Comprehensive analysis of the impact of allowing virtual asset spot ETFs in Hong Kong

Author: Bitke 

On the winter solstice, the Hong Kong Securities Regulatory Commission has given the virtual asset market a "big year" ahead of schedule .

On December 22, the Hong Kong Securities and Futures Commission issued two circulars, namely the "Circular on SFC-authorized funds investing in virtual assets" and the "Joint Circular on the virtual asset-related activities of intermediaries". Letter", Koala Finance will provide an in-depth explanation in this article.

Comprehensive analysis of the "Notice on Securities Regulatory Commission Authorized Funds to Invest in Virtual Assets" Letter》

The circular proposed that the Hong Kong Securities and Futures Commission consider the requirement to authorize investment funds with exposure to virtual assets (virtual assets) exceeding 10% of their net asset value (NAV) to be publicly offered in Hong Kong. Mainly include:

1. Virtual asset funds authorized by the Securities and Futures Commission should only invest (directly or indirectly) in virtual asset tokens that the Hong Kong public can trade on virtual asset trading providers licensed by the Securities and Futures Commission.

2. Virtual asset funds recognized by the China Securities Regulatory Commission can directly or indirectly invest in eligible virtual asset tokens in accordance with the following requirements.

3. For virtual asset futures, trading is only allowed on traditional regulated futures exchanges, but the management company must prove:

(i) The relevant virtual asset futures have sufficient Liquidity, and

(ii) the rollover costs of related virtual asset futures are controllable and how such rollover costs will be managed.

4. Indirect exposure to qualifying virtual assets through other exchange-traded products must comply with the applicable requirements in the Code and other requirements that may be imposed by the Securities Regulatory Commission.

5. Value-added service funds approved by the China Securities Regulatory Commission should not make leveraged investments in value-added services at the fund level.

6. For virtual asset funds approved by the Securities Regulatory Commission that mainly adopt futures investment strategies, they are expected to adopt active investment strategies to achieve flexibility in investment portfolios (such as those with multiple expiration dates). diversification of futures positions), rolling strategies, and handling any market disruptions.

Regarding the transactions and direct acquisitions of spot virtual assets, the Hong Kong Securities and Futures Commission pointed out:

1. Transactions of spot value-added transactions of value-added funds approved by the SFC and acquisitions should be conducted through a SFC-licensed value-added value-added scheme or a recognized financial institution (authorized institution) (or a subsidiary of a locally registered authorized institution) and comply with the regulatory requirements of the Hong Kong Monetary Authority (HKMA), in particular relating to:

(a) For cash subscriptions and redemptions, a spot virtual asset ETF approved by the CSRC is expected to acquire and dispose of spot virtual assets through a virtual asset trading platform licensed by the CSRC (on or off the platform); and

(b) For physical subscriptions, participating dealers (PDs) should transfer spot virtual assets that may be held locally or overseas to spot virtual asset ETFs approved by the Securities and Futures Commission. A trading platform or custody account of an authorized institution (or its subsidiary (a locally established authorized institution)). For physical exchange, the process is reversed.

2. Spot virtual asset ETFs approved by the China Securities Regulatory Commission allow subscription and redemption in physical and cash forms.

3. For ETFs that invest in spot virtual assets, their major shareholders should be

 (i) A corporation or registered institution licensed by the China Securities Regulatory Commission;

 (ii) Subject to additional terms and conditions imposed by the licensing authority, if applicable.

Regarding virtual asset custody, the Hong Kong Securities and Futures Commission stated:

1. The trustee/custodian of a virtual asset fund recognized by the Securities and Futures Commission should only The virtual asset custody function (if applicable) is delegated to

(i) a virtual asset trading platform licensed by the Securities and Futures Commission, or 

(ii) an authorized institution (or a locally registered authorized institution) subsidiaries) and the authorized institution complies with the expected standards for virtual asset custody promulgated by the HKMA from time to time.

2. The trustee/custodian and any representative responsible for the custody of virtual asset holdings of a virtual asset fund approved by the China Securities Regulatory Commission shall comply with the following regulations:

(a) Virtual assets shall be ensured be held separately from its own assets and the assets it holds for other clients;

(b) The majority of virtual asset holdings should be stored in cold wallets and virtual asset holdings stored in hot wallets The amount and period should be reduced as much as possible, unless the needs of subscription and redemption are met;

(c) The mnemonic phrase and private key should be ensured

(i) Safely stored in Hong Kong ;

(ii) Strictly restricted to authorized personnel; 

(iii) Sufficiently resistant to speculation (e.g., by non-deterministic generation) or collusion (through multiple signatures and keys Measures such as sharding);

(iv) Proper backup to reduce any single points of failure.

As for the valuation of virtual assets, the opinions of the Hong Kong Securities and Futures Commission are:

1. For the valuation of spot virtual assets, virtual assets recognized by the Securities and Futures Commission The management company of the fund should adopt an indexing method based on the virtual asset trading volume of major virtual asset trading platforms (i.e. a benchmark index published by a reputable provider that reflects a significant share of the virtual asset fund) of the underlying spot virtual assets trading activities).

For service providers, the Hong Kong Securities and Futures Commission believes:

1. The management company should confirm all necessary service providers (such as fund managers, designated Investors, market makers and index providers) are able, capable and ready to support value-added funds recognized by the Securities and Futures Commission.

2. The offering documents of value-added service funds approved by the China Securities Regulatory Commission, including the key product fact statement (KFS), should disclose the investment limits and major risks related to the value-added service risks of the fund.

3. The KFS of a virtual asset fund approved by the China Securities Regulatory Commission should include advance disclosure of investment objectives and major risks related to the fund’s VA risk, such as:

(a) Spot virtual Price risks, custody risks, network security risks and fork risks of asset investment; and

(b) Investment in virtual asset futures may involve greater rollover costs and operational risks (such as margin risks, measures taken by related parties risk of enforcement action).

Comprehensive analysis of the "Union of Intermediaries' Virtual Asset-related Activities" Circular》

The Intermediaries Department of the Hong Kong Securities and Futures Commission and the Banking Conduct Department of the Hong Kong Monetary Authority issued a "Joint Circular on Virtual Asset-Related Activities of Intermediaries". The two regulatory agencies responded to the latest market developments Update the policy and clearly set out the requirements applicable to virtual asset intermediaries when distributing virtual asset-related products; and set out the standards of conduct that virtual asset intermediaries should meet when distributing virtual asset funds authorized by the SFC. When intermediaries sell relevant products to retail customers, virtual asset intermediaries are required to set upper limits based on customer conditions and ensure that the products are included in at least two indices. Listed products do not mean they can be sold to retail customers. There are no changes at this stage to the relevant provisions on the transition period for intermediaries that provide virtual asset trading services to existing customers, and it is expected to end on January 20 next year.

According to the circular, except for a few listed products, regardless of whether the product is listed on an exchange, if it is traded on a complex exchange listed in the non-exhaustive list of examples of non-complex and complex products published on the SFC website Derivative products, not all of the same type, will all be considered complex products. These products are restricted to professional investors only. For virtual asset funds that can be offered to the public, these funds will not be subject to the "professional investors only" restriction, but the main premise is to ensure that there is no solicitation or advice involved. Whether virtual asset-related products can be sold to retail investors must also strictly comply with the sales restrictions of individual jurisdictions, exchanges or products.

At the same time, unless they are institutional professional investors and qualified corporate professional investors, virtual asset intermediaries should first evaluate the client's investment in virtual asset-related products before executing transactions on behalf of clients. Knowledge about virtual assets. If the customer does not have relevant knowledge, the virtual asset intermediary can only execute transactions after it has provided sufficient training to the customer. Intermediaries can only make withdrawals and deposits through platforms licensed by the Securities and Futures Commission and financial institutions approved by the Hong Kong Monetary Authority.

Based on the high-risk nature of virtual assets, when virtual asset intermediaries provide financial accommodation to customers, they should ensure that the customers have sufficient financial ability to fulfill their responsibilities. Otherwise, they should not accept instructions from the customers. In order to provide adequate investor protection, the Hong Kong regulatory authorities believe that if virtual asset intermediaries want to provide virtual asset trading services, they can only cooperate with virtual asset trading platforms licensed by the SFC. Through cooperation with brokers holding No. 1 license.

If the services provided by a virtual asset intermediary meet the minimum exemption requirements, for example, it has stated that the investment objective is to invest in virtual assets; or it intends to invest 10% or more of the total asset value of the investment portfolio in Virtual assets must comply with License No. 9 "Standard Terms and Conditions Applicable to Licensed Corporations or Registered Institutions that Manage Portfolios Investing in Virtual Assets". The SFC will make such requirements a condition for licensing or registration.

Summary

Hong Kong The two virtual asset circulars issued by the Securities and Futures Commission will undoubtedly further promote the development of the local market. As Hong Kong Financial Secretary Paul Chan said at the Hong Kong Web3.0 Security Summit, Hong Kong has developed into the third generation of Internet Web3.0 The goal of the hub is clear. Hong Kong issued a policy declaration on the development of virtual assets in Hong Kong at the end of October last year. It has been more than a year now. The third-generation Internet market has developed rapidly. During this period, some challenges have emerged, but at the same time, there are also greater opportunities. . Chen Maobo also said that safety is a must and development is a must. Driven by the pioneering effect and clustering effect of the online world, and in a winner-take-all situation, how to seize opportunities amid challenges and transform them into new blue oceans is a key question to continue to lead in the global Web 3.0 market.

Of course, the most critical thing in this circular is spot virtual asset ETFs. The Hong Kong Securities and Futures Commission and the Hong Kong Monetary Authority stated that they have reviewed the current policies for intermediaries who want to engage in virtual asset-related activities and are ready to accept them. Authorization applications for other funds involved in virtual assets, including virtual asset spot exchange-traded funds (virtual asset spot ETFs). In addition, the SFC sets out requirements for funds to invest directly in the same spot virtual asset tokens that the Hong Kong public can trade on an SFC-licensed virtual asset trading platform (VATP).

Hong Kong is ready to embrace spot crypto ETFs.