The global rise of digital assets has prompted financial hubs like Hong Kong to develop clear regulatory frameworks for virtual asset management. For fund managers aiming to operate legally in this dynamic market, understanding the Securities and Futures Commission (SFC) guidelines is essential. This article breaks down the compliance pathway for virtual currency funds in Hong Kong, focusing on licensing, operational standards, risk management, and investor protection—without unnecessary jargon or promotional content.
The Evolution of Hong Kong’s Crypto Fund Regulation
Prior to 2018, the SFC only regulated asset management activities involving traditional securities or futures contracts under the Securities and Futures Ordinance (SFO). This left many non-security digital assets—like utility tokens or decentralized cryptocurrencies—outside formal oversight, creating regulatory gaps and potential risks for investors.
A turning point came on November 1, 2018, when the SFC issued its Statement on Regulatory Framework for Virtual Asset Portfolio Managers, extending supervision to firms managing portfolios with significant virtual asset exposure. This was further strengthened on October 4, 2019, with the release of the Standard Terms and Conditions for Licensed Corporations Managing Investment Portfolios in Virtual Assets (the "Terms and Conditions").
These rules established that fund managers must obtain SFC authorization if they manage portfolios where:
- The investment objective explicitly targets virtual assets, or
- At least 10% of total assets are invested in virtual assets.
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This marked a pivotal shift: virtual assets were now subject to structured oversight regardless of whether they qualified as securities.
What Qualifies as a “Virtual Asset”?
Under SFC guidance, a virtual asset refers to digitally represented value, including but not limited to:
- Digital tokens (e.g., cryptocurrencies, utility tokens)
- Asset- or security-backed tokens
- Other virtual commodities or cryptographic assets
Crucially, this definition applies even if the asset does not meet the legal definition of a "security" or "futures contract" under the SFO. This broad scope ensures comprehensive investor protection across diverse blockchain-based instruments.
Key Compliance Requirements for Crypto Funds
Financial and Operational Capacity
Fund managers must maintain at least HK$3 million in liquid capital at all times unless a variable minimum applies based on business scale. This ensures sufficient financial resilience to manage operational risks and protect client interests.
Additionally, strict anti-money laundering (AML) and counter-terrorism financing (CFT) protocols must be followed, including:
- Customer due diligence
- Ongoing transaction monitoring
- Suspicious activity reporting
- Employee training programs
- Independent compliance audits
These align with the SFC’s Guideline on Anti-Money Laundering and Counter-Financing of Terrorism, emphasizing accountability and transparency.
Asset Custody: Security and Separation
One of the most critical aspects of compliance is asset segregation. Fund managers must ensure:
- Clear separation between fund assets and corporate assets
- Independent custody functions from management roles
- Use of trust declarations for crypto wallets and private keys
While self-custody is permitted, it requires robust internal controls and ideally, insurance coverage against theft or loss. Full disclosure of custody arrangements—including risks and safeguards—is mandatory for investor transparency.
Where third-party custodians are used, preference should be given to regulated providers, and using multiple custodians helps avoid concentration risk.
Daily Management: Fairness, Transparency, and Conflict Avoidance
Trade Allocation
All trades executed on behalf of funds must be allocated fairly. Managers must:
- Document allocation methods before execution
- Ensure immediate allocation post-trade
- Justify any deviations with clear records
This upholds fairness across investor portfolios.
Prohibited Activities
Cross-trading between funds is allowed only if:
- It serves the best interests of all involved parties
- Prices reflect fair market value
- Full disclosure is made to investors
- Transactions between company accounts and fund accounts require prior investor consent and full conflict-of-interest disclosure.
- Employee personal accounts are strictly prohibited from engaging in cross-trades with fund accounts.
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Moreover, fund orders always take precedence over proprietary trading. Any overlap must serve the fund’s interest first.
Risk Management Frameworks
Effective risk controls are non-negotiable. Licensed firms must implement policies addressing:
Market Risk
- Use of value-at-risk (VaR) models
- Regular stress testing under extreme market scenarios
Liquidity Risk
- Assess mismatches between portfolio liquidity and redemption obligations
- Apply both quantitative and qualitative metrics
Counterparty Risk
- Establish credit assessment systems for exchanges, custodians, and trading partners
Operational & Cybersecurity Risks
- Segregate incompatible duties
- Maintain accurate accounting records
- Ensure data security and timely reconciliation
- Conduct regular system penetration tests
These measures collectively strengthen operational integrity and protect against systemic failures.
Reporting, Disclosure, and Investor Protection
Record Keeping
Records related to virtual asset transactions must be retained for:
- At least 7 years for general business documents
- At least 2 years for trade order details
All records must be stored at SFC-approved locations.
Annual Audits
Each fund must undergo an annual audit by an independent auditor, with reports made available to investors upon request.
Side Pocket Mechanisms
When illiquid or hard-to-value assets are held, they may be moved into a side pocket account—separate from the main portfolio. Before doing so, managers must disclose:
- Maximum percentage allowed in side pockets
- Fee structures
- Redemption terms
- Criteria for inclusion/exclusion
- Potential transfer mechanisms
Ongoing fee disclosures for side-pocketed assets are also required.
Marketing and Distribution Rules
Only professional investors may invest in SFC-authorized virtual asset funds. All promotional materials must be:
- Accurate and verifiable
- Free from misleading claims
- Balanced with full risk disclosures
- Consistent with official offering documents
Misleading performance claims or omission of key risks can result in enforcement actions.
Ongoing Regulatory Reporting
Managers must notify the SFC at least seven business days before any major operational change. The SFC may also request periodic updates on:
- Investment concentrations
- Valuation methodologies
- Custody arrangements
Transparency remains central to ongoing supervision.
Required Risk Disclosures to Investors
Potential investors must be clearly informed about risks such as:
- High price volatility
- Market manipulation on unregulated exchanges
- Limited secondary markets for certain tokens
- Challenges in verifying ownership
- Most platforms and custodians remain unregulated
- Counterparty risks with issuers or private sellers
- Legal uncertainty around whether virtual assets constitute “property”
Notably, a recent Hong Kong court ruling affirmed that cryptocurrencies can be held in trust—marking a significant step toward legal recognition and enhanced investor protection.
Frequently Asked Questions (FAQ)
Q: Do I need an SFC license if my fund holds less than 10% in crypto?
A: If your fund holds less than 10% in virtual assets and doesn’t market itself as crypto-focused, you may not need additional authorization beyond standard Type 9 (asset management) licensing.
Q: Can retail investors access virtual asset funds in Hong Kong?
A: As of now, only professional investors are permitted to invest in SFC-regulated virtual asset funds. Retail access remains restricted pending further regulatory developments.
Q: Is self-custody of crypto assets allowed under SFC rules?
A: Yes, but only with strong internal controls, clear segregation of duties, insurance coverage, and full disclosure to investors about associated risks.
Q: What happens if a fund exceeds the 10% threshold unexpectedly?
A: The manager must immediately notify the SFC and seek appropriate authorization. Continued operation without approval could lead to penalties or license revocation.
Q: Are decentralized finance (DeFi) assets covered under these rules?
A: Yes, if DeFi tokens represent value and are part of the portfolio, they fall under the virtual asset definition and are subject to the same regulatory requirements.
Q: How often should fund valuations be updated?
A: Valuations should be performed regularly—ideally daily—with transparent methodologies documented and reviewed periodically by auditors.
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