Global menu

Our global pages


SFC enhances its regulatory framework to manage crypto-asset risks

  • Hong Kong
  • Other


On 1 November 2018, the Securities and Futures Commission (SFC) published a number of changes to its regulatory framework with the aim of enhancing protection for investors participating in crypto-asset markets. These comprise new requirements for crypto-asset portfolio managers and fund distributors, together with a conceptual framework applicable to crypto-asset trading platform operators.

The SFC has been innovative in how they have sought to impose their control on the crypto-asset market.  In particular, the SFC has used licensing conditions to enabled it to move the regulatory needle in circumstances where changes to the Securities and Futures Ordinance (SFO), which would otherwise be required to properly regulate this market, are virtually impossible.


At its peak in January 2018, the market capitalization of crypto-assets such as Bitcoin was estimated at more than US$800 billion. Today, although the crypto-asset market has an estimated capitalization of over US$200 billion, there remains a growing demand especially for funds investing in crypto-assets.

There is a consensus amongst securities regulators that crypto-assets pose significant investor protection risks. Under the SFO, crypto-assets are only regulated to the extent they can be considered to represent “securities” or “futures contracts”. As a result, to date, much of the investment that takes place in crypto-assets in Hong Kong is unregulated.

Crypto-Asset Portfolio Managers

Moving forwards, the following portfolio managers will be subject to specific requirements to address risks presented by crypto-assets:

  • Type 1 licensed firms who manage or plan to manage collective investment schemes investing solely in crypto-assets (which do not constitute securities or futures contracts) and distribute the same in Hong Kong; and                                                          
  • Type 9 licensed firms (or applicants) to the extent that these firms also manage portfolios which invest solely or partially (subject to the de minimis requirement[1]) in crypto-assets.

What are the new requirements?

These portfolio managers will be required to adhere to principles articulated in terms and conditions prepared by the SFC which are aimed at addressing the risks presented by crypto-assets.  Notably, the requirements restrict eligibility for investment in crypto-asset portfolios to Professional Investors.  This, of all the changes, represents the single biggest change to the market and arguably the biggest risk to licensed firms operating in these areas.

The full terms and conditions have not been published by the SFC.  However, the SFC has published a summary which indicates the terms and conditions will include provision for:

  • types of investors and disclosure to investors;
  • safeguarding of assets;
  • portfolio valuation;
  • risk management;
  • auditors; and
  • liquid capital.

How will they be imposed?

License applicants and licensed corporations are required to inform the SFC if they are presently managing, or are planning to manage, one or more portfolios that invest in crypto-assets (subject to the de minimis requirement). Upon being notified, the SFC will assess whether the firm is capable of meeting the expected regulatory standards and, if so, provide the terms and conditions to the firm.  The SFC accepts that it may be necessary to vary the terms and conditions in light of a firm’s business model to ensure they are reasonable and appropriate.

If a license applicant does comply with the terms and conditions, its licensing application will be rejected. If an existing licensed corporation with a crypto-asset portfolio does not comply with the terms and conditions, it will be required to unwind the relevant crypto-asset portfolios within a reasonable period of time.

After the license applicant or licensed corporation has agreed to the terms and conditions, they will be imposed as licensing conditions. Failure to comply with any licensing condition is likely to be considered as misconduct under the SFO.

Crypto-Asset Fund Distributors

The SFC has also published a circular which outlines additional requirements for intermediaries who engage in distributing crypto-asset funds[2] which are not authorized by the SFC.  Among other matters, the circular includes a requirement that intermediaries should only target Professional Investors for funds of this nature and provide sufficient information to clients about the fund’s underlying crypto-asset investments to allow them to make informed investment decisions.  This should include a prominent crypto-asset focused warning statement.  In addition, intermediaries are required to engage in detailed due diligence of the fund, as well as their fund managers and the parties which provide trading and custodian services to the fund. 

Crypto-Asset Platform Operators

Finally, and perhaps most controversially, the SFC has outlined what it terms a ‘conceptual framework’ for the potential regulation of crypto-asset trading platform operators (Platform Operators).

It is envisaged this framework could provide a path for compliance for Platform Operators capable and willing to adhere to a high level of standards and practices required by the SFC, setting licensed Platform Operators apart from those which are not licenced. This is an opt-in scheme, where interested crypto-asset trading platforms are placed into the SFC’s regulatory sandbox to identify and address any risks or concerns associated with their regulated activities. If the SFC makes a positive determination following this exploratory stage, it would consider granting licenses to qualified Platform Operators.

What are the proposed requirements?

If the SFC concludes that it may grant a to a Platform Operator, the SFC will impose specific conditions aimed at addressing the risks associated with its operations.  These are likely to include the following core principles:

  • all crypto-asset trading activities are to be conducted under a single legal entity;
  • compliance with the applicable regulatory requirements by the entire crypto-asset trading business (notwithstanding whether certain crypto-assets are or not securities);
  • offering services to Professional Investors only;
  • limitations on the trading of initial coin offering assets within the first 12 months after they are issued; and
  • ensuring all transactions are pre-funded, and no leverage, futures contracts or other derivative products are offered.

While many Platform Operators will welcome some form of regulatory oversight, it remains to be seen whether this will be sufficient to see adoption of the SFC’s ‘conceptual framework’ on a widespread basis.  In particular, the requirement to offer services to Professional Investors only may effectively prevent some operators from participating in the SFC’s approach due to the potential impact it would cause to their business model.

In addition to these core principles, the SFC expects that it may need to impose further conditions to provide enhanced protection for investors.  The nature of such conditions will vary according to the particular nature of a Platform Operators business. Examples of such additional conditions are:

  • maintaining a reserve equivalent to 12 months of operating expenses as a financial buffer;
  • taking out insurance policies for risks associated with the custody of crypto-assets;
  • assessing the client’s knowledge of crypto-assets prior to providing any services;
  • anti-money laundering and counter-financing of terrorism;
  • disclosure requirements regarding the risks crypto-assets;
  • due diligence requirements on crypto-assets prior to permitting trading on the platform;
  • creating and publishing trading rules governing platform operations;
  • preventing market manipulation and abuse activities;
  • establishing procedures governing employees dealings regarding conflicts of interest;
  • proprietary trading restrictions where there are conflicts with client or employee orders;
  • segregation and custody of client’s money and crypto-assets; and
  • ongoing reporting requirements.

[1] Only crypto-asset portfolio managers who intend to invest 10% or more of the gross asset value of the portfolios under management will be subject to specific SFC oversight in relation to crypto-assets.

[2] A fund which has a stated investment objective to invest in crypto assets or intends to invest or has invested more than 10% of their gross asset value in crypto-assets, directly or indirectly.