Original article by MetaLab William
Original source: Wu Says Real
On 22 December, the SFC issued the Joint Circular on Virtual Asset-related Activities of Intermediaries (the “Joint Circular”) and the Circular on SFC-authorized Funds Investing in Virtual Assets (the “Fund Circular”), stating that it was “ready to accept applications for authorization of virtual asset spot ETFs”. So what are the regulatory requirements for issuing BitcoinSpot ETFs in Hong Kong, and what are the implications in the future?
I. Interpretation of the issuance conditions of virtual asset Spot ETFs
In general, the issuance of the product needs to meet the requirements of the three regulatory documents of “Hong Kong Code on Unit Trusts and Mutual Funds + Joint Circular + Fund Circular”. The former document mainly deals with traditional regulatory requirements, because ETFs in Hong Kong are mainly issued by unit trusts (Unit Trusts), although ETFs issued by open-end funds companies (OFC) have also appeared in recent years, which we will not introduce here. In the case of the Joint Circular, the regulatory requirements for distribution, VA dealing, asset management and advisory are broadly covered, so we will only cover the policy section relating to BTC Spot ETFs. With regard to the Fund Circular, it clearly states that the scope of regulation is (1) offering to the public, (2) funds that invest 10% or more of the total asset value of the fund in Vitual Money, BitcoinSpot ETFs, so we will focus on them.
In terms of details, the issuance requirements are as follows:
1. Issuer qualifications
Unlike the US SEC, which does not clearly stipulate the issuer qualifications of BitcoinSpot ETFs, the Hong Kong SFC has made stricter regulatory requirements for issuers— asset management companies that issue virtual asset fund products need to meet the following three conditions:
Good track record of regulatory compliance. This means that asset management companies with bad records are basically excluded, and asset management companies that have just been established face certain uncertainties. Therefore, established asset management companies in Hong Kong have certain advantages in issuing BTC Spot ETFs.
The company has at least one competent employee with experience in the management of virtual assets and related products.
The company needs to have an upgraded number 9 plate. That is, the issuing company needs to meet the Terms and Conditions applicable to licensed corporate registrars that manage portfolios investing in virtual assets, and it should be noted that this document was amended in October 2023 to drop the application conditions and difficulty.
2. Underlying asset requirements
According to the Circular, the underlying asset of a virtual asset spot ETF must be a virtual asset that is currently available for retail trading on a licensed exchange in Hong Kong. This means that Spot ETFs of two virtual assets, BTC and ETH, can now be issued in Hong Kong.
3. Investment strategy
Virtual asset Spot ETFs are passive funds, so there are not too many requirements in terms of investment strategy. However, it should be noted that the circular states that the fund is not allowed to increase leverage. The role of Trade Credit Lender was mentioned in BlackRock’s BTC Spot ETF offering to provide lending services to ETFs in certain scenarios. This role may be banned in Hong Kong.
4. Spot virtual asset redemption and trading
At present, virtual asset spot ETFs are issued in Hong Kong, and both cash model and in-kind modder models are allowed. The main reason is that there are no specific regulations regulating virtual asset trading platforms in the United States. If physical redemption is accepted, then criminals may achieve the purpose of Money Laundering by directly subscribing to ETFs with BTC. However, in Hong Kong, licensed exchanges are required to meet the “Anti-Money Laundering Ordinance”, and deposits and withdrawals to the platform are subject to strict KYC/AML review, so physical subscription and redemption through licensed exchanges can effectively avoid the problems faced by the US market, but it also adds additional requirements to the Hong Kong market:
- Cash redemption is required to be made on a licensed exchange in Hong Kong, but it can be Exchange Trading (on-platform) or OTC Trading (off-platform);
- In-kind redemption requires the transfer of virtual assets to a licensed exchange in Hong Kong or HKMA-recognized Financial Institutions (AIs) and their subsidiaries;
- Traders (PDs) participating in redemption are required to hold an upgraded Type 1 license.
5. Managed
Similar to trading, virtual assets require independent custody by a third party, and the custodian must be a licensed exchange in Hong Kong or a financial institution recognized by the HKMA and its subsidiaries, in addition to meeting the following arrangements:
The custodian account must be separate from the asset manager’s own account;
Most of the assets are placed in cold wallets, and a small number are placed in hot wallets for redemption;
The private key is kept securely, and the private key must be kept in Hong Kong to effectively prevent external attacks and appropriate backup.
6. Valuation
When it comes to valuations, the SFC is on the accommodative side. The compilation of indices for valuation calculations does not require the inclusion of only Hong Kong licensed exchanges, which can be major overseas exchanges. There are no special restrictions on index providers, only good standing is required.
7. Risk Disclosure and Investor Education
This part is covered by the Joint Circular, which mainly covers the risk disclosure of offering documents and financial statements, and the Joint Circular which mainly addresses the risk disclosure requirements for the distribution sector. Of course, both circulars require issuers and distributors to conduct investor education, respectively.
8. Audit system
According to the Fund Circular, funds that intend to issue or plan to invest 10% or more of the total asset value of the fund in Vitual Money must seek prior advice and approval from the SFC.
9. Investor Restrictions
According to the Joint Circular, the sale of VA-related products must comply with the requirements of the relevant jurisdiction, i.e. virtual asset spot ETFs are prohibited from being sold to mainland Chinese investors.
II. 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:
The first is to clarify the regulatory policies of the Hong Kong market on virtual asset Spot ETFs. Unlike the US SEC’s unclear regulatory policies, which led to the approval of relevant BTC Spot ETFs not being completed after half a year, the Hong Kong Securities and Futures Commission has made clear regulations on the issuance qualifications of relevant 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 are allowed (the specific reasons will be analyzed later). This will give Hong Kong-based BTC Spot ETFs an edge over their counterparts in Europe and the United States.
Therefore, in the author’s judgment, the current issuance of BitcoinSpot ETFs in Hong Kong is “everything is ready”, the main regulatory hurdles have been removed, and the remaining issues are mainly some technical details, and the first BitcoinSpot ETF in Asia is expected to land in Hong Kong in the near future.
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