This week has started with a groundbreaking fund launch, the first SFC-regulated crypto fund in Hong Kong for professional investors. This now gives financial institutions a clear vehicle to get simple exposure to Bitcoin.
But the achievement took two years of volatile fortunes – in the markets, in negotiations, and in the management team.
On April 20, Venture Smart Asia announced it got the go-ahead from the Hong Kong Securities and Futures Commission to launch the territory’s first regulated virtual-assets fund.
This caps a long back-and-forth with the regulators, with Venture Smart ultimately agreeing to a 38-page booklet of terms and conditions on top of the usual type-9 license the SFC grants for managing assets.
That’s an incredible amount of compliance for what appears to be a simple product: a tracker fund that matches the price of Bitcoin for SFC-defined professional investors (institutions and high-net-worth individuals).
Lots of fine print
Avaneesh Acquilla, chief investment officer at Arrano Capital – the blockchain arm of Venture Smart, the brand under which the fund will be promoted – said, “The SFC was really thorough, as we would expect, in terms of compliance, our processes, our responsible officers, and how the business will actually function.”
The result is the proforma terms and conditions for virtual asset managers. Acquilla said that is designed to be a template for other products in the pipeline. “This is an extra layer of regulation that all managers in crypto will have to adhere to.”
The SFC only put its T&Cs in writing in October 2019, well after its chairman, Ashley Alder, had announced his willingness to bring crypto funds into the regulated fold a year before. Crypto managers had been pitching the SFC since spring 2018.
THIS IS AN EXTRA LAYER OF REGULATION THAT ALL MANAGERS IN CRYPTO WILL HAVE TO ADHERE TO
Simmons & Simmons, a law firm with a large roster of hedge-fund clients, served as Venture Smart’s legal advisor. “We had a lot of dialogue to fully understand the regime,” Acquilla said.
Arrano Capital aspires to build its business to be as digital as possible. Is that doable given the amount of regulation it must meet, above and beyond the usual requirements for a licensed asset manager?
Acquilla says there are not any problems with a straightforward fund tracking Bitcoin. But more complex strategies, such as an arbitrage fund, will find it difficult, because of the custody. A strategy involving a lot of trading, especially at ultra-low latency, needs to move virtual assets constantly in and out of hot wallets, on and off-chain. Arrano’s tracker product invests passively and offers daily liquidity, so it can store everything in a third-party custodian’s cold wallet.
The SFC and the industry will have to create some workarounds: the concept of hot and cold wallets is unique to digital assets. One possibility is that a fund might have to give SFC real-time access to its accounts and the sums trading in and out.
That might be anathema to investment firms, unless both sides could agree on data privacy measures. In theory, blockchain technology allows this (such as by using zero-knowledge proofs). But given the extensive work just to get a passive tracker up and running, getting all sides comfortable with something that novel will take time.
Not all of the delays in getting this product off the ground were due to the SFC’s needing time to formulate policy. Venture Smart went through a series of business ups and downs, according to sources familiar with its operations.
The company was originally set up by some of the same shareholders backing of Hong Kong’s Kenetic Capital, which was one of the region’s pioneering crypto investment firms. Kenetic began as a “friends & family” investor, run by entrepreneur Jehan Chu; Stephane Verhelst, an ex-HSBC derivatives trader; and financier Lawrence Chu (who runs BlackPine Group, his family’s investment arm), who was also behind Venture Smart. The businesses share office space.
The Kenetic team rode the highs of the 2017-2018 crypto boom, with hedge-fund veteran Ben Roth joining to head up trading. But the firm’s management structure was as volatile as bitcoin prices, with Verhelst leaving to join Natixis, to be replaced by ex-Optiver trader Daniel Weinberg.
Kenetic is a prop-trading, advisory and venture shop, without a securities license, so its proprietors turned to Venture Smart to serve as the regulated entity. Acquilla was originally hired by Kenetic as a portfolio manager from hedge fund Och-Ziff (joining fellow Och-Ziff colleague David Wills, who joined Kenetic as COO and is now CEO of its trading desk). He switched over to VS as CIO, while Mark Brady joined VS from BlackRock to bring institutional and passive-fund expertise.
The “crypto winter” of 2019 hit the organizations hard. Assets plummeted, Kenetic’s ICO consulting business died, and some prop investments fizzled (although a stake in SharesPost has done well; the firm still has positions in about 130 portfolio companies). Like many in the crypto space, the group slashed headcount, streamlined projects, and changed management, although sources say Lawrence Chu stepped back from the businesses to focus on running fintech lender Oriente, in which he is a shareholder. Brady also left, to join AWS. The year’s silver lining was that Kenetic’s internal fund performed well.
Going to market
But between internal changes and the crisis environment of 2019, it took Venture Smart a while to formally submit an application to SFC, which it did in April.
In addition to Simmons & Simmons, Arrano is relying on several other service providers.
Grant Thornton is serving as auditor, Mainstream Fund Services is administrator, Ogier is the administrator for the Cayman Islands (where the fund is domiciled), and BitGo is custodian. BitGo is a licensed trust company in the U.S., an important jurisdiction when it comes to regulatory comfort, and it is insured by Lloyds of London.
OSL, a unit of BC Group, and Cumberland Trading will serve as “authorized participants”, the brokers who make markets to keep the fund’s net asset value in line with the underlying price of Bitcoin.
Arrano is already accepting subscriptions but the fund won’t begin trading yet, with mid-May the target date to go live. The firm hopes to attract up to $100 million of client assets over the first 12 months of operation. It will charge a 1% front-end load and a 1% annual management fee.
Professional investors can trade bitcoin directly, should they wish. The importance of launching such a fund is that it is structured and regulated along traditional lines.
In Hong Kong, the SFC already allows funds that sell only to professional investors to allocate up to 10% of their assets to crypto. But the Arrano fund – which Acquilla declined to name, lest he cross SFC strictures against promotion to retail investors – allows financial institutions to invest in bitcoin in a manner that is easy to get internal compliance and risk approvals, as well as comfort investors’ shareholders.
Acquilla says institutions are interested in Bitcoin as a store of value in the face of global interest-rate cuts and negative-yielding public debt; as a diversification from traditional assets; and as a possible source of alpha, with a “halving” scheduled for May (when the protocol’s new supply of blocks is reduced by 50%).