Submission to the Financial Services and the Treasury Bureau in Response to the Public Consultation on the Legislative Proposals to Regulate Over-the-Counter Trading of Virtual Assets

1. The Consumer Council (the Council) is pleased to submit its views with respect to the public consultation issued by the Financial Services and the Treasury Bureau (FSTB) on the legislative proposals to regulate over-the-counter (OTC) trading of virtual assets (VA) through the introduction of a licensing regime for providers of VA OTC services (the proposed regime).

The Council’s Overall Stance

2. VA OTC services are highly active and easily accessible to the general public in Hong Kong.  Nevertheless, VA OTC trading often comes with different kinds of risks in respect of money laundering/terrorist financing (ML/TF) taking advantage of the anonymity inherent in VA, and other criminal activities such as fraud.  In the case of JPEX, as of February 2024, the Police received complaints from over 2,600 victims, involving losses of HK$1.6 billion.  Meanwhile, advertisements of VA OTC services are often seen in the marketplace, and consumers might easily be tempted into making VA transactions via OTC services by the seemingly high profitability of VA and thus exposed to potential risks and fraud.  Therefore, the Council supports widening the regulation of VA activities to bring in VA OTC services under a new licensing regime (Consultation Question 1).  The Council believes more stringent regulation of VA activities would ultimately facilitate a healthy market growth and offer sufficient consumer safeguards in the trading of this novel financial product in Hong Kong. 

3. In the following parts, the Council puts forward some principle-based suggestions to the consultation questions which touch on the welfare of retail investors, many of whom are general consumers.  Other comments/ suggestions are also provided for consideration with a view to enhancing the proposed regime from a consumer protection perspective.  The Council looks forward to a consultation process of establishing further details of the proposed regime when ready.

Responses to Consultation Questions

Scope of regulation (Consultation Question 3)

4. The Council agrees that the regulatory regime ought to be wide enough to cover all forms of VA OTC services.  It is believed that the definition of VA OTC business proposed in paragraph 2.6 of the consultation paper is comprehensive enough to achieve this purpose.  However, the proposed exemption of peer-to-peer trading from the regulatory regime might become a loophole susceptible to manipulation by unscrupulous traders disguising as individual VA traders.  The regulators should ensure stringent oversight and enforcement such as sting operations are in place.  Moreover, given the fast-evolving nature of VA, it is necessary for the FSTB and/or the Customs and Excise Department (C&ED) to actively monitor the market development and ascertain the need to update the definition of VA OTC activities as necessary to ensure all relevant trade activities could be regulated by the proposed regulatory regime.  

5. Furthermore, the Council deems that temporary custody/escrow service as part of the transaction process should be covered by the proposed regulatory regime in consideration of the associated potential risks.  In addition, the Council suggests that requirements in the following aspects should be clearly defined or introduced to strengthen the protection to retail investors:

• Maximum duration of temporary custody/escrow;
• Maximum value of the money or VA held in temporary custody/escrow;
• Measures to protect the money or VA held;
• Provision of receipts (or other appropriate forms of records) to consumers for the use of custody/escrow service with clear terms and conditions;
• Follow-up action for failure to complete the transaction with the money or VA held; and
• Remedy for loss of the money or VA held.

6. The Council also recommends that the regulators make reference to the licensing regime for VA trading platforms (VATPs) in this regard.  Requirements such as having in place a compensation arrangement and not allowing to pay client money to any employees of the trader could be considered.

Other regulatory requirements (Consultation Question 7)

7. Apart from the proposed regulatory requirements, the Council provides further suggestions below to mitigate the potential ML/TF and fraud risks of VA OTC services.  The Council also suggests that the regulators should consider the necessity of specifying further whether these requirements would be applicable to all licensees or vary according to their scale and business nature.

Disclosure requirements

8. The Council is of the view that the licensees should disclose all addresses and related contact information of their branches, including ATMs, on their websites, or any other information dissemination channels.  The licensee should also give reasonable notice to customers and update the specified information in case of any closure, relocation and service suspension of its branches and ATMs in a timely manner.

Reporting and alerting requirements

9. Given the potential risks of ML/TF of VA OTC services, the Council opines that the licensees should be held responsible to report to Commissioner of Customs and Excise (CCE) in case of any significant events, where the definition of “significant events” could be clearly defined by the FSTB and C&ED, such as major staff movement, abnormal amount and frequencies of transactions, and others suspicious practices observed in the course of their operation.  Whistle blowing policy may also be considered to encourage reporting.

10. Meanwhile, the Council deemed it necessary to require the licensees to provide proactive notifications to alert their customers of any significant event that is expected to have an impact on their interests and decision-making, especially for licensees who provide temporary custody or escrow services.  The Council considers that the notifications should be delivered to the customers in a timely manner so that they will have reasonable and sufficient time to take the necessary action accordingly.   

Complaint handling requirements

11. It is envisaged that consumers will encounter a myriad of issues such as unclear charges, incorrect transaction records, misleading claims, etc. in the course of using VA OTC services.  The Council suggests that the proposed regulatory regime should include compliant handling requirements to provide consumers with available channels to make complaints and seek redress.  It is also important to ensure such channels should be accessible, fair, accountable, timely and efficient.  Besides, the licensees should not introduce unreasonable cost, delays or burdens on consumers using the complaint channels, and should be required to acknowledge, resolve or provide a response to complaints within a reasonable time. 

12. Furthermore, the Council suggests that the licensees should be required to periodically submit a complaint handling report which include related records of consumer complaints to the CCE for monitoring and early detection of systematic issue of concern. 

Risk management requirements

13. The Council welcomes the proposed risk management requirements in paragraph 2.18 (e) of the consultation paper to mandate the licensees to have in place appropriate risk management policies and procedures for managing ML/TF, cybersecurity and other risks arising from their activities.  To further strengthen the safeguard of consumer interest, the Council opines that provision of more specified risk management requirements (such as robust continency plans, adequate security safeguards and effective fraud monitoring and detection measures) should be considered.  In addition, the Council opines that in-store security measures and measures to ensure the stability of the ATMs, should also be considered in the proposed risk management requirements to ensure consumers are well protected with sufficient safeguards during the use of VA OTC services. 

Record keeping requirements

14. As proposed in paragraph 2.18 (f) of the consultation paper, licensees will be required to maintain proper records of transactions and fund flows.  To mitigate the risk of ML/TF, the Council agrees that licensees should follow the know-your-client (KYC) requirements.  As the records of transactions and fund flows may include confidential and personal information, robust guidelines should be provided to the licensees to protect the records and data against unauthorised or accidental access, processing, erasure, loss or use.

15. Besides, as reported by the media, some of the existing VA OTC operators do not provide a receipt to consumers upon the use of their services_[1].  To empower consumers with the right to track their transactions and keep as record in case of technical or other potential issues arising from the use of the service, the Council suggests mandating licensees to provide proper records for consumers to follow through the transactions.  

Advertising requirements

16. The Council opines that VA OTC operators should ensure that advertisements do not contain information that is false, disparaging, misleading or deceptive.  The regulators could also consider demanding VA OTC operators to display their licence numbers and the issuing authority in their advertisements for facilitating the general public to identify their licensing status.  In this connection, the Council agrees with the proposal in paragraph 2.24 of the consultation paper that persons without a VA OTC licence should be prohibited from actively marketing a regulated VA OTC service to the public of Hong Kong (Consultation Question 11).

Other requirements on par with those for VATPs

17. The Council notes that the holistic and detailed requirements are set for VATPs in the corresponding licensing regime.  In comparison, the requirements for VA OTC service providers are not as comprehensive.  For instance, requirements in relation to financial soundness, prevention of market manipulative and abusive activities, and continuous professional training are not covered in the proposed regime.  To meet the “same activity, same risks, same regulation” principle as stated in paragraph 1.2 of the consultation paper, the Council suggests that the regulators should examine the necessity of aligning the key control items and certain requirements in the proposed regime with those in the licensing regime for VATPs.

Licence period and transitional period (Consultation Questions 8 and 9)

18. In view of the fast-changing market environment, the Council agrees with the proposal that successful applicant could be granted a licence of two years, renewable for two years upon application and to the satisfaction of CCE (paragraph 2.20 of the consultation paper).  Moreover, the Council deems that further details could be provided on the renewal process and requirements when formulating details of the regime, such as whether further supplementary documents should be provided in addition to those required in the first time application.

19. The Council considers transitional arrangement of Option 1 (No Deeming Arrangement) more appropriate from a consumer protection standpoint, given the higher risks of virtual assets compared to precious metals and stones.  Option 1 may also align better with the VATP licensing regime under the overarching regulatory principle of “same activity, same risks, same regulation” for VA-related activities. 

20. During the transitional period, the Council expects that similar disclosure arrangements (VATP’s approach), namely a list of VA OTC applicants with reminder that they may or may not be approved, and a list of closing down VA OTC service providers, should be made to inform or alert the public.  

21. Furthermore, the CCE may consider publicising the unsuccessful applications with reasons to alert the public.

Other Comments/Suggestions

22. Besides the above responses to specific consultation questions, the Council provides further comments/suggestions below to improve the proposed regime and strengthen consumer protection.

Public education

23. In accord with the Government’s policy to foster sustainable and responsible development of the VA sector in Hong Kong, the Council opines that the regulators should continue to allocate resources to public education about VA, and that such educational efforts should keep abreast of the rapid development and changing landscape of the VA market.  When the regulatory regime for VA OTC trading is introduced and such form of transaction grows more popular among ordinary consumers in the future, related topics such as the licensing requirements, benefits and risks, and differences between OTC shops and online exchanges, should be covered. 

24. Moreover, the Council suggests that the list of licensed VA OTC operators should be made available to the general public to facilitate easy access of consumers to licensed VA OTC services.  Meanwhile, similar to the VATP, regulators can publicise an Alert List_[2] to warn the public of unlicensed entities, suspicious websites, suspicious VA OTC operators and phishes.  The Council hopes that consumers could empower and protect themselves in the participation of VA-related activities in Hong Kong through effective public education.

International development

25. One of the most common types of crime that associate with VA OTC trading is money laundering, and ordinary consumers might unintentionally get involved when they make transactions through OTC shops.  To efficiently combat issues as such, in January 2024, the European Union took a significant step towards enhancing anti-money laundering measures in the cryptocurrency sector by provisionally agreeing on stricter regulations for cryptocurrency firms.  Cryptocurrency firms will be required to conduct more thorough customer due diligence checks, particularly for transactions exceeding €1,000_[3].  The European Banking Authority also extended its guidelines on ML/TF risk factors to encompass the cryptocurrency sector_[4].  

26. Besides, the International Monetary Fund has proposed some high-level recommendations, including:

• Develop strong supervisory capacity;
• Maintain tight international collaboration and information sharing; and
• Take advantage in the progress in digital technology_[5].

27. As the VA market evolves quickly, the Council fully supports the regulators to proactively review their practices regularly so as to keep abreast with international standards and regulatory approaches, and thus protect consumers against related risks.  In the long run, especially when other new VA-related business models emerge, the FSTB might also consider whether a sectorial approach or a centralised approach would be adopted to better protect retail investors and consumers from the potential risk of regulation arbitrage.

Conclusion

28. The Council hopes that the FSTB will take into account the above responses and comments/suggestions in the implementation of the proposed regime for enhancing consumer safeguards against risky and unscrupulous VA OTC services.