Key Takeaways from Hong Kong's Money Laundering and Terrorist and Proliferation Financing Risk Assessment 2022

Overview

In July 2022, the Hong Kong government published its second money laundering (ML) and terrorist financing (TF) risk assessment report¹, based on an assessment completed in 2021, (the "Report"). The Report provides an overview of the ML, TF and, for the first time, proliferation financing (PF) risks in Hong Kong. 

The Report acknowledges the significant developments in digital financial technologies, partially accelerated by COVID-19, since the first risk assessment was published in April 2018 (the "2018 Report")². It also sets out five key areas of work moving forward, including amendments to Hong Kong's principal ML and TF legislation, the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO) (see further below). The Report also identifies the key stakeholders involved in coordinating and implementing the anti-money laundering and counter-terrorist financing (AML/CTF) regime, which is ultimately coordinated by the Central Coordinating Committee (CCC), chaired by Hong Kong's Financial Secretary. 

This Legal Update covers:

• the significant ML/TF/PF risks identified and the changes to risk ratings since the 2018 Report;
• provides a summary of some of the key proposed amendments to AMLO; and
• sets out the future key areas of work for the AML/CTF regime in Hong Kong.

Prior FATF Recommendations

As a member of the Financial Action Task Force (FATF), Hong Kong is subject to FATF periodic assessments and in September 2019, FATF issued its fourth Mutual Evaluation Report of Hong Kong's AML/CTF regime (HK MER)³, listing a number of 'priority actions' for Hong Kong to implement. These priority actions included:

• the need for relevant regulatory bodies to increase their understanding of sectoral risks;
• addressing coverage gaps regarding the definition of politically exposed person; and
• implementing an AML/CTF regime for dealers in precious metals and stones (DPMS).

In 2020, FATF also issued a recommendation for members to assess exposure to PF. Accordingly, in addition to assessing ML and TF risks, the Report includes an assessment of PF risk in Hong Kong.

Risk Ratings Changes from 2018 Report

The Report found no changes to the overall risk exposure ratings identified in the 2018 Report but did find that Hong Kong's ability to combat ML/TF/PF had improved from the 2018 Report rating of medium-high to high in the Report.

As in the 2018 Report, the Report found that Hong Kong is exposed to a medium-high level of ML risk overall, noting that fraud poses a high level of risk, both internally and externally, with drugs, corruption and tax evasion posing a medium-high risk. The Report also notes that the banking sector and money service operators (MSOs) continue to be exposed to relatively higher risks.

Consistent with the 2018 Report, the Report found overall a medium-low level of TF risk, noting that there had been no confirmed prosecution or conviction of TF in Hong Kong to date and referencing the implementation of the Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region (National Security Law) as having reduced the risk of domestic TF.

In its first assessment of PF risk, the Report found overall that Hong Kong had a medium-low level risk to PF. Vulnerabilities include its position as an international finance centre and busy transportation hub, as well as the global trend towards use of virtual assets (“VAs”) with a resulting lack of audit trail for sanctioned activities. Despite such vulnerabilities, the Report found Hong Kong has a robust counter-PF regime with 'comprehensive legislation and a proper institutional framework'⁴ involving public and private sector collaborations to counter PF risk. Further, the Report notes that 'no substantial evidence' of PF activity in Hong Kong has been found to date⁵.

Emerging Themes Impacting Hong Kong's Exposure to ML Risk since 2018 Report

The Report references the following trends as emerging challenges to AML:

• Increased remote/contactless transactions worldwide, and in Hong Kong, with the Faster Payment System (FPS), launched in September 2018 which, by end of 2021, had 9.6m registered accounts⁶.

• Emergence of remote customer onboarding processes, hastened by the COVID-19 pandemic, with more than 970,000 personal accounts being opened remotely in 2021, compared with circa 18,000 in 2019.⁷
• Increased use of stored value facilities (SVF), defined in the Report as 'retail payment products whose target market is predominantly, though not exclusively, small-value payments or transfers'⁸, attracting attempts of transfers of illicit funds.
• Development of virtual banks (VBs). In May 2018, the Hong Kong Monetary Authority (HKMA) issued a “Guideline on Authorization of Virtual Banks” to encourage the development of VBs. By the end of 2021, VBs had collectively onboarded a total of 1.25m customers with deposits totalling HK$24bn.⁹
• Increased use of VAs globally. While not legal tender in Hong Kong, the increasing popularity of VA activities in Hong Kong has led to the decision to introduce a licensing regime for virtual asset service providers (VASPs) (see further below).

Looking Ahead

The Report lists five key areas of work to address the issues identified:

1. enhancing the AML/CTF legal framework in Hong Kong;
2. strengthening risk-based supervision and partnerships;
3. sustaining outreach and raising awareness;
4. monitoring new and emerging risks; and
5. strengthening law enforcement efforts.

On 24 June 2022, the Hong Kong government published the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the "Amendment Bill") in the Gazette to introduce new regulatory regimes for VASPs and DPMS in Hong Kong, amongst other related and miscellaneous amendments.¹⁰

With respect to VASPs and DPMS, the Amendment Bill introduces:

• a licensing regime for VASPs requiring registration with the Securities and Futures Commission (SFC). A licence will only be granted subject to satisfaction of a fit and proper test, as well as other AML/CTF and regulatory requirements;¹¹ and
• a registration regime for DPMS, with two categories of registrants classified on the basis of whether the DPMS is seeking to engage in cash transactions at or above HK$120,000. Dealers who engage in such cash transactions above the threshold amount will be subject to additional requirements under AMLO.¹²

The more significant miscellaneous amendments address a number of technical issues identified in HK MER and other FATF contexts, including:

• amending the definition of 'politically exposed person' to include individuals from other parts of mainland; and
• better aligning the definition of 'beneficial owner' of a trust under AMLO with that of 'controlling person' under the Inland Revenue Ordinance (Cap. 112) by clarifying that with respect to trusts, this includes trustees, beneficiaries and classes of beneficiaries.

The next step is for the Amendment Bill to be considered by a Bills Committee to be formed. At present, the amendments to AMLO are expected to come into effect on 1 January 2023, excluding certain provisions relating to the VASP regulatory regime, which are expected to come into effect on 1 March 2023.¹³

Concluding Remarks

The Hong Kong government has taken considerable steps to enhance the AML/CTF/counter-proliferation financing regime since the 2018 Report and the Report acknowledges the government's ongoing commitment to addressing new and emerging risks. In his Foreword to the Report the Financial Secretary states that the government "is committed to ensuring Hong Kong remains one of the world’s safest and cleanest cities in which to work, do business and enjoy life".

Notwithstanding the above, given the pace at which new risks and illicit activities can emerge, as illustrated by COVID-19, Hong Kong, as with all FATF members, will need to remain vigilant and continually adapt and enhance their AML/CTF/CPF regimes to keep abreast of new ML/TF/PF typologies and techniques.