Hong Kong SFC's New Rules Explained: Bitcoin / Ethereum Spot ETFs to be Approved Soon?

Globally, the virtual asset ("VA") landscape has been evolving rapidly. A wider range and number of investment products offering exposure to VA, including VA-related exchange traded funds (ETFs) available in major overseas markets, are now available to both retail and professional investors, and these products are becoming increasingly popular. Demand for these products has also increased in Hong Kong.

In light of these developments, the SFC has introduced a regime to allow certain VA services products to be offered to the Hong Kong public subject to appropriate investor protection measures. For example, in October 2022, the SFC started accepting applications for ETFs with VA exposure primarily through futures contracts. The SFC's licensing regime for virtual asset trading platforms (VATPs) also came into effect in June 2023, enabling Hong Kong investors to gain direct access to large-scale spot VATs subject to certain eligibility requirements and robust investor protection measures.

This Circular sets out the requirements for a SFC-authorized fund to (i) invest directly in the same spot VA tokens that are available to the public in Hong Kong for trading on a VATP licensed by the SFC; and/or (ii) acquire an indirect investment in such VA through, for example, futures traded on a regular regulated futures exchange and other exchange-traded products.

SFC Requirements for Authorized VA Funds VA funds authorized by the SFC should comply with the applicable provisions of the SFC's "Umbrella Principles" in the "Handbook on Unit Trusts and Mutual Funds", "Investment-Linked Assurance Schemes" and "Code on Unlisted Structured Investment Products", and the "Code on Unit Trusts and Mutual Funds" (UT Code). and;

The additional requirements listed below and the relevant requirements in the Joint Circular on Intermediary Virtual Asset Related Activities (Joint Circular) shall be fulfilled.

Management Company The management company of a SFC-recognized VA fund should have (i) a good regulatory track record; and (ii) at least one qualified staff member with relevant experience in the management of VA or related products.

The management company of a SFC-authorized VA fund is subject to additional terms and conditions imposed by the Licensing Department (if applicable)

Eligible VAs SFC-authorized VA funds should only invest (directly or indirectly) in VA tokens that are available to the public in Hong Kong for trading on the SFC-licensed VA trading platform.

Investment Strategy SFC-authorized VA Funds may invest directly or indirectly in eligible VA Tokens in accordance with the following requirements.

For VA futures, only those traded on traditional regulated futures exchanges are permitted provided that the management company demonstrates that (i) there is sufficient liquidity in the underlying VA futures and (ii) the rolling costs of the underlying VA futures are manageable and how such rolling costs are managed.

Indirect exposure to Eligible VA through other exchange-traded products is subject to the applicable requirements of the UT Code and such other requirements as may be imposed by the SEC.

SEC-recognized VA funds should not have leveraged exposure to VA at the fund level.

For SEC-authorized VA funds that primarily employ futures investment strategies, an active investment strategy is required to achieve portfolio mix flexibility (e.g., diversification of futures positions with multiple maturities), rollover strategies, and to deal with any market disruptive events.