When Hong Kong’s financial secretary, Paul Chan, delivered his keynote address during the city’s FinTech Week conference at the end of October, it was seen as both a watershed and somewhat of an awkward moment.
The meeting of blockchain experts, policymakers, and investors was held alongside other large gatherings, including the Global Financial Leaders' Investment Summit and the Rugby Sevens, ostensibly with the aim of showcasing Hong Kong’s return to normality after stringent social restrictions since the start of the pandemic.
But after testing positive for Covid-19 during a work trip in the Middle East, secretary Chan was unable to attend the gathering in person. Instead at FinTech Week, he gave a statement by video link. The irony was not lost among the crowd, but with all well accustomed to videoconferencing, his digital message underscored a more important point: that Hong Kong was about to embrace the virtual world.
While short on policy detail, his announcement outlined a roadmap for both investors and tech entrepreneurs. It came alongside plans by the Hong Kong Securities and Futures Commission (SFC) to push ahead with a series of public consultations examining the appetite of retail investors for virtual assets under a new licensing regime. In addition, the Hong Kong regulatory body is exploring access to those exchange-traded funds (ETFs) that have exposure to Bitcoin and Ether futures, via the Chicago Mercantile Exchange.
Facilitating cryptocurrency ETF exposure in Hong Kong would be considered a significant policy development that could enable the city to assert itself as a regulatory leader by providing appropriate guardrails for retail investors, Rachel Lin, CEO and founder of SynFutures, explained to FinanceAsia. Lin views the recent progress as noteworthy. “For their part, companies can enhance education prospects to support retail investors exploring opportunities in crypto,” she said, which will facilitate better understanding of the associated risks involved with the virtual asset universe.
Digital tokens with Hong Kong characteristics
Traditionally, Hong Kong has been able to draw upon its deep liquidity pools, international talent, and financially supportive rule of law to raise capital for Asian companies. But the city also serves as a historical financial gateway to China. At the end of June, the local bourse announced updates to its Bond Connect and Stock Connect programmes which facilitate capital flows between international investors and mainland-based companies. These were further enhanced in July, when ETF trading was made available via the Stock Connect channel, and in the autumn, the stock exchange proposed changes to some of its listing requirements.
But regarding cryptocurrencies, Hong Kong’s position has been relatively disengaged, particularly when compared to regional neighbours such as Singapore, South Korea, and Thailand.
The Special Administrative Region’s (SAR) renewed foray into blockchain comes as Singapore pares back its earlier regulatory enthusiasm. Following the collapse of high-profile funds and digital tokens, the Monetary Authority of Singapore (MAS) is exploring new ways to curb speculative behaviour, including by enforcing restrictions on retail borrowing to acquire cryptocurrencies, and limiting digital token lending in search of the above-market yields available via distributed ledger technology (DLT) platforms.
While Singapore’s central bank reminds investors that, as with other risky investments, digital tokens could lose their entire value, MAS has also praised the role that cryptocurrencies can play in broadening the digital asset ecosystem, rendering a complete ban undesirable and impractical.
Hong Kong’s blockchain aspirations contrast those of Beijing, where activity related to digital coins outside of the nationally supported central bank digital currency (CBDC) pilot, is illegal. Even with room for improvement in terms of regulatory clarity, Hong Kong’s position will remain separate from the mainland, suggested Michelle Ta, partner of Simmons & Simmons. She told FA that this is where tangible characteristics of the SAR’s “one country, two systems” are likely to emerge. “Hong Kong is still the bridge between China and the world, holding a unique role within the Greater Bay Area (GBA),” she said. As such, “there is room for growing southbound investment. [Consider] if ETF trading via Stock Connect were to expand to include virtual asset ETFs in the future,” she posited.
The benefits of hindsight
Bitcoin held its value at $20,000 during Hong Kong’s FinTech Week, stabilising after losing nearly two-thirds of its value twelve months earlier. The performance returned the digital asset’s valuation highs of 2021, when broader acceptance for crypto grew alongside relaxed custodian rules. But when the calendar turned to 2022, the market values for risky investments headed south.
As commodity prices surged amid geopolitical turmoil and a global energy crisis, concerns materialised when central bank governors fell behind the policy curve and speculated a series of aggressive interest rate hikes that threatened the international economy. Global markets began mass selloff, including of Hong Kong dollar assets.
Indeed, since the start of 2022, the Hang Seng Index has lost nearly a fifth of its value, breaching a 13-year low that was last encountered in April 2009. Though cited as an investment hedge against rising interest rates – given that digital tokens do not offer a cash dividend yields – Bitcoin too, slumped alongside world equites.
Coupled with these market valuation woes, confidence towards digital tokens further waned. The summer’s collapse of high-profile crypto funds, Celsius and Three Arrows Capital, whose investments into lesser-known digital currencies and stable coins soured, exposed the risk of investing in virtual currency.
“The growth of the unregulated crypto marketplace has allowed for various types of entrepreneurs and technology companies to enter into the financial services space in ways they hadn’t been able to previously,” Justin Chapman, global head of Digital Assets and Financial Markets at Northern Trust, told FA.
“[The promise] of high potential returns has encouraged suboptimal risk management and market practices. As with other financial market events over the years, trust must be rebuilt through the inclusion of strong risk management programmes and a greater focus on client protection,” he added.
Any regained stability across digital token values achieved during FinTech Week proved short-lived. The floor was shaken less than a week later by the surprise collapse of crypto exchange FTX, which was valued at $32 billion, in early 2022. Contagion worries soon followed as other exchanges froze customer withdrawals.
In response to the FTX fiasco, secretary Chan reiterated the need for better regulation and transparency across the asset class, a sentiment also echoed by BTSE chief executive, Henry Liu. Liu explained that Hong Kong’s institutions were not as seriously impacted by FTX's downfall compared to others, given the city’s sustained apprehension towards crypto.
“This is why FTX left Hong Kong in the first place. It's difficult for service providers and exchanges to obtain licences in the territory,” he told FA, referring to the relocation of the firm’s headquarters in 2021 from the city to the Bahamas. “We still expect regulators to move forward with a much more encouraging approach towards the industry.
Technological infrastructure
Experts view Hong Kong’s cautious approach as being vindicated. “While Hong Kong has announced that it intends to foster the vibrancy of the sector locally, this has always been in the context of fit-for-purpose regulation. The FTX collapse shows that this is sorely needed,” said Ta.
Crypto advocates often mention that volatile price fluctuations distract from the fundamental benefits of blockchain technology. Indeed, when FTX’s CEO and founder, Sam Bankman-Fried, spoke at Hong Kong’s FinTech conference, he proposed that the fall in value of the cryptocurrency market this year had strengthened the credibility for decentralised finance, since it proved that the technology did not collapse on itself.
The source of FTX’s problem is the age-old practice in the securities industry of “borrowing” customer deposits for proprietary trading, Christopher Wood, equity strategist at Jefferies, explained in a research note. He suggested that the core issue with the collapse was less about technological hype, and more about human behavior.
“Liquidity stresses on other crypto exchanges in such a context should be expected. But it does not invalidate the investment case for blockchain technology or indeed Bitcoin. What it does do, however, is make it much more likely that there is a wave of regulation in the crypto space, which will not please libertarian purists.”
Since the collapse of FTX, other crypto exchanges have rushed to publish their reserves to ensure confidence and prevent another wave of massive withdrawal. But when decentralised technology and shareholder capital are packaged together, the optimism for blockchain begins to lose substantial support.
Facebook’s Meta took a marketing gamble in October 2021 by renaming the company to underscore its optimism for Web 3.0. But after losing almost two thirds of its value and mass lay-offs, calls from investors and company executives have grown louder to refocus its strategy away from the metaverse.
This comes as the success of transitioning traditional industries towards blockchain technologies remains uneven. While both the EU and the UK have launched pilot projects to support distributed ledgers, in November, the Australian Stock Exchange (ASX) abandoned its move to upgrade its clearing house system from legacy to blockchain technology. The decision wrote off more than $170 million spent since 2017 and calls into question whether new technology can entirely replace existing infrastructure, given the complexity of back-office functions.
Defining Hong Kong’s message
In the months ahead, Hong Kong’s crypto ambitions will take shape. Policymakers have already pointed to a wider adoption of blockchain technology to issue tokenised green bonds and an e-Hong Kong dollar. Indeed, more regulatory announcements should be expected, said Mark Basa, managing director at XWECAN Crypto, but he maintains that a branding message overhaul is needed.
“Ask the Bitcoin community of Australia what they want, or the Ethereum community in Spain, and you’ll get vastly different and unique approaches to designing, planning, and executing a roadmap for how their respective governments should build a crypto or digital asset hub,” he opined.
Work must be done to reflect the voices of the local community, in order to achieve regulatory success, he said.
For Ta, the direction of travel in Hong Kong is clear. She sees the demand factor as driving policy, given requests for institutional and retail participation in crypto. “There must be some friction in buying these assets to filter out any mis-selling,” she explained.
Tech entrepreneurs, investors, and legal experts agree that adequate capital backed by sufficient real-world fiat money is a key necessity for Hong Kong to cement itself as Asia’s digital hub, and that this involves embodying traditional finance sector characteristics into a new and digital sphere. For Hong Kong, this implicit message suggests that the best way to manage new digital money, is with old school rules.
