HKMA Sets Standards for Digital Asset Custody Providers

Hong Kong Monetary Authority (HKMA) have introduced comprehensive regulations for the sale and distribution of tokenized financial products.

For the sale and distribution of tokenized financial products by approved institutions, the Hong Kong Monetary Authority (HKMA) set full regulatory criteria on February 20.

Within the rapidly growing subject of tokenization—the process of digitally representing real-world assets (RWA) using distributed ledger technology or comparable systems—the effort seeks to encourage innovation while guaranteeing strong consumer protection.

This new legal framework is defined in the recommendations, with the explicit exception of tokenized goods that are already governed by the Securities and Futures Ordinance or by particular regulations issued by the Securities and Futures Commission (SFC) or the Hong Kong Monetary Authority (HKMA).

The swift development and implementation of tokenization technology in the banking industry prompted the change. In recent months, Hong Kong has shown a marked shift toward accepting Web3 technology and is now intent on establishing thorough regulations for the industry.

Current regulations should be implemented
Tokenized products should be subject to the same regulations and safeguards as traditional financial products because of the similarities in their terms, features, and dangers, as laid out in the regulatory notice.

The Securities and Futures Ordinance does not apply to structured investment products or tokenized precious metals, but this notice specifically states that stablecoins are not covered.

Before authorized institutions can offer tokenized products to customers, the HKMA requires them to conduct extensive due diligence to verify they conform to these criteria. That means being familiar with the product’s characteristics, hazards, and nature, and doing your best to adjust to new information as it becomes available.

Tokenization involves issuers and third-party service providers; institutions must investigate these parties thoroughly to determine their level of expertise, past performance, and any risks connected with the tokenization arrangements.

Risk management and disclosures
Financial institutions have a duty to their customers to protect their interests by being transparent about the features, hazards, and important terms of tokenized products.

Legal ambiguity surrounds the ownership and finality of transactions on DLT networks, and there are hazards related to the underlying DLT networks themselves, as well as possible security threats like hacking.

Among the many important topics covered by the HKMA is risk management. For the purpose of identifying and mitigating risks associated with the sale and distribution of tokenized products, authorized institutions must set up sufficient rules, methods, systems, and controls.

Included in this is a thorough framework for managing risks, which addresses policies, controls, complaints, compliance, auditing, and business continuity.

Tokenized product custody providers, meanwhile, need to be trustworthy and safe by meeting the HKMA’s requirements for digital asset custody.