The Hong Kong Monetary Authority (HKMA) on February 20 unveiled comprehensive regulatory standards for the sale and distribution of tokenized financial products by authorized institutions.
The initiative aims to promote innovation while ensuring robust consumer protection within the fast-growing field of tokenization, which involves digitally representing real-world assets (RWA) using distributed ledger technology or similar systems.
The guidelines delineate the scope of tokenized products that fall under this new regulatory framework, explicitly excluding products already covered by the Securities and Futures Ordinance and specific regulations of the Securities and Futures Commission (SFC) and HKMA.
The move is in response to rapid advancements in tokenization technologies and their application in the financial sector. Hong Kong has become increasingly open to Web3 technology in recent months and is focusing on implementing comprehensive regulations for the sector.
Existing rules must be applied
The regulatory notice establishes clear principles that existing rules and protections for traditional financial products should apply similarly to tokenized products, given their similar terms, features and risks.
This includes structured investment products and tokenized precious metals which are not regulated by the Securities and Futures Ordinance, while it is explicitly stated that this notice does not cover stablecoins.
To ensure that authorized institutions adhere to these standards, the HKMA requires thorough due diligence before offering tokenized products to customers. This includes understanding the nature, features, risks and ongoing due diligence of the product to adapt to any changes.
Institutions should also conduct due diligence on issuers and third-party service providers involved in the tokenization process, assessing their experience, track record and the risks associated with the tokenization schemes.
Disclosure and risk management
In the area of product and risk disclosure, institutions are required to act in the best interests of their customers, by providing full disclosure of the key terms, features and risks associated with tokenized products.
This includes risks associated with the underlying Distributed Ledger Technology (DLT) networks, potential security risks such as hacking and legal uncertainties regarding ownership and finality of transactions on DLT networks.
Risk management is another crucial area outlined by the HKMA. Authorized institutions must establish adequate policies, procedures, systems and controls to identify and mitigate risks associated with the sale and distribution of tokenized products.
This includes a comprehensive risk management framework covering policies, internal controls, complaints handling, compliance, internal audit and business continuity planning.
Meanwhile, institutions offering custody services for tokenized products must comply with the HKMA’s expected standards for digital asset custody, and ensure these services are secure and reliable.