Contrary to the market's expectation that it would maintain tight regulation of the virtual asset industry, during the Hong Kong Fintech Week 2022, the Hong Kong government announced significant initiatives to open up the virtual asset industry to provide Hong Kong with a competitive edge as a virtual asset hub in the Asia region. In this newsflash we briefly summarise the recent announcements, which relate to "Virtual Asset Futures ETFs", "Retail Security Token Offerings" and "Retail Virtual Asset Services".
Virtual Asset Futures Exchange Traded Funds
Given the rapid development of the virtual asset market and the increased availability of virtual asset products to both professional and retail investors globally, the Hong Kong Securities and Futures Commission (the "SFC") is now prepared to accept applications for authorization of virtual asset futures exchange traded funds ("VA Futures ETF") that will be available to retail investors upon authorization.
On 31 October 2022, at the start of the Hong Kong Fintech Week 2022, the SFC published a circular on VA Futures ETF (the "ETF Circular"), that sets out requirements for VA Futures ETF that are seeking SFC authorization for public offering, in addition to the requirements set out in Chapters 7 and 8 of the SFC's Code on Unit Trust and Mutual Funds ("UT Code"). The main additional requirements in the ETF Circular include:
- Eligible management company – The management company of the VA Futures ETF must have a good track record of regulatory compliance, and a proven track record in managing ETFs of at least three years . The relevant experiences in managing the same or similar type of products (i.e. virtual asset related products) from the group of companies to which the management company belongs will be taken into account. The SFC may consider, on a case-by-case basis, whether they will accept a delegation or co-management arrangement.
- Eligible futures – The VA Futures ETF must only invest in futures contracts that are listed and traded on conventional regulated exchanges, currently confined to Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange. The SFC may further expand the scope of eligible futures in the future upon further review.
- Investment strategy – The VA Futures ETF must adopt an active strategy that allows flexibility in portfolio management and describes its strategy in the event of rolling of futures contracts and market disruptions. The net derivative exposure (as in defined in the UT Code) must not exceed 100% of the VA Futures ETF's total net asset value.
As one of the leading advisers to virtual asset ETFs in the United States, please contact us or your usual Dechert attorney should you wish to explore potential opportunities in this area.
Retail Security Token Offerings
In the keynote speech in the Hong Kong Fintech Week 2022, Ms. Julia Leung, the deputy chief executive officer and executive director of the Intermediary Division of the SFC, commented that security token offerings ("STOs") have been gaining traction amongst traditional financial institutions, including the tokenization of traditional financial instruments, such as debt securities and units in collective investment schemes.
Ms. Leung stated that the SFC will be issuing a circular setting out the requirements applicable to STOs and the listing of STOs, which will largely mirror the existing SFC regime for traditional securities offerings. Ms. Leung also noted that, where the security token is a digital representation of a traditional security but is issued or traded on a blockchain, the security token will be treated the same way as the existing underlying traditional security in terms of regulatory status. This means that the security token will no longer be a "complex product" solely because it is issued or traded on blockchain. If, however, the tokenization process leads to additional features that make the security token "complex", then such security token will be regarded as a "complex product", and distribution will be restricted to professional investors only.
In addition, the SFC expects distributors who distribute security tokens to perform reasonable due diligence and conduct smart contract audits before the security tokens are distributed. These new regulations, together with the modified requirements for listing security tokens on licensed virtual asset exchanges, will be addressed in the upcoming SFC circular.
Retail Virtual Asset Services
The Hong Kong Legislative Council ("LegCo") is currently undertaking the legislative vetting process of the Anti-Money Laundering Amendment Bill ("AML Bill"), which was introduced to the LegCo for first reading on 6 July 2022. The AML Bill seeks to make it mandatory for centralised virtual asset exchanges that offer services in Hong Kong to be licensed by the SFC. In light of feedback received from LegCo members and the public and following soft consultations with the industry and stakeholders, Ms. Leung indicated in her keynote speech that the SFC will be launching a public consultation on whether retail investors should be able to access SFC-licensed trading platforms. The upcoming public consultation will include proposals on governance procedures and listing criteria to admit tokens for secondary market trading by retail investors.
While it is anticipated that Hong Kong will exercise caution in developing its legal and regulatory framework in the virtual asset industry given that it has been subject to many controversies, these announcements are welcomed as an indication that Hong Kong's policy makers and regulators see that virtual assets are here to stay. Interesting times are ahead and Hong Kong has taken significant first steps in regulating the virtual asset industry, which should increase the region's competitive advantage.