Understanding Hong Kong’s spot Bitcoin and Ethereum ETF

Just three months after application, the Hong Kong Securities and Futures Commission (SFC) has greenlit the launch of Bitcoin and Ethereum spot ETFs, setting the stage for a financial shift that could beckon over 1.4 billion Chinese to dip their toes into cryptocurrency investments via Hong Kong.

The SFC’s nod to Harvest Global Investments, Bosera Asset Management (International), and ChinaAMC (Hong Kong) marks a huge shift from the cautious approach of other financial heavyweights like the United States, which remains hesitant about physical cryptocurrency dealings.

Rapid Approvals and Strategic Moves

The approval process for these ETFs was notably swift, reflecting Hong Kong’s more streamlined regulatory environment. Unlike the conflicting regulatory approaches observed in the U.S., Hong Kong has one central authority, the SFC, which has clearly stated that cryptocurrencies like Bitcoin and Ethereum are not securities. This classification has allowed these assets to be more accessible to retail investors sooner, paving the way for their inclusion in ETF products.

OSL Digital Securities Limited has been important in this development.

As the first licensed and insured digital asset platform in Hong Kong approved by the SFC, OSL has partnered with two of the three institutions to provide custody and trading services. This partnership is crucial for addressing common market challenges such as excessive margin requirements and the accurate reflection of Bitcoin’s real-time value.

Patrick Pan, CEO of OSL, explained the expedited approval timeline by highlighting the early start both Bosera and ChinaAMC took in researching and preparing for ETF offerings shortly after the SFC’s announcement in December 2023. By January 2024, these companies were already in active discussions with OSL to launch their ETFs, underscoring the pro-active stance of Hong Kong’s financial regulators.

Addressing Compliance and Market Dynamics

Physical delivery of ETFs is a key differentiator for Hong Kong. This feature is supported by stringent Anti-Money Laundering (AML) and Know Your Customer (KYC) checks that all licensed exchanges must adhere to in the region. Such regulatory rigor ensures that the risks associated with physical transactions are manageable, allowing Hong Kong to offer more flexible investment models compared to the strictly cash-based structures seen in the U.S.

This regulatory assurance has facilitated two models of ETFs: Cash Model and In-Kind Model. Physical redemption and subscription must be handled through licensed exchanges or financial institutions recognized by the Hong Kong Monetary Authority (HKMA) and their subsidiaries, a process that bolsters security and compliance while providing a framework for physical asset transactions.

Despite the enthusiasm, the provisional nature of the approvals implies that there are still some procedural hurdles to overcome, such as the final subscription setups with clients and the filing details with the Hong Kong Stock Exchange. These steps are expected to be completed without major changes to the content of the approval documents.

Moreover, the question of whether mainland Chinese can invest through southbound channels remains open, with indications that initial offerings will focus more on offshore funds. This approach seems prudent, given the strict controls on mainland capital flows into Hong Kong’s financial markets.

The SFC’s active exploration of the market may lead to the introduction of additional cryptocurrencies into the ETF framework. This would build on the already high consensus around Bitcoin and Ethereum, which have been traded by local investors long before their consideration for ETF inclusion. The potential for more structured or leveraged products is also on the horizon, suggesting a strong development phase for cryptocurrency-based financial instruments in Hong Kong.