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 3. Circulars


CIRCULAR ON SFC-AUTHORISED FUNDS WITH EXPOSURE TO VIRTUAL ASSETS

22 Dec 2023



 1.  This circular sets out the requirements under which the Securities and
     Futures Commission (SFC) would consider authorising investment funds1 with
     exposure to virtual assets (VA)2 of more than 10% of their net asset value
     (NAV) for public offerings in Hong Kong (SFC-authorised VA Funds) under
     sections 104 and 105 of the Securities and Futures Ordinance.

 2.  This circular supersedes the Circular on Virtual Asset Futures Exchange
     Traded Funds issued on 31 October 2022.
     
     Background

 3.  Globally, the VA landscape has been evolving rapidly. A broader range and a
     larger number of investment products providing exposure to VA, including
     VA-related exchange traded funds (ETFs) offered in major overseas markets,
     are now available to both retail and professional investors, and have
     become increasingly popular. Demand for these products has also increased
     in Hong Kong.

 4.  In light of these developments, the SFC has introduced regimes that allow
     the offering of certain VA products to the Hong Kong public with
     appropriate investor protection safeguards. For example, the SFC started
     accepting applications in October 2022 for ETFs that obtain exposure to VA
     primarily through futures contracts. The SFC’s licensing regime of virtual
     asset trading platforms (VATPs) also became effective in June 2023,
     enabling Hong Kong investors to directly access large-cap spot VA, subject
     to certain eligibility requirements and robust investor protection
     safeguards.

 5.  This circular sets out the requirements for SFC-authorised funds to (i)
     invest directly in the same spot VA tokens accessible to the Hong Kong
     public for trading on SFC-licensed VATPs (ie, direct exposure); and/or (ii)
     acquire indirect investment exposure to such VA (ie, indirect exposure),
     for example, through futures traded on conventional regulated futures
     exchanges and other exchange-traded products.
     
     Requirements on SFC-authorised VA Funds

 6.  SFC-authorised VA Funds should meet the applicable requirements in the
     Overarching Principles Section and the Code on Unit Trusts and Mutual Funds
     (UT Code) in the SFC Handbook for Unit Trusts and Mutual Funds,
     Investment-Linked Assurance Schemes and Unlisted Structured Investment
     Products.

 7.  Additional requirements as set out below, as well as the relevant
     requirements in the joint circular on intermediaries’ virtual asset-related
     activities (Joint Circular)3, should be satisfied.
     
     Management companies

 8.  The management companies of SFC-authorised VA Funds should have (i) a good
     track record of regulatory compliance; and (ii) at least one competent
     staff member with relevant experience in the management of VA or related
     products.

 9.  The management companies of SFC-authorised VA Funds are subject to
     additional terms and conditions to be imposed by the Licensing Department
     (where applicable)4.
     
     Eligible underlying VA

 10. SFC-authorised VA Funds should only invest (directly or indirectly) in VA
     tokens that are accessible to Hong Kong public for trading on SFC-licensed
     VATPs.
     
     Investment strategy

 11. SFC-authorised VA Funds may invest directly or indirectly in eligible VA
     tokens in accordance with the following requirements.

 12. For VA futures, only those traded on conventional regulated futures
     exchanges are allowed, subject to the management company demonstrating that
     (i) the relevant VA futures have adequate liquidity and (ii) the roll costs
     of the relevant VA futures are manageable and how such roll costs will be
     managed.

 13. Indirect exposures to eligible VA via other exchange-traded products are
     subject to applicable requirements in the UT Code and other requirements
     which may be imposed by the SFC.

 14. SFC-authorised VA Funds should not have leveraged exposure to VA at the
     fund level.

 15. For SFC-authorised VA Funds that primarily adopt a futures-based investment
     strategy, they are expected to adopt an active investment strategy to allow
     flexibility in portfolio composition (eg, diversification of futures
     positions with multiple expiry dates), rolling strategy, and handling of
     any market disruption events.
     
     Transactions and direct acquisitions of spot VA

 16. Transactions and acquisitions of spot VA by SFC-authorised VA Funds should
     be conducted through SFC-licensed VATPs5, or authorised financial
     institutions (AIs) (or subsidiaries of locally incorporated AIs) in
     compliance with Hong Kong Monetary Authority’s (HKMA) regulatory
     requirements. In particular:
     
     (a) for in-cash subscriptions and redemptions, SFC-authorised spot VA ETFs
     are expected to acquire and dispose of spot VA through SFC-licensed VATPs
     (either on-platform or off-platform); and
     
     (b) for in-kind subscriptions, participating dealers (PDs) are expected to
     transfer spot VA, which may be held locally or overseas, to SFC-authorised
     spot VA ETFs’ custody accounts with SFC-licensed VATPs, or AIs (or
     subsidiaries of locally incorporated AIs). The process is vice versa for
     in-kind redemptions.

 17. Both in-kind and in-cash subscription and redemption are allowed for
     SFC-authorised spot VA ETFs.

 18. For ETFs that invest in spot VA, their PDs should be (i) SFC-licensed
     corporations or registered institutions; and (ii) subject to additional
     terms and conditions to be imposed by the Licensing Department (where
     applicable)6.
     
     Custody

 19. The trustee/custodian of an SFC-authorised VA Fund should only delegate its
     VA custody function (where applicable) to (i) an SFC-licensed VATP, or (ii)
     an AI (or subsidiary of a locally incorporated AI) which meets the expected
     standards of VA custody issued by the HKMA from time to time.

 20. The trustee/custodian and any delegate responsible for taking custody of VA
     holdings of an SFC-authorised VA Fund should comply with the following:
     
     (a) it should ensure that the VA holdings are segregated from its own
     assets and the assets it holds for its other clients7;
     
     (b) it should store most of the VA holdings in the cold wallet. The amount
     and duration of VA holdings stored in the hot wallet should be minimised as
     much as possible, save for meeting the needs of subscriptions and
     redemptions; and
     
     (c) it should ensure the seeds and private keys are (i) securely stored in
     Hong Kong; (ii) tightly restricted to authorised personnel; (iii)
     sufficiently resistant to speculation (eg, through generation in a
     non-deterministic manner) or collusion (through measures such as
     multi-signature and key sharding); and (iv) properly backed up to mitigate
     any single point of failure.
     
     Valuation

 21. For the valuation of spot VA, the management companies of SFC-authorised VA
     Funds should adopt an indexing approach based on VA trade volume across
     major VA trading platforms (ie, a benchmark index published by a reputable
     provider that reflects a significant share of trading activities in the
     underlying spot VA).
     
     Service providers

 22. The management companies should confirm that all necessary service
     providers (such as fund administrators, PDs, market makers and index
     providers) are competent, available and ready to support the SFC-authorised
     VA Funds.
     
     Disclosure and investor education

 23. The offering documents, including the product key facts statements (KFS),
     of SFC-authorised VA Funds should disclose the investment limits and key
     risks related to the funds’ VA exposures.

 24. The KFS of SFC-authorised VA Funds should contain upfront disclosure of the
     investment objectives and the key risks associated with the funds’ VA
     exposures, such as:
     
     (a) price risk, custody risk, cybersecurity risk and fork risk for
     investments in spot VA; and
     
     (b) potentially large roll costs and operational risks (such as margin risk
     and risk associated with mandatory measures imposed by relevant parties)
     for investments in VA futures.

 25. The management companies of SFC-authorised VA Funds are expected to carry
     out investor education before launch as per existing requirements under the
     UT Code.
     
     Distribution

 26. Please refer to the relevant requirements for intermediaries and
     distribution of SFC-authorised VA Funds as set out in the Joint Circular.
     
     Others

 27. The SFC may consider introducing additional requirements or conditions as
     deemed necessary or appropriate in the discharge of its functions.
     
     Application and prior consultation

 28. Subject to paragraph 29, the requirements above are not applicable to
     Recognised Jurisdiction Schemes (including UCITS funds) and those under
     mutual recognition of funds arrangements.

 29. For (i) funds having or intending to have VA exposure of more than 10% of
     NAV that wish to seek the SFC’s authorisation or (ii) existing
     SFC-authorised funds that plan to obtain VA exposure of more than 10% of
     their NAV, prior consultation with and approval of the SFC are required.

 30. If you wish to seek clarification of any aspects of this circular, please
     contact the team supervisor or case officer of the Investment Products
     Division who is responsible for overseeing the SFC-authorised funds of your
     fund group or client.

Investment Products Division
Securities and Futures Commission

1 This circular is not applicable to Recognised Jurisdiction Schemes (including
UCITS funds) and those under mutual recognition of funds arrangements, save for
the prior consultation and approval requirement in paragraph 29.

2 “Virtual asset” refers to any “virtual asset” as defined in section 53ZRA of
the Anti-Money Laundering and Counter-Terrorist Financing Ordinance.

3 Available at SFC website.

4 See Appendix 7 of the Joint Circular.

5 These transactions and acquisitions may be conducted on-platform or
off-platform (ie, over-the-counter) on SFC-licensed VATPs.

6 See Appendix 6 of the Joint Circular.

7 Unless client assets are held in an omnibus account, in that case, it should
adhere to the standards as set out in 4.5(a)(iv)(3) of the UT Code.


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