New rules have been introduced in Hong Kong to shield retail investors from risks associated with investing in cryptoassets.

The measures were outlined last week by the Securities and Futures Commission (SFC) in Hong Kong and will impact both fund managers and distributors who operate in the city.

In a new regulatory statement, the SFC said volatility, liquidity, fraud and money laundering are among the “risks associated” with investing in cryptoassets, and it highlighted limitations in Hong Kong’s regulatory regime to help it address those risks.

While firms that distribute funds which invest in cryptoassets are required to be licensed by or registered with the SFC, specific controls on offering investment opportunities in cryptoassets have only applied if the assets could be defined as ‘securities’ or ‘futures contracts‘. The SFC said it has therefore decided to bring “a significant portion of virtual asset portfolio management activities into its regulatory net”.

Under the new regime, firms managing funds which solely invest in cryptoassets that do not constitute securities or futures contracts but which distribute them in Hong Kong will be subject to a licensing regime.

In addition, firms that already licensed to manage portfolios including securities and/or futures contracts in Hong Kong will also be subject to licensing conditions where they “intend to invest 10% or more of the gross asset value (GAV) of the portfolios under its management in virtual assets”.

The SFC has set a number of “principles-based” terms and conditions for licensees to meet. One condition is that fund managers only generally allow “professional investors” to invest in cryptoasset portfolios. Retail investors will only be able to invest in mixed portfolios that include cryptoasset funds where licensed securities and/or futures contracts asset managers ensure those funds fall below the 10% “de minimis requirement”, the regulator said.

The SFC warned fund managers that breach the new requirements will face enforcement action.

The regulator also explained that fund distributors will also require a broker’s licence or to be registered with it if they wish to distribute cryptoassets in Hong Kong where those firms do not manage the funds themselves.

Those distributors will need to comply with existing rules, including those that require them to ensure the suitability of a recommendation they make to clients to invest in cryptoassets, it said.

The combined effect of these measures is that the management or distribution of crypto funds will be regulated in one way or another, so that investor interests will be protected either at the fund management level, at the distribution level, or both,” said SFC chief executive Ashley Alder in a speechlast week.

The SFC has also set out its intention to consider tighter regulation of cryptoasset trading platforms after identifying “serious investor protection issues”. The regulator will evaluate the case for new regulation in this area in ‘sandbox’ testing with “interested virtual asset platform operators that have demonstrated a commitment to adhering to the high expected standards”, it said, but promised that any new rules it introduces will be “comparable to those applicable to existing licensed providers of automated trading services”.

The SFC said: “In the initial exploratory stage, the SFC would not grant a licence to platform operators. Instead, it would discuss its expected regulatory standards with platform operators and observe the live operations of the virtual asset trading platforms in light of these standards. It will also consider the effectiveness of the proposed regulatory requirements in addressing risks and providing adequate investor protection.”

“The SFC will critically consider whether the virtual asset trading platforms are, in fact, appropriate to be regulated by the SFC in light of the performance of these trading platforms in the sandbox. Factors to be considered include the adequacy and effectiveness of the proposed conceptual framework; ability to comply with the terms and conditions; investors’ interests; as well as local market and international regulatory developments,” it said.

In its statement, the SFC said that current uncertainty over whether cryptoasset trading platforms could meet anti-money laundering obligations is one reason why it could decide not to regulate the platforms. It suggested that the uncertainty stems from the fact that blockchain technology relied upon by cryptoassets offers anonymity and could undermine customer due diligence checks.

“The exploratory stage is crucial for the SFC to understand the actual operations of platform operators to determine whether these platforms are suitable for regulation,” it said. “If the SFC makes a positive determination at the end of this stage, it would then consider granting a licence to a qualified platform operator.”

For more see Conventus Law.