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FTX Lessons Learnt: Hong Kong Sets Precedent for Client Asset Protection

Last Updated February 21, 2024 1:06 PM
Shraddha Sharma
Last Updated February 21, 2024 1:06 PM

Key Takeaways

  • HKMA issued guidance on custodial services for digital assets after the FTX collapse.
  • Regulatory push for Hong Kong to reclaim crypto hub status amid increased interest.
  • Major players seek regulatory approval in Hong Kong.

Hong Kong might be taking lessons from the FTX collapse to safeguard domestic investor interests. The Hong Kong Monetary Authority (HKMA) has released  crypto guidance to regulate digital asset custodial services in the country.

Hong Kong previously laid the rules for a licensing regime in the Web3 space. Since clear rules attract more sectoral business, the country is committing to fostering a compliant crypto ecosystem.

HKMA Guidance on Crypto Custodial Services

Taking the red flags from the FTX collapse and concerns over the security of client assets into account, the HKMA has issued comprehensive guidance for firms offering custodial services for digital assets.

The guidance, outlined in an 11-page document, emphasized the importance of segregating client assets from the firm’s assets. The arrangement will ensure that clients can claim the asset in case of a crypto institution’s insolvency. By setting clear standards, the HKMA aims to mitigate the risks associated with digital asset custody.

The release said, “An AI [authorized institution] should allocate adequate resources, including the necessary manpower and expertise, for its custodial activities to ensure proper governance, operations, and effective risk management.”

The agency warns against transferring any right or ownership in the client asset.

Hong Kong has released circulars on crypto risk guidance and regulatory framework several times in the past year. In June 2023, the securities regulator started handing out crypto licenses with retail safeguards.

Learnings From FTX 

Before the collapse of FTX in November 2022, top exchange executives, including Sam Bankman-Fried, faced the heat for diverting customer funds to allied trading firm Alameda Research.

Recently, Protos cited  court filings that allege Bahamian-based Deltec Bank and Trust knowingly made the transfers.

The now-defunct exchange taught crucial lessons about the bifurcation and protection of client funds away from business money.

Regulatory Push for Crypto Hub Status

Hong Kong’s ambition to reclaim its status as a leading crypto hub can be seen in recent regulatory initiatives. Laws that provide clarity build legitimacy for the industry.

The introduction of a licensing regime for crypto exchanges paved the way for increased regulatory oversight and compliance. Businesses have since rushed to acquire virtual asset trading platform (VATP) licenses, making Hong Kong an attractive jurisdiction.

Several players, including HTX and Crypto.com, applied for regulatory approval to operate in Hong Kong in February. Local financial institutions and brokers also submit applications to the Hong Kong Securities and Futures Commission (SFC) for approval.

The move to Hong Kong reflects confidence in the region’s regulatory framework and compliance guidelines.

Meanwhile, a new government release  claims that Hong Kong’s chief financial authority plans to present stablecoin and over-the-counter cryptocurrency trading legislation to the Legislative Council.

The statement said, “Subject to the consultation outcomes and progress of the preparatory work, the Government will submit bills on the above licensing regimes to the Legislative Council as soon as practicable.”

Competing in Asia, UAE

The HKMA’s issuance of guidance on digital asset custodial services marks another step towards establishing itself as a regulated crypto hub. Especially when regions like Singapore and Dubai have recognized the innovation and business opportunities that Web3 offers.

As regulatory frameworks mature, the industry will turn to regions with greater transparency, accountability, and investor protection. Right now, it includes Asia and UAE over the UK and US. The regions will continue solidifying their position as a leading global hub for digital assets.

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