Tokenization has promised to revolutionize traditional finance, but regulatory uncertainties have hindered its widespread use. Pioneers and innovators faced legal disputes and regulatory challenges. However, Hong Kong has emerged as a jurisdiction providing much-needed regulatory clarity for tokenizing securities. This newfound clarity positions Hong Kong as an ideal environment for exploring Real-World Asset (“RWA”) tokenization.
Author: Louie Lee, Consultant
SFC’s Newfound Clarity on Tokenized Securities
For the first time, the Hong Kong’s Securities and Futures Commission (SFC) has made a distinction in its circular, dated 2 November 2023, between:
Tokenized Securities – subset of Digital Securities that are traditional financial instruments (e.g. bonds or funds) which utilise DLT as a tokenization wrapper; and
Digital Securities – structured in more complicated forms, with some existing exclusively on a DLT-based network with no links to extrinsic rights or underlying assets and having no controls to mitigate the risks that ownership rights may not be accurately recorded.
Assuming that a tokenised RWA falls within the definition of “securities” e.g. a tradable financial asset, under the Securities and Futures Ordinance (SFO) and Tokenized Securities, aside from the existing legal and regulatory requirements that would apply to such a tokenised RWA (e.g. the prospectus regime for offers of Tokenized Securities as well as the offers of investments regime under the SFO), the SFC has also highlighted and given concrete examples of the relevant factors that intermediaries should consider when engaging in tokenisation activities, for example, the:
experience and track record of third-party vendors involved in the tokenization arrangement;
technical aspects of the Tokenized Securities;
legal and regulatory status associated with the Tokenized Securities; and
custody arrangements for the Tokenized Securities.
Digital Securities, being structured in more bespoke ways, will be subject to increased scrutiny and regulatory oversight from the SFC.
Equipped with an enhanced understanding of the regulator’s concerns, intermediaries venturing into RWA tokenization can shape their business plans and strategies to effectively alleviate these concerns, which will hopefully enable a more streamlined approval process.
Licensed Activities Involving Tokenized Securities in Hong Kong
Intermediaries who intend to conduct Tokenised/Digital Securities-related activities may do so under the following licences:
Type 1 licence (dealing in securities):
Acting as a distributor in the primary issuance of Tokenised/Digital Securities
Acting as a brokerage firm connecting clients to SFC-licensed virtual asset trading platforms (licensed crypto exchanges) for the secondary trading of Tokenised/Digital Securities.
Type 4 licence (advising on securities):
Advising clients on investment activities in relation to Tokenised/Digital Securities.
Issuing research reports on Tokenised/Digital Securities
Type 9 licence (asset management):
Managing portfolios that invest in Tokenised/Digital Securities
Managing and distributing a tokenised fund product
Type 1 and type 7 licence + Anti-money Laundering Ordinance licence (virtual asset trading platform):
Secondary trading of Tokenised/Digital Securities
It should be noted that licensed intermediaries who are looking to expand their business into RWA tokenization are obligated to notify the SFC of their plans in advance.
As a final note, the recent regulatory clarity provided by the SFC addresses the previous uncertainties in regulatory frameworks that impeded the widespread embrace of tokenization within regulatory frameworks. By delineating the factors for intermediaries to consider when engaging in tokenization activities, this development is poised to allure traditional financial institutions towards harnessing tokenization technology for their product offerings.
Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.
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