The Securities and Futures Commission of Hong Kong (SFC) has issued regulations for fund managers investing in virtual assets, setting requirements for the custody of virtual assets, how to manage counterparty risk, and more.

On October 4, 2019, The financial market watchdog announced that a set of rules will be imposed on licensed corporations that manage portfolios investing in virtual assets, such as digital currencies like bitcoin and ether, but also utility tokens, security or asset-backed tokens, as well as other virtual commodities, and crypto-assets.

Key takeaways

The 37-page regulation, effective immediately, details a series of requirements virtual asset fund Managers must comply with in terms of management and operations, liquid capital, cybersecurity, compliance, custody, and counterparty risks. It applies to entities overseeing funds that allocate more than 10% of their portfolio in virtual assets.

The following are some of the main requirements:

Financial resources: Virtual asset fund managers must at all times maintain liquid capital of HK$3 million or higher.

Management audit: They must maintain an independent audit function or appoint external auditors to report on the adequacy, effectiveness and efficiency of their management, operations and internal controls.

Compliance function: Fund managers must maintain an effective and independent compliance function, including a compliance officer, to ensure the compliance with its own internal policies and procedures, and with all applicable legal and regulatory requirements.

Financial audit: Fund managers must ensure that an independent auditor is appointed to perform an audit of the financial statements of the fund in order to make available, at a minimum, an annual report for each of the funds they manage.

Participation in initial offerings: They can participate in initial offerings of Virtual Assets on behalf of funds they manage.

Segregated Hong Kong bank account: Virtual asset fund managers must establish one or more segregated bank accounts for holding the fiat money they received from clients. These bank accounts should be established and maintained with an authorized financial institution in Hong Kong or another bank in a jurisdiction approved by the SFC.

Custody: Fund managers must ensure that fund assets are properly and adequately safeguarded. They must select the most appropriate custodial arrangement for holding the fund’s virtual assets, whether that’s self-custody, selecting an independent custodian, or using hot or cold wallets. Virtual asset fund managers should also document the reasons for selecting their custodial arrangements, including self-custody of virtual assets.

Investors: Only professional investors are allowed to invest in virtual asset funds.

Counterparty risk: Fund managers have to establish and maintain an effective credit assessment system to evaluate the creditworthiness of the funds’ counterparties, such as virtual asset trading platforms. Factors such as the experience and track record of the platform, the legal and regulatory status of the platform’s operator, including its compliance history, the corporate governance structure and the background of the founders and senior management of the trading platform, should be meticulously considered.

The regulations come at a time of local interest in bitcoin is reaching unprecedented levels in Hong Kong. According to data from CoinDance, bitcoin trading reached an all-time high last month, with more than HK$12 million worth of bitcoins being exchanged on peer-to-peer bitcoin marketplace LocalBitcoins during the week of September 28, surpassing the previous record of US$11.6 million set in late January 2018.

eToro analyst Mati Greenspan believes there is a correlation between the recent spike in bitcoin trading in Hong Kong and the ongoing political crisis.

“I can’t help but feel that this could very well be a sign that some Hong Kong protesters are seeing bitcoin as a way to opt-out of the local economy, which is run by governments and financial institutions,” Greenspan said in a blog post on October 2.