Riding the momentum of virtual assets investment: Insights for asset managers

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Authored by: Joyce Li

Hong Kong Exchanges and Clearing Limited (HKEX) launched, on 15 November 2024, the HKEX Virtual Asset Index Series, which offers a single and reliable real-time reference price for Bitcoin and Ether, reinforcing Hong Kong’s position as a leading hub for crypto investments in Asia. The introduction of the Index Series comes as the Hong Kong Securities and Futures Commission (SFC) is looking to expand Hong Kong’s virtual assets (VA) licensing regime to regulate new VA service providers. Six spot VA exchange traded funds (ETFs) were listed on HKEX earlier in April this year.

With no signs of slowing interest in the establishment of unauthorised VA funds and a boost in momentum in the authorised fund space, our FSPG partners Joyce Li, Pinky Siu and Isabella Wong were joined by industry experts Jessie Huang, Head of Institutional Sales of Hash Blockchain Limited, and Davy Kong, Managing Director of ASCENT Fund Services (Hong Kong) Ltd in our recent client seminar to share insights on the key considerations for asset managers looking to gain VA exposure in their portfolios.

The panellists discussed wide-ranging topics from SFC licensing requirements, fund structuring considerations, service provider selection and public offering of funds which invest in VA.

SFC licensing considerations: 10% is the magic number

As many would already know, simply being licensed to conduct Type 9 (asset management) regulated activities will not automatically enable a manager to manage funds or portfolios with VA exposure.

Prior approval from the SFC is required if the VA investments of a fund or portfolio are more than 10% of the fund’s or portfolio’s gross asset value (GAV) — explained Isabella, who specialises in advising financial institutions on licensing and regulatory matters. Type 9 licensed corporations must satisfy the SFC’s eligibility requirements, such as having competent personnel with relevant VA experience and appropriate internal controls, in order to obtain the SFC’s approval. The approved licensed corporation will be subject to additional terms and conditions relating to the management of VA investments (see link).

For Type 9 licensed managers who only intend to introduce up to 10% investments in VAs (in terms of GAV) to their funds or portfolio, Isabella reminded such managers should still notify the SFC of its intention to make VA investments.

A clear upward trajectory has been observed over the years. There are, as of today, 29 Type 9 licensed managers who got their licences uplifted.

Choice of fund vehicle: Hong Kong vs off-shore structures

While the Hong Kong open-ended fund company (HK OFC) has emerged as the fund vehicle of choice for ETFs, offshore fund vehicles, such as the Cayman Islands’ exempted open-ended investment companies (including segregated portfolio companies) (Cayman Corporate Fund Vehicles), appear to be favoured by managers managing unauthorised funds with VA investments; even though, the HK OFC and the Cayman Corporate Fund Vehicles share plenty of similarities. One of the potential reasons for the slow adoption of the HK OFC as a structure for VA funds, as explained by Joyce, who regularly advises on retail funds and private funds, could be the need for an HK OFC to appoint a custodian that meets the SFC’s requirements. While great strides have been made to promote Hong Kong as a fund domicile centre, the popularity of the HK OFC as the fund vehicle of choice for VA funds may be stifled until we see a greater number of VA custodians meeting the SFC’s requirements enter the market.

Selecting service providers: the right expertise and ensuring operational resilience

As one would expect, the administrative needs and support for VA funds and its managers are rather different from those for traditional funds, owing to, amongst other things, the nature of the underlying assets and the increased considerations to safeguard against anti-money laundering. Davy remarked that different methodologies and tools are required for the calculation of net asset value for VA funds and additional measures will also need to be established to support in-kind subscription/redemptions by investors. Extra care should be paid to the design of a VA fund and its investment strategy to ensure operational feasibility, be it on service providers’ expertise, system capabilities, or regulatory considerations.

Isabella also shared that finding qualified service providers to support VA fund operations can be challenging and Type 9 licensed managers have on-going oversight obligations on their service providers. She further pointed out the importance of asset managers implementing a robust risk management infrastructure (and in particular, covering cybersecurity risks and counterparty risks), if they intend to manage VA funds.

When it comes to selecting a VA trading platform, Jessie highlighted that trading volume and liquidity of tokens are key, as this will very likely affect the price for the same VA token. However, the technological infrastructure behind the platform should not be overlooked.

Additional considerations for managers of authorised funds venturing into the crypto space

If a manager wishes to offer a VA fund to the retail public of Hong Kong, the fund will need to be authorised by the SFC. This will naturally attract additional considerations. Pinky, who assisted in the authorisation of one of Hong Kong’s first spot VA ETFs, explained that fund managers intending to launch authorised VA funds will need to look into SFC considerations apart from SFC licensing. In particular, the experience requirements for the manager’s key investment personnel are different from the experience requirements for a responsible officer. A fund manager looking to launch a VA spot ETF will need to ensure that it can demonstrate to the SFC that it has investment personnel with experience in VA investments as well as investment personnel with proven ETF capability. In addition, the SFC will consider whether the manager has a good track record of regulatory compliance. For a new ETF issuer who wishes to launch VA ETFs, the SFC may require the manager to engage qualified auditors to conduct an internal control review on the manager’s operational framework to ensure its compliance with the SFC requirements.

What lies ahead

Noting that there is little product differentiation between the 6 spot VA ETF, Jessie shared that they are in regular dialogue with the SFC on new product ideas and new initiatives which will enrich Hong Kong’s VA offering. Jessie noted that, so far, the SFC has been facilitative, demonstrating a readiness to understand industry needs and share regulatory concerns. Aside from VA funds, Pinky also shared the regulatory willingness to develop Hong Kong’s VA ecosystem, as demonstrated by the recent launch of Project Ensemble Sandbox by the Hong Kong Monetary Authority, which aimed at accelerating tokenization adoption including that of investment fund units.

The panellists are cautiously optimistic that this is only the beginning of the growth of the VA investment ecosystem in Hong Kong. With careful planning, and working with the right partners, joining the VA bandwagon may not be as daunting as it may initially appear.

Key Contacts

Joyce Li

Partner | Financial Services

Email or call +852 2825 9318