Hong Kong's Financial Services and the Treasury Bureau (FSTB) issued the Policy Declaration on Development of Virtual Assets in Hong Kong on October 31, 2022, signaling a progressive and open stance toward virtual asset innovation. The declaration highlighted the government's intent to foster a robust ecosystem for virtual assets, covering public trading, property rights for tokenized assets, and the development of stablecoins. The Hong Kong government has also initiated several pilot programs, including NFT issuance, green bond tokenization, and the digital Hong Kong dollar (e-HKD), to explore the technological benefits and potential financial market applications.
The rapid evolution of the virtual asset sector has prompted regulators worldwide to develop frameworks that balance innovation with risk management. In Hong Kong, key bodies like the Securities and Futures Commission (SFC), FSTB, and the Hong Kong Monetary Authority (HKMA) have been actively shaping the regulatory environment through circulars, consultation papers, and legislative proposals. This article explores the latest regulatory developments in Hong Kong's virtual asset space.
Introduction
The licensing regime for Virtual Asset Service Providers (VASPs) came into effect on June 1, 2023. Since then, Hong Kong has continued to adapt its regulatory approach to keep pace with industry advancements. This article provides an overview of recent key updates, including guidelines on tokenized securities, virtual asset ETFs, and stablecoin regulations.
Tokenized Securities
Real-World Asset (RWA) tokenization gained significant traction in 2023, with growing interest in representing physical assets like gold, real estate, and financial instruments on blockchain networks. The Hong Kong government demonstrated its commitment to this innovation by issuing HK$800 million in tokenized green bonds in February 2023. The SFC acknowledges that tokenization can enhance efficiency, transparency, and cost-effectiveness in traditional finance but also introduces new risks.
In response to industry demand, the SFC issued two circulars on November 2, 2023: Circular to Intermediaries on Activities Related to Tokenized Securities and Circular on Tokenized SFC-authorized Investment Products.
Key Aspects of Tokenized Securities
Tokenized securities refer to traditional financial instruments (e.g., bonds or funds) that utilize distributed ledger technology (DLT) during their lifecycle. They are a subset of digital securities, which may include more complex or native digital structures without links to external assets.
Since tokenized securities are essentially traditional securities represented digitally, existing securities laws and regulations continue to apply. However, intermediaries must address new risks related to ownership recording and technology (e.g., forking, network disruptions, and cybersecurity).
Issuers of tokenized securities are responsible for the overall operation of the tokenization arrangement and should consider risk factors outlined in the circulars. Intermediaries engaging in activities like trading or advising on tokenized securities must conduct due diligence on issuers and third-party service providers.
The circulars clarify that tokenization itself does not make a product "complex." Thus, the mandatory "professional investors only" requirement for security token offerings, as stated in the SFC's 2019 declaration, no longer applies. However, non-tokenized digital securities may still be classified as complex products.
Requirements for Tokenized Investment Products
The circular on tokenized SFC-authorized investment products outlines requirements for public offerings in Hong Kong. Key points include:
- Tokenization Arrangements: Product providers must ensure reliable management and operation of the tokenization system, maintain accurate ownership records, and implement robust cybersecurity and business continuity plans. Public non-permissioned blockchain networks are discouraged without additional controls.
- Disclosure: Offering documents must clearly describe the tokenization process, ownership representation, and associated risks (e.g., cybersecurity, regulatory uncertainties).
- Intermediaries: Distributors must be regulated entities (e.g., SFC-licensed corporations or registered institutions) and comply with existing rules on client relationships and suitability.
- Expertise: Product providers must have at least one qualified staff member with relevant experience in managing tokenized arrangements.
👉 Explore regulatory frameworks for tokenized assets
Virtual Asset ETFs
The U.S. Securities and Exchange Commission (SEC) approved the first batch of spot Bitcoin ETFs on January 10, 2024, marking a milestone for the industry. Spot virtual asset ETFs offer traditional investors a convenient way to gain exposure to digital assets, with advantages in liquidity and security compared to direct holdings.
On December 22, 2023, the HKMA and SFC jointly issued an updated Joint Circular on Intermediaries’ Virtual Asset-Related Activities, indicating readiness to accept applications for spot virtual asset ETFs. The SFC also released the Circular on SFC-authorized Funds Investing in Virtual Assets, replacing its October 2022 circular and introducing new requirements for both futures and spot virtual asset ETFs.
Key Requirements for Virtual Asset ETFs
- Manager Qualifications: ETF managers must have a good compliance record, at least one staff member with virtual asset experience, and an upgraded Type 9 license.
- Underlying Assets: ETFs may only invest (directly or indirectly) in virtual assets tradable by retail users on licensed exchanges in Hong Kong.
- Investment Strategy: Leverage at the fund level is prohibited.
- Subscription and Redemption: Spot ETFs may allow in-cash or in-kind transactions. For in-kind transactions, virtual assets must be transferred through brokers with an upgraded Type 1 license.
- Custody: Virtual assets must be custodied with licensed exchanges or HKMA-recognized financial institutions. Most assets should be held in cold storage, with private keys stored in Hong Kong.
Stablecoin Regulatory Regime
Stablecoins, which are pegged to assets like fiat currencies or gold, play a critical role as a medium of exchange in crypto markets. Hong Kong has been proactive in developing a regulatory framework for stablecoins. Following a discussion paper issued by the HKMA in early 2023, the FSTB and HKMA jointly published a consultation paper on December 27, 2023, proposing a licensing regime for stablecoin issuers.
Highlights of the Proposed Stablecoin Regime
- Legislative Approach: The government plans to introduce new legislation specifically for stablecoins, rather than amending existing laws.
- Scope: The regime will apply to fiat-referenced stablecoins (FRS), which maintain a stable value relative to one or more fiat currencies. Exclusions include deposits, authorized collective investment schemes, and central bank digital currencies (CBDCs).
Licensing Requirements: Issuers of FRS linked to Hong Kong dollars or targeting the Hong Kong public must obtain a license. Key requirements include:
- Reserve assets must always cover the total face value of circulating FRS, with segregation from other assets.
- Issuers must enable timely redemption at face value without unreasonable fees or conditions.
- Issuers must be Hong Kong-based companies with local management and minimum paid-up capital of HK$25 million or 2% of circulating FRS value (whichever is higher).
- Distribution Restrictions: Only licensed virtual asset exchanges, licensed FRS issuers, SFC-licensed firms, and HKMA-recognized institutions may offer FRS to the public. Only licensed issuers' FRS can be sold to retail investors.
👉 Learn about stablecoin compliance best practices
Conclusion: A New Phase in Virtual Asset Regulation
Hong Kong's regulatory approach in 2023 reflected a commitment to the "same activity, same risk, same regulation" principle, with a technology-neutral stance. The year 2024 is poised to bring further developments, including the conclusion of the VASP transition period, stablecoin legislation consultation, and new proposals for regulating over-the-counter (OTC) trading services. The HKMA's planned sandbox for stablecoins will also provide a testing ground for innovation.
As the virtual asset industry continues to evolve, Hong Kong's adaptive regulatory framework aims to foster growth while ensuring investor protection and market integrity.
Frequently Asked Questions
What are tokenized securities?
Tokenized securities are traditional financial instruments, such as bonds or funds, that use distributed ledger technology to represent ownership. They combine the benefits of blockchain with the regulatory safeguards of existing securities laws.
Can retail investors trade virtual asset ETFs in Hong Kong?
Yes, provided the ETFs are authorized by the SFC and traded on licensed exchanges. Retail investors can access both futures and spot virtual asset ETFs, subject to suitability assessments and distribution rules.
How does Hong Kong regulate stablecoins?
Hong Kong is developing a dedicated licensing regime for fiat-referenced stablecoin issuers. The proposed rules focus on reserve backing, redemption rights, and issuer governance. Only licensed issuers can offer stablecoins to retail investors.
What is the status of the VASP licensing regime?
The VASP licensing regime took effect on June 1, 2023. Existing operators must submit applications by February 29, 2024, to qualify for transitional arrangements.
Are there any restrictions on blockchain networks for tokenized products?
The SFC discourages the use of public non-permissioned blockchains without additional controls. Product providers must ensure reliability, ownership record-keeping, and compliance with cybersecurity standards.
What are the custody requirements for virtual asset ETFs?
Assets must be held with licensed exchanges or HKMA-recognized institutions. Private keys must be stored in Hong Kong, with most assets kept in cold wallets for security.