In our previous blog, we discussed the Hong Kong Securities and Futures Commission (SFC)’s position on the taxonomy of tokenized securities and digital securities, and whether tokenized securities will be regarded as “complex products”. In this blog, we explore the guidance set forth in the SFC’s circular on intermediaries engaging in tokenized securities-related activities (the Circular).

Responsibilities of Intermediaries

Intermediaries engaging in tokenized securities-related activities, such as (i) issuance of tokenized securities, or (ii) dealing in, advising on, or managing portfolios investing in tokenized securities, are expected to fulfill a number of regulatory expectations.

Generally speaking, these intermediaries should (i) have sufficient manpower and expertise to understand the nature of tokenized securities businesses and manage new risks arising therefrom appropriately, (ii) act with due skill, care and diligence and perform due diligence on the tokenized securities (e.g. on the underlying products being tokenized and tokenization technology used) and (iii) provide clients with material information on tokenized securities including risks of tokenized securities and the tokenization arrangement, among others.

Intermediaries engaged in the issuance of tokenized securities are expected to (i) remain responsible for the overall operation of the tokenization arrangement, notwithstanding any outsourcing, (ii) perform a holistic risk assessment of all relevant technical and other factors on tokenized securities and (iii) select the most appropriate custodial arrangement for the tokenized securities to manage ownership and technology risks.

Intermediaries dealing in, advising on, or managing portfolios investing in tokenized securities are expected to (i) conduct due diligence on the issuer, third-party vendors or service providers and the tokenization arrangement and (ii) understand and be satisfied with the risk management controls implemented by the issuer, third-party vendors or service providers.

In view of new risks from tokenization, intermediaries should have the ability to manage ownership risks (e.g. transfer or recording of ownership interests) and technological risks (e.g. forking, blockchain network outages and cybersecurity risks).

Offerings to Retail Investors

Acknowledging that tokenized securities are fundamentally traditional securities with a tokenization wrapper, the SFC removed the blanket professional investor (PI)-only restriction.

However, intermediaries should be aware that the requirements of the prospectus regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance and the offers of investments regime under Part IV of the Securities and Futures Ordinance (SFO) would still apply to the offering of tokenized securities to retail investors in Hong Kong. This means any offer of tokenized securities that is not authorized under Part IV of the SFO or has not complied with the prospectus regime can be made only to PIs or pursuant to any other applicable exemption.

Conclusion

Interested intermediaries are reminded to notify and discuss tokenization-related business plans with the SFC in advance.

Looking ahead, it seems that the SFC may continue to prioritize to provide regulatory certainty and customer protections on tokenized securities. Intermediaries should closely monitor related developments to look for more opportunities as well as continuous compliance.