Web3 Legal Education: How to set up a compliant crypto fund in Hong Kong?

Author: Mankiw Blockchain

In the ever-changing financial world, crypto funds are quickly emerging and becoming the new favorite in the investment world. However, choosing which region to set up your crypto fund in is crucial. Hong Kong, the international financial center, is attracting more and more attention with its unique advantages and broad prospects.

Choosing to set up a crypto fund in Hong Kong is not only a strategic decision, but also an important step towards future financial innovation.

So, why are more and more investors and fund managers choosing to set up crypto funds in Hong Kong? Lawyer Bai Qin from Mankiw Law Firm takes everyone to uncover the background and far-reaching significance behind this decision.

Advantages of setting up a crypto fund in Hong Kong

There are many advantages to setting up a crypto fund in Hong Kong, the first of which is its robust legal and regulatory environment. Hong Kong has a stable legal system and friendly financial regulatory policies, especially the transparent and stable regulatory framework provided by the Hong Kong Securities and Futures Commission (SFC), which protects the operation of crypto funds. This environment provides investors and fund managers with reliable legal protection. At the same time, Hong Kong's financial regulatory system and the supervision of major developed countries in the world have achieved mutual recognition, paving the way for Hong Kong's financial products to be sold under restrictive conditions in other regions.

In addition, Hong Kong’s tax incentives are also an important factor in attracting crypto funds. Hong Kong is famous for its low tax rate and partial tax exemption policy, which gives funds a clear competitive advantage in terms of tax costs. Hong Kong is undoubtedly an ideal choice for crypto funds looking to optimize their tax structure globally.

Finally, as an international financial center, Hong Kong has a highly developed financial market and convenient cross-border financial services. This not only promotes the liquidity of funds, but also provides crypto funds with broad market opportunities and diversified investment channels. Hong Kong's degree of internationalization makes it an important hub connecting the financial markets of the East and the West.

Requirements for submitting applications to the Hong Kong Securities and Futures Commission

To manage crypto funds in Hong Kong, you need to apply for a Type 9 (Asset Management) license from the Securities and Futures Commission (SFC).

Involving business

Businesses that need to apply for and hold a Type 9 license (asset management) include two major categories:

Securities management. If the investment portfolio managed by the fund includes securities or futures contracts, you must apply for this license. Securities can include digital tokens that represent equity or debt.

Virtual asset management. The China Securities Regulatory Commission has implemented an expanded licensing regime for managing investment portfolios of virtual assets such as Bitcoin and Ethereum. This involves additional terms and conditions (Pro Forma T&Cs) on existing Class 9 licences.

It is worth noting that for companies that manage a portfolio (or portion of a portfolio), if:

less than 10%(minimum limit) of the total asset value of the portfolio; or

invest indirectly in virtual assets ( For example, the Securities and Futures Commission will supervise these fund managers based on the existing traditional system of the Securities and Futures Ordinance, and the terms and conditions attached to the Type 9 license will be Not applicable to such companies. Conversely, if the company falls into any of the following categories, then the terms and conditions of a virtual asset fund manager will apply:

Category 9 License.

Fund managers who manage portfolios invested in securities/futures contracts, as well as portfolios invested in virtual assets.

• Class 9 license. A fund manager who manages a portfolio that invests both in securities/futures contracts and partly in securities/futures contracts and partly in virtual assets.
• Class 1 license. Manage a collective investment scheme (collective investment scheme) that invests only in non-securities/futures contract virtual assets and distribute or plan to distribute these assets in Hong Kong.
• Application materials
If you meet the above conditions and are about to apply for a license, the applicant or applicant needs to prepare the following main documents:

• Business Plan. Detail the business model, target market and strategy.
• Compliance Manual. Outline compliance policies and procedures to ensure compliance with regulatory requirements.
• Risk Management Framework. Describe the risk management strategy, including measures to address market, operational and liquidity risks.
• Corporate Governance. Provide information on governance structure, including board composition and responsibilities.

Difficulties in applying

Speaking of which, what are the difficulties in applying for a Category 9 (Virtual Assets) license?

Applying for a traditional Category 9 license usually takes 4 to 5 days from preparing the application to finally obtaining the license. months to 12 months. However, the timing can vary significantly when applying to become a crypto fund manager. Here are the main reasons why the application process may take longer, as well as key points to pay special attention to when preparing your application.

First of all, the Hong Kong Securities Regulatory Commission will carefully examine the key personnel to ensure that they have relevant virtual asset fund management experience (preferably 3 years of experience within the past 6 years). In particular, the CSRC will focus on the company's senior managers, such as department heads, team leaders and key investment personnel.

Secondly, the Hong Kong Securities Regulatory Commission will pay close attention to the company’s proposed operating procedures. Questions to consider:

• Is there appropriate separation of key functions (e.g. portfolio management, risk management, valuation, asset custody)?
• Who is involved when transferring assets from a fund or custodian, and what security measures are in place?
• Who is responsible for reconciling trades and positions, and how often?
• Who is the pricing method and its person in charge, and how to evaluate the reasonableness of the pricing of each virtual asset?

Third, there is no doubt that the company’s information technology will become the focus of the Hong Kong Securities and Futures Commission. The following questions need to be considered:

• How will the company ensure appropriate controls and access? For example: a. The private key of the wallet? b. Transfer assets from location X to location Y? c. Always maintain an appropriate proportion of assets in hot and cold wallets?
• Does the company self-custody its assets? If so, is appropriate insurance in place?

The above are just some of the key considerations. The actual nature of fund management activities and the counterparties such as trading platforms and custodians involved also need to be considered.

The process of setting up a crypto fund in Hong Kong

In addition to applying for the No. 9 license, if you want to set up a crypto fund in Hong Kong, the process includes the following steps:

Preliminary assessment

• Determine the scope of supervision. Assess whether your fund investment portfolio contains securities or futures contracts to determine whether you need to apply for a Type 9 license.
• Virtual asset classification. Clarify whether digital assets in an investment portfolio are considered securities under Hong Kong law.

Application preparation

• Document preparation. Prepare required documents including detailed business plan, compliance manual, risk management framework and corporate governance structure.
• Consultation. Work with legal and compliance advisors to ensure all documents comply with SEC standards.

Submit your application

• Submit your application. Submit a complete application package to the Securities and Futures Commission, including all required documents and application fees.

China Securities Regulatory Commission review

• review period. The CSRC reviews the application, which may involve multiple rounds of feedback and requests for additional information. This process may take several months.

License decision

• Decision notification. After passing the review, the China Securities Regulatory Commission will grant the license. If conditions are attached, they must be followed to ensure compliance.

Fund establishment

• Establish the fund structure. Create the legal structure of the fund, hire service providers (administrators, auditors, custodians), and set up the necessary operational infrastructure.
• Investor opening an account. Start marketing the fund to potential investors and handle the subscription process.

The cost of setting up a crypto fund

The costs of setting up and maintaining a crypto fund in Hong Kong can vary widely. Specific fees depend on a number of factors, including fund size, management strategy and compliance requirements. Often, legal and audit fees are required to ensure compliance with local regulations. In addition to this, there is also the cost of license applications and annual fees to consider. To improve operational efficiency and cost-effectiveness, it is recommended to work with a professional service provider who is familiar with the crypto fund market. The following table outlines typical fees:

Mankiw Lawyer Advice

Crypto funds are revolutionizing the investment landscape, presenting both exciting opportunities and complex challenges. Successfully integrating virtual assets into traditional fund frameworks requires a nuanced approach. Future asset managers must carefully select service providers and legal advisors with deep expertise. This includes a deep understanding of the unique risks, characteristics and operational details of crypto funds. By assembling the right team and leveraging expertise, asset managers can effectively navigate the complexities of this innovative asset class and tap its full potential in evolving financial markets.

Setting up a crypto fund in Hong Kong is a complex process that requires careful planning and compliance with regulatory requirements. By understanding the licensing requirements, following the outlined processes, and budgeting for the associated fees, you can successfully set up and operate a crypto fund in one of Asia's leading financial centers. However, despite Hong Kong’s structured regulatory environment, the crypto industry’s interest in domiciled fund structures in Hong Kong remains low due to past tax issues. Offshore vehicles are more popular among investors and fund managers. Past tax issues have made jurisdictions such as the Cayman Islands or the British Virgin Islands more attractive, highlighting the need for Hong Kong to continue its efforts to enhance its attractiveness as a destination for crypto funds.

In short, although setting up and managing crypto funds is full of challenges, with reasonable planning and professional team support, you can occupy a place in the emerging financial market. Although Hong Kong faces obstacles in some areas, it still has the potential to become an important center for crypto funds. To achieve this goal, Hong Kong must continue to optimize its regulatory and tax environment and increase its attractiveness to global asset managers.

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