SFC Sets Out New Regulatory Approach For Virtual Assets

Author:Shearman & Sterling LLP
Profession:Shearman & Sterling LLP

On 1 November, 2018, the Securities and Futures Commission of Hong Kong (SFC) issued a statement (the "Statement"), which sets out a new approach aiming to regulate virtual asset portfolio managers and distributors of virtual asset funds and a conceptual framework for the potential regulation of virtual asset trading platforms. In an accompanying circular (the "Circular"), the SFC provided detailed guidance and reminded firms that distribute funds investing in virtual assets of the registration and regulatory requirements.

The Statement

The SFC warns investors of the significant risks of virtual assets, some of which are inherent in the nature and characteristics of virtual assets while others arise from the operations of platforms or portfolio managers. In particular, the SFC focuses the regulatory attention on the following risks: (i) valuation, volatility and liquidity; (ii) accounting and auditing; (iii) cybersecurity and safe custody of assets; (iv) market integrity; (v) risk of money laundering and terrorist financing; (vi) conflicts of interest; and (vii) fraud.

Under the existing regulatory regime, virtual assets that fall into the definition of "securities" or "futures contracts" under the Securities and Futures Ordinance and activities related to such virtual assets are subject to regulation by the SFC. Firms must also comply with certain notification requirements if they intend to provide trading and asset management services involving crypto-assets. In addition, firms engaging in the distribution of funds that invest in virtual assets, regardless of whether such assets amount to "securities" or "futures contracts," need to be licensed by or registered with the SFC. However, since some virtual assets may not constitute "securities" or "futures contract," many investors are still left unprotected if they trade in virtual assets through unregulated trading platforms or invest in virtual asset portfolios that are managed by unregulated portfolio managers.

To address such regulatory concerns, the SFC plans to bring a significant portion of virtual asset portfolio management activities into its regulatory net through the following means.

Scope of Supervision. The expanded scope of supervision of the SFC catches (i) persons managing funds which solely invest in virtual assets that do not constitute "securities" or "futures contracts" and distribute the same in Hong Kong; (ii) persons that are licensed or are to be licensed for Type 9...

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