Since June 2023, Hong Kong has been pursuing the vision of "competing for the global virtual asset center" and has implemented a series of intensive virtual asset policies at a speed beyond expectations, from exchange licensing to new STO regulations, licensed funds and ETFs, and stablecoin regulations, creating a world-leading favorable regulatory environment. In the second half of the year, Hong Kong's virtual asset exchanges, securities firms, asset management funds, venture capital institutions, and OTC merchants have successively started operations. Although there was a lack of infrastructure in the early stage and some companies suffered losses, all businesses are now up and running.
Hong Kong virtual asset policy timeline summary:
May, 2021, the Treasury Department of the Hong Kong Monetary Authority launched a public consultation on "Legislative Proposals to Strengthen the Regulation of Combating Money Laundering and Terrorist Financing in Hong Kong" to discuss the licensing system for virtual asset service providers;
2022 January 10The Policy Statement on the Development of Virtual Assets in Hong Kong was released;
2022 January 12The Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 was officially passed by the Legislative Council, and virtual asset service providers are officially regulated by Hong Kong law;
2023 January 1, the Hong Kong Monetary Authority released a consultation summary on virtual assets and stablecoins;
2023 January 5, the HKMA’s official website announced the results of the public consultation on the “Guidelines on Combating Money Laundering and Terrorist Financing”;
2023 January 5The Hong Kong Securities and Futures Commission’s official website published a circular on the implementation of a new licensing system specifically for virtual asset trading platforms.
2023 January 6, a new licensing system for virtual asset trading platforms came into effect;
2023 January 10The Joint Circular on Virtual Asset-Related Activities of Intermediaries was issued, allowing securities firms and banks to conduct virtual asset retail business with a license;
2023 January 11The Circular on Intermediaries Engaging in Tokenized Securities-Related Activities was released, and STO does not require professional investors. On the same day, the Circular on Tokenized SFC-Approved Investment Products was released.
2023 January 12The Hong Kong Securities and Futures Commission’s official website published the “Notice on Funds Involving Virtual Assets Approved by the Securities and Futures Commission”, and is ready to accept applications for virtual asset spot ETFs; on the same day, the “Joint Circular on Virtual Asset-Related Activities of Intermediaries” was updated again, clarifying the distribution regulations including virtual asset spot ETFs;
Interpretation of the issuance conditions of virtual asset spot ETFs:Generally speaking, the issuance of products needs to meet the requirements of three regulatory documents: "Hong Kong Code on Unit Trusts and Mutual Funds" + "Joint Circular" + "Fund Circular".
The previous document mainly involves traditional regulatory requirements, because ETFs in Hong Kong are mainly issued by unit trusts. Of course, in recent years, ETFs issued by open-ended fund companies (OFCs) have also appeared. We will not introduce them here. The Joint Circular mainly introduces the regulatory requirements for virtual asset distribution, VA dealing, asset management and advisory, which covers a wide range. Therefore, we only introduce the policy part involving BTC spot ETFs.
Regarding the Fund Circular, it clearly states that the scope of supervision is (1) funds issued to the public, and (2) funds that invest 10% or more of their total asset value in virtual currencies. Bitcoin spot ETFs are included, so we will focus on them.
In detail, the issuance requirements are as follows:
1. Issuer qualifications
Unlike the US SEC, which has no clear regulations on the qualifications of issuers of Bitcoin spot ETFs, the Hong Kong SFC has made relatively strict regulatory requirements for issuers - asset management companies that issue virtual asset fund products need to meet the following three conditions:
- Have a good record of regulatory compliance.This means that asset management companies with bad records are basically excluded, and newly established asset management companies face certain uncertainties. Therefore, established asset management companies in Hong Kong have certain advantages in issuing BTC spot ETFs.
- The company has at least one qualified employee with experience in virtual asset and related product management.
- The company needs to hold an upgraded No. 9 license plate.That is, the issuing company needs to meet the "Terms and Conditions for Licensed Issuers Registered Institutions Managing Investment Portfolios Investing in Virtual Assets". It should be noted that the document was revised in October 2023 to lower the application conditions and difficulty.
2. Underlying asset requirements
According to the circular, the underlying assets of virtual asset spot ETFs must be virtual assets that are currently available for retail users to trade on licensed exchanges in Hong Kong. This means that spot ETFs for the two virtual assets BTC and ETH can currently be issued in Hong Kong.
3. Investment strategy
Virtual asset spot ETFs are passive funds, so there are not many requirements on investment strategies. However, it should be noted that the circular states that leverage is not allowed for funds. The role of Trade Credit Lender is mentioned in BlackRock's BTC spot ETF issuance document, which provides loan services for ETFs in certain scenarios. This role may be prohibited in Hong Kong.
4. Redemption and trading of spot virtual assets
Currently, the issuance of virtual asset spot ETFs in Hong Kong is allowed to adopt two models: cash model and in-kind model. The main reason is that the United States currently has no special regulations to regulate virtual asset trading platforms.
If physical redemption is accepted, criminals may launder money by directly subscribing to ETFs with BTC. However, in Hong Kong, licensed exchanges are required to comply with the Anti-Money Laundering Ordinance, and deposits and withdrawals from the platform must undergo strict KYC/AML audits. Therefore, physical redemption through licensed exchanges can effectively avoid the problems faced by the US market, but this also adds additional requirements to the Hong Kong market:
- Cash subscription and redemption must be conducted on a licensed exchange in Hong Kong, but can be either on-platform or off-platform.
- Physical redemption requires that the virtual assets be transferred to a licensed exchange in Hong Kong or a financial institution (Authorized Financial Institutions, AIs) and its subsidiaries approved by the HKMA;
- Traders (PD) participating in subscription and redemption need to hold an upgraded No. 1 license.
5. Hosting
Similar to trading, virtual assets require independent third-party custody, and the custodian must be a licensed exchange in Hong Kong or a financial institution approved by the HKMA and its subsidiaries. In addition, the following arrangements must be met:
- Custody accounts must be separate from the asset management company’s own accounts;
- Most of the assets are placed in cold wallets, and a small portion is placed in hot wallets for redemption;
- Safekeeping of private keys requires that private keys must be kept in Hong Kong to effectively prevent external attacks and be properly backed up.
6. Valuation
In terms of valuation, the SFC has shown a relaxed attitude. The index compilation used for valuation calculation is not required to include only licensed exchanges in Hong Kong, but can be a major overseas exchange. There are no special restrictions on index providers, only a good reputation is required.
7. Risk Disclosure and Investor Education
This part is covered in both the Joint Circular and the Fund Circular. The Fund Circular mainly covers the risk disclosure in the issuance documents and financial statements, while the Joint Circular mainly targets the risk disclosure requirements in the distribution process. Of course, both circulars require issuers and distributors to conduct investor education.
8. Audit system
According to the requirements of the Fund Circular, funds that are preparing to issue or plan to invest 10% or more of the total asset value of the fund in virtual currencies must consult the SFC in advance and obtain approval.
9. Investor Restrictions
According to the requirements of the Joint Circular, the sales of virtual asset-related products must comply with the requirements of the relevant jurisdictions, that is, virtual asset spot ETFs are prohibited from being sold to mainland Chinese investors.
2023 January 12The Hong Kong Financial Secretary and the Hong Kong Monetary Authority jointly issued a public consultation document to collect suggestions on new legislation for stablecoins.