Key Points
- Under Hong Kong’s liberal regulations, several dozen asset managers have been licensed to manage virtual asset funds.
- A number of index funds, tied to individual cryptocurrencies and baskets, have also been formed.
- Since 2018, Hong Kong-licensed asset managers have been permitted to execute trades on virtual asset exchanges, including derivatives exchanges, opening up the possibility for hedge funds to pursue an array of virtual asset-related investment strategies.
- At the same time, Hong Kong’s reputation for effective regulation to protect investors offers them reassurance.
Hong Kong’s robust financial system benefits from many market factors, including its deep pool of Asian investors interested in virtual assets, and Hong Kong has taken advantage of that demand. Since 2018, asset managers licensed in Hong Kong have been able to manage and distribute cryptocurrency funds, and intermediaries have been allowed to provide virtual asset-related dealing and advisory services to crypto investors. Today, there are over 35 licensed virtual asset fund managers in Hong Kong.
The Securities and Futures Commission of Hong Kong (SFC) reviews and grants permission to qualified licensed asset managers to manage portfolios that invest in “virtual assets,” defined by statute to include most cryptocurrencies, coins and tokens. Licenses are subject to a preagreed operating protocol, and the asset managers are subject to continuous SFC supervision.
Since late 2023, the SFC has expanded the types of activities that several of the licensed asset managers are permitted to perform for their clients, including executing trades for their virtual asset funds on certain global crypto exchanges. (Such funds do not need to be physically incorporated in Hong Kong, so long as they are managed by an SFC-licensed asset manager.)
The regulatory regime is shaped by Hong Kong’s goal to gain a greater slice of the global crypto industry pie. The SFC’s strong reputation as a regulator and its monitoring of crypto service providers offers investors reassurance.
Regulatory Requirements and Expectations
SFC-licensed managers must comply with the SFC’s “Joint Circular on Intermediaries’ Virtual Asset-Related Activities” (2023) and “Terms and Conditions for Licensed Corporations or Registered Institutions Which Manage Portfolios That Invest in Virtual Assets” (2023) (collectively, Terms) when providing virtual asset-related services. They are also required, prior to launching each virtual asset fund or product, to discuss their plans with the SFC (subject to certain carve-outs).
Based on the Terms, some of the most significant expectations the SFC has for its licensed managers are:
- Money laundering risks and the cybersecurity risk of asset loss (i.e., custody risk) are key concerns in the asset management arrangement. The SFC generally expects funds to only trade through and with regulated exchanges and counterparts that implement proper anti-money laundering, cybersecurity, investor compensation and custody measures. This includes, to date, virtual asset and derivative exchanges and counterparts licensed in Hong Kong, the U.S., the U.K., Dubai and Japan.
- Effective maker-checker systems, requiring dual approval of transactions, must be implemented with respect to the whitelisting of wallet addresses and the transfer of virtual assets. This is in part due to the inherent difficulty in tracing and freezing any misappropriated virtual asset.
- At least one of the responsible officers of a licensed asset manager must possess at least three years of virtual asset portfolio management or proprietary trading experience.
- Sufficient resources must be put in place to ensure the portfolio will be under active, 24-hour supervision.
- If clients are permitted to invest with crypto and/or redeem their investments in crypto (i.e., in-kind subscriptions and redemptions), the SFC expects additional measures to be implemented to verify the investor’s control and ownership of the relevant wallet address, and to assess the client’s compliance with the relevant anti-money laundering standards.
Trends
In the last six months, the SFC began allowing certain licensed managers to trade on Deribit and Binance, two of the world’s largest cryptocurrency and digital asset derivative exchanges.
In addition, in April 2024, Hong Kong saw the listing of Asia’s first bitcoin spot exchange-traded funds (ETFs) and the first ether spot ETFs.
Such listed ETFs are allowed to accept in-kind subscriptions and redemptions, and two of them have also been permitted by the regulator to stake up to 30% of their coin holdings, meaning the funds can generate meaningful additional income for their investors.
We have also witnessed growth in the number of hedge funds and venture capital fund sponsors that are active in the Hong Kong crypto market, either actively trading coins and tokens or investing in early-stage blockchain projects (through instruments such as Simple Agreement for Future Tokens, Simple Agreement for Future Equity and/or token warrants).
With access to the deeper order books of the approved global exchanges, and with the beneficial infrastructure of Hong Kong’s robust financial system, such growth is expected to pave the way for asset managers to engage in various algorithmic and other complex trading strategies, such as arbitrage, high-frequency trading and market-making strategies.
The bottom line: The growing sophistication of both the regulator and the regulatory regime, and the sizable crypto ecosphere they have fostered, is expected to make Hong Kong increasingly attractive to institutional crypto industry participants globally.
(See also “The Proliferation of Cryptoasset Treasury Strategies in Public Markets” and “A Plan To Authorize and Regulate Stablecoins Could Soon Become US Law.”)
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.