February 22, 2024

Hong Kong Establishes New Standards for Digital Asset Custody and Tokenization

The Hong Kong Monetary Authority (HKMA) has introduced guidelines for authorized institutions (AIs) regarding the custody and tokenization of digital assets.

In a proactive move to navigate the evolving landscape of digital finance, the Hong Kong Monetary Authority (HKMA) has released comprehensive guidelines aimed at authorized institutions (AIs) engaging in digital asset custody and tokenization. This initiative underscores the HKMA's dedication to aligning the practices of AIs with international standards, thereby fortifying the regulatory framework governing digital finance.

The guidelines, communicated through two letters addressed, delineate regulatory expectations and standards for participating in digital asset custody and tokenization activities. The first letter underscores the imperative of establishing robust governance frameworks and risk management practices for AIs involved in custodial services. It stresses the importance of ensuring that senior management and custodial staff possess the requisite knowledge, skills, and expertise to proficiently fulfill their responsibilities.

Included in the annex of the first letter are standards covering eight critical areas, encompassing governance, risk management, asset segregation, outsourcing, disclosure, and compliance with anti-money laundering and counter-financing of terrorism regulations. These guidelines are designed to be applicable regardless of whether AIs offer standalone custodial services or integrate them into broader financial activities. AIs are mandated to engage in dialogue with the HKMA prior to offering these services, demonstrating their adherence to the stipulated standards and requirements.

The second letter issued by the HKMA addresses the sale and distribution of tokenized products falling beyond the scope of the Securities and Futures Ordinance and thus not subject to the Securities and Futures Commission's requirements. This communication clarifies that existing supervisory requirements and consumer/investor protection measures applicable to traditional financial products also extend to their tokenized equivalents, given their similarity in terms, features, and associated risks.

However, the letter distinguishes stablecoins, which are subject to a separate licensing regime as per a consultation paper jointly released by the HKMA and other regulatory bodies in December. Additionally, the HKMA highlights that tokenization structures could alter the nature of assets, potentially transforming fractionalized interests in an asset into a collective investment scheme. The letter elaborates on the requisite due diligence, disclosure, risk management, and custodial services necessary for dealing with tokenized products, signaling the HKMA's supportive stance towards AI initiatives in tokenization while acknowledging the industry's advancements in this domain.

The recent directives from the HKMA underscore its proactive stance towards regulating the digital asset space, aiming to ensure the competitiveness of Hong Kong's financial institutions while upholding high standards of consumer protection and financial stability. By delineating these guidelines, the HKMA seeks to foster innovation within the financial sector, encouraging authorized institutions to explore the potential of digital assets and tokenization within a secure and regulated framework.

The emphasis on governance, risk management, and compliance with anti-money laundering measures underscores the HKMA's commitment to preserving the integrity of Hong Kong's financial system. As the digital asset market continues to evolve, these guidelines will play a pivotal role in shaping the practices of AIs, equipping them to navigate the complexities of this burgeoning sector.

The HKMA's initiative is poised to pave the way for further advancements in digital finance, offering authorized institutions a clear roadmap for integrating tokenization and digital asset custody into their service portfolios. As the industry progresses, adherence to these standards will be instrumental in fostering a secure, dependable, and innovative financial landscape in Hong Kong.

Hong Kong’s crypto market is not just thriving in a regulated environment; it’s also booming in terms of transaction volume. The region transacted an estimated $64 billion in crypto received between July 2022 and June 2023. The active over-the-counter (OTC) market significantly drives this market activity.

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