Hong Kong Regulator Calls for Tough Rules Despite Ambitions to Be Crypto Hub

Crypto service providers are moving from the fringe to provide a full range of financial services, making a "light touch" regulatory approach “far from adequate,” a Hong Kong regulator said on Thursday.

Julia Leung, deputy CEO and executive director at Hong Kong’s Securities and Futures Commission (SFC), said that the recent turmoil in crypto markets highlighted not only the volatility and structural vulnerabilities in the industry, but also how it is becoming more connected with traditional financial services.

Leung's comments during a speech at a crypto conference in London comes just as Hong Kong expressed a desire to open itself up to crypto – and possibly relax its tough regulations.

International cryptocurrency exchange FTX, which filed for bankruptcy last Friday, was once based in Hong Kong, and sources told CoinDesk that the exchange still has staff in the city.

Leung noted that Hong Kong’s opt-in regulatory framework requires that client assets be separated from a firm's own assets. To address conflicts of interest, it prohibits virtual-asset platforms from trading on their own account and they can't lend or pledge client assets.

Centralized virtual-asset trading platforms operate in ways similar to stock exchanges and broker-dealers, Leung said, adding that the SFC will hold the platforms to similar standards that apply to stock exchanges and broker-dealers.

She noted that the SFC had announced its opt-in framework for centralized trading platforms in 2018 but that authorities could apply the full force of their legal power only to platforms willing to trade at least one security token.

Only two companies in Hong Kong, OSL and HashKey, are licensed under the opt-in regime. Most retail investors in the city use unlicensed platforms.

A bill now in Hong Kong’s Legislative Assembly would expand the existing regulatory regime to platforms that don't trade security tokens. If that bill is passed, all centralized platforms would need to be licensed by the SFC, whether or not they trade security tokens, although they would receive a grace period.

Leung said that given recognition of the growing investor demand for virtual assets, particularly among private banks and hedge fund customers, it was important for regulators to provide clarity to banks, brokers and fund managers.

“Many financial institutions are now exploring how to tokenize financial assets or develop their own tokens on private blockchains,” Leung said.

The SFC plans to issue a notice to clarify that tokenized debt securities as digital representations of traditional securities on the blockchain should be treated in a similar way as existing conventional securities, she said.

Leung also spoke about decentralized finance, saying that “most DeFi activities operate outside any regulatory system”.

According to Leung, some operators are intentionally elusive to minimize liability and regulatory scrutiny. She said that regulators worldwide have reached a consensus on a coordinated approach and that they would be “relentless” in pursuing DeFi regulation.