[ AUTHORS’ NOTE: By a communique dated 15 July 2022, the Financial Services Commission announced that the series of rules issued under the Virtual Assets and Initial Token Offerings Rules came into effect on 01 July 2022. Please refer to the updated note below for substantial differences between the draft and the final published rules.]

In this second article, we highlight the key features of the VAITOS (Client Disclosure) Rules (the ‘Client Disclosure Rules’) and the VAITOS (Publication of Advertisement) Rules (the ‘Publication of Advertisement Rules’). Similarly to the VAITOS (Capital and other Financial Requirement) Rules and the VAITOS (Risk Management) Rules, the Client Disclosure Rules and the Publication of Advertisement Rules should be read in conjunction with one another, given the overlap in the requirements.

General principles of the Client Disclosure Rules and the Publication of Advertisement Rules

 The Client Disclosure Rules and the Publication of Advertisement Rules regulate virtual asset service providers (‘VASPs’), and more particularly holders of ‘Class M’ licences (i.e. virtual asset broker dealers), ‘Class S’ licences (i.e. virtual asset marketplaces) and ‘Class I’ licences (i.e. virtual asset advisory service providers), concerning their interactions with clients and their advertising practices.

Both Rules impose a number of obligations on VASPs to implement appropriate safeguards with a view to ensure consumer protection and avoid unfair market practice. As a general principle, a VASP must ensure fair, unambiguous and non-misleading communications with and advertisements aimed at any potential and actual clients at all times.

The spirit of that general principle is set out in Rules 4 of the Client Disclosure Rules and Rule 4 of the Publication of Advertisement Rules. Essentially, a VASP should communicate, whether in the form of advertising materials or in its interactions with clients, in a “clear, fair, unbiased and non-misleading manner”. Before selling a product or service as a consequence of an advertisement, the VASP must ensure that the client received sufficient information to make an informed decision, including as regards risk factors.

This obligation of transparency and fairness is also reflected in contractual arrangements between a VASP and its clients. Indeed Rule 5 of the Client Disclosure Rules sets out a list of information which should be included in such contracts. Likewise, the granular details of the disclosures in any advertisements by a VASP are outlined in Rule 7 of the Publication of Advertisement Rules (including a prohibition on the use of misleading and unreasonably promising language).

Other salient obligations under the Client Disclosure Rules and the Publication of Advertisement Rules

1. Specific disclosure requirements

(a) Concerning risks and fees

Rules 8 of the Client Disclosure Rules and rule 10 of the Publication of Advertisement Rules refer to a VASP’s obligation to disclose to clients all special or unusual risks relating to products or services (such as the volatility of the virtual assets, the fact that the virtual assets may not always be liquid or transferable, or that the past performance of a virtual asset may not be a reliable indicator of future performance).

Fees and costs must be reflected in a realistic manner in all advertisements and any disclaimers, exclusions or qualifications must be clearly and prominently labelled in accordance with rule 9 of the Publication of Advertisement Rules.

Rule 9 of the Client Disclosure Rules further reflects this intention in that it imposes an obligation on a VASP to properly inform clients concerning (a) payment arrangements, (b) all fees, costs and charges, and (c) conversion rates if such fees are paid in foreign currency or virtual assets. Where a VASP provides continuous services, clients should be updated at least on a quarterly basis.  

Where cancellation rights are available to clients of a VASP, rule 11 of the Publication of Advertisement Rules provides that such cancellation rights and any specific conditions (such as the manner in which such right is exercised, or any liabilities attached to such rights) should be set out in the advertisement or in the contractual terms and conditions.

(b) Concerning the suitability of virtual assets as an investment class

In addition to the general disclosure requirements, the rules impose specific disclosure requirements depending on the category of licence held by a VASP.

Class M licencees and Class S licencees must, pursuant to Rule 6 of the Client Disclosure Rules, disclose to clients the factors taken into account (such as price, costs, speed, likelihood of execution and settlement, size and nature, and so on) by those licencees when executing transactions on behalf of clients.

Class I licencees must, in accordance with Rule 7 of the Client Disclosure Rules, disclose to clients any benefits received in connection with those virtual assets (such as fees, dividends, commissions, etc), as well as any information which could create conflicts of interest in relation to recommendations or advice by the licencee concerning the virtual assets. Pursuant to Rule 11 of the Client Disclosure Rules, those licencees must also inform clients on the range and type of recommended virtual assets and whether assessments on the suitability of those virtual assets will be provided periodically.

(c) Concerning safekeeping and custody of virtual assets

Whenever third-party custodians are appointed, a VASP must inform clients of any encumbrances on the virtual assets, and furnish certain information prescribed under rule 10 of the Client Disclosure Rules. In any event, safekeeping should be conducted in accordance with the VAITOS (Custody of Client Assets) Rules, which we shall explore in the final part of this series. 

2. Advertising conduct standards and client interactions

Rules 12 and 15 of the Publication of Advertisement Rules appear to impose a higher standard on advertising conduct standards, compared to the Guidelines for Advertising and Marketing of Financial Products published by the Financial Services Commission (the ‘Commission’).

Employees of a VASP should, amongst other obligations, (a) properly identify themselves when introducing themselves to clients, (b) act responsibly and with integrity, and (c) avoid aggressive or offensive sale practices. The overall theme of transparency is once more reflected as employees should disclose all monetary benefits (such as fees, commission, dividends, etc) to which they are entitled under any contractual arrangements between the VASP and the client.

In the online sphere, misleading internet advertising practices remains a real threat to customers. According to rule 15 of the Publication of Advertisement Rules, electronic advertisements of products or services must be identical with the most up-to-date paper versions. In addition, a VASP should restrain from cold calling practices, unless it has an existing relationship with the client, and the conditions on non-written and direct marketing prescribed under rule 16(2) of the Publication of Advertisement Rules are met.

Rule 13 of the Publication of Advertisement Rules goes one step further in prohibiting VASPs and their employees from making unreasonable inducements or gifts to customers (such as entertainment and soft commissions), which could influence client choices and decisions.

3. Record keeping and filings

Similarly to anti-money laundering practices and company law practices, rule 12 of the Client Disclosure Rules and Rule 18 of the Publication of Advertisement Rules impose the same 7-year rule for the retention of data.

In terms of filing obligations, advertisements and ancillary documents targeting the general public must be submitted to the Commission 14 days before their publication or issue pursuant to rule 18 of the Publication of Advertisement Rules. The Commission also has a discretion to order any amendments before advertisements are published or issued.

Updated note

Rule 7(4)(a) of Publication of Advertisement Rules refer to the general prohibition regarding the utilisation by VASPs of misleading and unreasonably promising language in advertisements.

The draft version of the Publication of Advertisement Rules initially provided an exception to rule 7(4)(a) – the advertisement could refer to a minimum rate of return or yield, if there was a corresponding indication of resources sufficient to support such references.

The final and published version of the Publication of Advertisement Rules imposes a different standard.  VASPs can only use promissory language in an advertisement where they can fully and properly evidence that such language is true, fair and accurate, including if applicable there were sufficient resources in support of those claims. In addition, VASPs must maintain a record of the basis on which such determinations are made for at least 7 years (or any longer period if so prescribed) after the advertisement ceases to be available to consumers.

 Tania Li