In late October, Zodia Custody, a Standard Chartered-backed crypto custody firm announced its entrance to Hong Kong via CNBC, targeting the city’s institutional-grade digital asset custody market.
Hong Kong is the fourth market in Asia Pacific (Apac) it has entered after its expansion into Australia, Japan and Singapore.
In a conversation with FinanceAsia, Julian Sawyer, chief executive officer (CEO) at Zodia, cited a great institutional opportunity in the market, as well as a “regulatory roadmap”, where regulators actively engage with the industry and want to promote digital assets.
In June, the Securities and Futures Commission (SFC) launched its new licensing regime for virtual assets service providers (VASP).
The new licensing regime, effective June 1, requires centralised digital asset trading platforms operating in Hong Kong to apply for a licence under the city’s anti-money laundering and counter-terrorist financing ordinance (AMLO), and/or the Securities and Futures Ordinance (SFO).
Only two exchanges, OSL and HashKey, have obtained a licence from the SFC under the regime so far.
The licensing regime is seen as an important regulatory development with the special administrative region (SAR) looking to become a global crypto hub, while keeping emerging risks under control.
Hong Kong’s regulation is predominantly seeing crypto exchanges and custodians as one, Sawyer told FA. The new guidelines cover only some custody players in the field, by requiring a platform operator to hold client assets on trust through an associated entity instead of a third-party custodian.
He added that the team is in active conversations with regulators including the SFC and the Hong Kong Monetary Authority (HKMA) on the development of a standalone framework dedicated to digital asset custody.
“Once custodians are being regulated differently from exchanges, the risk profile and adoption within the industry will be different,” he said.
Fragmentation
An existing licensing regime in Hong Kong for trust service providers is the licensing of Trust or Company Service Providers (TCSPs) under the Companies Registry.
Effective from March 2018, the licensing regime put in place a dedicated regulatory framework for trust companies in the city, requiring all individuals and companies providing trust services to apply for a three-year valid licence from the Companies Registry.
The TCSP licensing regime falls under AMLO, which differentiates it from a registration process with Companies Registry as a trust company under the Trustee Ordinance. The latter's registration rules require a minimum issued shared capital of HK$3,000,000 ($380,000), therefore setting a higher threshold for companies to include the word “trust” in name, according to Michael Wong, partner at Dechert.
As an example, Wong said that a digital wallet service provider in Hong Kong only needs a TCSP licence under AMLO to operate its businesses, as long as it does not run as a “trust company”, or engage in trading activities.
AMLO and SFO are two overarching laws in Hong Kong empowering digital asset regulatory authorities including SFC and HKMA, he added.
In a ruling by Hong Kong’s high court earlier this year in April, cryptocurrencies are deemed by court as a property that is capable to be held on trust.
The case involving crypto exchange Gatecoin has put Hong Kong in line with other common law jurisdictions in recognising the “proprietary nature” of digital assets, according to law firm Hogan Lovells, which first reported the case.
Wong told FA that the ruling facilitated current legal framework doesn’t distinguish digital assets from traditional finance.
As there aren’t existing digital asset-specific laws in Hong Kong, further legal clarifications depend on how the regulators would like to regulate the sector, Wong said.
Duncan Fitzgerald, risk assurance partner at PwC Hong Kong, told FA that there are differences between being licenced and being fully regulated, as the TCSP regime does not fall under the purview of the SFC.
Regulators need to think about the most appropriate way of regulating financial services trustees in general, not just digital assets, he suggested.
Fitzgerald said: “In an ideal world, there would be a body that regulates the custody of securities, and not just a licensing regime. However, achieving this would likely require a change in law.”
The VASP licensing regime is the best viable option for the SFC under the current legal framework, in order to have oversight of digital custodians which are subsidiaries of VATPs (virtual asset trading platforms), he said.
In response to the regulatory landscape, some custodian players in the market, such as Payment Asia, have taken another way around, utilising external affiliated parties that are licensed in another jurisdiction, for example in Singapore and Dubai.
Apart from above mentioned registration and licensing schemes from Company Registry and SFC, players in the market are subject to rules from the Money Service Operators (MSO) Licensing System; from customs; money remittance rules overseen by the HKMA; among those of other regulatory bodies in the city, Kavi Harilela, business director at Payment Asia, told FA.
A greater degree of regulatory clarity is welcomed when it comes to digital asset custody services in Hong Kong, he said.
Striking the balance
Keith Hung, CEO at local custodian technology provider Custonomy, agreed that a regulatory regime dedicated to digital asset custodians would be beneficiary.
“We very much want to become regulated,” he said. “Obtaining a licence can help boost customer confidence, giving us an advantage over competitors.”
At the same time, Hung thinks it’s not easy for regulators to strike a balance between enhancing regulation and offering the market enough freedom to grow.
“The Web 3 world started off completely without regulation in place to grow to its size today. And I don’t think it’s a bad thing. It’s difficult to draw the line of regulation, when the market growth is still beneficial to the entire ecosystem,” he added.
Harilela at Payment Asia echoed this view, saying that putting too much regulation in place might drive crypto players away, while too little regulation would not be beneficial for the market.
Wong at Dechert agreed that while being regulated could help boost investors’ confidence, over-regulation might hinder the growth of an industry.
“Unless we see another big scandal, after which people would start to talk about further regulations needed in this space;, I’m not seeing an urgent need for additional intervention from [the] SFC, just as is the case in [the] traditional asset custody sector,” Wong said.
SFC and Companies Resgistry did not respond to FA's request for comments prior to publication.
