Hong Kong currency traders welcome the Oppenheimer moment, OTC regulation is poised to take off

Author: Xiao Za Lawyer

From the perspective of the Sa Jie team in practical cases, cryptocurrency dealers can generally be divided into two types based on their behavior patterns: reliable and unreliable. Unreliable dealers are usually bold and reckless, willing to accept cash payments offline and not screening clients; reliable dealers, on the other hand, tend to act cautiously, avoiding transactions with strangers, and if they operate online, they often publicly issue multiple risk disclosures and disclaimers (although many of these "statements" cannot truly exempt them from liability).

Recently, as China's public security authorities have intensified their crackdown on online crimes and cryptocurrency-related offenses, many dealers (even reliable ones) have been implicated, making the consideration of whether to "go overseas" for business a "must-answer question" for old friends. As companions on the entrepreneurial journey of Web3 friends, the Sa Jie team will analyze the feasibility of moving business to Hong Kong in light of a series of OTC regulatory measures set to be implemented in Hong Kong in 2024 and recent regulatory trends.

01 How is the Hong Kong OTC industry developing?

(1) Paying salaries in cryptocurrency does not constitute valid payroll, posing risks of labor disputes

Cryptocurrency OTC (over-the-counter) generally refers to entities providing services such as "crypto-to-crypto exchange" and "fiat-to-crypto exchange" outside of licensed cryptocurrency trading platforms, and is a broad category of cryptocurrency service providers (referred to as "VASP").

Since Hong Kong publicly embraced cryptocurrency in 2023, OTC has indeed experienced rapid development in Hong Kong. A recent unofficial figure indicates that there are approximately 200+ offline cryptocurrency dealer entities (or automated trading machines) providing fiat and cryptocurrency exchange services in Hong Kong, as well as over 200 OTC dealers based in Hong Kong targeting local residents, overall indicating a thriving scene.

However, developments are not without challenges. The JPEX incident at the beginning of 2024 (where numerous OTC dealers were implicated, providing money laundering channels for fraud groups, severely harming the interests of Hong Kong cryptocurrency investors) dealt a significant blow to the OTC industry in Hong Kong, prompting regulatory authorities to accelerate the regulation of cryptocurrencies, leading to a rapid shortening of the policy window. This has resulted in a not-so-complete OTC regulatory framework entering a preparatory phase.

Of course, the Sa Jie team does not believe that regulating OTC in Hong Kong is a wrong action; after all, in the absence of legal regulations, we cannot expect industry self-discipline to completely eliminate "bad money." Regulation of the OTC industry and dealers is imperative, but whether the specific regulatory measures are "appropriate" remains to be seen.

02 Detailed Explanation of Hong Kong OTC Regulatory Rules

In February 2024, the Hong Kong government released a public consultation document titled "Legislative Proposals for Regulating Virtual Asset Over-the-Counter Transactions" (hereinafter referred to as "public consultation"), planning to further amend the "Anti-Money Laundering and Counter-Terrorist Financing Ordinance" (hereinafter referred to as "AML Ordinance"). Overall, the public consultation reveals that Hong Kong plans to implement licensing regulation for VASPs engaged in OTC business, while limiting the types of cryptocurrencies that VASPs engaged in OTC business can exchange based on the principle of "same risks, same regulation." Details are as follows:

(1) Which businesses will be regulated?

It is important to note that the regulatory scope of the above businesses is predicated on "operating virtual asset over-the-counter trading business in Hong Kong" or "actively promoting virtual asset over-the-counter trading services to the public in Hong Kong."

(2) Who will regulate?

Unlike the VASP license being solely governed by the Hong Kong Securities and Futures Commission (hereinafter referred to as "SFC"), Hong Kong OTC falls under the jurisdiction of customs. VASPs engaged in cryptocurrency OTC business need to apply for a license from Hong Kong Customs.

In fact, Hong Kong Customs has always played an important role in financial regulation and security in Hong Kong. For example, the "Money Service Operator License" stipulated in the Hong Kong AML Ordinance, commonly referred to as "MSO License," is issued by Hong Kong Customs. Considering that cryptocurrency OTC business shares certain similarities with the money laundering and terrorist financing risks commonly associated with MSO licenses, Hong Kong Customs may have more regulatory experience with such businesses, which is why the Hong Kong government intends to place cryptocurrency OTC licensing under customs management.

(3) What qualifications are needed to apply for an OTC license?

1. Eligibility of the applicant

According to the recommendations made in the "public consultation," applicants for the OTC license must meet two conditions: (1) be a company established in Hong Kong with a fixed place of business; or (2) be a non-Hong Kong company registered under the Hong Kong Companies Ordinance. This requirement is actually similar to the eligibility requirements previously set by the SFC for applicants of the VASP license.

It is important to note that if the applicant operates in a non-physical store format (for example, trading via an internet platform), they must provide detailed information such as the office address and communication address of their local management personnel in Hong Kong, as well as the location where the platform stores its books in Hong Kong.

2. Requirements for suitable candidates

According to the recommendations made in the "public consultation," applicants for the OTC license must meet the "suitable candidate" standards, meaning that the applicant, directors, and ultimate owners (i.e., actual controllers) must not: (1) have been convicted of crimes related to money laundering and terrorist financing or other serious crimes; (2) have been convicted of fraud, embezzlement, or dishonest conduct; (3) be involved in any bankruptcy or liquidation proceedings; (4) fail to comply with applicable laws and regulations regarding anti-money laundering and counter-terrorist financing.

The Sa Jie team believes that this requirement can be seen as a version of the "suitable candidate" requirement for MSO licenses, with overall requirements being relatively lenient. There are no similar requirements for work experience or educational background for suitable candidates as seen in the VASP license. From this perspective, the overall difficulty of obtaining the license should be lower. Of course, obtaining the OTC license also requires dealers to appoint a compliance officer and a money laundering reporting officer.

03 Is it feasible for mainland dealers to move their business to Hong Kong?

The Sa Jie team has previously analyzed in an article that operating OTC business within mainland China carries a high risk of crossing legal boundaries, with the most common consequence being conviction for illegal business operations. So, can mainland dealers move their business to Hong Kong?

The Sa Jie team believes this is feasible, but Hong Kong is not a lawless land. Moving the business first requires bearing high compliance costs, and secondly, it requires ensuring compliance along the business lines and cutting ties with black and gray industries.

It is worth noting that the "public consultation" has currently proposed two requirements that significantly impact dealers' businesses in Hong Kong OTC: (1) For virtual asset transfers involving HKD 8,000 or more, customer due diligence must be performed, including full name, ID number, etc.; (2) The assets that OTC dealers can trade are limited to tokens available for retail trading on licensed virtual asset trading platforms approved by the SFC, as well as stablecoins licensed by the Monetary Authority, meaning that currently only Bitcoin and Ethereum can be exchanged.

The public consultation has now concluded, and relevant regulations are imminent. In this Oppenheimer moment for OTC business, compliance is particularly important.

04 Final Thoughts

Even in the face of these strict regulatory requirements, many dealers still see potential opportunities in Hong Kong as an international financial center. The Sa Jie team believes that although Hong Kong provides a relatively lenient regulatory environment for mainland dealers, risks and challenges still exist. In this unpredictable market, dealers need to maintain keen insight and flexible adaptability to respond to various situations that may arise. Only in this way can dealers establish themselves in Hong Kong, this international financial center, and achieve sustainable development.