How global regulators are approaching cryptocurrencies

The Hong Kong government sponsored Advisor’s Edge’s trip to cover Hong Kong FinTech Week. Our coverage is written without any input or oversight from the sponsor.

A year after Bitcoin’s meteoric rise, regulators are still figuring out what to do about cryptocurrencies while acknowledging the assets aren’t going away.

Speaking Thursday at Hong Kong FinTech Week, Hong Kong Securities and Futures Commission (SFC) CEO Ashley Alder said regulators have to accept that virtual assets, or cryptocurrencies, “are now part of the landscape.”

Figuring out how to regulate them is not simple, however.

“The most frustrating thing about this area at the moment is regulators rightfully identifying activities, conduct, assets that need to be regulated but not providing a way for companies—including our clients—to engage in those activities in a regulated manner,” said Jai Massari, a partner at Davis Polk in Washington, D.C., speaking on a panel at the fintech conference.

Massari said regulators have had to either develop a new regulatory framework for cryptocurrencies or cram them into existing regimes.

“When regulators do that, you can see pretty clearly that they’re taking a look at what the activity is, what the market is, and deciding how they want to classify something based on how they want to regulate it,” she said.

This functional approach can mean treating cryptocurrencies as money, securities or commodities, depending on the context, she said.

Alder said in his speech that a core challenge for regulators has been determining whether they have legal jurisdiction over crypto firms.

“Some have decided that their current regulations already apply to those virtual assets which can be classified as securities, and have been active in this space,” he said. “Others have found they need to develop new legal frameworks. Others are adopting a wait and see approach.”

The U.S. Securities and Exchange Commission regards most cryptocurrencies as securities. In Canada, the CSA has said that many cryptocurrencies are securities, and must comply with securities law.

The U.K.’s Financial Conduct Authority said this week that it would launch a consultation early next year on whether to ban the sale of derivatives based on cryptocurrencies to retail investors.

Benedicte Nolens, head of compliance at global crypto finance company Circle, described the current regulatory environment as “a discovery exercise.” A former executive at Goldman Sachs and Credit Suisse, and former SFC regulator, Nolens told the panel that “every market is coming up with something slightly different.”

On Thursday, the SFC announced new rules for cryptocurrencies. Firms that invest more than 10% of a mixed portfolio in “virtual assets” will need to follow new requirements targeting crypto assets, “irrespective of whether they amount to ‘securities’ or ‘futures contracts,’” Alder said.

The measures are designed to protect investors at both the fund management level and the distribution level, he said. There is a “sizeable population” of investors in Hong Kong interested in trading virtual assets through unregulated platforms, as well as a growing demand for funds that invest in cryptos.

The SFC’s circular includes a framework for crypto exchanges whose activities don’t fall under the SFC’s purview but that wish to be supervised. The opt-in approach will allow operators to explore the framework in a sandbox environment.

Investors will benefit if the platforms that wish to be supervised are set apart, Alder said.

“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,” Alder said.

Ronen Assia, co-founder and chief product officer of eToro, a cryptocurrency trading platform, told the panel he’s eager for more regulation.

Companies are ready to comply, he said, and he’s looking for more regulators to “step in and say, ‘This is the way to do business.’”

Massari said she sees cryptocurrencies expanding through institutional and private fund managers, and through retail brokerages. While exchanges have had “a relatively open field,” she said, “there are pretty significant legal or regulatory obstacles to address in terms of a broader mass retail adoption or an institutional adoption.” Those obstacles include clearing, custody, auditing and insurance.

Alder raised some of these concerns in his keynote, noting that there are no standards on how to obtain audit evidence or to “judge the reasonableness of valuations.”

Because crypto exchanges can act as both agents for investors and dealers, it’s difficult to monitor conflicts of interest if they aren’t regulated, he added.

Still, he said it’s too early to create crypto-specific legislation.

“This world moves too fast to be pinned down by a bespoke legal framework; an international consensus on standards is yet to emerge and there is still much to learn,” he said, adding that the sandbox would contribute to the learning.

Crypto trends to watch

In addition to increased regulation, Massari said she expects fewer initial coin offerings. Instead, there will be more startup companies building networks and issuing tokens once that network is running, rather than as a pre-sale.

She also said she expects more interest in stable coins, or those pegged to real-world assets—usually a currency such as the U.S. dollar or the euro.

Assia said he expects to see more institutional investors buying directly from cryptocurrency miners. “It’s like the buying the purest form of crypto assets,” he said, which can make it easier for compliance purposes.