Web3 Lawyer: How can cryptocurrency quantitative funds operate in compliance in Hong Kong?

“How do the large traders in the crypto market lead the crypto market, relying not on luck however on power? Crypto quantitative funding refers to attaining funding returns in cryptocurrency by means of mathematical modeling, information evaluation and automatic buying and selling methods. 24-hour buying and selling, scientific objectivity and excessive effectivity. Primarily based on these benefits of the crypto market, the quantitative workforce makes use of high-frequency buying and selling and automatic methods to cut back the impression of human feelings on funding choices and procure returns safely and transparently.”

 ▲The event logic of the quantitative system

As a world monetary heart, Hong Kong, China occupies a pivotal place in the world with its open market surroundings, sound regulatory system and superior infrastructure, and can also be on the forefront of the event of cryptocurrency.

In 2017, the Hong Kong Securities and Futures Fee (SFC) issued the “Announcement on Preliminary Coin Choices”, clarifying that digital tokens concerned in preliminary coin choices (ICOs) could also be “securities” and {that a} license is required to interact in associated actions; and the discharge of the “Round to Licensed Firms and Registered Establishments on Bitcoin Futures Contracts and Cryptocurrency-Associated Funding Merchandise” each symbolize that Hong Kong has begun to manage cryptocurrencies.

In 2023, the digital asset service supplier (VASP) licensing system will come into impact. All centralized digital asset exchanges that operate companies in Hong Kong or promote providers to Hong Kong traders should be licensed and controlled by the SFC.

These coverage modifications present traders with a secure market basis, making Hong Kong the popular location for the event of the worldwide cryptocurrency and blockchain know-how.

Many individuals could also be conversant in these names: HashKey Group, OSL, MaiCapital, and the success of those main digital forex exchanges and funds in Asia is inseparable from the quantitative workforce.

On this metropolis with limitless potential, the crypto funding market could face unprecedented alternatives and challenges.

Subsequent, let lawyer Mankiw take you to a deeper understanding of why Hong Kong has change into the popular vacation spot for crypto funding quantitative groups.

Frequent quantitative buying and selling strategies

Crypto asset quantitative buying and selling has a selected construction and applicability based mostly on its totally different traits, and has progressively change into an vital a part of the crypto market. These buying and selling methods are pushed by algorithms, decreasing the impression of human feelings on buying and selling, thereby enhancing buying and selling effectivity and accuracy. The next are a number of main quantitative buying and selling strategies:

1.

Hedge buying and selling : refers to traders making two transactions concurrently with associated merchandise, reverse instructions and equal positions. In easy phrases, it’s to purchase and promote extremely correlated digital currencies in totally different markets on the similar time. The transaction danger is comparatively low. It’s extra generally utilized by start-ups for enterprise capital or non-public fairness funding to take care of the diversification of asset portfolios.

Authorized and compliance concerns: Since hedging transactions contain a number of markets and buying and selling platforms, fund managers want to make sure the {qualifications} and safety of the buying and selling platforms, particularly in cross-border transactions, in compliance with anti-money laundering (AML) and know your buyer (KYC) necessities.

2.

Development buying and selling: Utilizing market circumstances and development indicators, the pc program robotically determines the timing of shopping for and promoting. When the market exhibits a transparent development, it robotically sends a purchase or promote sign. This buying and selling technique is comparatively complicated, but it surely can assist traders seize alternatives for market rises or falls.

Authorized and compliance concerns: Development buying and selling entails high-frequency buying and selling (HFT). The Hong Kong Securities and Futures Fee’s supervision of HFT is principally centered on conventional monetary markets, and there are fewer particular rules for crypto asset buying and selling. Nevertheless, fund managers want to make sure that algorithmic buying and selling methods have sufficient danger administration and audit mechanisms to cut back potential compliance dangers brought on by operational errors.

3.

Hybrid mannequin: It combines the traits of a number of fashions, together with each buying and selling in cryptocurrencies and their derivatives and fairness funding in associated firms. Hong Kong fund administration firms have established strict funding allocation and redemption mechanisms and conduct common audits to make sure the safety and equity of the funds. This construction gives managers with flexibility to modify between totally different funding methods based mostly on market circumstances and funding alternatives.

Authorized and compliance concerns: The hybrid mannequin entails various kinds of belongings and buying and selling strategies, and managers must adjust to the regulatory necessities of the related fund sorts. For instance, fairness investments should adjust to the Securities and Futures Ordinance (SFO) necessities, whereas crypto asset transactions should adjust to anti-money laundering (AML) and know your buyer (KYC) rules.

When figuring out the relevant legal guidelines and rules for Hong Kong fund managers, we should additionally think about whether or not the fund car is a personal fund or an SFC-authorized fund. For instance, for SFC-authorized hedge funds, there are particular hedge fund tips that should be adopted. In keeping with these tips, sure varieties of licensed hedge funds require a minimal subscription quantity, for instance, $10,000 for funds of funds and $50,000 for single hedge funds, whereas hedge funds with 100% capital assure traits haven’t any subscription quantity restrict. As well as, the SFC has set larger requirements for danger administration and inside management methods for licensed hedge funds.

Forms of funding sources and compliance necessities

Below the supervision of the SFC, funds from totally different sources want to satisfy totally different compliance necessities to make sure authorized and clear transactions and defend operators and traders:

1. Personal funds: The funds could come from the non-public belongings of workforce members, the interior accumulation of the workforce, or the workforce’s personal revenue accumulation. This sort doesn’t contain funds from exterior traders, so the compliance necessities are comparatively low, however it’s nonetheless essential to adjust to inside danger administration and inside management processes.

2. Personal fairness: Personal fairness funds often come from excessive web price people, company skilled traders or institutional traders. In contrast with licensed retail funds, such funds often have larger funding thresholds and are topic to comparatively unfastened regulatory necessities. If fund administration actions are carried out in Hong Kong, a Sort 9 license should be utilized for whatever the nature of the fund. Below Hong Kong’s open-ended fund firm (OFC) framework, these funds have to be registered with the Hong Kong SFC. Personal fairness funds can be closed-end or open-end funds, relying on the general funding construction and funding belongings. Personal fairness funds should be outfitted with licensed fund managers and have exterior fund directors and auditors. Compliance necessities for such funds embrace compliance with AML and KYC procedures, in addition to different necessities akin to common compliance audits and danger administration stories.

3. Public funds: Some funds could come from cryptocurrency ETFs, that are oriented to public traders, extra strictly regulated, largely undertake passive methods, are managed by a 3rd get together, and flow into in the secondary market. Their compliance necessities contain the general public issuance and buying and selling of funds, together with data disclosure, investor safety, and market habits norms.

Whatever the kind, it’s essential to adjust to the regulatory necessities of the Hong Kong SFC, akin to impartial deposit of buyer funds, anti-money laundering and anti-terrorist financing compliance, danger administration and cybersecurity measures. So, what’s Hong Kong’s regulatory framework?

Regulatory framework

1. Compliance necessities in Hong Kong, Singapore, Switzerland and the USA

Within the world Chinese language neighborhood, there are some variations in the regulatory frameworks for crypto funds in a number of well-liked international locations and areas:

Singapore : The Financial Authority of Singapore (MAS) launched stricter rules on cryptocurrency and digital fee token (DPT) providers in 2024, overlaying areas akin to custody providers and cross-border fund transfers. In November, it launched two new trade frameworks to advertise the tokenization of funds and fixed-income devices.

Switzerland : The Swiss Monetary Market Supervisory Authority (FINMA) is among the first monetary regulators in the world to develop a transparent regulatory framework for cryptocurrencies and blockchain know-how. FINMA ensures the legality and transparency of cryptocurrency companies by means of its “Swiss Blockchain Act” and “Monetary Market Infrastructure Act (FMIA)”.

United States : The U.S. Securities and Alternate Fee (SEC) and the Commodity Futures Buying and selling Fee (CFTC) play an vital function in regulating crypto actions. Nevertheless, because of the decentralized supervision of the U.S. states, discussions have to be performed on a regional foundation.

Hong Kong : The Securities and Futures Fee (SFC) of Hong Kong gives a clear and secure regulatory surroundings. Totally different licenses are utilized for in response to the enterprise they’re engaged in. At the least a Sort 9 license is required, which primarily regulates fund managers and fund merchandise.

In abstract, Hong Kong ‘s crypto coverage tends to be versatile, with a secure regulatory surroundings and pleasant tax insurance policies, encouraging market innovation and strengthening cooperation with conventional monetary establishments; Singapore is extra engaging to digital asset firms, with secure insurance policies and a deal with compliance and danger administration; Switzerland developed earlier on the regulatory stage and is a pioneer and promoter of the worldwide cryptocurrency market; in the USA , attributable to inconsistent supervision, crypto fund managers are additionally comparatively restricted.

2. The function of the Hong Kong Securities and Futures Fee (SFC)

In an effort to improve the general public’s understanding of the operation and capabilities of crypto funds, present safety to the general public who make investments in or maintain cryptocurrency merchandise, and scale back unlawful and prison actions in the trade, Hong Kong regulators have put ahead a sequence of compliance necessities for crypto fund groups.

The Securities and Futures Fee (SFC) of Hong Kong is the principle regulator of the securities and futures market in Hong Kong, and likewise the principle regulator of cryptocurrencies. The SFC regulates the cryptocurrency market by formulating and implementing related rules, together with the Securities and Futures Ordinance, to make sure that cryptocurrency funds operate beneath supervision and enhance the transparency and standardization of the market.

3. SFC regulatory rules

When selecting to do crypto quantification in Hong Kong, the SFC has put ahead not less than 4 necessities:

Compliance operation: The SFC regulates the cryptocurrency market by formulating and implementing the Securities and Futures Ordinance and different tips and circulars on digital belongings to make sure that all the crypto market operates beneath the supervision of the SFC.

Licensing system: All cryptocurrency exchanges and cryptocurrency platform operators working in Hong Kong must receive a license, elevating the safety and soundness threshold for these platforms.

Due Diligence : All cryptocurrency-related companies should adjust to Hong Kong’s Anti-Cash Laundering and Countering Terrorist Financing (AML/CTF) rules, carry out buyer due diligence (KYC), and report suspicious transaction actions.

Regulatory Sandbox: The SFC and the Hong Kong Financial Authority (HKMA) have collectively established a FinTech Regulatory Sandbox, the place crypto-related firms can take a look at their services in a managed surroundings and make danger assessments in advance.

Compliance and Danger Administration

So, if you wish to operate a crypto fund, what elements of danger administration must you deal with?

1. Compliance framework : A sound compliance framework and efficient danger administration technique should be established, together with anti-money laundering (AML) and counter-terrorism financing (CFT) measures, to cut back the dangers of digital asset investments.

2. Asset separation : Make sure that belongings are impartial of the belongings of the supervisor and different associated events to safeguard the property safety of traders.

3. Buyer Due Diligence ( KYC ) : All cryptocurrency-related companies, together with exchanges and pockets service suppliers, should carry out buyer due diligence and report suspicious buying and selling actions.

4. Inner management and monitoring mechanism : It’s needed to determine an inside management and monitoring mechanism to repeatedly audit and report associated actions to make sure compliance.

5. Chilly storage answer : To forestall hacker assaults and asset theft, chilly storage (offline storage) needs to be used.

6. Common reporting : The custodian wants to offer common asset stories to the administration firm and traders to make sure timeliness and transparency of knowledge.

Subsequently, it isn’t a simple job to keep away from these dangers and efficiently construct a crypto quantitative workforce. It is vitally vital to have affordable planning and the assist of an expert workforce.