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Quick comments on SFC proposals

November 2, 2018

The SFC made some proposals on bitcoin regulation in Hong Kong, and it’s been making quite a bit of news. They are trying to do the right things, but I think their approach is going to lead to more confusion and that they are going down the wrong path.

Before going into the proposals, it’s best to read the keynote speech from Ashley Alder, CEO of the SFC.

Click to access Ashley%20HK%20FinTech%20Week.pdf

The most important paragraph that Alder mentions is this….

First of all, it is important to understand that some crypto markets are not legally capable of being regulated by the SFC if the virtual assets involved fall outside the legal definition in Hong Kong of “securities” or “futures contracts”

Those are his words, not mine.  The SFC simply does not have the legal authority to regulate things that are not securites or futures contracts.  But much of the speech is devoted to his view that certain things should be regulated.  The result is that much of the “conceptual framework” for regulation involves the SFC trying to regulate things that they have no legal authority to regulate.  And what you have is a total mess.

Again to quote Alder.

We have seen some of the world’s largest platforms set up in Hong Kong. However, unlike crypto asset funds, a significant part of their activities do not yet fall within the regulatory perimeter of the SFC or any other local regulator.
Nevertheless, given the serious investor protection issues at stake, we see a real need to examine how the SFC might regulate these platforms under our existing legal powers, but without resorting to new legislation. This is the part that requires us to be creative.

To put it in plain English, it’s called the “Securities and Futures Commission”.   They simply cannot regulate anything that’s not a “securities” or “future”.  To the extend that cryptocurrencies are not securities or futures, they cannot be regulated by the SFC.  They think that certain things should be regulated, but they don’t have to legal power to regulate them, so they want to get creative.

Also let me point out that the SFC here is working with cross-purposes with the rest of the Hong Kong government and possibly at cross purposes with Beijing.  Legislation in Hong Kong begins with a proposal by the HK government, and this usually begins with a policy address by the Chief Executive.  Also the legislative process is set up to effectively give Beijing a veto on any new legislation.  There is no mention of new legislation in Carrie Lam’s policy address, so this means no new legislation for this year.

Now if you regard the SFC’s statements as a “request for discussion” or “first draft” then they aren’t necessarily a bad thing.  But as concrete proposals, I think they are completely unworkable.

Part of the problem is that what the SFC is doing is that they are talking with the other securities regulators, coming up with a common approach and then implementing them in their own jurisdictions.  However, this is a terrible approach and simply will not work.  The problem is that different places are different.  The regulatory approach that the SFC is taking is that of London or Singapore, but this ignores the fact that Hong Kong is simply not London or Singapore.  In particular, London and Singapore are more “administrative states” in which the political authorities have a lot of power.

If you try to take this approach in Hong Kong, you run straight into the Basic Law and “one country, two systems” in which you have a constitution structure that requires limited government.  So what the SFC seems to be doing which is to copy London’s regulations in Hong Kong, simply will not work and is dead on arrival.

The basic problem here is that the SFC is putting the cart before the horse.  They’ve decided that certain things need to be done, and are trying to do them.  But they don’t ask why these things should be done, and they are making decisions that they have no authority to make, and that have been made in other places.

Hong Kong is unique in that it is the only place in the world where “capitalism” and “free enterprise” are written into the constitutional law.  The Basic Law of Hong Kong was written with the idea that it’s a very bad thing to take how things are done in Beijing or Shanghai and copy them in Hong Kong.  I think it’s equally bad to take how things are doing in London or Singapore and copy them in Hong Kong.

My own feeling is that the Basic Law provides an excellent foundation for deciding how things are to be done in Hong Kong, and so that when you put together a regulatory structure for Hong Kong, you absolutely have to start with the principles from the Basic Law and work outward, rather than by starting with “best practices” from the rest of the world.  It’s not as if you have much choice in the matter.

So if you take the approach that the SFC is taking of trying to creatively work around the legal framework, you’ll cause a lot more confusion. So over the next few weeks, I’ll try to prepare two documents.  The first is a document on what authority the SFC does and does not have.  The second is an alternative proposal for a regulatory framework.  I think that the proposal by the SFC will not work and is dead on arrival.  However, as a first draft to stimulate discussion, it’s useful.

So as far as the problems that the SFC proposal has:

  • First, the Securities and Futures Commission can only regulate “securities” and “futures”.  To dump everything into “virtual assets” just mixes regulated “securities” and “futures” with everything else that is unregulated will lead to a mess.
  • Second, I wish people in Hong Kong would stop talking about “regulatory sandboxes”.  “Regulatory sandboxes” make absolutely no sense in Hong Kong, and it’s a matter of taking London/Singapore rules and putting them were they are not necessary.  Why have a sandbox when you can play on a beach?
  • Third, the focus is totally wrong.  The SFC simply should not spend it’s time thinking about how to regulate things that it has no business regulating.  What the SFC should focus on is the question of how do you allow existing regulated entities in Hong Kong participate in the world of cryptocurrencies?

So for example rather than focusing on standards for cryptocurrency exchanges (which is a waste of time because they have no legal authority to regulate cryptocurrency exchanges) the question that the SFC should focus on is that if a securities broker wants to offer cryptocurrencies to their clients, on what exchanges would they be allowed to do so?

Anyway, I’m in the process of drafting two documents.  The first describes what the SFC legally can and can’t do.  The second describes what I think will work as a regulatory framework.


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