Hong Kong Explores SFC Oversight for Crypto OTC Trading

• The SFC has been consulting with industry players about a new licensing regime for cryptocurrency OTC services
• The SFC has been in discussions with companies about introducing a licensing regime for cryptocurrency custodial services. 

Hong Kong is considering involving the Securities and Futures Commission (SFC) in regulating over-the-counter (OTC) virtual asset trading services, alongside the Customs and Excise Department (C&ED), as the city struggles to bring order to its crypto sector.

Over-the-counter trading is the process of buying and selling cryptocurrency, without the use of a formal exchange.

According to reports, the SFC has been consulting with industry players about a new licensing regime for cryptocurrency OTC services, which would involve the securities regulator working with the C&ED. Previously, C&ED was the sole authority responsible for OTC services under a February proposal. 

In addition, the SFC has been in discussions with companies about introducing a licensing regime for cryptocurrency custodial services. Both proposals are still in the early stages, and details could change.

“To foster the sustainable and responsible development of the virtual assets industry in Hong Kong, the SFC works closely with the government and other regulators in developing a robust, clear, and consistent regulatory environment,” the SFC said in a statement on Wednesday.

The renewed focus on OTC regulation follows one of Hong Kong’s largest financial frauds, involving the crypto exchange JPEX, which led to around HK$1.6 billion (US$225 million) in losses. Physical OTC shops were found to be significant channels for funneling retail investors’ funds into fraudulent schemes, raising concerns about oversight.

Some in the industry, however, have expressed confusion over placing OTC shops under C&ED, which regulates money changers, especially as the SFC oversees other aspects of cryptocurrency investment. These overlapping responsibilities have led to uncertainty about the appropriate regulatory body for different crypto activities.

The Financial Services and the Treasury Bureau (FSTB) had previously opened a two-month public consultation on the regulation of OTC services. Although the results have yet to be published, an FSTB representative confirmed that the proposal has “received general support” and that they are currently reviewing the feedback.

Hong Kong has been adapting its regulatory framework for the crypto industry over the past two years, aiming to strike a balance between attracting crypto businesses and protecting retail investors. In June 2023, the city introduced its first licensing requirement for cryptocurrency exchanges. It has also launched exchange-traded funds (ETFs) that invest directly in cryptocurrencies and is developing regulations for stablecoins.

The Hong Kong Monetary Authority (HKMA) also recently launched Project Ensemble , which aims to look into interbank settlement using central bank digital currency and real-world asset tokenization.

Despite the ongoing regulatory developments, only two fully licensed virtual asset trading platforms currently operate in Hong Kong: Hash Blockchain and OSL Digital Securities. Since June 1, operating an unlicensed virtual asset trading platform in the city has become a criminal offense.

The SFC recently intensified its scrutiny, publishing an “alert list” of suspicious virtual asset trading platforms. In mid-August, the regulator discovered deficiencies in 11 “deemed-to-be-licensed” exchanges, raising questions about their ability to meet full licensing requirements.

The probe brought to light that some exchanges were overly reliant on a few number of executives to manage client asset custody, while others were not “properly guarding against cybercrime risks.”