A Detailed Explanation of the Regulation of Hong Kong's Bitcoin Spot ETF: Everything is Ready Except for the Right Moment
The Hong Kong region has drawn on the regulatory norms for crypto assets from jurisdictions such as the United States, and is flexibly applying them considering its own regulatory situation, gradually growing into a crypto-friendly jurisdiction.Author: Xiaoza Team
Recently, partners in the cryptocurrency space have been enthusiastically discussing news related to the first Bitcoin spot ETF in the United States. According to the official website of the U.S. Securities and Exchange Commission (hereinafter referred to as "SEC"), the ARK 21Shares Bitcoin ETF (ARKB) applied for by 21Shares/ARKInvest (hereinafter referred to as "ARK21") is nearing the end of its review period (January 10, 2024), and the SEC will soon make a decision on Ark21's ETF application. At this sensitive time, due to the delay in official announcements, the SEC's official social media platform was hacked, and false news was released stating, "All applications for Bitcoin spot ETFs to be listed on national exchanges in the U.S. have been approved." However, SEC Chairman Gary Gensler urgently "debunked" this on his personal account, stating that the SEC account had been compromised and that the SEC had not approved the listing and trading of spot Bitcoin ETFs.
This blunder has caused a dual shock in the capital and cryptocurrency markets, as the market previously believed that the SEC was likely to approve the application from ARK21 and would subsequently approve a large number of Bitcoin spot ETF applications. The SEC's "debunking" indeed affected market confidence. Today, the Xiaoza team will provide a detailed explanation of the situation regarding Bitcoin spot ETFs and analyze the relevant regulatory rules for Bitcoin spot in Hong Kong.
What is a Bitcoin Spot ETF?
Before explaining what a Bitcoin spot ETF is, we first need to understand what an ETF is.
ETF, short for "Exchange-Traded Fund," is a type of open-end fund that is traded on an exchange with variable fund shares, representing a basket of stocks that track a specific industry or index. The term "exchange-traded" means that ETF shares can be bought and sold like stocks, commonly referred to as "on-market purchases"; "open-end" means that investors can subscribe to or redeem fund shares from the fund management company, commonly referred to as "off-market subscriptions and redemptions."
Simply stating the concept may not be easy to understand, so let's use a technology ETF as an example to illustrate the practical operation of ETFs and their advantages for investors.
Since 2021, AI technology, high-speed wireless internet, and other fields have experienced significant development, leading to rapid price increases in many individual stocks within the technology sector, and the market has a very optimistic outlook on this sector. However, due to the large number of technology stocks and the high level of professional knowledge required for investment, ordinary investors may find it difficult to choose reliable stocks. If there are many promising stocks, buying all of them may require too much investment, and any market fluctuations could significantly impact their wealth. At this point, ETFs become the best choice for investors.
As mentioned earlier, an ETF is a basket of stocks that can track a specific industry or index, and the cost of buying a single share is not high, making it affordable for most investors. Therefore, as an efficient index investment tool that combines the features of stocks, open-end index funds, and closed-end index funds, ETFs are widely popular in the capital market.
A Bitcoin spot ETF essentially holds a "basket" of assets, including stocks, bonds, commodities, and soon-to-be-held Bitcoin. As early as 2013, a Bitcoin trust fund applied to the SEC for a Bitcoin spot ETF, but in recent years, the SEC has not approved any applications related to Bitcoin spots due to a cautious regulatory stance and has not issued any normative documents for this special financial product. It was not until a court ruling in the U.S. in August 2023 deemed the SEC's rejection of such applications as "unfair" that the SEC began to re-examine Bitcoin spot ETFs.
In Hong Kong, the development of Bitcoin spot ETFs is slightly behind that of the U.S., but the Hong Kong Securities and Futures Commission (hereinafter referred to as "SFC") has quickly introduced relevant regulatory rules based on its own regulatory characteristics, providing guidance for applicants.
What are the Key Points of Hong Kong's Bitcoin Spot ETF Regulation?
In 2022, after initially establishing a licensing regulatory system for cryptocurrency assets, we have clearly seen Hong Kong's determination to embrace cryptocurrency assets. On December 22, 2023, the SFC issued the "Joint Circular on Virtual Asset-Related Activities of Intermediaries" and the "Circular on SFC-Recognized Funds Investing in Virtual Assets," announcing that it is "ready to accept applications for recognition of virtual asset spot ETFs and other funds," intending to make Hong Kong the first region in Asia to accept the listing of Bitcoin, Ethereum, and other cryptocurrency spot ETFs.
In general, the issuance of Bitcoin spot ETFs in Hong Kong must first meet the SFC's regulatory requirements for traditional ETF issuance. The former document mainly involves traditional regulatory requirements, meaning it must comply with the "Code on Unit Trusts and Mutual Funds" regarding ETF regulation. Considering the habits of issuing ETFs in Hong Kong, the Xiaoza team believes that if a Bitcoin spot ETF is issued in Hong Kong, it will likely be primarily based on unit trusts. Below, we will detail the regulatory focus for issuing Bitcoin spot ETFs in Hong Kong based on the requirements of the two circulars.
(1) Issuer Qualification Requirements
The SFC has strict requirements for the qualifications of issuers:
Must have a good compliance reputation. In other words, newly established entities and those with a regulatory "black history" are less likely to pass the review.
At least one employee with experience in managing cryptocurrency products. The Xiaoza team suggests that the qualifications of this employee can refer to the RO (Responsible Officer) for cryptocurrency license applications in Hong Kong.
The entity must already hold a Type 9 license, and this Type 9 license must meet the relevant requirements of the "Standard Terms and Conditions Applicable to Licensed Corporations Managing Investments in Virtual Assets."
(2) Categories of Virtual Assets that ETFs Can Include
The Xiaoza team believes that, according to the current regulatory rules for cryptocurrency assets in Hong Kong, the categories of virtual assets that such ETFs can include will not exceed BTC and ETH, which are the only licensed exchange-traded cryptocurrencies.
(3) Anti-Money Laundering Requirements with Hong Kong Characteristics for Subscription and Redemption and Trading Models
The two circulars clarify that virtual asset spot ETFs issued in Hong Kong can adopt either a Cash Model or an In-Kind Model for trading. However, if it involves physical redemption of cryptocurrency assets, the assets must first be transferred to a licensed exchange in Hong Kong or another regulated financial institution. This is primarily to prevent illegal actors from converting BTC and ETH through physical redemption. Additionally, the Xiaoza team specifically points out that traders engaging in subscription and redemption must hold a Type 1 license that complies with the "Standard Terms and Conditions Applicable to Licensed Corporations Managing Investments in Virtual Assets."
(4) Custody Requirements for Cryptocurrency Assets
To ensure the stability of the cryptocurrency market, the SFC requires that relevant cryptocurrency assets be independently custodied by a third-party institution, and the custodian must be a compliant institution from a licensed exchange in Hong Kong, while also meeting three conditions:
- Custody accounts must be segregated from asset management company accounts;
- The majority of virtual assets must be stored in offline wallets (cold wallets), with a small portion stored in online wallets (hot wallets) for subscription and redemption;
- Private keys must be stored in Hong Kong, with measures taken to prevent cyberattacks and ensure proper backups.
(5) Investor Restrictions
A common concern among many partners is whether residents from mainland China can buy and sell cryptocurrency ETFs in Hong Kong. A simple answer: No. The "Joint Circular on Virtual Asset-Related Activities of Intermediaries" has clearly stated, "The sale of virtual asset-related products must comply with the requirements of the relevant jurisdictions." The Xiaoza team believes that cryptocurrency ETFs, especially those based on BTC and ETH, fall within the scope of prohibited transactions as outlined in the September 24 notice. The notice on "Further Preventing and Addressing Risks of Virtual Asset Trading Speculation" explicitly states that activities related to virtual currency are considered illegal financial activities. Therefore, the cryptocurrency ETFs issued in Hong Kong will be prohibited from being sold to investors in mainland China, and it is very likely that residents from mainland China cannot purchase these products even if they physically go to Hong Kong.
Final Thoughts
Despite the SEC's major blunder late at night and the subsequent indications that the emergence of Bitcoin spot ETFs in the U.S. may be a long way off, the Xiaoza team believes that Hong Kong has fully leveraged its latecomer advantage, learning from the regulatory norms of jurisdictions like the U.S. regarding cryptocurrency assets. Considering Hong Kong's own regulatory status, it is being flexibly applied, and thus, Hong Kong is gradually growing into a crypto-friendly jurisdiction. The Xiaoza team believes that instead of trying to navigate the "narrow bridge" of the SEC in the U.S., issuers might as well adopt a dual approach and explore the Hong Kong market, which may yield unexpected benefits.
