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2021 has seen significant price volatility for major cryptocurrencies. With such volatility, fortunes have been made and lost, with losses often borne by inexperienced retail clients. It is therefore not surprising that we have seen increased attention from international regulators in the cryptocurrency space.
The Cayman Islands were ahead of other jurisdictions in developing a tailored regulatory framework for the provision of virtual asset services. This was implemented through the Virtual Assets (Service Providers) Act (the âVASP lawâ) Of the Cayman Islands, which entered into force on October 31, 2020 (subject to phased implementation).
In Hong Kong, the Financial Services and the Treasury Bureau published its findings document (the âFSTB proposals“) on May 21, 2021 following a three-month public consultation on a licensing regime for virtual asset service providers.
This memo focuses on the operation of a virtual asset trading platform (a “VA exchangeââ That would be subject to regulation under the VASP Act or FSTB proposals. Platforms on which the exchange does not come into possession or control of virtual assets during its operation (e.g. peer to peer platforms corresponding to buyers and sellers for off-platform trading ) will not require a license under the VASP Act. 1 and are also excluded from FSTB proposals. Accordingly, this memo focuses on factors relevant to VA exchange traders who come into possession or control of virtual assets in the course of their operation and who may consider becoming regulated in the Cayman Islands.
THE FSTB’S PROPOSALS
The FSTB proposals observe that virtual asset activity outside of the VA exchanges is negligible in Hong Kong and therefore is primarily focused on operating a VA exchange in Hong Kong.
Anyone operating a VA stock exchange in Hong Kong would need a license from the Hong Kong Securities and Futures Commission (the “SFC“) and would require a local presence by being incorporated or registered in Hong Kong. Significantly, an SFC licensed VA exchange would only be permitted to provide services to professional clients and would not be permitted to serve retail clients. .
Based on the timeline outlined in the FSTB proposals, Hong Kong’s new regulatory regime is expected to be in place in 2022.
CAYMAN REGULATORY REGIME
The VASP Act regulates the provision of virtual asset services “within or within” the Cayman Islands. The use of the phrase âwithin or withinâ the Cayman Islands means that the VASP Act extends to the provision of virtual asset services. outside in the Cayman Islands (e.g. Hong Kong) using a vehicle (e.g. an exempt company) established in the Cayman Islands. A license from the Cayman Islands Monetary Authority (“CIMA“) will be2 required for the operation of a VA Exchange as part of a business using a Cayman Islands entity or otherwise from the Cayman Islands.
The VASP law also imposes other requirements for a VA exchange with respect to annual accounts, security of personal data, protection of virtual client assets, and various information and notification requirements to CIMA.
Strict compliance with the fight against money laundering (“AMLA“) and the financing of the fight against terrorism (“FCTâ) Is required of a VA Exchange under the VASP Act. A Cayman Islands-based VA scholarship will require a designated officer responsible for AML and CTF compliance and CIMA will review the AML and CTF controls that a potential VA scholarship has in place for the purpose of deciding whether or not to license. .
COMPARED CAYMAN AND HONG KONG
Both the VASP Law and the FSTB Proposals rightly place paramount importance on regulatory compliance and customer protection.
Both also broadly adopt the Financial Action Task Force‘s definition of virtual assets (being a digital representation of value that can be traded or transferred digitally and can be used for payment or investment purposes, but not including a digital representation of fiat currencies).
The concept of a VA exchange is also largely aligned, both with the VASP law and the FSTB proposals applying to trading platforms that come into the possession or control of virtual assets while in operation. Peer to peer platforms corresponding to buyers and sellers for off-platform trading are therefore excluded.
However, there are also some key differences that will be relevant for VA exchange operators who wish to become regulated. The most important of these is that the FSTB proposals provide that an SFC licensed VA exchange will be do not be allowed to provide services to retail customers while the VASP law does not contain a similar prohibition.
This means that a CIMA licensed VA exchange may, under Cayman Islands law, provide services to retail clients in the Cayman Islands or elsewhere.
A CIMA licensed VA scholarship must be headquartered in the Cayman Islands. There are no specific requirements in the VASP Act for agents or employees who are residents of the Cayman Islands. CIMA will, however, take into account the knowledge, expertise and experience of the applicant (which implicitly includes its staff and senior management) in deciding whether or not to grant a license. In addition, the issuance of a license by CIMA may be subject to requirements that CIMA considers to be in the best interests of VA scholarship users. Therefore, the approach CIMA will take to operational needs such as âfieldâ staff remains to be determined.
An important consideration for an offshore VA stock exchange (e.g. regulated by CIMA) will be the extent to which the laws of other jurisdictions (e.g. Hong Kong) limit the ability of the offshore VA stock exchange to provide services to the public in those jurisdictions. . The FSTB proposals would ban a VA scholarship that is not SFC licensed from ‘active marketing‘to Hong Kong audiences (whether in Hong Kong or elsewhere).
It remains to be seen whether this ban will mean that an offshore VA exchange (which does not “actively market” to Hong Kong residents) will not be able to accept Hong Kong clients (including retail clients). who contact the relevant VA offshore exchange on their own initiative. Offshore VA stock exchanges will need to seek Hong Kong local law advice on this point (and any other aspect specific to FSTB proposals).
VA exchanges often seek regulated status as a âquality badgeâ that provides assurance to their clients, the public, and often their investors and financiers.
The Cayman Islands offers a VA stock exchange a path to regulated status based on a clear regulatory framework that is already in place, without any local legal restrictions on the provision of services to retail clients.
It will be interesting to observe whether the implementation of more restrictive regulatory regimes in competing jurisdictions (eg Hong Kong) serves to direct VA trading activities to offshore financial centers such as the Cayman Islands.
1 Operators of peer-to-peer platforms, however, will need to ensure that they do not provide any of the other prescribed âvirtual asset servicesâ that may require registration or licensing by CIMA.
2 At the time of writing, the relevant provisions of the VASP Act requiring the licensing of VA stock exchanges have not entered into force, but are expected to come into force imminently by way of opening ordinance. As part of the progressive implementation of the VASP law, people engaged or wishing to engage in the operation of a VA exchange are required to register with CIMA in order to obtain a full license. once the relevant provisions of the VASP law have entered into force.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.