Six keys for Hong Kong to upgrade the virtual asset sector

Article author: Patrick Chan, President of the Hong Kong Securities and Futures Professional Association

Article Source: Orange News

As a renowned international financial center, Hong Kong's open and diverse market environment has long attracted global funds and investors. In December 2023, the Securities and Futures Commission and the Monetary Authority jointly issued a circular on virtual asset-related activities of intermediaries. However, the policy has sparked widespread controversy due to strict restrictions on mainland residents' participation in virtual asset activities.

With more and more virtual asset exchange licenses being issued, given the current market size in Hong Kong, it is believed that newly established virtual asset exchanges will find it more difficult to survive, which is not conducive to market development.

These restrictive policies have mainly manifested their impact on Hong Kong in the following aspects:

1. Capital outflow and declining competitiveness

Firstly, due to the exclusivity of policies, large capital reserves and potential investors from mainland China may be excluded from the Hong Kong market, and these funds may flow to more open markets. Especially in the United States, during the election campaign of former President/President-elect Trump in 2024, his attitude towards cryptocurrency changed from hostility to friendliness and he expressed a push for reduced regulation, which greatly enhances the competitiveness of the United States in the virtual asset trading field. This policy shift may attract more international and mainland funds to flow into the US market, further weakening Hong Kong's international financial status.

The Missed Opportunities of Market

The influence of virtual assets in the global financial market is increasing. If Hong Kong does not adjust its policies in a timely manner to adapt to market changes, it will be difficult to gain a leading position in this emerging market. In contrast, other financial centers such as New York, London, and Singapore will attract more investment and innovative companies due to their relatively open market regulatory policies, further consolidating their position in the global financial market. In fact, before the year, many virtual asset platforms established in Hong Kong have already relocated their headquarters to Singapore.

3 Regulatory Challenges and Lack of Innovation

Although the current virtual asset regulatory framework in Hong Kong aims to ensure market stability and investor protection, its adherence to the TradFi regulatory mindset is out of touch and inadequate when faced with the rapid innovation and changes in the emerging virtual asset industry. The top ten virtual asset exchanges in the world had to withdraw their exchange license applications in Hong Kong due to the inability to meet the excessively strict regulatory requirements, reflecting Hong Kong's insufficient support for innovation and adaptation to market changes.

4 long positions regulatory and compliance burden

In addition, the bullish regulatory structure in Hong Kong further increases the Compliance burden and operating costs of the industry. The regulation of different virtual asset businesses involves multiple institutions, including the SFC, HKMA, and customs, which require good coordination and unified regulatory standards among these institutions. Otherwise, companies will incur additional costs and difficulties in complying with different regulations.

In order to enhance Hong Kong's competitiveness in the virtual asset field and ensure its status as an international financial center, Hong Kong should consider taking the following measures:

1. Relax restrictions on mainland residents' participation.

Allowing more mainland residents to participate in Hong Kong's virtual asset market will introduce a large amount of capital and technology, enhance market vitality and liquidity, and expand Hong Kong's influence as a financial center. Recently, there was even a case in which the People's Court of Songjiang District, Shanghai ruled that individuals holding virtual money did not violate the law. Taking this direction into consideration and based on forex regulations, the practice of 'Hong Kong Stock Connect' can be referenced, allowing domestic funds to invest in Hong Kong's virtual asset-related products through a closed-loop method, starting with ETFs.

Under the 'one country, two systems' framework, Hong Kong should complement the mainland market and meet the legitimate investment needs of investors. On November 20, 2024, the Shanghai High People's Court clarified its position on a dispute over a Virtual Money issuance financing service contract, stating that Virtual Money has property value as a commodity, and individuals simply holding it is not illegal. However, business entities are not allowed to participate in Virtual Money investments or Token issuance. In other words, mainland investors should be allowed to invest in licensed virtual asset exchanges in Hong Kong and hold Cryptocurrency.

2. Improve regulatory system

It is necessary to evaluate and adjust the regulatory framework to better adapt to the unique operating model and rapid changes of the virtual asset industry. This may include introducing more flexible and innovative regulatory approaches, reducing unnecessary compliance burdens, while maintaining a high level of risk control.

3. Simplified dealing process

Speed up the approval process of virtual asset platform licenses, provide clear timelines, industry-standard requirements, clearer guidelines, and a transparent application process to attract more international participants. This can be achieved by introducing an electronic application system and increasing the capacity of competent reviewers.

4. Establish a unified regulatory body

Consider establishing a unified virtual asset regulatory commission to coordinate the work of different regulatory agencies, ensure the consistency and effectiveness of regulatory standards, reduce Compliance costs for companies and improve regulatory efficiency.

5. Strengthen cooperation with the mainland

The special administrative region government should closely cooperate with the relevant regulatory authorities in the mainland to explore a collaborative mechanism for the regulation of virtual assets, promoting the interconnectedness of the two markets and the two-way flow of funds.

6. Introduce more professional knowledge and industry experience

Introduce more professional knowledge and industry experience in the regulatory process, hire industry experts to participate in supervision and approval work, ensure that the regulatory process is rigorous and efficient, and that the regulatory framework and requirements do not deviate from industry common practices. At the same time, more new products should be developed, such as Real World Assets (RWA). To complement the announcement in the Policy Address to establish a gold warehouse and related trading facilities, the development of gold RWA can become one of the virtual assets.

Through these measures, Hong Kong can overcome current challenges and maintain competitiveness in the global virtual asset market. The government and the industry need to work together to ensure Hong Kong's leading position in the international financial sector, promote the sustainable development of the virtual asset industry, enhance Hong Kong's market attractiveness, consolidate its status as an international financial center, and serve as a bridgehead for the country to connect with the global virtual asset development.