Circular on tokenisation of SFC-authorised investment products

On November 2, 2023, the Securities and Futures Commission of Hong Kong (SFC) issued a circular addressed at all asset management firms engaged in the trading or distribution of investment products. The circular outlines the requirements under which the SFC would consider permitting the tokenization of investment products under Part IV of the Securities and Futures Ordinance for offering to the public in Hong Kong. The circular thereby addresses various issues ranging from the responsibilities of product providers and those of intermediaries, to disclosure requirements, to prior approval obligations.
According to the SFC, tokenization aims to digitize investment products and make them more efficient and cost-effective which is why the SFC has been assessing suggestions for tokenizing SFC-authorized investment products, both for primary dealing (subscription and redemption) and secondary trading on SFC-licensed virtual asset trading platforms (VATPs). Generally speaking, primary dealing of tokenized SFC-authorized investment products is allowed, provided all applicable product authorization requirements are met and additional safeguards are taken to reflect inherent risks in tokenization arrangements. When it comes to the secondary trading of tokenized investment products, a higher degree of caution and thoughtful deliberation is needed to ensure an investor protection level that closely aligns with that of traditional, non-tokenized products. Key factors to be mindful of encompass maintaining accurate and immediate records of token ownership, ensuring the readiness of trading infrastructure and market participants to facilitate liquidity, and establishing equitable pricing for the tokenized offerings.
The key requirements for primary dealing of tokenized SFC-authorized investment products are as follows:
– Product providers must ensure that the underlying products meet relevant rules and regulations, including eligibility, product structure, investment and operational requirements, disclosure, and ongoing compliance obligations.
– Product Providers are responsible for managing and maintaining ownership records of tokenization arrangements, ensuring operational compatibility with service providers, implementing cybersecurity measures, and not using „public-permissionless blockchain networks“ without additional controls.
– Product Providers also need to provide third-party audits and legal opinions upon the request of the SFC to ensure the soundness and integrity of the tokenization arrangement.
– Offering documents should contain information on the tokenization arrangement, ownership representation of tokens, and associated risks.
– Distributors of tokenized products should be regulated intermediaries and comply with existing rules and guidelines, including regulations governing product suitability and know-your-client.
– Product providers must have competent staff with relevant experience to manage the tokenization arrangement and new risks.
To conclude, the SFC notes that prior consultation with the SFC is required for new investment products with tokenization features. The tokenization of existing SFC-authorized investment products may also require prior approval.