Tokenised Securities and Digital Bonds in Hong Kong: The Regulatory and Legal Framework

Introduction

The tokenisation of securities — the representation of traditional financial instruments such as bonds, equities, and fund interests as digital tokens on a distributed ledger — has moved from theoretical concept to commercial reality with remarkable speed. Major financial institutions, sovereign wealth funds, multilateral development banks, and technology companies have now issued tokenised securities in multiple jurisdictions, and the volume and variety of tokenised issuances continues to grow.

Hong Kong has positioned itself at the forefront of this development. The Hong Kong government issued the world's first government green bond using distributed ledger technology in February 2023, demonstrating its commitment to digital securities at the highest level. The Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) have issued detailed guidance on the regulatory treatment of tokenised securities, and the government has launched a range of initiatives to support the development of Hong Kong's digital securities ecosystem.

For legal practitioners, issuers, investors, and market infrastructure providers, understanding the regulatory and legal framework for tokenised securities in Hong Kong is essential to participating in this rapidly developing market. This article examines the key features of that framework, with particular focus on the SFC's regulatory approach, the specific legal considerations applicable to tokenised bonds, the infrastructure requirements for issuance and trading, and Hong Kong's broader digital securities strategy.

What are Tokenised Securities?

Tokenised securities are digital representations of traditional financial instruments, issued and recorded on a distributed ledger (blockchain) rather than through conventional paper-based or centralised electronic record-keeping systems. The token serves as the primary record of ownership, and transfers of ownership are recorded on the blockchain rather than in a central securities register or through a traditional clearing and settlement system.

Key characteristics of tokenised securities include the use of smart contracts to automate certain functions (such as interest payments, dividend distributions, and corporate actions), the potential for near-instantaneous settlement (compared to the T+2 or T+3 settlement cycles of conventional securities markets), enhanced transparency through the use of a shared ledger, and the possibility of fractional ownership, which can lower the minimum investment threshold and broaden investor access.

Tokenised securities should be distinguished from native digital assets (such as Bitcoin or Ether), which are not representations of traditional financial instruments but are themselves the underlying asset. The regulatory treatment of native digital assets differs significantly from that of tokenised securities, which are subject to the same regulatory framework as their conventional equivalents.

Regulatory Framework: The SFC's Approach

The SFC has adopted a technology-neutral regulatory approach to tokenised securities, which means that it applies the same regulatory requirements to tokenised securities as to their conventional equivalents. A tokenised share is regulated as a share; a tokenised bond is regulated as a bond; a tokenised fund is regulated as a collective investment scheme. The method of recording and transferring ownership — whether on a blockchain or in a centralised register — does not change the fundamental regulatory characterisation of the instrument.

SFC Circular on Tokenisation of SFC-Authorised Investment Products

In November 2023, the SFC issued a circular on the tokenisation of SFC-authorised investment products, setting out its approach to authorising retail investment products that incorporate distributed ledger technology. The circular established that the SFC would consider applications for authorisation of tokenised products on a case-by-case basis, subject to additional requirements designed to address the specific risks of distributed ledger-based issuance, including requirements relating to the technology provider, the integrity of the smart contract, and investor disclosures.

HKMA Guidance on Tokenised Products

The HKMA has also issued guidance on tokenised products for the banking sector, addressing the treatment of tokenised deposits, tokenised money market funds, and other tokenised instruments held by banks. The HKMA's guidance emphasises the need for robust technology risk management, sound legal frameworks for establishing ownership and enforceability of tokenised instruments, and appropriate controls on access to and management of the distributed ledger.

Project Evergreen and the Government Digital Green Bond

The Hong Kong government's issuance of a tokenised green bond under Project Evergreen (Phase 2) in 2023 was a significant milestone in the development of the tokenised securities market. The bond was issued using a purpose-built platform developed by the Central Moneymarkets Unit of the HKMA, and settlement was conducted in real time using tokenised cash. The transaction demonstrated that tokenised securities issuance is technically and legally feasible in Hong Kong and provided a template for future government and private sector issuances.

Legal Considerations in Tokenised Securities Issuance

Legal Nature and Enforceability

A fundamental legal question in any tokenised securities issuance is whether the token constitutes the security itself or merely a representation of an underlying security recorded in a conventional register. This distinction has important implications for the enforceability of the holder's rights, the priority of competing claims, and the effectiveness of security interests taken over tokenised instruments.

Hong Kong law does not have specific legislation addressing the legal status of tokenised securities. In the absence of such legislation, the legal framework applicable to tokenised securities is constructed from existing principles of property law, trust law, and contract law. The Law Reform Commission of Hong Kong has considered these issues, and the HKMA's Project Evergreen legal work has addressed specific aspects of the legal framework for tokenised bonds. However, there remains legal uncertainty in some areas, and issuers should obtain specific legal advice on the structure of their issuance to ensure that token holders' rights are clearly established and enforceable.

Custody and Safekeeping

The custody of tokenised securities requires careful attention to the management of private keys — the cryptographic credentials that confer the ability to transfer tokens on the blockchain. An institution holding tokenised securities on behalf of clients must have robust procedures for the secure generation, storage, and management of private keys, and must address the risk of loss or compromise of private keys. The SFC has issued guidance on the custody of tokenised securities by licensed intermediaries, emphasising the importance of technology risk management and investor protection measures.

Smart Contract Risk

Where a tokenised security incorporates a smart contract to automate payment, transfer, or corporate action functions, the legal and operational risks associated with the smart contract must be carefully considered. Smart contract code may contain bugs or vulnerabilities that cause unintended outcomes; the interaction between smart contract logic and off-chain legal obligations must be clearly defined; and the procedures for amending or upgrading the smart contract must be governed by appropriate legal documentation. Issuers and their counsel should ensure that the legal documentation for a tokenised securities issuance clearly specifies the relationship between the on-chain smart contract and the off-chain legal terms.

Secondary Market Trading

Tokenised securities may be traded on licensed exchanges or over the counter. Where a tokenised security is listed on a recognised exchange, the trading, clearing, and settlement of the security must comply with the applicable exchange rules and the regulations governing central clearing and settlement in Hong Kong. The potential for peer-to-peer transfer of tokenised securities outside of regulated market infrastructure raises regulatory questions that the SFC and HKMA continue to address.

Tokenised Bonds: Specific Considerations

Tokenised bonds have emerged as the most commercially active segment of the tokenised securities market in Hong Kong. The legal documentation for a tokenised bond issuance typically includes a trust deed or fiscal agency agreement (which establishes the issuer's obligations to bondholders), the terms and conditions of the bonds (which define the economic rights and obligations), a subscription agreement (governing the initial issuance), and technology-specific documentation addressing the platform, smart contract, and custodial arrangements.

Key legal considerations specific to tokenised bonds include the definition of the register of bondholders (which may be maintained on-chain, off-chain, or through a hybrid arrangement), the procedures for making payments of principal and interest (which must address both the on-chain and off-chain mechanics), the rights of bondholders to call meetings and pass resolutions, and the remedies available on default.

Hong Kong's Digital Securities Strategy

The Hong Kong government and regulators have articulated a clear strategic commitment to developing Hong Kong as a global hub for digital securities. Key elements of this strategy include the development of a regulated digital securities exchange, continued government tokenised bond issuances to build market confidence and establish best practices, targeted regulatory guidance to provide legal certainty for market participants, and collaboration with international standard-setting bodies to promote consistent global regulatory approaches.

The Grant Matching Scheme for Tokenisation launched by the HKMA provides financial support for pilot tokenisation projects by financial institutions, further stimulating market development. These initiatives, combined with Hong Kong's existing strengths as an international financial centre, position it well to attract tokenised securities issuances and to build a vibrant secondary market in digital securities.

Conclusion

Tokenised securities and digital bonds represent a significant evolution in the structure of financial markets, with the potential to deliver efficiency gains, improved transparency, and broader investor access. Hong Kong has moved deliberately and strategically to position itself as a leading jurisdiction for tokenised securities, combining clear regulatory guidance, practical market development initiatives, and a supportive legal environment.

For issuers, investors, and market participants considering tokenised securities transactions in Hong Kong, the combination of a technology-neutral regulatory framework, an active and experienced legal community, and strong government support makes Hong Kong an attractive jurisdiction. Legal counsel with expertise in both traditional capital markets and digital assets is essential to navigating the specific legal considerations that tokenised issuances present.