC) has recently released the initial list of tokens that will be included in the indexes. By providing access to well-constructed indexes, investors can gain exposure to a diversified portfolio of major cryptocurrencies and make informed investment decisions based on reliable market benchmarks.

Keep a Watch

As a crypto investor outside of Hong Kong, staying informed about the tokens that receive clearance from the Hong Kong Securities and Futures Commission (SFC) is indeed crucial. The SFC’s decision on which tokens are approved for regulated environments provides valuable insights into the regulatory landscape and the future prospects of those tokens.

Clearance from the SFC indicates that a token has met certain criteria and complied with the regulatory requirements set by the commission. This approval signifies that the token has undergone a thorough due diligence process and has been deemed compliant, transparent, and suitable for trading within a regulated framework.

By keeping track of the tokens that receive clearance, you gain a better understanding of the SFC’s approach to regulating crypto assets. It can provide you with insights into the types of tokens that are more likely to be embraced by other regulatory bodies and countries in the future.