23 October 2020 - Article
The Hong Kong Securities and Futures Commission (‘SFC’) announced a new set of rules on 1 November 2018, which will bring portfolio managers and distributors of funds dealing with virtual assets under its regulatory purview. The new set of rules seek to impose further regulatory requirements on such licensed firms that the SFC currently regulates. Virtual assets are digital representations of value, examples of such include “cryptocurrencies”, “crypto assets” and “digital tokens’. Firstly, all licensed portfolio managers and funds that invest more than 10% of their portfolios in virtual assets will be required to obtain a license and only qualified institutional investors, are allowed to invest in virtual asset portfolios. This will apply regardless of whether these virtual assets fall under the definition of “securities” or “future contracts”.
Secondly, virtual asset trading platforms and exchanges in Hong Kong may put themselves forward as a candidate in the so-called SFC’s regulatory “Sandbox”. Those that manage to obtain a license will be able to prove to investors that it is willing to adhere to a high level of regulatory standards, which will naturally give it a competitive edge over its unlicensed peers. This is expected to solve the long-standing problems for these operators to open bank accounts for general banking transactions in Hong Kong. The regulatory “Sandbox” will involve an exploratory stage, during which the SFC will negotiate applicable licensing conditions for each participant based on their operations. Such licensing conditions will be comparable to those applicable to existing licensed providers of automated trading services. Licensed “Sandbox” participants will then have to demonstrate that they can conform to the licensing conditions imposed for a minimum period of 12 months, after which they may apply to remove or vary such conditions so as to be regulated in the same way as other licensed providers of automated trading services operating outside of the “Sandbox”.
Until now, investment activity in virtual assets and virtual asset exchanges in Hong Kong have been unregulated, despite the risks inherent in the nature and characteristics of virtual assets themselves – including high volatility and the lack of cybersecurity for the safe custody of such assets. This stems from the restricted statutory authority of the SFC, which was previously limited to only regulating virtual assets that constitute “securities” or “future contracts”. By closing this regulatory loophole, the SFC should be able to bring more activities involving cryptocurrencies under its regulatory net and afford better investor protection.
While it is inevitable that there will be mixed responses to the new measures taken by the SFC, a substantial number of targeted players in the virtual asset industry should be able to benefit from establishing added credibility and legitimacy of their businesses through the SFC’s effective regulation.