Trading Tokenised Funds on VATPs

In Hong Kong, the ecosystem for digital assets is expanding at pace, lately with the introduction of secondary trading of tokenised SFC-authorised funds (“Tokenised Funds”). This development provides investors with additional flexibility to trade Tokenised Funds on SFC-licensed virtual asset trading platforms (VATPs).

Understand tokenised funds

In addition to subscribing to or redeeming the Tokenised Funds in the primary market, the secondary trading allows investors to buy and sell certain fund units with other investors on VATPs, either directly or through connecting brokers (generally refer to entities which direct investors’ secondary trading orders to VATPs), similar to how shares or exchange-traded funds (ETFs) are traded on stock exchanges. This not only provides investors with an alternative way for entering or exiting the Tokenised Funds with generally shorter settlement time than dealing in primary market, but also enhances price discovery, particularly outside the regular trading hours of traditional markets.

Secondary trading of Tokenised Funds on VATPs are offered based on on-platform, order-matching mechanisms and is subject to regulations similar to those for ETFs. Specifically:

• Pre-funding requirement
  Investors must have sufficient funds or product holdings in their accounts with the VATP or relevant connecting brokers to cover their trades, before the trades can be executed.

• Trading price vs. Net asset value (NAV)
  Secondary trading of Tokenised Funds takes places directly on VATPs through an order matching mechanism where investors may conduct trading directly on the VATPs or via connecting brokers. Fund units are traded at market price determined by supply and demand, which may not be equal to its NAV calculated with reference to the market value of the investments held by the fund.

• Indicative NAV per unit
  An indicative NAV per unit refers to an indicative, real time estimate of the per-unit NAV of a Tokenised Fund, calculated during the fund’s trading hours on VATPs and typically based on the most recently available market prices of the fund’s underlying portfolio constituents. A Tokenised Fund is required to provide the real time or near-real time indicative NAV per unit (typically updated at least 15 seconds during trading hours) through an online dedicated interface (e.g. website or app).

• Price deviation alert
  Investors should exercise extra caution if the trading price of the Tokenised Fund is at a large premium or discount to the indicative NAV.
  
  While VATPs and connecting brokers are required to alert investors where the price to be executed would deviate significantly from the indicative NAV, it is always a good practice for investors to check the NAV and indicative NAV before trading a Tokenised Fund in any circumstances.

• Market maker arrangements
  Arrangements must be put in place to ensure that at least one market maker is available. Broadly, market makers provide liquidity for the Tokenised Funds by quoting bid and offer prices.

• Availability of primary market alternative
  Investors may choose to subscribe to or redeem the Tokenised Funds in primary market at NAV on each normal dealing day, e.g. from Monday to Friday. Subscriptions and redemptions of fund units are executed at forward price, i.e. subscription and redemption prices are based on the fund’s NAV calculated at market close on that same day, and may be higher or lower than the prevailing secondary market prices. Generally, settlement of fund transactions in primary market would take longer time than secondary trading. In addition, the fund may use liquidity risk management tools to manage redemption pressure and it may take even longer time for investors to redeem the Tokenised Fund units.

• Transfer of Tokenised Fund units between primary and secondary markets
  Tokenised Fund units subscribed through primary market can be traded in the secondary market, and Tokenised Fund units purchased in the secondary market can be redeemed in the primary market.

Investors should carefully assess the risks associated with secondary trading of Tokenised Funds, including:

• Price deviation / trading risks
  Tokenised Funds may trade on VATPs at a substantial premium or discount to the fund’s NAV, as the trading price is driven by market factors such as the demand and supply of the units. Prices may also be stale when trading activity is thin.
  
  In addition, as investors will pay certain charges (e.g. trading fees and brokerage fees) to buy or sell units on VATPs, investors may pay more than the trading price when buying units, and receive less than the trading price when selling units.

• Liquidity risk
  Trading activity may be thin, especially outside normal operating hours of the Hong Kong financial market and during weekends. Investors may not be able to buy or sell their holdings quickly or may be forced to sell them at a price significantly below the NAV.

• Price fragmentation risk
  Tokenised Fund units may trade at different trading prices across multiple trading channels or VATPs. As a result, investors on one platform may buy or sell Tokenised Fund units at a less favourable price, as compared to a different platform. In addition, with liquidity spread across multiple platforms, a large order will have a greater price impact on its platform, than it would otherwise do in a consolidated market.

• Market maker reliance risk
  Although market making arrangements are in place, it is possible that there is only one market maker for the Tokenised Fund units or the fund manager may not be able to appoint a substitute market maker within the termination notice period (at least 3 months) of a market maker. Liquidity in the market for the Tokenised Fund units may be adversely affected if there is no or only one market maker for the units. There is also no guarantee that any market making activity will be effective.

Investors should thoroughly understand the underlying fund, including its investment objectives, strategies, features, operations and the associated investment risks. They should also understand the tokenisation arrangements, including whether off-chain or on-chain settlement is final and the associated risks (see the article “Tokenised Funds” for more).

Information of secondary trading are disclosed in the offering documents, including product key facts statements, of the relevant Tokenised Funds and the online dedicated interfaces (e.g., websites and/or apps) of the relevant VATPs and connecting brokers. Investors should, in particular, pay attention to the following:

For the secondary trading arrangements, investors should be aware of the followings:

• Information of the trading channel, such as operational flow, settlement process, settlement time, pre-funding requirement, differences between the secondary and primary markets, and whether the Tokenised Funds can be traded interchangeably across trading channel or VATPs;
• Market making arrangements;
• Applicable fees;
• Circumstances under which trading may be suspended;
• Risks associated with secondary trading; and
• The alternative to subscribe or redeem Tokenised Fund units at NAV and the resulting implications.