(Bloomberg) -- Hong Kong is assessing whether to allow exchange-traded funds that invest directly in crypto as officials step up efforts to create an Asia-Pacific digital-asset hub while tackling the fallout of the JPEX scandal.

The city is weighing retail-investor access to such spot ETFs providing regulatory concerns are met, Securities and Futures Commission Chief Executive Officer Julia Leung said.

“We welcome proposals using innovative technology that boosts efficiency and customer experience,” Leung said in her first interview with international media since taking office on Jan. 1. “We’re happy to give it a try as long as new risks are addressed. Our approach is consistent regardless of the asset.”

The crypto sector sees ETFs as a way of making digital assets more mainstream since the funds are readily available to a variety of investors. Bitcoin has surged 110% this year partly on expectations that the likes of BlackRock Inc. will soon win permission to start the first US spot ETFs for the token.

ETF Outlook

Both Hong Kong and the US currently allow futures-based crypto ETFs, but the take-up has been modest compared to the overall size of the fund industry. The Asian city current lists the Samsung Bitcoin Futures Active, CSOP Bitcoin Futures and CSOP Ether Futures ETFs. They have combined assets of about $65 million.

Just how popular spot funds will be is an open question following the 2022 digital-asset rout and the conviction of Sam Bankman-Fried for the multibillion dollar FTX fraud, which damaged crypto’s reputation.

Hong Kong rolled out a dedicated virtual-asset regulatory framework in June, part of an effort to restore its luster as a cutting-edge financial center. The rules seek to woo companies but also focus on investor protection — a need underlined by the alleged HK$1.6 billion ($204 million) fraud that recently erupted in the city at the unlicensed JPEX crypto exchange.

“The incident underscores the requirement for a robust, comprehensive regulatory framework,” Leung said. The SFC has enhanced transparency over applications for virtual-asset exchange licenses, she said.

The JPEX blowup ensnared some 2,600 people and a police investigation is ongoing. Leung declined to comment on the details of the probe.

Tokenization

Under the SFC’s digital-asset regime, retail investors can trade major tokens like Bitcoin and Ether on licensed exchanges. BC Technology Group Ltd.’s OSL and HashKey Exchange are the only platforms with Hong Kong crypto permits at the moment. Mandatory rules for stablecoins — crypto tokens that are meant to hold a constant value — are due by 2023-2024.

Officials are also exploring tokenization, or digital representations of real-world assets. The segment has long been touted as a potentially key use of crypto’s underlying blockchain technology. Hong Kong sold its inaugural digital green bonds in February and the SFC just updated its regulatory guidance to open a path to tokenized products for retail investors.

“As the crypto ecosystem evolves step-by-step to the point where we’re comfortable, then we’re happy to open up more access to the wider investing public,” Leung said in the Nov. 2 interview.

The SFC latest circulars released the same day provided a road map for issuing tokenized funds and bonds to retail investors. Leung said she expects to see experimentation with “different levels of tokenization” initially. 

Security Tokens

A restriction on security token offerings limiting them to professional investors has been removed based on the latest circular. Tokenized securities are basically traditional securities with a tokenization wrapper, according to the regulator.

The city’s central bank, the Hong Kong Monetary Authority, is looking into providing guidance for banks on providing digital-asset custodial services. Such services would be one of the keys to developing a digital-asset ecosystem.

Citigroup Inc. estimates that by 2030, there will be as much as $5 trillion of tokenized private-sector securities and funds, spanning everything from corporate debt and financing collateral to alternative assets such as real estate, private equity and venture capital.

Hong Kong is one of a number of jurisdictions trying to develop digital-asset hubs as the industry slowly recovers from last year’s $1.5 trillion market crash. Competitors include Singapore, Dubai and the European Union, whereas the US has imposed a clampdown.

©2023 Bloomberg L.P.