Xiao Sa Team | Can Mainland Residents Purchase Hong Kong Bitcoin ETFs? Yes, But Not Now

Author: Lawyer Xiao Sa

A month ago, the Xiao Sa team published an article discussing the news that on April 15th, three fund companies announced via social media that they had received approval to issue ETFs that can invest in spot Bitcoin and spot Ethereum. The announcement from these three fund companies immediately triggered a reaction in the global capital markets. Hong Kong, as the region in Asia that has advanced the furthest and fastest in the financial operations of crypto assets, added fuel to the crypto bull market.

Just before Hong Kong approved the spot Bitcoin ETF, the U.S. SEC approved more than ten spot Bitcoin ETFs in one go, marking a milestone event in the crypto asset market. Following the U.S., Hong Kong, as a pioneer in crypto assets in Asia, naturally launched the spot Bitcoin ETF. For those familiar with Hong Kong's crypto asset regulatory trends, the approval of spot Bitcoin and Ethereum ETFs in Hong Kong was not surprising. Regarding the choice of crypto asset exchanges, according to public information, two of the approved funds chose OSL, while the other chose to partner with HashKey. This shows the significant advantages of OSL and HashKey as licensed crypto asset trading platforms allowed to serve retail customers.

For Hong Kong residents, the Hong Kong Bitcoin/Ethereum ETF means that local residents can directly use their securities accounts to purchase spot Bitcoin and Ethereum without needing to open an account on a crypto asset exchange. So the question arises: can mainland Chinese residents also trade spot Bitcoin ETFs directly using their securities accounts like Hong Kong residents? Today, the Xiao Sa team will delve into this issue.

Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect, and Hong Kong Spot Bitcoin ETF

Investors familiar with the Chinese A-share market often encounter the term "northbound funds." In the A-share market, "north" generally refers to the Shanghai and Shenzhen markets, while "south" refers to Hong Kong stocks. Therefore, northbound funds are funds flowing from Hong Kong stocks into A-shares. When investors see a large influx of northbound funds, they subconsciously feel a bull market is coming; conversely, a large outflow of northbound funds signals a bear market. The reason funds can flow between Hong Kong stocks and A-shares (and vice versa) is due to the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect mechanisms.

As the names suggest, the Shanghai-Hong Kong Stock Connect is an interconnection system between the Shanghai Stock Exchange and the Hong Kong Stock Exchange, and the Shenzhen-Hong Kong Stock Connect is an interconnection system between the Shenzhen Stock Exchange and the Hong Kong Stock Exchange. Through these systems, investors on the Hong Kong Stock Exchange can invest in the A-share market ("northbound funds"), and A-share investors can invest in the Hong Kong stock market ("southbound funds").

Returning to ETFs, the history of the Shenzhen-Hong Kong Stock Connect dates back to 2016, while the Shanghai-Hong Kong Stock Connect started even earlier, in November 2014. However, the interconnection of ETFs began much later, officially starting in July 2022. This mechanism allows qualified mainland and Hong Kong investors to invest in each other's ETF products across borders.

From stock interconnection to ETF product interconnection, both the mainland's Shanghai and Shenzhen markets and the Hong Kong Stock Exchange have been very cautious. Stocks eligible for "northbound funds" must meet a series of market value and liquidity requirements, usually being constituent stocks of major indices. The requirements for ETF products are even more stringent.

If mainland residents want to buy Hong Kong spot Bitcoin ETFs through the interconnection system, the Hong Kong spot Bitcoin ETFs must meet the conditions set by the Hong Kong Stock Exchange. Can these conditions be met? The answer is not now, but very likely in the future!

Index Constituents: A Current Issue, but Not Necessarily in the Future

The Xiao Sa team says that buying Hong Kong spot Bitcoin ETFs through the interconnection system is currently not possible because the Hong Kong Stock Exchange has clear requirements for the listing time and management scale of ETFs. However, looking at the issue from a developmental perspective, these requirements can definitely be met in a year or two. The only current issue is the index constituents. Currently, the constituent securities of ETFs in the interconnection system are mainly Hong Kong stocks, but spot Bitcoin and Ethereum ETFs are virtual asset ETFs, which do not meet the requirement of constituent securities being mainly Hong Kong Stock Connect stocks. This is the core issue that needs to be resolved. Of course, this issue is not unsolvable; it is purely a regulatory issue. According to publicly disclosed information, a well-known fund investment company, one of the first issuers of virtual currency ETFs in Hong Kong, has stated that it is currently working on opening Bitcoin and Ethereum ETFs to Chinese investors through the Hong Kong Stock Connect. The CEO of this well-known fund investment company also revealed through public media that if progress is smooth in the next two years, they do not rule out applying to include their ETFs in the interconnection plan.

In other words, the Xiao Sa team predicts that it will take about two more years for mainland residents to invest in Hong Kong spot Bitcoin ETFs through the interconnection mechanism. So, let's wait a little longer; what is meant to come will eventually come.

In Conclusion

It must be said that Hong Kong Bitcoin and Ethereum ETFs have many advantages, the most important of which is security. Buying spot crypto asset ETFs does not require actually holding and storing Bitcoin, Ethereum, and other assets, so investors no longer need to worry about losing their private keys for stored crypto assets (one of the Xiao Sa team's clients once lost a large number of Bitcoin private keys due to improper storage). Another advantage is the low technical threshold. Hong Kong spot crypto asset ETFs can be traded directly on the Hong Kong Stock Exchange in a manner similar to trading traditional securities, without the need for complex registration and KYC processes on various Hong Kong crypto asset trading platforms. This greatly reduces the technical threshold for crypto asset trading. Additionally, traditional securities exchanges have higher liquidity due to their larger capital size compared to most existing crypto asset trading platforms, and their regulatory measures are more comprehensive.

Because of these advantages, mainland investors are also motivated to purchase Hong Kong spot Bitcoin ETFs. However, during recent exchanges with legal professionals, the Xiao Sa team has heard other concerns. For example, if mainland residents can purchase Hong Kong spot Bitcoin ETFs through the interconnection plan, does this violate the "Announcement on Preventing the Risks of Token Issuance and Financing" and the "Notice on Further Preventing and Dealing with the Risks of Virtual Currency Trading and Speculation" issued by the People's Bank of China and six other departments? After all, these policies clearly state that providing account opening and fund settlement services for virtual currency-related businesses is prohibited, and virtual currency-related business activities are illegal financial activities. The Xiao Sa team believes that this does not conflict with the interconnection mechanism of Hong Kong Bitcoin ETFs. The background of these policies is the lack of regulation of virtual assets, which severely affects financial security and stability. However, investing in Hong Kong spot Bitcoin ETFs through the interconnection mechanism already has a sound mechanism and regulatory trajectory. In this context, once the time is ripe, regulatory trends will naturally change. Let's look forward to that day together.