Legal Update: Developments in virtual asset regulation in Hong Kong

In this snapshot legal update, we report on various announcements and policy updates announced during Hong Kong FintechWeek in respect of virtual assets (“VA”).

On 31 October 2022, the Securities and Futures Commission (“SFC”) issued a circular on virtual asset futures exchange-traded funds (“VA Futures ETFs”). This is a positive step for the SFC since the SFC will now accept applications for authorisation of VA Futures ETF that is accessible to retail investors, whereas the prior position was that VA Futures ETFs could only be offered to professional investors.

The circular sets out additional requirements that the SFC would consider when authorising VA Futures ETFs for public offering to retail investors in Hong Kong. Some key requirements include:

1. Management companies
   
   The management company of a VA Futures ETF must have (i) a good track record of regulatory compliance; and (ii) demonstrate at least three years of proven track record in managing ETFs. The SFC will also take into account relevant experience in managing the same or similar type of products from the group of companies to which the management company belongs. The SFC may also consider accepting delegation or co-management of a VA Futures ETF.  
    
2. Eligible Futures
   
   The VA Futures ETFs can only invest in VA futures traded on conventional regulated futures exchanges. These are currently limited to Bitcoin futures and Ether futures traded on Chicago Mercantile Exchange. The SFC is considering expanding the scope of eligible VA futures markets.
    
3. Investment Strategy
   
   The management company of a VA Futures ETF is 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.
   
   The net derivative exposure (as defined under paragraph 7.26 of the Code on Unit Trusts and Mutual Funds in the SFC Handbook for Unit Trusts and Mutual Funds) of a VA Futures ETF must not exceed 100% of the ETF’s total net asset value.
    
4. Distribution
   
   Intermediaries will be subject to the applicable requirements under the “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” and relevant guidelines such as the “Joint circular on intermediaries’ virtual asset-related activities” (“Joint Circular”) issued by the SFC and the Hong Kong Monetary Authority in January 2022. The Joint Circular allows SFC-licensed and registered intermediaries to distribute VA-related derivative products to retail investors under specific circumstances. Earlier this year, we published an article on the Joint Circular on our website.

A full version of the circular on VA Futures ETFs (English only) is available here.

The SFC’s circular on VA Futures ETFs followed after the keynote speech of the SFC’s Deputy Chief Executive and Executive Director of the Intermediaries division, Ms Julia Leung, at Hong Kong FinTech Week 2022. In her remarks, Ms Leung addressed various matters related to VAs, including retail access to VA products, ETFs and security token offerings (“STO”). 

Ms Leung noted that the SFC considered that some initial concerns about VA Futures ETF have become manageable, and it was now appropriate to review the “professional investor only” requirement for the distribution of VA products. At the initial stage, the underlying assets are expected to be confined to Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange. Ms Leung also stated that the SFC was soft consulting the industry and stakeholders on this and other issues before finalising the proposals.

Turning to STOs, Ms Leung noted that tokenised securities that are digital representations of traditional securities on a blockchain should be treated in a similar way as existing financial instruments. Therefore, the SFC is of the view that it is not appropriate to classify these tokenised securities as “complex products” merely because they are issued or traded on a blockchain. However, licensed firms must perform reasonable due diligence and conduct smart contract audits before security tokens are distributed to clients. The SFC is revisiting the requirements for listing security tokens on licensed virtual asset exchanges and will issue a circular setting out the modification in due course.

The full speech by the SFC’s Deputy Chief Executive and Executive Director of the Intermediaries division, Ms Julia Leung, at Hong Kong FinTech Week 2022 is available here. Further policy announcements and speeches were published by the Financial Services and Treasury Bureau (see here), and the Hong Kong Monetary Authority (see here).

As always, we at Tanner De Witt, are ready to help you with the changes ahead.

Pádraig Walsh, Alan Wong and Stephanie Sy

If you would like to discuss any of the matters raised in this article, please contact:

Pádraig Walsh
Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.