On 22 December 2023, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) issued an updated joint circular on intermediaries’ virtual asset-related activities (Joint Circular) with appendices. The Joint Circular supersedes the previous joint circular of 20 October 2023 (October Joint Circular).
The Joint Circular was issued on the same day as the circular on SFC-authorised funds with exposure to virtual assets (VA Funds Circular), which supersedes an earlier circular on Virtual Asset Futures Exchange Traded Funds of 31 October 2022. In the VA Funds Circular, the SFC sets out the requirements under which it would consider authorising investment funds with exposure to virtual assets (VAs)1 of more than 10% of their net asset value (VA Funds) for retail offering in Hong Kong.
We summarise the key takeaways from each circular below.
VA Funds Circular
In the VA Funds Circular, the SFC sets out the requirements for SFC-authorised VA Funds to:
- invest directly in spot VA tokens accessible to the Hong Kong public for trading on SFC-licensed virtual asset trading platforms (SFC-licensed VATPs); and/or
- acquire indirect exposure to such VAs through, e.g. exchange-traded futures.
In addition to meeting the applicable requirements in the Overarching Principles Section and the Code on Unit Trusts and Mutual Funds (the UT Code) in the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products, SFC-authorised VA Funds must also satisfy the following key requirements which are set out in the VA Funds Circular:
- Management company of an SFC-authorised VA Fund: The management company: (a) should have a good track record of regulatory compliance and at least one competent staff with relevant experience in the management of VAs or related products; and (b) will be subject to the “Terms and conditions for licensed corporations or registered institutions which manage portfolios that invest in virtual assets”.
- Eligible underlying VAs: The SFC-authorised VA Fund should only invest (whether directly or indirectly) in VA tokens that are accessible to the Hong Kong public for trading on VATPs (Eligible VA Tokens). This will mean that the underlying VA tokens must be eligible large cap VAs pursuant to the SFC’s Guidelines for Virtual Asset Trading Platform Operators.
- Investment strategy: SFC-authorised VA Funds may invest directly or indirectly in Eligible VA Tokens subject to the following requirements:
- for VA futures, only those traded on conventional regulated futures exchanges are eligible, subject to the management company demonstrating that (i) the relevant VA futures have adequate liquidity and (ii) the roll costs of the relevant VA futures are manageable and how such roll costs will be managed;
- indirect exposure to Eligible VA Tokens via other exchange-traded products will be subject to the UT Code and other requirements of the SFC;
- SFC-authorised VA Funds should not have any leveraged exposure to VAs at the fund level; and
- SFC-authorised VA Funds that primarily adopt a futures-based investment strategy are expected to adopt an active investment strategy to allow flexibility in portfolio composition (e.g., diversification of futures positions with multiple expiry dates), rolling strategy, and handling of any market disruption events.
- Transactions and direct acquisitions of spot VAs: SFC-authorised VA Funds conducting spot VA trading should only do so through SFC-licensed VATPs (whether on or off-platform) or authorised institutions by the Hong Kong Monetary Authority (the HKMA) (AIs).
- Custody: The trustee/custodian of an SFC-authorised VA Fund should only delegate its custody function to an SFC-licensed VATP or an AI which meets the expected standards of VA custody issued by the HKMA from time to time. In addition, the trustee/custodian (including its delegates) must: (a) segregate the VA holdings of such VA Fund from its own assets and the assets of its other clients; (b) ensure most of the VA holdings are stored in cold wallets, and where a hot wallet is used, the amount and duration of VA holdings stored in such wallet should be minimized; and (c) ensure seeds and private keys are securely stored in HK, restricted to authorised personnel only, sufficiently resistant to speculation or collusion, and properly backed up to mitigate any single point of failure.
- Valuation: For the valuation of spot VAs,the management company should adopt an indexing approach based on VA trade volume across major VA trading platforms (i.e. a benchmark index published by a reputable provider that reflects a significant share of trading activities in the underlying spot VA).
- Disclosure: The offering documents, including the product key facts statements (KFS), of SFC-authorised VA Funds should disclose limits and key risks related to such funds’ VA exposures. The KFS should also contain risk disclosures regarding: (a) price risk, custody risk, cybersecurity risk and fork risk for investments in spot VA, and (b) potentially large roll costs and operational risks for investments in VA futures.
The Joint Circular contains additional requirements relating to product distribution which are set out below.
For new and existing funds intending to have VA exposure of more than 10% of their NAV, prior consultation with and approval of the SFC is required.
Note that the VA Funds Circular is not applicable to recognised jurisdiction schemes (including UCITS funds) and those under mutual recognition of funds arrangements, save for the prior consultation and approval requirements described above.
In light of the VA Funds Circular, the Joint Circular provides updated guidance in relation to the distribution by intermediaries of VA-related products (including VA Funds)2. In particular, a VA Fund will no longer be restricted to “professional investors” only.
The guidance in relation to:
- the provision of VA dealing services;
- the provision of asset management services in respect of VAs; and
- the provision of VA advisory services,
remain unchanged from the October Joint Circular. Please refer to our previous publication for a summary of the guidance on these topics.
Updated guidance in relation to the distribution of investment products with exposure to VAs
As explained in our previous publication on the October Joint Circular, VA-related products are likely to be complex products. Intermediaries distributing such products (except VA-related derivative products traded on regulated exchanges specified by the SFC3 (Specified VA Derivative Products) must comply with the SFC’s complex product requirements, including complying with the suitability obligation and providing minimum information and warning statements to clients4. The October Joint Circular also set out the additional investor protection measures, such that: (a) VA-related products (except Specified VA Derivative Products) should only be distributed to professional investors (PI-only selling restriction); and (b) clients dealing in these products must demonstrate adequate knowledge in VAs.
The Joint Circular updates the guidance such that VA Funds authorised by the SFC for offering to retail investors will no longer, along with Specified VA Derivative Products, be restricted to the PI-only selling restriction. However, their distribution will be subject to the following requirements:
- for funds listed and traded on the Hong Kong Stock Exchange and where there has been no solicitation or recommendation, intermediaries may execute orders in them on-exchange without complying with the suitability requirement, the minimum information requirement and the warning statements requirement. However, intermediaries should still assess the relevant clients’ knowledge in VAs;
- for funds that are not listed or those that are listed but with trading in their fund units conducted off-exchange, intermediaries will be subject to the suitability requirement, the minimum information requirement, and the warning statements requirement. The VA-knowledge assessment requirement will also apply; and
- in respect of VA derivative funds, existing derivative product requirements will also apply to intermediaries (e.g. ensuring that the client understands the nature and risks of derivative products and providing adequate information and warning statements / risk disclosures, etc.).
The Joint Circular and the VA Funds Circular demonstrate the SFC’s continued willingness to allow Hong Kong retail investors to gain access to a wider range of VA-related products, provided that the relevant requirements are satisfied by intermediaries. This is a result of a rapidly evolving VA market, increased market demand for VA-related products and regulators’ increased familiarity with VAs. As regulators gain a better understanding of how VA-related risks can be managed, we expect to see further changes to the existing VA regulatory framework going forward.
- “Virtual Assets” refer to digital representations of value which may be in the form of digital tokens (such as utility tokens, stablecoins or security-backed or asset-backed tokens) or virtual commodities, crypto assets or other assets of essentially the same nature, irrespective of whether or not they amount to “securities” or “futures contracts” as defined under the Securities and Futures Ordinance, but excludes digital representations of value issued by central banks or governments and digital representations of value similar to a customer loyalty or reward point.
- “VA-related products”, including VA Funds, VA ETFs, VA ETPs, VA derivative funds and VA related derivative products, refer to investment products which: (a) have a principal investment objective or strategy to invest in VAs; (b) derive their value principally from the value and characteristics of VAs; or (c) track or replicate the investment results or returns which closely match or correspond to VAs.
- This refers to the list of specified exchanges set out in Schedule 3 to the Securities and Futures (Financial Resources) Rules (Cap. 571N).
- Except for institutional professional investors and qualified corporate professional investors. The complex product regime requirements are set out in paragraph 5.5 of the Code of Conduct for Persons Licensed by or Registered with the SFC and Chapter 6 of the Guidelines on Online Distribution and Advisory Platforms.