Can mainland residents purchase Bitcoin ETFs in Hong Kong? Yes, but not at the moment

Author: Xiao Za Lawyer

The Za Jie team published an article a month ago discussing the news that three fund companies were approved to issue ETF products that can invest in spot Bitcoin and spot Ethereum through social media on April 15 this year. The announcement from these three fund companies immediately triggered a reaction in the global capital markets. As the region in Asia that has gone the farthest and fastest in the financial capital operation of crypto assets, Hong Kong has added fuel to the crypto bull market.

Just before Hong Kong approved the Bitcoin spot ETF, the U.S. Securities and Exchange Commission approved more than ten Bitcoin spot ETFs, marking a milestone event in the crypto asset market. Following the U.S., it was a foregone conclusion that Hong Kong, as a pioneer in crypto assets in Asia, would launch a Bitcoin spot ETF. For those familiar with the regulatory trends of crypto assets in Hong Kong, the approval of Bitcoin and Ethereum spot ETFs was not surprising. In terms of the choice of crypto exchanges, according to public sources, among the approved funds, two chose OSL, while the other chose to partner with HashKey, indicating that OSL and HashKey's significant advantages as licensed crypto asset trading platforms allowing retail clients to trade have begun to show.

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 accounts on crypto asset exchanges. So now the question arises: Can residents from mainland China also trade spot Bitcoin ETFs directly using their securities accounts like Hong Kong residents? Today, the Za Jie team will discuss this issue in detail.

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

Investors in the A-share market in China must often come across a term: northbound funds. In A-shares, "north" generally refers to the Shanghai and Shenzhen markets, while "south" refers to Hong Kong stocks. Therefore, northbound funds are the funds flowing from Hong Kong stocks into A-shares. When investors see a large influx of northbound funds, they subconsciously feel that a bull market is coming; when they see a large outflow of northbound funds, they subconsciously feel that a bear market is approaching. The reason funds from Hong Kong can flow into the A-share market (and vice versa, A-share funds can flow south into Hong Kong stocks) is due to the mechanisms of the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect.

As the name suggests, the Shanghai-Hong Kong Stock Connect is an interconnection system for investors of the Shanghai Stock Exchange and the Hong Kong Stock Exchange, while the Shenzhen-Hong Kong Stock Connect is for investors of the Shenzhen Stock Exchange and the Hong Kong Stock Exchange. Through these two systems, investors on the Hong Kong Stock Exchange can invest in the A-share market (referred to as "northbound capital"); A-share investors can also invest in the Hong Kong stock market (referred to as "southbound capital").

Returning to ETFs, the history of the Shenzhen-Hong Kong Stock Connect can be traced back to 2016, while the Shanghai-Hong Kong Stock Connect was launched earlier, in November 2014. However, the interconnection of ETFs came much later. The ETF interconnection officially started in July 2022. This mechanism allows qualified mainland and Hong Kong investors to cross-border invest in each other's ETF products.

From stock interconnection to ETF product interconnection, both the mainland's Shanghai and Shenzhen markets and the Hong Kong Stock Exchange are very cautious. Stocks that can access "northbound funds" must meet a series of market capitalization 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 Bitcoin spot ETFs through the interconnection system, then the Hong Kong Bitcoin spot ETFs must meet the various conditions set by the Hong Kong Stock Exchange. Is it possible for these conditions to be met? The answer is no for now, but it is very likely in the future!

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

The Za Jie team states that purchasing Hong Kong spot Bitcoin ETFs through the interconnection system is currently not feasible because the Hong Kong Stock Exchange has clear requirements regarding 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 mainly consist of Hong Kong stocks, but Bitcoin and Ethereum spot ETFs belong to virtual asset ETFs, which do not meet the requirement that constituent securities primarily consist of stocks eligible for the Hong Kong Stock Connect. This is the core issue that needs to be resolved. Of course, this issue is not insurmountable; it is purely a regulatory matter. According to currently disclosed information, a well-known fund investment company that is among the first batch of virtual currency ETF issuers in Hong Kong has stated that it is currently promoting the opening of Bitcoin and Ethereum exchange-traded funds to Chinese investors through the Hong Kong Stock Connect. The CEO of this well-known fund investment company has also revealed through public media that if progress goes smoothly in the next two years, they do not rule out applying to include their ETFs in the interconnection plan.

In other words, the Za Jie team predicts that in about two years, mainland residents will be able to invest in Hong Kong Bitcoin spot ETFs through the interconnection mechanism. So everyone, please be patient; what is meant to come will eventually arrive.

In Conclusion

It must be said that the Hong Kong Bitcoin and Ethereum ETFs have many advantages, the most important of which is security. Buying crypto asset spot ETFs does not require actual holding and storage of Bitcoin, Ethereum, and other assets, so investors no longer have to worry about losing the private keys of their stored cryptocurrencies (one client served by the Za Jie team once lost a large number of Bitcoin private keys due to improper storage). Additionally, the technical threshold is low; Hong Kong crypto asset spot 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 crypto asset trading platforms in Hong Kong. This greatly lowers the technical barriers to trading crypto assets. Furthermore, due to the capital volume issues, traditional securities exchanges generally have higher liquidity than most existing crypto asset trading platforms, and the relevant regulatory measures are also more comprehensive.

Because of these numerous advantages, mainland investors also have the motivation to purchase Hong Kong Bitcoin spot ETFs. However, during recent discussions with legal professionals, the Za Jie team has also heard other opinions. For example, if mainland residents are allowed to purchase Hong Kong Bitcoin spot ETFs through the interconnection plan, would this violate the "Announcement by the People's Bank of China and six other departments on preventing risks of token issuance and financing" and the "Notice on further preventing and dealing with risks of virtual currency trading speculation"? After all, these policies clearly state that no services such as account opening and fund settlement should be provided for virtual currency-related businesses, and activities related to virtual currency are considered illegal financial activities. The Za Jie team believes that this does not contradict the interconnection mechanism for Hong Kong Bitcoin ETFs. The background for the issuance of the above policies is the lack of regulation of virtual assets, which severely affects financial security and stability. However, the current investment in Hong Kong Bitcoin spot ETFs through the interconnection mechanism already has a sound mechanism and regulatory trajectory. In this context, once the timing is right, regulatory trends will naturally change. Let us look forward to the arrival of that day together.