Hong Kong provides guidance on crypto and tokenised securities-related activities by intermediaries

The SFC is supportive of the efforts made by intermediaries in conducting pilots for the tokenisation of traditional securities, and considers it timely to provide further guidance on tokenised securities-related activities. This circular clarifies regulatory expectations and provides guidance to intermediaries in addressing and managing the new risks arising from the tokenisation technology.

Key takeaways

• Prior guidance superseded – This Tokenised Securities Circular supersedes the SFC’s previous statement on security token offerings dated 29 March 2019.

• Tokenised Securities – These are traditional financial instruments (such as bonds or funds) that are “securities” as defined under the Securities and Futures Ordinance (SFO) which utilise distributed ledger technology (DLT) or similar technology in their security lifecycle.

• Existing requirements to continue to apply – Given that Tokenised Securities are fundamentally traditional securities with a tokenisation wrapper, the existing legal and regulatory requirements governing the traditional securities markets will continue to apply, including those relating to the public offering of securities and the conduct of intermediaries engaging in securities-related activities.

• Retail access to distribution and marketing of Tokenised Securities permitted – The PI-only restriction will no longer apply to the distribution and marketing of Tokenised Securities.

• Complex product categorisation – Tokenised Securities will no longer be regarded as complex products and be subject to additional investor protection measures by default. Intermediaries should adopt a see-through approach in assessing whether a Tokenised Security is a complex product, with reference to the SFC’s existing guidance for traditional securities.

• Issuance of Tokenised Securities – Intermediaries should consider the list of non-exhaustive factors in Part A of the appendix to the Tokenised Securities Circular) when assessing the risks relating to the technical and other aspects of Tokenised Securities and considering the most appropriate custodial arrangement to manage ownership and technology risks. Additional considerations in Part B of the appendix apply to the custodial arrangement for bearer form Tokenised Securities which use permissionless tokens on public-permissionless networks.

• Dealing in, advising on, or managing portfolios investing in Tokenised Securities – Prior to engaging in such activities, intermediaries should conduct due diligence on the issuers and their third-party vendors or service providers involved in the tokenisation arrangement and be satisfied with the controls implemented by such parties (see Parts A and B of the appendix).

• Information for clients – Intermediaries should make adequate disclosure of relevant material information specific to Tokenised Securities and provide clients with material information on the tokenisation arrangement.

Further details on the key requirements and regulatory clarifications under the Tokenised Securities Circular are provided here.

This circular sets out the requirements and the additional safeguards under which the SFC would consider allowing tokenisation of SFC-authorised investment products for offering to the Hong Kong public (primary dealing).

Since secondary trading of tokenised SFC-authorised investment products warrants more caution and careful consideration, the SFC will keep this under review for the time being.

Key takeaways

• Existing requirements – Product providers of tokenised SFC-authorised investment products (Product Providers) should ensure that the underlying products meet the applicable requirements in the relevant rules and regulations and product codes, including eligibility of Product Providers, product structure, investment and operational requirements, disclosure and ongoing compliance obligations. Additional requirements (as set out below), as well as the requirements under the Tokenised Securities Circular must also be met.

• Responsibility for tokenisation arrangement – Product Providers should remain and be ultimately responsible for the management and operational soundness of the tokenisation arrangement adopted and record keeping of ownership, regardless of any outsourcing arrangement, taking into account the list of non-exhaustive factors in Part A of the appendix to the Tokenised Securities Circular, where applicable. Product Providers should also have appropriate measures in place to manage and mitigate cybersecurity risks, data privacy risks, and system outages, and maintain a comprehensive and robust business continuity plan. Upon the SFC’s request, Product Providers should obtain satisfactory legal opinion to support its application, and should demonstrate to the SFC’s satisfaction (or obtain third party verification on) the management and soundness of the tokenisation arrangement, record keeping of ownership and integrity of smart contracts. In addition, Product Providers should have at least one competent staff with relevant experience and expertise to operate and/or supervise the tokenisation arrangement.

• Distributors limited to regulated intermediaries – Distributors of tokenised SFC-authorised investment products should be regulated intermediaries such as SFC-licensed corporations or registered institutions.

• Disclosure – Offering documents of a tokenised SFC-authorised investment product should set out clearly the tokenisation arrangement, the ownership representation of the tokens, and the associated risks with the tokenisation arrangement.

• Public-permissionless blockchain networks – Product Providers should not use such networks without additional and proper controls.

• Prior consultation or approval – Prior consultation with the SFC is required for new investment products that have tokenisation features for which the SFC’s authorisation is sought, as well as the tokenisation of existing SFC-authorised investment products.

Further details on the key requirements under the Tokenised Investment Products Circular are provided here.