HK Spot Crypto ETFs to Drive Collaboration with TradFI Firms

With regulatory safeguards in place, the success of crypto ETFs hinges on institutional interest tied to market conditions, including crypto valuations.
The recent announcement from Hong Kong’s Securities and Futures Commission (SFC) that it will consider allowing listings by spot crypto ETFs is expected to be another step in not just regulating the digital assets market but also promoting product innovation in broader financial markets.
The Asian regulator’s decision came weeks ahead of the US Securities and Exchange Commission’s (SEC) much-anticipated decision to potentially approve the trading of spot Bitcoin ETFs, a proposal that was rejected a decade ago. US customers have had access to futures-backed Bitcoin ETFs since 2021, but the regulator has to date not approved any applications for spot Bitcoin ETFs. A decision by the SEC is expected on 10 January with 13 companies filing for approvals.
Paul Moloney, Partner, Mayer Brown
Paul Moloney, Partner in the Corporate & Securities Practice at Mayer Brown said that this decision builds on the regulatory support shown by the Hong Kong regulators for the virtual asset industry by their earlier approval of ETFs that obtained exposure to virtual assets through futures contracts traded on conventional regulated futures exchanges and the licensing regime for virtual asset trading platforms (VATPs) that became effective in June 2023.
Spot crypto ETFs create an additional pathway for investors, both professional and retail, to gain price exposure to major digital assets through traditional financial channels. “The SFC’s move signals that the authorities are actively exploring ways to build Hong Kong as a multi-faceted Web 3 hub,” added Chengyi Ong, Head of Policy APAC, Chainalysis.
Sharp regulatory oversight
The SFC’s rules included details on issuer qualifications that mandate strict criteria for asset management companies and spell out the underlying asset requirements by stating that the ETFs will focus on major cryptocurrencies like Bitcoin and Ethereum, ensuring that these are traded on licensed exchanges and accessible to retail investors. It also stipulated that ETFs should operate as passive funds, prohibiting the use of leverage.
To tackle money laundering, the SFC has proposed both the cash and in-kind model with stringent KYC and AML checks. It has also explained the requirement for third-party independent custodians as well as emphasised transparency, risk disclosure and investor education.
Gary Tiu, Executive Director and Head of Regulatory Affairs of OSL, said that the SFC’s product design requirements for spot crypto ETFs have placed great importance on the use of Hong Kong licensed intermediaries and digital asset platform operators – for trading, custody as well as the subscription and redemption processes.
“This ensures the whole value chain that supports the ETF product is under Hong Kong regulatory oversight – particularly when it comes to handling the fund’s valuable underlying digital assets,” he pointed out.
This is expected to be immensely beneficial to the growth of Hong Kong’s regulated digital asset ecosystem – particularly, for the players already experienced in supporting institutional players and intermediaries.
Ong said that these circulars are likely a response to market interest, so some applications should come through. “How much traction these funds gain will depend on investor interest, particularly among institutional investors, which will in turn hinge on market conditions including crypto valuations. Should spot crypto ETFs take off in Hong Kong, the winners may be within the VATP community, since funds are required to conduct their activity through licensed VATPs,” she said.
Licensed and experienced operators like OSL or HashKey are expected to play a crucial role in facilitating the trading, and custody of spot digital assets, as well as potentially supporting the subscription and redemption processes for the ETF products.

“For spot crypto ETF products, each and every part of the product’s operational workings require highly experienced, transparent and compliant players to work seamlessly – to ensure investor protection, market integrity, and operational efficiency,” elaborated Tiu.
Market readiness
The recent rebound in virtual assets is expected to drive investor interest, which in turn will drive asset managers to launch more crypto ETFs.
Moloney said: “The price of virtual assets has been on an upward trajectory in the later part of 2023, which has caught the attention of investors. Providing investors with well-regulated investment options when they decide to make an investment into VA can only assist with improving liquidity.”
Besides, Hong Kong’s regulatory structure for cryptos and recent acceptance of digital asset ETFs is expected to incentivise market participants and attract billions in retail capital.
A number of managers have done an enormous amount of preparatory work with their service providers and partners for this product already, said Tiu adding that more will ride the tailwind to design and launch their own products.
Samsung Asset Management (Hong Kong) and CSOP Asset Management have already launched Bitcoin futures ETFs. Recently Hong Kong-based Value Partners too revealed that it has plans for this segment. When contacted, none of the asset managers were willing to comment but, according to a local media report, Zhao Shande, senior strategist of ETF business at Value Partners, said that the firm is considering issuing ETFs related to virtual assets and tokens.
Market analysts said that the approach taken by Hong Kong’s regulator for spot ETF issuers allowing both cash and in-kind models is different from the US SEC, which is in favour of using only the cash creation model.
They said that the in-kind model allows investors to exchange their existing Bitcoin holdings for ETF shares and vice-versa – redeeming the ETF shares for Bitcoins. Many existing Bitcoin holders could find this model attractive as it allows portfolio diversification without transitioning to fiat currencies.
On the other hand, the cash ETF model is more traditional as investors would have to purchase or sell the ETF shares using fiat currencies such as HKD or USD. “This may be more suitable for those who do not possess Bitcoins. However, SFC’s proposal of using both models is likely to broaden the market, besides improving stability and liquidity,” said an analyst.
Investor safeguards

The SFC’s decision to permit spot ETFs has come with several safeguards being built for investors. ”These include the requirement for transactions of spot virtual assets by SFC authorised virtual asset funds to be conducted only through SFC licensed VATPs or authorised financial institutions (or their subsidiaries of locally incorporated authorised financial institutions), that in-cash subscriptions and redemptions and in-kind subscriptions should be done through SFC licensed VATPs and SFC licensed participating dealers or AIs respectively, and that the virtual asset custody function must be delegated to an SFC authorised VATP or AIs,” said  Moloney.
Ong added that spot crypto ETFs do have the potential to increase retail uptake by enabling convenient access to crypto assets. As with any financial product, it will be important to ensure that retail investors have a strong understanding of the risks involved. “Consumer protection is clearly a concern for regulators, given the requirement that investors undertake a knowledge assessment before being able to purchase the ETF,” she noted.
Meanwhile, Tiu said that overall orderliness will help to ensure prices and valuations of underlying assets are better protected from disorderly or abusive market practices. It will also accelerate integration with TradFi.
“This product will require deep levels of collaboration and integration between the regulated digital asset platform operators and traditional financial institutions – such as banks, fund administrators, asset managers, stock exchanges and licensed intermediaries,” he added.
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