Author: Bai Qin, Mayer Brown
As an international financial center, Hong Kong has a mature asset management system, which has also been extended to the virtual asset sector. Especially since 2024, various crypto-friendly policies have attracted Web3 entrepreneurs to try to settle in. Bai Qin, the head of Mayer Brown's Hong Kong office, found in previous consultations that many Web3 entrepreneurs who choose to set up a crypto fund in Hong Kong are often confused, such as not being able to distinguish some fund concepts, and worrying about the complex regulatory environment and cumbersome procedures.
If you also have such confusion, don't worry, Mayer Brown lawyers will answer for you.
3 Core Concepts
Before setting up a crypto fund, you first need to clarify three core concepts, which are also often the "culprits" that cause confusion for fund founders.
1. Fund Manager
The Fund Manager is the person responsible for making investment decisions.
Unlike the mainland, Hong Kong allows private funds to be independently managed by fund management companies, without the need to appoint a fund manager. However, for public funds investing in virtual assets, such as Bitcoin ETFs, the SFC requires the appointment of at least one Key Investment Personnel (KIP), i.e. a qualified employee with relevant experience, responsible for investment strategy and compliance.
2. Fund Management Company
The Fund Management Company, i.e. the company operating the crypto fund, needs to obtain the SFC's Type 9 license (Asset Management). This involves the following requirements:
- Capital Requirements. Maintain a minimum capital level, the specific amount depending on the size of the company.
- Compliance Framework. Establish a sound compliance framework, including anti-money laundering (AML) and counter-terrorist financing (CTF) measures.
- Risk Management. Implement effective risk management strategies to mitigate the risks of virtual asset investments.
3. Fund Product Structure
As an investment vehicle, the fund product must ensure that its assets are completely separate from the personal assets of the fund management company and the fund manager. This segregated fund product structure (Fund Product Structure) is to reduce the risk of asset misappropriation and protect the interests of investors. The fund product structure usually includes the following key points:
- Asset Segregation. Ensure that the fund's assets are independent of the assets of the fund manager and other related parties, to safeguard the property safety of investors.
- Legal Entity. Funds are usually registered as independent legal entities to enhance asset protection and management transparency.
- Investor Rights. The fund product structure design should clearly define the rights of investors, including profit distribution, asset redemption and other terms.
After mastering these three key concepts, the next key issue is "how to set up the fund structure".
Crypto Fund Establishment
The following are the key steps and elements to consider when setting up a crypto fund:
1. Choose the Appropriate Fund Type
When setting up a crypto fund in Hong Kong, you first need to choose the appropriate fund type. There are two main categories:
- Private Funds. Targeting high-net-worth individuals (individual professional investors), corporate professional investors or institutional professional investors, with a higher investment threshold and relatively more relaxed regulation in some aspects.
- Public Funds. Targeting retail investors, with stricter regulation, such as Bitcoin ETFs. For crypto funds targeting the retail market, the following specific requirements also need to be considered:
- Investment Scope. Only invest in virtual assets recognized by the SFC to reduce risks.
- Disclosure Requirements. Provide comprehensive information disclosure to investors, including investment nature, risks and fund structure.
- Ongoing Reporting. Regularly report to the SFC on fund performance, compliance status and changes in management strategies.
2. Determine the Fund Structure
The following are some common fund structures:
- Unit Trust. In this arrangement, investors purchase units of the fund, which represent a proportional ownership of the underlying assets of the fund. The fund's assets are supervised by a trust company, which is responsible for managing and servicing these assets. The unit trust model is particularly adept at pooling resources from multiple investors, which is very beneficial for the capital-intensive operations typically required to establish and manage crypto funds in Hong Kong.
- Open-Ended Fund Company (OFC). The OFC is an investment fund registered as a company in Hong Kong. It differs from the unit trust in that it is a separate legal entity with a board of directors. The directors owe fiduciary duties and statutory duties of care, skill and diligence to the OFC. Note: Don't be misled by the name "open-ended". In the Hong Kong SFC OFC fund structure, although the name suggests "open-ended", OFCs can actually be closed-ended, as long as the OFC's offering documents stipulate redemption restrictions and the OFC's articles contemplate the OFC as a closed-end fund.
- Limited Partnership. The partners include general partners and limited partners, with clear responsibilities and equity distribution. The limited partnership structure is commonly used for private equity projects involving illiquid assets.
The following is an example of the Hong Kong OFC structure. The Cayman Islands' SPC/SP structure includes a master fund (SPC = Segregated Portfolio Company) and multiple sub-funds (SP = Segregated Portfolio). Hong Kong also has a similar OFC open-ended fund company framework, and this structure can reduce operating costs as there is no need to set up a new company for each sub-fund.
* Source: SFC website
In the context of crypto funds, structures like SPC or OFC have advantages, as they allow fund managers to implement different strategies in different investment portfolios, depending on the virtual assets in each portfolio. In this regard, this is a win-win for both managers and investors, as investors can independently choose which investment portfolio they want to invest in, without worrying about their assets flowing into other portfolios, while managers do not need to set up separate investment portfolios, which is relatively convenient.
In addition to setting up the crypto fund, another key component that needs to be considered is asset custody, to ensure the independence, security and transparency of the fund's assets.
Fund Asset Custody
The quality of custody services directly affects investor confidence and the sound operation of the fund, so special care must be taken when selecting them. Hong Kong fund management companies typically use the following custody arrangements for different types of assets:
1. Segregated Accounts
Segregated Accounts mean that each client's assets are held in separate accounts. This arrangement facilitates accurate calculation of each client's net asset value (NAV) and significantly reduces the risk of asset misappropriation. By managing segregated accounts, the traceability and transparency of assets are enhanced, which meets the strict requirements of Hong Kong regulatory authorities on fund asset management.
2. Commingled Funds
Commingled Funds, where the investment manager collects funds from different investors and combines them into a single fund product. This method simplifies the management process and reduces operating costs through economies of scale. However, it also requires more complex administrative procedures and higher compliance requirements. To protect the interests of each investor, Hong Kong fund management companies have established strict investment allocation and redemption mechanisms, and conduct regular audits to ensure the security and fairness of the fund.
Additional custody measures and considerations for Hong Kong crypto funds include: 'TRON' remains as 'TRON'. 'UNI' remains as 'UNI'. 'HT' remains as 'HT'. 'XEM' remains as 'XEM'. 'OP' remains as 'OP'. 'COMP' remains as 'COMP'. 'AR' remains as 'AR'. 'RON' remains as 'RON'. 'ONG' remains as 'ONG'.
- Encryption technology. Custodian services typically employ advanced encryption techniques to ensure the security of virtual assets during storage and transactions.
- Cold storage solutions. To prevent hacking attacks and asset theft, cold storage (offline storage) should be used.
- Compliance and regulation. Custodian services in Hong Kong must comply with the SFC's regulatory requirements, including but not limited to anti-money laundering and counter-terrorist financing requirements.
- Periodic reporting. Custodians need to provide regular asset reports to fund management companies and investors to ensure the timeliness and transparency of information.
- Risk management. Custodian service providers must establish a comprehensive risk management system to address market volatility and potential risk events.
Through these measures, crypto fund management companies in Hong Kong can provide investors with a secure and reliable investment environment.
Next, when you formally start your crypto fund business, you can also focus on Hong Kong's Unified Fund Exemption Scheme.
Can crypto funds be exempted from profits tax in Hong Kong?
Hong Kong's Unified Fund Exemption Scheme allows funds to be exempt from Hong Kong's profits tax, provided they meet certain specific conditions, regardless of the fund's place of incorporation, as long as the key conditions are met, including:
I. It must constitute a "fund". The structure you adopt needs to be assessed to see if it meets the definition of a "collective investment scheme" under the Securities and Futures Ordinance.
II. All transactions of the fund must be conducted through an entity licensed for Type 9 (asset management) by the Hong Kong SFC.
III. The fund's investment portfolio must include assets that qualify as "securities" as defined in the Securities and Futures Ordinance.
It is important to note that conditions (I) and (II) are relatively clear, but condition (III) has uncertainties for crypto currency funds. Therefore, you must be cautious in determining whether your virtual asset portfolio falls under the definition of "securities" assets under the Securities and Futures Ordinance!
Conclusion by Manqun Lawyers
Establishing a crypto fund in Hong Kong is full of opportunities, but the complex regulatory environment also requires careful handling. Understanding the roles of fund managers, fund management companies, and fund products is crucial. Fund management companies can successfully operate crypto funds by complying with SFC regulations, selecting appropriate custodians, and maintaining transparent communication with investors. As the virtual asset field continues to evolve, understanding regulatory changes and market trends is critical to long-term success.
