The SFC and the Hong Kong Monetary Authority released a blog discussing the growing interest in distributing virtual asset-related products and the responsibilities of intermediaries that provide access to these assets. The SFC acknowledges that the virtual asset landscape has developed significantly since 2018, with a wider variety of investment products becoming available for both retail and professional investors, along with the tools and techniques for trading platforms and exchange-traded funds (ETFs) to supply these products.
Hong Kong regulators have recognised the complexity of some of these products as something that needs to be addressed. Both regulators have observed an uneven global regulatory landscape for virtual assets with different levels and objectives of regulation. This asymmetric regulation can pose significant risks to investors, prompting the SFC to call for more significant investor protection measures due to the complexity of some financial products.
For instance, an overseas virtual asset non-derivative exchange-traded fund would be classified as a complex product suitable only for professional investors. The authorities also emphasised that intermediaries must verify clients’ understanding of investing in virtual assets or related products before proceeding with any transactions. Knowledge assessment will be done through a knowledge test on virtual assets, which is expected to be moderate.
How effective will this regulatory position prove to be?
Regulating the exchanges is one of the few regulatory tools within the policy box to protect retail traders genuinely. However, as the SFC and HKMA highlighted, many virtual asset trading platforms will likely not adhere to the same regulatory standards as the SFC framework. This will likely push retail investors to seek exchanges in other regulatory regions and invest without consumer protection. Thus, the protections for investors trading on these platforms are ‘manifestly insufficient.’
The motivation for these updated guidelines comes as authorities are looking to address the fallout from the Hong Kong-based crypto exchange JPEX, embroiled in a $200.7 million scandal and facing a massive enforcement crackdown, which lured investors with promises of returns as high as 20%.
What are the challenges in regulating crypto-assets?
Different national regulatory bodies have been taking various approaches to regulation and consultation. An example would be Australia’s current focus on regulating exchanges that offer cryptocurrency and digital asset services, mirroring a similar approach to their traditional finance approach. Conversely, within the ‘Markets in Crypto Assets’ framework, the EU has gone as far as regulating the current state of tokens and what they can be used for. This begs the question, why does regulating cryptocurrencies and digital assets seem so complex?
Global in Nature
Crypto assets are global by design, while traditional finance tends to be more localised. This global aspect of cryptocurrencies makes coordinating regulations across different jurisdictions challenging, especially in similar cases discussed above. Creating a safe yet potentially limiting environment for consumers in one market may become entirely redundant if consumers opt for less regulated exchanges for their transactions.
Regulating crypto assets requires a deep understanding of blockchain technology, cryptography, and distributed ledger systems. Regulators, who are often not experts in these fields, must keep up with rapidly evolving technologies. If regulators cannot keep pace with regulation, it could lead to a critical loss of investment in crypto by failing to create a positive and safe regulatory environment for consumers and investors.
Innovation, Experimentation, and Regulation
The digital asset space is known for constant innovation and experimentation, leading to an endless supply of new tokens and blockchain projects that add to the complexity of regulating emerging technologies and products. Regulators must balance fostering innovation and protecting investors, a concern less common in traditional finance. An excellent example of this is the regulatory sandbox undertaken by Brazil in 2019, which generated a variety of startups and regulatory insights that can be implemented moving forward.
Determining the regulatory status of tokens can be challenging. Tokens come in various forms and serve various purposes, from governance and utility to a store of value. These functions and purposes evolve and change depending on available technology and specific use cases, features of a coin, and its related tokenomics. In contrast, traditional finance is more straightforward to classify and predict in terms of its various functions.”