The approval of Bitcoin spot ETF is not new. According to Reuters yesterday, at least three offshore Chinese asset management companies will soon launch Hong Kong virtual asset spot ETFs (Bitcoin spot and Ethereum spot ETFs). The Hong Kong government's strong support for Web3 and the frequent favorable policies have become the expected consensus of the industry. OKLink Research Institute observed that the approval of Hong Kong Bitcoin and Ethereum spot ETFs did not cause a big sensation in the market like the approval of the US Bitcoin spot ETF, but when we accepted media inquiries, we learned that everyone is more concerned about how much money it brings and its more far-reaching significance. Through this article, the author explores the following issues from the perspective of "Hong Kong stock traders":
1. When calculating the scale of capital inflows, why do institutions attach so much importance to southbound funds?
Since July 2022, ETFs have been included in the "Stock Connect" for the first time. The program allows investors in mainland China and Hong Kong to buy, sell and settle stocks listed in each other's market through the stock exchanges and clearing houses in their own markets, and therefore has two categories: southbound funds (mainland China to Hong Kong) and northbound funds (Hong Kong to mainland China).
If southbound funds are approved, the virtual asset market represented by Bitcoin will become a new financial market for both China and the United States. According to public data from the China Securities Regulatory Commission, as of December 31, 2023, although there are only 8 southbound qualified ETFs available for mainland investors to choose from, their daily trading volume is as high as 108.3 billion yuan (about 15 billion US dollars), which means that 5% of the eligible ETFs that can be traded by southbound funds have attracted 16% of the capital inflows of the Hong Kong Stock Exchange (RMB channel).
However, we also note that the number of qualified ETFs that enter the Hong Kong ETF market through the Shanghai-Hong Kong Stock Connect/Shenzhen-Hong Kong Stock Connect channels is quite limited. In addition, the Hong Kong Securities and Futures Commission proposed in its 2024 outlook to consolidate Hong Kong's position as the world's leading offshore RMB center through "swap connection", "HKD-RMB dual counter model" and dual counter market maker mechanism. Considering the current attitude of the mainland towards virtual asset trading, after communicating with relevant financial markets in Shanghai and Hong Kong and Web3 industry insiders, OKLink Research Institute concluded that it is extremely unlikely that Hong Kong Bitcoin and Ethereum spot ETFs will be approved and opened to mainland investors in the short term. Based on the comprehensive opinions of various regulatory agencies and industry insiders, we believe that under the current circumstances, mainland residents cannot invest in Bitcoin and Ethereum spot ETFs through the Shanghai-Hong Kong Stock Connect/Shenzhen-Hong Kong Stock Connect.
However, the funds cashed out through the Shanghai/Shenzhen-Hong Kong Stock Connect can only return along the original route in the local settlement system, that is, the RMB funds flow in and out through the Shanghai/Shenzhen-Hong Kong Stock Connect, and will not remain in the Hong Kong market in the form of other assets. This means that offshore RMB is not within the channel of the Shanghai/Shenzhen-Hong Kong Stock Connect.
2. US Bitcoin ETF vs. Hong Kong ETF, is Hong Kong still attractive?
We note that Eric Balchunas, senior ETF analyst at Bloomberg, believes that $500 million would be a rather optimistic figure. However, we firmly believe that the potential of Hong Kong's virtual asset ETF market far exceeds this figure. This article will analyze the risk appetite of Hong Kong ETF investors, the situation of Hong Kong's virtual asset market before the announcement, and the ETF settings of the two places:
Eric Balchunas used the ETF market size for comparison. It is true that the overall size of the Hong Kong ETF market is much smaller than that of the United States, but we also found an interesting phenomenon. Among the top ten ETFs in Hong Kong, the ETF ranked first by AUM accounts for 54% of the total AUM, while the United States is 20%. This means that investors in the Hong Kong ETF market are unevenly distributed, with more than 50% of investments concentrated in the top.
In addition, the ETF with the No. 1 AUM in the Hong Kong market is also the gold-based ETF (SPDR GOLD TRUST) used as a comparison by Bitcoin investors, with an AUM of approximately US$69.8 billion, while the No. 1 ETF in the U.S. ETP market is based on The S&P500 is the underlying asset, with AUM of approximately US$518.7 billion, and SPDR GOLD TRUST AUM accounts for 13.5% of the top stocks in the United States. Therefore, it can be concluded that the head effect of Hong Kong ETF market is more significant, and compared with US ETF investors who are more willing to invest in US stocks (such as S&P500 as the target), Hong Kong investors are more interested in investing in gold. This shows that investors in the two markets have certain differences in their understanding of risk preferences and economic cycles. The Hong Kong market will have greater acceptance of Bitcoin as "digital gold".
Data source: HKEX, ETFdatabase
Hong Kong people seem to have a higher enthusiasm for Bitcoin. At the end of last year, when the OKEx Research Institute conducted a field survey of the virtual asset OTC market in Hong Kong, it was found that as of January this year, there were at least 200 physical crypto OTC exchange shops in the virtual asset market in Hong Kong. According to our calculations, the average annual transaction volume of the exchange shop channel is more than US$10 billion. Before the ETF channel, Chainalysis also estimated the Hong Kong market: Although Hong Kong has a much smaller population than the United States, Hong Kong's active over-the-counter cryptocurrency market drove US$64 billion in trading volume during the bear market last year (June 2022 to June 2023). Compared with other parts of Asia, Hong Kong dominates large institutional cryptocurrency transactions. Among Hong Kong's annual virtual asset transactions, 46.8% are institutional transactions of more than US$10 million, which is higher than the global average for similar transactions.
Data source: Chainalysis
In addition, in terms of the redemption mechanism, since Hong Kong has a comprehensive regulatory system for the virtual asset market, the physical redemption mechanism will be more beneficial to "Crypto-native" investors. The four methods of coin-in-cash-out, coin-in-coin-out, money-in-coin-out, and money-in-cash-out are more flexible than the US cash redemption mechanism (the last one), and there is also room for arbitrage. In addition, we believe that for Hong Kong investors who already hold BTC and ETH, the probability of obtaining illegal funds when exchanging Bitcoin for fiat currency is reduced to a greater extent, thereby protecting investors' assets.
As for the Ethereum spot ETF, although the current market value of Ethereum is 371.7 billion US dollars, compared with the Bitcoin market value of 1.25 trillion, the issuer is more motivated to promote it. Because in addition to the benefits brought by price increases, the Ethereum spot ETF also has additional returns from staking. As early as February 7, 2024, local time, Ark Invest submitted an updated S-1 revised application form, adding "the sponsor may pledge part of the trust assets on one or more trusted third-party staking platforms from time to time."
For qualified investors in Hong Kong, especially those with large transactions, the management fees in Hong Kong are not advantageous as far as we know. However, there are other factors to consider for capital inflows. FBTC, which currently has a fund fee of 0, is not ranked first in terms of capital inflows. This may be related to the fact that FBTC uses self-custody rather than third-party (coinbase, gemini) custody.
Data source: The Block, Public Info
Hong Kong's deployment of Web3 and the opening of the more familiar ETF channel are even more meaningful. This is not only a positive adjustment to the balance sheet of financial institutions due to the "shrinkage" of overall assets, but also a strategic strategy to stay at the "table" or even to be the leader of the new financial table. With the fundamental benefits such as the halving of Bitcoin, we will wait and see the future potential of Hong Kong's virtual asset spot ETF!
