Original author: MetaLab William
Original source: Wu Shuo Real
On December 22, 2019, the Hong Kong Securities and Futures Commission issued the Joint Circular on Intermediaries Virtual Asset-Related Activities (hereinafter referred to as the Joint Circular) and the Circular on SFC-authorized funds investing in virtual assets (hereinafter referred to as the Joint Circular). Fund Circular), and stated that it was ready to accept applications for recognition of virtual asset spot ETFs. So what regulatory requirements need to be met to issue Bitcoin spot ETFs in Hong Kong? What impact will it have in the future? This article will do a detailed analysis.
1. Interpretation of the issuance conditions of virtual asset spot ETFs
Generally speaking, the issuance of products needs to meet the requirements of three regulatory documents: Hong Kong Code on Unit Trusts and Mutual Funds + Joint Circular + Fund Circular. The former document mainly involves traditional regulatory requirements, because ETFs in Hong Kong are mainly issued by unit trusts (Unit Trust). Of course, in recent years, ETFs issued by open-ended fund companies (OFC) have also appeared. Here we No introduction. Regarding the Joint Circular, it mainly introduces the regulatory requirements related to virtual asset distribution (Distribution), transaction (VA dealing), asset management (asset management) and advisory (advisory). The scope is relatively wide, so we only introduce the relevant Policy section of the BTC Spot ETF. Regarding the Fund Circular, it clearly stipulates that the scope of supervision is (1) issuance to the public, (2) funds that invest 10% or more of the total asset value of the fund in virtual currencies, and Bitcoin spot ETFs are covered, so we Will make key introductions.
In detail, the issuance requirements are as follows:
1. Issuer qualifications
Unlike the U.S. SEC, which has no clear regulations on the issuer qualifications of Bitcoin spot ETFs, the Hong Kong SFC has stricter regulatory requirements for issuers—asset management companies that issue virtual asset fund products need to meet the following three conditions:
Have a good regulatory compliance record. This means that asset management companies with bad records are basically excluded. As for asset management companies that have just been established, they face certain uncertainties. Therefore, established asset management companies in Hong Kong have certain advantages in issuing BTC spot ETFs.
The company must have at least one competent employee with experience in virtual asset and related product management.
The company needs to hold an upgraded No. 9 plate. That is, the issuing company needs to meet the Terms and Conditions for Licensed Group Registration Institutions Applicable to Management of Investment Portfolios Investing in Virtual Assets. It should be noted that this document was revised in October 2023, lowering the application conditions and Difficulty.
2. Underlying asset requirements
According to the circular, the underlying assets of virtual asset spot ETFs must be virtual assets currently available for trading by retail users on licensed exchanges in Hong Kong. This means that spot ETFs of two virtual assets, BTC and ETH, can currently be issued in Hong Kong.
3. Investment strategy
Virtual asset spot ETFs are passive funds, so they do not have too many requirements on investment strategies. However, it should be noted that the circular states that funds are not allowed to increase leverage. The role of Trade Credit Lender was mentioned in BlackRocks BTC spot ETF issuance document to provide loan services for the ETF in certain scenarios. This character may be banned in Hong Kong.
4. Subscription, redemption and transaction of spot virtual assets
Currently, virtual asset spot ETFs are issued in Hong Kong, allowing the use of two modes: cash model and in-kind modder. The main reason is that the United States currently does not have special regulations regulating virtual asset trading platforms. If physical redemption is accepted, criminals may launder money by directly using BTC to subscribe for ETFs. However, in Hong Kong, licensed exchanges are required to comply with the Anti-Money Laundering Regulations, and deposits and withdrawals to the platform need to undergo strict KYC/AML reviews. Therefore, physical redemption and redemption through licensed exchanges can effectively avoid the problems faced by the U.S. market. problem, but this also adds additional requirements to the Hong Kong market:
Cash subscription and redemption are required to be conducted on a licensed exchange in Hong Kong, but it can be on-platform or off-platform;
Physical redemption requires the virtual assets to be transferred to a Hong Kong licensed exchange or HKMA-recognized financial institutions (Authorized Financial Institutions, AIs) and their affiliates;
Traders (PD) participating in redemptions need to hold an upgraded No. 1 license.
5. Hosting
Similar to trading, virtual assets require independent third-party custody, and the custodian must be a licensed exchange in Hong Kong or a financial institution and its affiliates recognized by the HKMA. In addition, the following arrangements must be met:
Custody accounts must be separated from the asset management company’s own accounts;
Most assets are placed in cold wallets, and a small amount are placed in hot wallets for redemption;
The private key is kept securely and requires that the private key must be kept in Hong Kong to effectively prevent external attacks and have appropriate backups.
6. Valuation
In terms of valuation, SFC reflects the loose side. The index compilation used for valuation calculation is not required to include only Hong Kong licensed exchanges, it can be major overseas exchanges. There are no special restrictions on the index provider, just being in good standing.
7. Risk Disclosure and Investor Education
This part is covered by both the Joint Circular and the Fund Circular. The Fund Circular mainly covers risk disclosure in issuance documents and financial reports; the Joint Circular mainly focuses on risk disclosure requirements in the distribution link. Of course, both circulars require the issuer and distributor to conduct investor education respectively.
8. Audit system
According to the requirements of the Fund Circular, funds that prepare to issue or plan to invest 10% or more of the total asset value of the fund in virtual currencies must consult the SFC in advance and obtain approval.
9. Investor restrictions
According to the requirements of the Joint Circular, the sales of virtual asset-related products must comply with the requirements of the relevant jurisdictions, that is, virtual asset spot ETFs are prohibited from being sold to investors in mainland China.
2. Future arrangements
As can be seen from the above, the importance of the policy on virtual asset spot ETFs in Hong Kong is reflected in two aspects:
First, the Hong Kong market’s regulatory policy for virtual asset spot ETFs has been clarified. Unlike the U.S. SEC, where the regulatory policy is unclear and the approval of the relevant BTC spot ETF has not been completed after half a year, the Hong Kong Securities Regulatory Commission has made clear regulations on the issuance qualifications of related fund products, the trading and custody of virtual assets, etc.
Second, unlike the US SEC which only allows cash redemption (Cash Model), the Hong Kong SFC clearly stipulates that both cash redemption and in-kind redemption (In-kind Model) are allowed (the specific reasons will be analyzed later). This will give Hong Kongs BTC spot ETF an advantage over similar products in Europe and the United States.
Therefore, the author judges that the current issuance of Bitcoin spot ETFs in Hong Kong is “all ready, all we need is the east wind”. The main regulatory obstacles have been eliminated, and the remaining issues are mainly technical details. Asia’s first Bitcoin spot ETF is expected to be launched in the future. Will land in Hong Kong soon.
