On November 1, 2018, the Securities and Futures Commission (“SFC”) announced that it will bring virtual asset funds under its regulatory purview to improve investor protections.

In a statement on regulatory framework and the accompanying circular, the SFC provided clarity and guidance around virtual assets management, distribution of fund interests, and trading platforms, with the most notable announcements being:

1. Investment in distribution and management of virtual assets constitute regulated activities: It was confirmed that funds that invest in and distribute virtual assets will trigger the licensing and registration requirement under the Securities and Futures Ordinance (Cap. 571) (“SFO”) as a Type 1 regulated activity (dealing in securities), regardless of whether the underlying virtual assets constitute a “security” or a “futures contract” as defined under the SFO. Similarly, to the extent that firms that are licensed for Type 9 regulated activity (asset management) also manage portfolios that invest solely or partially (subject to a de minimis requirement) in virtual assets that do not constitute a “security” or a “futures contract” as defined under the SFO, such firms will also fall under the SFC’s oversight. Hence, investment in, distribution of, and dealing in virtual assets may constitute a Type 9 and/or Type 1 regulated activity and will be held to a set of standards that the SFC developed based on the existing regulatory requirements applicable to the Type 9/Type 1 licensees.
2. Additional requirements imposed on managers and distributors of virtual assets funds not authorized by the SFC: Portfolio managers who manage virtual assets funds (subject to a de minimis requirement) should allow only professional investors as defined under the SFO to invest in those funds. Similarly, intermediaries who distribute virtual assets funds are asked to target only professional investors. For managers who manage funds that are not authorized by the SFC, additional requirements imposed by the SFC also include maintaining a liquid capital of not less than HK$3million. For intermediaries who distribute such unauthorized funds, other additional requirements under the heightened standards include: concentration assessments (namely, the client’s aggregate investment should be “reasonable” considering its net worth), heightened due diligence requirements, additional client disclosure requirements, and compliance and risk-management-related requirements.
3. Intention to launch exploratory regulation program for virtual asset trading platforms: The SFC indicated that it intends to allow virtual asset trading platforms to opt in to a new regulatory exploratory program, under which the interested platform operators will be put into the SFC Regulatory Sandbox for a minimum period of 12 months. During the exploratory stage, the SFC will consider, among other things, the adequacy and effectiveness of the proposed regulatory framework, the operators’ ability to comply with the SFC regulatory standards, investors’ interests, and international regulatory developments. At the end of such an exploratory stage, the SFC indicated that it may consider granting licenses to adequate operators with conditions that are likely to be based on those applicable to existing licensed providers of automated trading services. At the present stage, it is clear that licensed operators would be able to offer trading in virtual assets that fall under the SFO definition of “securities,” but it is uncertain as to non-securities virtual assets.

The SFC has delivered a clear message that cryptocurrency firms are welcome in Hong Kong and that the SFC is willing to support the growth of the cryptocurrency industry in a transparent, safe, and sustainable way. In addressing the media on this development, the CEO of the SFC indicated that the SFC hopes to encourage the responsible use of new technologies while also providing investors with more choices and better outcomes.

Compared to the blanket ban of digital currencies and initial coin offerings in China, the regulatory framework in Hong Kong offers a balanced approach taken by the SFC and renders Hong Kong an attractive regional alternative, especially to high-net-worth investors and more established cryptocurrency firms who are looking for further growth and expansion.