The Hong Kong Securities and Futures Commission and the Hong Kong Stock Exchange are speaking out! Proposed to launch virtual asset futures ETF!

On October 31, Ms. Leung Fung Yee, Deputy Chief Executive Officer and Executive Director of Intermediaries of the Securities and Futures Commission of Hong Kong ("SFC"), disclosed in her speech at "In Hong Kong Fintech Week 2022" that the SFC plans to issue guidelines on virtual asset futures exchange-traded funds ("ETFs"). HKEx Co-Operating Director and Co-Head of Markets, Mr. K.Y. Yiu, then said that HKEx welcomed the SFC's decision to allow virtual asset-based ETFs to be listed in Hong Kong.

Hong Kong Securities and Futures Commission: Proposed recognition of virtual asset futures

ETFs to be publicly offered in Hong Kong

In her speech, Ms. Leung revealed that the SFC has been actively studying the establishment of a system to recognize ETFs that invest in mainstream virtual assets with proper investor protection measures. We now believe that some of the initial concerns about virtual asset futures ETFs have now become manageable and can be addressed with proper safeguards in place," she said. In addition to the existing requirements applicable to ETFs, virtual asset futures ETFs will also be subject to additional requirements in terms of their management companies, investment strategies, disclosure and investor education. Initially, we expect the underlying assets to be limited to Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange (CME)."

Subsequently, the Hong Kong Securities and Futures Commission's website published a "Circular on Exchange Traded Funds for Virtual Asset Futures" (the "Circular"), detailing the circumstances surrounding the public offering of ETFs for accredited virtual asset futures in Hong Kong.

The Circular states that the SFC will consider allowing virtual asset-based ETFs to be publicly offered in Hong Kong primarily through futures contracts in accordance with the Hong Kong Securities and Futures Ordinance.

According to the Circular, the SFC's requirements for the recognition of virtual asset-based futures ETFs are to comply with the "General Principles" section ("General Principles") of the SFC's Handbook on Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products (SFC Handbook) and the "General Principles" section ("General Principles") of the SFC Handbook. ("General Principles" section) and the applicable provisions of the Code on Unit Trusts and Mutual Funds and other provisions contained in the Circular.

The management company of a virtual asset futures ETF must have a good track record of regulatory compliance; and a track record of at least three years in managing ETFs. Relevant experience in managing the same or similar types of products by group companies to which the management company belongs will be taken into account.

In addition, the Circular also provides detailed descriptions of eligible futures, investment strategies, information disclosure, issuance, investor trading, etc. related to recognized virtual asset futures ETFs.

HKEx: Welcomes the introduction of virtual asset ETFs by the HKSCC

On the same day, HKEx Co-Operating Director and Co-Head of Markets, Mr. Yiu Ka Yan, said HKEx welcomes today's announcement by the SFC to allow virtual asset-based ETFs to be listed in Hong Kong, further strengthening Hong Kong's position as an international financial center and supporting the continued development of Hong Kong as Asia's preferred ETF market.

We are very excited about the opportunities that the virtual asset space will bring," he said. HKEx is ready to embrace market innovations and to implement its corporate strategy of 'connecting the present with the future'. HKEx will work closely with issuers and stakeholders to focus on the smooth introduction of such new products into the Hong Kong ETF market. We will update the market on the latest developments in due course."

Hong Kong SFC to allow retail securities-based token offerings

In her speech, Ms. Leung also revealed that the SFC is now ready to adjust its regulatory response and allow retail investors to participate in securities-based token offerings (STOs) if appropriate safeguards are put in place.

She said the SFC recognizes the potential benefits of distributed ledger technology for securities issuance and trading, which can improve the efficiency and transparency of the traditional financial industry, while also helping to reduce costs. The SFC issued a simple statement in 2019 explaining how the SFC's regulatory requirements apply to parties involved in STOs, including that only relevant sales to professional investors are permitted.

STOs are increasingly popular with traditional financial institutions, most of which are interested in 'tokenizing' traditional financial instruments such as debt securities or investment fund units," said Fung Yee Leung. We are now ready to adjust the regulatory response and allow retail investors to participate in the relevant investments if appropriate safeguards are put in place."

She said the licensee should take additional measures for all security-based tokens by conducting a reasonable degree of due diligence and auditing smart contracts before distributing them to customers. Therefore, the SFC will revisit the requirements for securities-based tokens to be included in transactions on licensed virtual asset exchanges and will assess whether changes are needed.

The SFC is currently preparing a circular based on the above idea and will detail the revised security-based token regime in it and will make an announcement upon completion.

The SFC is consulting on a system for retail investors to participate in virtual asset trading

Ms. Leung also introduced the public consultation on the new virtual asset service provider regime. Under the Anti-Money Laundering Amendment Bill, which is currently in the legislative stage, a central virtual asset exchange offering services in Hong Kong must be licensed by the SFC. Subject to the passage of the Bill, the SFC will consult the public on the details of the requirements.

Although this provision is not included in the Bill, there have been many comments from legislators and members of the public during the Bills Committee's deliberations on whether to restrict SFC-licensed virtual asset service providers to professional investors only. The "professional investors only" side argued that relaxing the requirement would be tantamount to "legalizing" crypto assets.

On the other hand, those in favor of a SFC-licensed platform for retail investors point out that if retail investors are shut out, they will be driven to trade on overseas online virtual asset trading platforms that are subject to limited or no regulation at all. In fact, some platforms are even fraudulent websites.

In view of the above, the SFC intends to consult the public on whether to relax the "professional investor only" requirement; if so, what should be the governance procedures before virtual asset service providers launch tokens for retail investors to trade in the secondary market? What trading guidelines should be included? The SFC's Financial Technology Unit is currently conducting intensive informal consultations with industry and stakeholders on this and other issues before finalizing the proposals.