The current regulatory requirements in Hong Kong with regards to managing funds that invest in "virtual assets" ("VA") can be summarized as follows – if an asset manager has a licence from the Hong Kong Securities and Futures Commission (“SFC”) to conduct Type 9 regulated activity (asset management) (“Type 9 Licence”) and that licensed manager intends to (a) manage funds (or portions of funds) that invest in VA and such investment is a stated investment objective; or (b) invest 10 percent or more of the gross asset value of its portfolio in VAs ("Criteria"), it would be required to apply to the SFC to “upgrade” its Type 9 Licence. At the time of writing, we understand that around 10 SFC asset managers have successfully "upgraded" their Type 9 Licence ("VA Fund Managers") – Dechert Hong Kong's market-leading team has involved in four of those VA Fund Managers with their upgrade applications.
“VA” are defined as digital representations of value, which take the form of digital tokens (e.g., digital currencies, utility tokens or asset-backed tokens); any other virtual commodities; and crypto assets or other assets of essentially the same nature, irrespective of whether they may be deemed “securities” or “futures contracts” as defined in the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) (“SFO”). China Trademark Revocation
As part of the application to “upgrade” its Type 9 Licence, a licensed manager would be required to enter into standard form terms and licencing conditions issued by the SFC, the “Proforma Terms and Conditions for Licensed Corporations, which Manage Portfolios that Invest in Virtual Assets”1 (“VA Fund Manager T&Cs”), with minor variations depending on the business model. The VA Fund Manager T&Cs are imposed on all upgraded VA fund managers and are substantially similar to the SFC’s Fund Managers Code of Conduct ("FMCC"), but adapted specifically for VA Fund Managers and business operations applicable to VA Fund Managers.
If a fund manager with a Type 9 Licence manages funds (or portions of funds) that invest in VA that do not meet either Criteria, the manager would not be required to "upgrade" its licence ("De Minimis Exemption"), but would nevertheless be required to notify the SFC of its intention to manage such VA funds and that it falls within the De Minimis Exemption.
VA Fund Managers responsible, or to which responsibility has been delegated, for the overall operation of a fund but who do not conduct discretionary account management are only subject to certain of the VA Fund Manager T&Cs.
VA Fund Managers that (i) conduct discretionary account management (in the form of an investment mandate or a pre-defined model investment portfolio) and (ii) receive management fees and/or performance fees as remuneration for managing the discretionary accounts ("VA Discretionary Account Managers") are subject to additional requirements that are set out in Appendix 1 of the VA Fund Manager T&Cs.
Summarized below some of the key responsibilities of VA Fund Managers under the VA Fund Manager T&Cs.
Additional Requirements Applicable to Virtual Asset Discretionary Account Managers
VA Fund Managers that are also VA Discretionary Account Managers are subject to certain provisions of the VA Fund Manager T&Cs relevant to discretionary account management, as well as additional requirements set out in Appendix 1 of the VA Fund Manager T&Cs.
Appendix 1 also sets out the following additional requirements applicable to VA Discretionary Account Managers: (i) minimum content requirements of discretionary client agreements; and (ii) the additional requirements that are summarized below.
Contravention of the VA Fund Manager T&Cs is likely to reflect adversely on the fitness and properness of a VA Fund Manager or VA Discretionary Account Manager, and may result in disciplinary action by the SFC. The SFC has said it will adopt a pragmatic approach when implementing the VA Fund Manager T&Cs, taking into account all relevant circumstances, including the size of the VA Fund Manager or VA Discretionary Account Manager, as the case may be, as well as any compensatory measures implemented by their senior management.
A fund manager who is applying for a Type 9 Licence or an existing Type 9 Licence fund manager who wishes to upgrade its existing licence ("Upgrade Applicant") is required to inform the SFC if it plans to manage one or more funds that invest in VAs, subject to the De Minimis Exemption. Once it receives this information, the SFC will first seek to understand the Upgrade Applicant's business activities. If the Upgrade Applicant appears to be capable of meeting the expected regulatory standards, the proposed VA Fund Manager T&Cs will be provided to the Upgrade Applicant (where applicable) and the SFC will discuss them with the Upgrade Applicant and vary them in light of its particular business model so as to ensure that they are reasonable and appropriate.
In practice, an Upgrade Applicant will be required to complete a questionnaire that covers, among others, the considerations (set out below). This should enable the SFC to determine whether the Upgrade Applicant is able to comply with the VA Fund Manager T&Cs. Then there will likely be several rounds of questions and queries from the SFC on the responses in the questionnaire, often resulting in a call or meeting with the SFC. A successful Upgrade Applicant will then be required to agree and comply with the VA Fund Manager T&Cs, which will be imposed as a licensing condition.
From our experience and understanding from the market, this application process can take any time from six months to over a year, depending on various factors including the Upgrade Applicant's responsiveness, the complexity of the application and the proposed key terms of the funds, the ability to demonstrate the Upgrade Applicant's willingness and capability to comply with the VA Fund Manager T&Cs, amongst other things.
We have set out below some key considerations for an Upgrade Applicant when submitting its application. These are in addition to those set out in the VA Fund Manager T&Cs:
Feasibility Report Looking at the developments of the Hong Kong laws and regulations in relation to VAs, including the VA Fund Manager T&Cs regime, it is encouraging to see that the Hong Kong Government has lived up to its pledge to open up the virtual asset industry to provide Hong Kong with a competitive edge as a virtual asset hub in the Asia region. Hong Kong has developed a wide array of licensing and regulatory regimes which allows VA industry players to navigate the market in confidence.