Hong Kong Securities Regulator to Release Comprehensive Tokenization Guidance

The Hong Kong Securities and Futures Commission (SFC) is set to release detailed guidance on the tokenization of authorized investment products. The announcement was made at the recent buy-side forum in Hong Kong, where the commission emphasized its commitment to fostering innovation in the asset management industry while ensuring investor protection and market integrity.

The SFC, Hong Kong’s securities regulator, recognizes the need to facilitate innovation in the products and services it oversees. To achieve this, it aims to broaden the range of investment products offered in Hong Kong, especially those targeted at retail investors. Over the years, the SFC has authorized numerous exchange-traded funds (ETFs), many of which were Asia’s first or even global firsts. These include groundbreaking products like the first carbon futures ETF in Hong Kong and the world’s first green bond ETF focusing on Asia ex-Japan.

Beyond product innovation, the SFC has actively worked to help buy-side firms expand their market reach. Initiatives such as the Mutual Recognition of Funds arrangement with Mainland China, the Guangdong-Hong Kong-Macao Greater Bay Area Wealth Management Connect program, and ETF Connect have connected Hong Kong’s investment products to other markets, boosting liquidity and returns for investors.

However, the most significant recent development highlighted by the SFC is the tokenization of investment products. The regulator has received proposals to tokenize its authorized products, such as public funds, in response to amendments to Hong Kong’s Anti-Money Laundering and Counter-Terrorist Financing Ordinance. These amendments require central trading platforms of non-security tokens to obtain an SFC license, allowing Hong Kong residents to trade eligible crypto assets on SFC-licensed virtual asset trading platforms (VATPs).

Tokenization involves creating blockchain-based tokens that represent ownership in an investment product. These tokens can be traded on VATPs, making it a potentially efficient and cost-effective way to reach end-investors while reducing intermediaries.

However, the SFC is cautious about secondary trading of tokenized SFC-authorized products on VATPs. Secondary trading introduces new risks, such as 24/7 trading, which necessitates instant token ownership records and business continuity plans capable of matching this speed. Additionally, secondary trading would effectively turn tokenized products into “exchange traded products,” raising questions about liquidity, pricing, and investor understanding.

The SFC is working on detailed guidance for tokenization and believes that, at this stage, primary trading of tokenized products is more suitable, given the nascent state of the VATP regime in Hong Kong. Secondary trading requires further consideration and robust measures to address the challenges it poses.

In closing, the SFC emphasized the importance of responsible innovation with proper regulation. The commission believes that innovation without regulation is unsustainable, and a balance must be struck to ensure market integrity and investor protection. The SFC will continue to support innovation in the buy-side industry, striving to maintain high standards and a quality market.

The release of detailed guidance on tokenization by the SFC is eagerly awaited by the financial industry, as it has the potential to transform how investment products are offered and traded in Hong Kong’s markets.

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