The Hong Kong Monetary Authority (HKMA) recently introduced new regulatory standards on the sale and distribution of tokenized financial products by authorized institutions. The goal of these standards is to promote innovation while safeguarding consumer protection in the rapidly growing field of tokenization. This innovative technology involves digitizing real-world assets (RWA) using distributed ledger technology, or similar systems, to streamline processes and enhance accessibility.
These guidelines clearly outline the scope of tokenized products covered by the new regulatory framework, which excludes products already regulated by the Securities and Futures Ordinance, Securities and Futures Commission (SFC), and HKMA-specific regulations. The move comes in response to the increasing adoption of tokenization technologies within the financial sector. With Hong Kong embracing Web3 technology and its potential applications, the need for comprehensive rules and protections has become imperative.
The regulatory notice emphasizes the importance of applying existing rules and protections for traditional financial products to tokenized products due to their similar terms, features, and risks. This includes structured investment products and tokenized precious metals not currently covered by the Securities and Futures Ordinance. However, it is important to note that stablecoins are not included within the scope of this regulatory framework.
Authorized institutions are mandated to conduct thorough due diligence before offering tokenized products to customers. This includes a comprehensive understanding of the product’s nature, features, and associated risks. Additionally, institutions must continuously monitor and adapt to any changes in the product’s characteristics. Due diligence extends to issuers and third-party service providers involved in the tokenization process, with a focus on assessing their experience, track record, and risk profiles.
Product and Risk Disclosure Responsibilities
Institutions are required to act in the best interests of their clients by providing full disclosure of key terms, features, and risks associated with tokenized products. This includes risks related to underlying distributed ledger technology (DLT) networks, potential security threats like hacking, and legal uncertainties surrounding ownership and transaction finality on DLT networks. Transparent and comprehensive disclosure is critical to ensuring customer protection and informed decision-making.
Risk management is a key focus area outlined by the HKMA, requiring authorized institutions to establish robust policies, procedures, systems, and controls to identify and mitigate risks associated with the sale and distribution of tokenized products. This comprehensive risk management framework encompasses areas such as policies, internal controls, complaint handling, compliance, internal audit, and business continuity planning. Institutions providing custody services for tokenized products must adhere to the expected standards for digital asset custody, prioritizing security and reliability.
The introduction of comprehensive regulatory standards for tokenized financial products by the Hong Kong Monetary Authority represents a significant step towards enhancing consumer protection and fostering innovation in the evolving landscape of tokenization. These standards not only promote transparency and risk management but also set the stage for the responsible adoption of emerging technologies within the financial sector. Adherence to these regulatory requirements will be crucial for authorized institutions seeking to offer tokenized products while ensuring the integrity and security of the financial ecosystem.