Cryptocurrencies have caught the attention of everyone from individual punters to the pornography industry, and now also – says a new Morgan Stanley report – institutional investors, as some have suggested they should. Regulators in Asia are now pitching in. 

Hong Kong's Securities and Futures Commission (SFC) is the latest to show its hand. The markets watchdog has responded to the rise of fintech in asset management and the attendant risks to investors by introducing new rules designed to cover so-called "virtual funds" and their distributors.

Speaking at a Hong Kong Fintech Week event on Thursday, SFC chief executive Ashey Alder explained how it is looking to provide new forms of protection for investors as virtual assets such as cryptocurrencies grow in popularity.

"In Hong Kong, we now have a sizeable population of investors who have an interest in trading virtual assets through unregulated trading platforms," he said. "At the same time, there is a growing demand for funds which invest in virtual assets."

Alder cited robo-advice as a good example of how fintech has forced regulators to adapt, so that new platforms can thrive in a conventional regulated environment.

Ashley Alder

The SFC is to introduce new guidance on automated, or robo, advice and how suitability assessments can be applied in the online environment, Alder said, adding that the framework for this will take effect next April.

Alder is the current chairman of the International Organization of Securities Commissions (Iosco), which acts as the global standards-setter. Fintech is “at the very top of our agenda”, he said, with cryptocurrencies as the single dominant risk identified by all.

“The market for virtual assets is still very young and trading rules may not be transparent and fair. Outages are not uncommon, as is market manipulation and abuse. There are also outright scams or frauds, as seen in many failed initial coin offerings [ICOs].”

He said the SFC has been working "to come up with a creative framework which should bring a significant number of these activities into our regulatory net for the first time."

For crypto funds, the regulator's starting point is the recognition that many Hong Kong investors gain exposure to virtual asset portfolios through niche fund managers or their distributors. The new rules announced yesterday will require those funds supervised by the SFC intending to invest more than 10% of a mixed portfolio in virtual assets to observe new requirements targeting crypto assets, irrespective of whether they amount to “securities” or “futures contracts”.

To afford better investor protection, the SFC is recommending that only professional investors be allowed to participate for the time being. Nevertheless, the SFC's reach will not extend to managers of “pure” crypto funds – funds that invest purely in cryptocurrencies – because these are deemed to fall outside the scope of the SFC, not being securities.

The SFC can plug this gap by looking at fund distribution, said Alder. Under the new rules, firms who distribute virtual asset funds will have to be registered with, or licensed by, the SFC as brokers.

“The combined effect of these measures is that the management or distribution of crypto funds will be regulated in one way or another, so that investor interests will be protected either at the fund management level, at the distribution level, or both," Alder said.

He acknowledged that "new financial technologies are already having a tremendous impact on our markets and the businesses we regulate. We need to be open to the benefits of innovation but we also need to stay vigilant about [the] potential risks."

Other regulators in Asia are bringing their rules up to date to cover cryptocurrencies and ICOs. Malaysia's Securities Commission has also today announced a new regulatory framework for digital  asset exchanges and ICOs is expected to come into effect in the first quarter of 2019.