The Hong Kong Securities and Futures Commission has authorized the listing of exchange-traded funds tracking either Bitcoin or Ethereum.
Three asset management companies, all backed by mainland firms, have received licenses.
The Hong Kong entities of Bosera Asset Management, China Asset Management, and Harvest Global Investments have each been granted permission to launch spot BTC and spot ETH ETFs.
These are among the first spot ETFs permitted anywhere after the US authorized 11 spot Bitcoin ETFs in January. They are the second spot Ethereum ETFs licensed worldwide, following the listing of several in Canada.
Hong Kong, as with other markets, including Europe, already allows futures crypto ETFs, which are restricted to accredited investors. The spot ETFs are available for retail investors as well.
The funds will list on either of Hong Kong’s two licensed virtual-asset exchanges. Bosera’s ETFs will be listed and sub-custodied on HashKey, and ChinaAMC and Harvest will list and sub-custody on OSL.
How big a draw?
US spot ETFs issued by the likes of BlackRock have attracted approximately $12 billion of inflows, not withstanding outflows from a closed-end fund, Grayscale, that also converted to an ETF structure but charges closed-end mutual fund fees.
The approval is a milestone for Hong Kong, which continues to push for becoming a global hub for a regulated crypto industry.
But the licensed exchanges have struggled to attract volume: they have to conform to traditional compliance measures, while unlicensed exchanges do not, and in a digital world, Hong Kong retail investors can easily choose where to trade.
ETFs are supposed to make it easy for ordinary investors who don’t want the fuss of setting up a wallet with self-custody to get exposure to crypto assets. They are also supposed to become the vehicle of choice for institutional investors. The US experience has yet to prove the thesis.
That’s especially true for Ethereum spot ETFs. There are five listed in Canada. They have gathered a total of C$450 million (there’s one with about $370 million, and then the dregs). That comes out to 0.016 percent of the total equity market cap across all Canadian stock exchanges. The equivalent portion in Hong Kong would be US$960 million. The Bitcoin products will presumably attract more.
The mainland question
The real hope for Hong Kong’s industry is not to attract pension funds. It’s to attract the vast horde of mainland-based investors who are desperate to get their money overseas.
Crypto is banned in mainland China. There is still plenty of Chinese who hold crypto, but unless they are themselves overseas, it’s impossible for them to convert it into renminbi at home.
However, mainland retail investors do have access to qualified funds in Hong Kong. Structurally, that includes ETFs. This is via the Stock Connect program that links Hong Kong Exchanges and Clearing (HKEX), Shanghai Stock Exchange and ChinaClear (the mainland’s depository). It allows investors in either market to trade in the other’s listed equities.
Were crypto ETFs to be made available in Stock Connect, the demand from the mainland could be off the charts.
HKEX
However, there are two flies in the ointment. First is HKEX, which must approve inclusion. The virtual-asset exchanges are not part of Stock Connect.
HKEX already lists Bitcoin futures exchange-traded products, and it has no competitive reason to open its doors to spot ETFs available on upstart crypto platforms.
There are other, technical criteria for a fund to be eligible for “southbound” flows in Stock Connect.
The ETF needs a daily average assets-under-management of HK$1.7 billion ($218 million) over six months, a benchmark that’s been listed for over a year, and the ETF can’t be synthetic – so these funds must enable subscriptions and redemptions in crypto, not just dollars.
Does HKEX need crypto ETFs? It’s doing well with its own traditional products, but crypto could match Stock Connect flows.
As of June 2023, average daily turnover of southbound trading was HK$33.8 billion (US$4.3 billion), or about 14 percent of HKEX’s total volumes, according to the exchange. (Although total volumes are down from a peak of HK$41.7 billion in 2021, activity on HKEX has declined by more, so the portion of Stock Connect flow in Hong Kong has risen.)
A big driver of those flows are equity ETFs: there are now six eligible ETFs in Hong Kong, accounting for HK$2.9 billion in southbound average daily trading.
In 2016, the Stock Connect parties removed total quotas, although there remain daily quotas.
HKEX is bullish on growing volumes, as mainland investors are on average very under-exposed to overseas exposures, and Hong Kong remains an attractive (and readily accessible) destination for many affluent people
There are ways HKEX can grow this market without having to offer crypto products. It’s looking to introduce block trading, for example (to make it easier to arbitrage between stocks and futures, an important means of keeping equity ETFs closely tracking the valuation of their underlying basket of securities). Enabling mainlanders to subscribe to IPOs is also on HKEX’s wish list.
Were crypto to match Stock Connect flows in short order, the HKEX would have to come up with a strategy.
Beijing
The second fly in the ointment is whether mainland regulators would allow their citizens to invest in crypto ETFs. Crypto is banned on the mainland.
This raises the question of why Beijing tolerates digital-asset trading in Hong Kong. On the mainland, the government is pushing its (non-blockchain-based) central-bank digital currency. It is adamantly opposed to private forms of money.
Hong Kong might be views as an experiment which can be allowed so long as it doesn’t touch mainlanders. Maybe Beijing thinks anything bitcoin is a subtle way to undermine US dollar hegemony. Or maybe it saw Hong Kong struggling as a capital center and agreed to let it attempt a crypto play.
Would Beijing be sanguine about letting its people access an asset that is illegal onshore? Does it need to approve these funds?
The likeliest answer to these questions is No. Which means these Chinese fund managers will need to rely on either the local market (limited!) or make these products attractive to the international world of crypto traders – if those people are willing to go through the SFC-compliant onboarding process.
The type of investor who prefers to avoid US regulation might find this accessible, but such investors are even more likely to dislike any compliance at all.
Nonetheless, Hong Kong now has a unique product to offer. It has a window of opportunity before other jurisdictions catch up. (Indeed, the US regulators are resisting approving an Ethereum spot ETF.) They need to attract big volumes quickly: to strike while the spot ETF is hot.
