Bitcoin futures remain a ‘buyers beware market’ for Hong Kong investors

Investors in cryptocurrency futures contracts in Hong Kong are trading at their own peril, as highlighted by the recent controversy around Okex, the world’s second-largest cryptocurrency exchange.

The company, which is registered in the Seychelles and based in Hong Kong, delivered its bitcoin cash futures contracts on November 14, earlier than scheduled, leading to losses for some traders. The incident comes fresh on the heels of a new conceptual framework introduced by Hong Kong’s Securities and Futures Commission, and some of the aggrieved traders approached the watchdog and filed a case.

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OKex wrong-footed some of its users by settling and delivering three of its bitcoin cash futures contracts earlier than expected. Its decision affected contracts worth more than US$400 million, according to Hong Kong-based trading company Amber AI. The incident borders on fraud, according to a post by the latter in the online publication Medium. OKex’s move was indicative of market manipulation, according to Amber AI, as the platform’s internal trading desk was trading against its clients’ positions. OKex has denied these claims.

The SFC, which on November 1 introduced a regulatory sandbox for exchanges that wish to apply for a licence in Hong Kong, however, does not accept platform operators trading virtual assets that are futures contracts or derivatives. Under this framework, which has not yet been implemented, it is therefore unlikely to regulate these operators.

Given this, it seems the traders who have filed a case with the SFC have misinterpreted the regulator’s stance, wherein it has left cryptocurrency futures and derivatives unregulated – a “buyers beware market”. Hence, they cannot expect any form of redress.

This is not the first time OKex has been in the news for causing losses for its investors. In July this year, it took a portion of the gains in equal percentage from all traders making a profit under a clawback mechanism, and used it to plug a client’s margin call loss. It made the decision after the client’s long position exceeded its risk limit, which led to OKex forcibly liquidated trades in that account.

In fact, spreading losses among users seems to be within cryptocurrency exchanges’ contractual rights, according to Hoi Tak Leung, counsel at law firm Ashurst.

“Many of these exchanges do have ‘loss-socialising’ mechanisms stipulated as part of their terms and conditions for users. And this does not just apply to trading losses incurred on the positions on the exchange’s order books, but is also applied to losses caused by other events, such as hacking,” said Leung.

Some market participants also told the South China Morning Post they found the SFC requirement that exchanges should operate an online trading platform in Hong Kong for them to be eligible for entry into its regulatory sandbox perplexing.

Does this mean exchanges not registered in Hong Kong do not fall under the watchdog’s purview?

Gaven Cheong, partner at law firm Simmons & Simmons, said operations should be understood “as a matter of substance”.

“I don’t think the jurisdiction of incorporation matters as much as whether, as a matter of substance, operations are being carried out in Hong Kong. [One of the] core principles of the SFC Statement provides that it expects all services to be conducted under one single legal entity, but there is no specific requirement that this legal entity be a Hong Kong company or entity registered here,” he said.

Ultimately, as long as some exchanges remain unregulated, the onus is on professional traders and fund managers dealing with virtual assets to carefully weigh the credit and operational risks associated with their exchange counterparties.

“Our principle is always use multiple exchanges and avoid concentrated positions,” the head of a Hong Kong-based trading firm said on condition of anonymity.