The virtual asset spot ETF will be launched. Can Hong Kong break through in this trend?

The approved Bitcoin spot ETFs and Ethereum spot ETFs from Jiashi International, Huaxia Fund (Hong Kong), and Bosera International will be launched at the end of the month. This is significant for Hong Kong, as it is the first approved virtual currency spot ETF in Asia, and not only has the Bitcoin spot ETF been approved, but it also leads the approval process of the Ethereum spot ETF ahead of the United States.

Previously, Hong Kong had launched Bitcoin and Ethereum futures ETFs, and some asset management companies had attempted to create funds related to virtual assets. On December 22, 2023, the Hong Kong Securities and Futures Commission issued a circular titled "Regarding the SFC's Recognition of Funds Investing in Virtual Assets," indicating that the regulatory body was ready to accept recognition applications for other funds involving virtual assets, including virtual currency spot ETFs.

In less than four months since the circular was issued, three companies' products have been approved. How was this efficiency achieved? What does the launch of virtual currency spot ETFs mean for traditional finance in Hong Kong? What details of virtual currency spot ETFs should investors pay attention to?

Futures, Funds, Brokers, Asset Management: Traditional Finance Has Already Tested the Waters of Web3

Before the spot ETFs, Hong Kong had already made some attempts to combine virtual currencies with traditional financial markets.

In December 2022, Southern Eastern Asset Management launched Asia's first virtual asset ETFs: Southern Eastern Bitcoin Futures ETF (3066.HK) and Southern Eastern Ether Futures ETF (3068.HK). These were officially traded on the Hong Kong stock market in the same month. The sub-fund primarily invests in Bitcoin futures on the Chicago Mercantile Exchange (CME).

In terms of fund net value performance, the futures ETF product launched by Southern Eastern, FA Southern Bitcoin, surged against the backdrop of poor market performance and low investor sentiment in the Hong Kong stock market in 2023. The net value of FA Southern Bitcoin increased by 1.34 times in 2023, and within the first four months of 2024, its annual return has already exceeded 50%.

Moreover, Southern Eastern's Bitcoin futures ETF has the highest return rate among all ETFs in Hong Kong in 2023, with a scale of 0.35 billion, making it the largest ETF.

In addition to high returns, the most critical indicator for the survival of ETF products is trading volume. FA Southern Bitcoin's average daily trading volume has recently maintained around 30 million Hong Kong dollars, which is quite considerable.

Besides Southern Eastern, Samsung's actively managed Bitcoin futures ETF was also launched in January 2023.

Established brokerages have mostly tested virtual currency-related businesses. Paolo, Chief Strategy Officer of VDX, revealed that previously, Victory Securities had a monthly trading volume related to virtual currencies reaching the billion-dollar level.

Some asset management companies originating from the crypto space have also made attempts. For instance, in 2021, New Fire Asset Management established Hong Kong's first compliant virtual currency fund with an active management strategy. Jessica Soong, Deputy Director of Business Development at New Fire Asset Management, told Golden Finance that this virtual currency fund achieved a 55% annualized return in 2023.

Under the shadow of the "International Financial Center Ruins," traditional finance in Hong Kong needs to find a breakthrough for business growth. For the crypto space, compliance and embracing mainstream finance have become a development mainline in recent years.

However, for both traditional finance and native crypto institutions, creating a virtual currency spot ETF is not an easy task.

No Experience to Follow, Need for Win-Win Cooperation

The fundamental challenge lies in the fact that there is almost no experience to follow in this matter. From the government to institutions, continuous practice and exploration are required.

The approved spot ETFs are from three fund companies: Jiashi International, Huaxia Fund (Hong Kong), and Bosera International. These three institutions are significant players in the traditional financial sector.

Market insiders close to Jiashi told Golden Finance that two years ago, Jiashi International established a research department related to virtual currencies, which at that time only focused on research without specific business activities.

By October 2022, after the Hong Kong government issued the "Policy Declaration on the Development of Virtual Assets in Hong Kong," Jiashi International's virtual currency-related department began to engage more with Hong Kong's regulatory authorities, learning about relevant policies and regulations from other countries and taking action in response to policy changes.

Insiders close to Jiashi indicated that since the release of the "Policy Declaration on the Development of Virtual Assets in Hong Kong," Jiashi International has maintained contact with relevant regulatory bodies. Jiashi International is also planning business related to stablecoins in Hong Kong.

Jiashi International was the first to submit an application in January 2024 and became one of the first approved institutions. The main reason for its success may be its continuous attention to the application status of spot ETFs in Europe, Asia, and America, along with its rich experience in issuing ETFs.

Applicants need to submit a comprehensive ETF issuance plan to the Securities and Futures Commission, detailing how users can subscribe, trade, risk control, investor protection, and anti-money laundering measures.

There are two main challenges: first, how to design the plan, especially how to handle subscriptions and redemptions, where most institutions tend to get stuck; second, where to find the service providers involved in the entire process.

Taking service providers as an example, Victory Securities is currently the participating broker (PD) for these three Bitcoin spot ETF issuers and is also the only broker in the market for VA (virtual asset) ETF physical delivery.

The ETFs issued by Huaxia Fund (Hong Kong) and Jiashi International are deployed in collaboration with OSL Digital Securities Limited. HashKey is jointly applying for the ETF with Bosera Fund (International), with HashKey fully participating as the custodian.

For instance, as the PD for the three ETF issuers, Victory Securities' role is to create and redeem ETF units within the product framework of the ETF.

At the same time, clients can subscribe to the ETF directly with cryptocurrencies through Victory Securities. Victory Securities is the only broker in Hong Kong that allows for direct cryptocurrency transactions without going through an exchange. Currently, only a few brokers have successfully upgraded their Type 1 licenses to virtual asset trading, and upgrading the Type 1 license is the first step to providing such services.

Insiders close to Jiashi stated that Jiashi International is the first company in Hong Kong to successfully navigate the entire process for spot ETFs and is also the first to submit an application to the Securities and Futures Commission. Huaxia and Bosera have drawn lessons from Jiashi's application. Jiashi believes this is a direct opportunity for cooperation. After all, the compliant virtual currency business in Hong Kong is a blue ocean, and cooperation is essential to enlarge the pie.

According to Hong Kong's requirements for the qualifications of managers issuing spot ETFs, the following criteria must be met: 1. A good regulatory compliance record; 2. At least one competent employee with experience in managing virtual assets and related products; 3. Holding an upgraded Type 9 license.

Although there are as many as 2,000 asset management companies with Hong Kong's Type 9 license, only a little over ten have the upgraded Type 9 license.

In this context, cooperation is essential for mutual benefit. Entering Web3, or more precisely, in the matter of spot ETFs, what everyone needs to do is to work together to enlarge the pie and then share the results.

The Largest Market Still Lies in Mainland China

It is worth noting that compared to the United States' Bitcoin spot ETFs, Hong Kong has an additional channel for subscribing to spot ETF shares using virtual currency on exchanges.

An anonymous industry insider from Hong Kong told Golden Finance that this is because Hong Kong has licensed exchanges that have opened up this channel. For those in the industry, this is also a compliant inflow and outflow channel.

Chen Peiquan, Executive Chairman of Victory Securities, believes that using physical asset subscriptions eliminates the need to wait for transaction processing between banks or brokers, as the fiat currency inherently involves the action of repurchasing VA for trading, and the cutoff trading time for physical assets is also longer than for cash. Therefore, physical asset subscriptions can enjoy a time advantage.

In recent years, the downturn in the Hong Kong stock market has shown little improvement. By the end of 2023, the total market capitalization of Hong Kong stocks was approximately 31 trillion Hong Kong dollars. The Hong Kong stock market has experienced four consecutive years of decline, while capital from Europe and the United States has withdrawn, leading to reduced liquidity. In fact, in 2023, Hong Kong was once jokingly referred to as the "International Financial Center Ruins."

Some believe that the Hong Kong stock market has entered a slow bear phase due to "soil degradation." As Hong Kong gradually transforms from an international financial center to an ordinary Chinese city, foreign capital is likely to leave the Hong Kong financial market. A specific example of foreign capital withdrawal is that the main pension fund of the U.S. federal government announced it would exclude stock investments in China and Hong Kong from its $68 billion international fund.

Tony Luk, Investment Director at New Fire Asset Management, stated that after the launch of the Bitcoin spot ETF, the expected daily inflow is around $10 million to $20 million. Considering the relatively small scale of the Hong Kong ETF market and limited trading volume, large inflows will take some time, and the initial daily inflow will not be too large. The expected scale of the spot ETF is around $1 billion to $2 billion.

Currently, the overall scale of Hong Kong ETFs is only $50 billion, and the Bitcoin ETF faces limitations such as high trading costs. In this context, $2 billion would be considered a relatively large scale in the Hong Kong market.

At present, BlackRock's Bitcoin spot ETF alone has already exceeded $10 billion in scale. The United States occupies over 80% of the Bitcoin spot ETF market, ranking first, while Canada, in second place, accounts for only 7%, with a specific scale of about $3 billion. If Hong Kong can reach $2 billion, it will rank high globally.

Although $2 billion is a drop in the bucket for Hong Kong's overall financial market, embracing Web3 is a commendable initiative by the government to revitalize Hong Kong's financial industry. Although currently, residents of mainland China cannot purchase virtual currency spot ETFs, it is foreseeable that as policies continue to open up, mainland China will become the largest market for virtual currency spot ETFs.

Tony Luk told Golden Finance that if a successful connection with the mainland market can be established, there is expected to be some growth potential, but the growth rate will also depend on policy progress, with a scale of $5 billion to $10 billion potentially achievable.

As Hong Kong gradually becomes a cast-off for capital from Europe and the United States, actively embracing the mainland market is the key to truly revitalizing virtual currency spot ETFs. Of course, this is not something Hong Kong can decide.