Tokenised Securities in Hong Kong: SFC Regulatory Framework and Investment Opportunities

Introduction: The Emergence of Tokenised Securities

Tokenised securities — traditional financial instruments such as equities, bonds, and fund interests represented as digital tokens on a blockchain or distributed ledger — have attracted increasing attention from regulators, issuers, and investors worldwide. The technology offers potential benefits including increased efficiency in settlement, greater accessibility for retail and institutional investors, enhanced transparency, and the ability to fractionalise ownership of traditionally illiquid assets.

Hong Kong has positioned itself as a regional leader in the regulation of tokenised securities, with the Securities and Futures Commission (SFC) having issued extensive guidance on the applicable regulatory framework. This article examines the SFC's approach to tokenised securities, the regulatory requirements applicable to their issuance and trading, and the investment opportunities that tokenisation presents.

The SFC's Approach to Tokenised Securities

The SFC has consistently applied its technology-neutral regulatory approach to tokenised securities. A tokenised security is still a security for the purposes of the Securities and Futures Ordinance (SFO), regardless of the technology used to represent or transfer it. This means that all existing securities law obligations — including licensing requirements, prospectus requirements, market conduct rules, and short selling regulations — apply to tokenised securities in the same manner as to conventional securities.

The 2023 Circular on Tokenised Products

The SFC issued a significant circular on tokenised investment products in November 2023, which set out its expectations for SFC-authorised investment products that incorporate tokenisation technology. The circular addressed tokenised funds, tokenised bonds, and other tokenised collective investment schemes, providing guidance on the specific features and disclosures required for products using distributed ledger technology (DLT).

Key points of the 2023 circular included:

Permissible tokenisation approaches: The SFC distinguished between "full tokenisation" (where all interests in an investment product are represented as tokens) and "partial tokenisation" (where a conventional product has a tokenised class or series). Both approaches are permissible, subject to meeting the SFC's requirements.

Smart contract requirements: Tokenised products using smart contracts must ensure that the smart contracts have been audited by qualified independent parties, that the smart contract code accurately reflects the terms of the product, and that appropriate security measures are in place to protect against exploits.

Investor disclosures: Offering documents for tokenised products must include enhanced disclosures about the tokenisation technology used, the risks specific to DLT (including smart contract risk, key management risk, and cyber risk), and the process for exercising investor rights.

Safekeeping of tokenised assets: The SFC requires that the safekeeping of tokenised assets comply with the same standards as for conventional securities, with appropriate arrangements for private key management, access controls, and insurance.

Primary Issuance of Tokenised Securities

Prospectus Requirements

The primary issuance of tokenised securities to the public in Hong Kong is subject to the same prospectus requirements that apply to conventional securities under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (CWUMPO) and the SFO. Issuers must prepare and register a prospectus with the Companies Registry (for shares) or file a prospectus (for debentures), unless a statutory exemption applies.

For tokenised securities offered exclusively to professional investors (as defined in the SFO), the prospectus requirements do not apply, and a private placement memorandum or similar document may be used instead. Many tokenised security offerings have been structured as professional investor placements to take advantage of this flexibility.

Offering Structure

Tokenised securities offerings can take various forms, including initial token offerings (ITOs) that are structured as securities offerings, tokenised versions of traditional bond issuances, and tokenised interests in closed-ended or open-ended investment funds. The choice of offering structure affects the applicable regulatory requirements, the investor base that can be targeted, and the ongoing obligations of the issuer.

Green and Sustainability Bond Tokenisation

The Hong Kong government has led by example in tokenised bond issuance. In February 2023, the Government of Hong Kong SAR issued HKD 800 million of tokenised green bonds — the first tokenised government bond issued in Hong Kong — using Goldman Sachs' private tokenisation platform, GS DAP. A further tokenised green bond issuance of HKD 6 billion followed in February 2024, demonstrating the government's continued commitment to developing Hong Kong's tokenisation capabilities.

These government-led issuances have helped validate the technology and the regulatory framework, and have encouraged private sector issuers to explore tokenisation for their own bond and fund offerings.

Secondary Trading of Tokenised Securities

Recognised Stock Exchanges

The secondary trading of tokenised securities in Hong Kong can occur on SFC-authorised automated trading systems (ATS) or recognised stock exchanges. The Hong Kong Stock Exchange (HKEX) has been exploring the listing of tokenised securities, and HKEX's subsidiary HKEX Synapse is developing blockchain-based settlement infrastructure that could support tokenised asset trading.

Licensed Virtual Asset Trading Platforms

SFC-licensed virtual asset trading platforms (VATPs) that are licensed to trade securities tokens may facilitate the secondary trading of tokenised securities. However, only VATPs that have been specifically licensed to trade security tokens — in addition to non-security virtual assets — are permitted to offer tokenised securities trading services.

The licensing requirements for VATPs that wish to trade security tokens are demanding, and as of 2024, the number of licensed VATPs with authorisation to trade security tokens remains limited. The SFC has signalled its intention to streamline the authorisation process for tokenised securities trading as the market matures.

Tokenisation of Real-World Assets

Beyond traditional financial instruments, tokenisation is increasingly being applied to real-world assets (RWAs) such as real estate, infrastructure projects, art, and commodities. Tokenising RWAs can unlock liquidity in traditionally illiquid markets, facilitate fractional ownership, and enable new forms of asset-backed financing.

Real Estate Tokenisation

Tokenised real estate allows investors to acquire fractional interests in individual properties or property portfolios, potentially with lower minimum investment thresholds than traditional property investment. In Hong Kong, where property prices are among the highest in the world, tokenisation could democratise access to real estate investment. Regulatory considerations include the characterisation of the tokenised interests (which may be collective investment schemes), the property law implications of fractional ownership, and the stamp duty treatment of token transfers.

Infrastructure and Project Finance Tokenisation

Large infrastructure projects — power plants, transportation networks, data centres — can be financed through tokenised bonds or equity instruments that are distributed to a broad base of investors. Tokenisation can reduce the cost of capital for issuers by broadening the investor base, while providing investors with liquidity through secondary market trading.

Smart Contracts and Legal Enforceability

A central question in tokenised securities issuance is the legal relationship between the smart contract code that governs the token and the underlying legal documentation (such as a prospectus, indenture, or trust deed) that governs the investor's rights. In most Hong Kong tokenised securities issuances to date, the legal relationship has been structured so that the underlying legal documentation governs investor rights, with the smart contract serving as an operational mechanism for transfer and settlement rather than as the primary source of legal rights.

This approach avoids the complex legal questions that would arise if the smart contract were itself the governing document, but it requires careful coordination between the smart contract functionality and the underlying legal terms to ensure that they are consistent.

Custody and Private Key Management

The custody of tokenised securities requires specialised expertise in private key management. If the private key controlling a wallet holding tokenised securities is lost, the securities held in that wallet may become permanently inaccessible. Conversely, if the private key is compromised, an unauthorised party may be able to transfer the tokenised securities without the owner's consent.

Hong Kong's regulatory framework for custody of tokenised securities requires that licensed custodians implement appropriate key management systems, including multi-signature controls, hardware security modules, and offline storage for the bulk of private keys. Insurance arrangements covering loss of private keys and cyber incidents are increasingly expected by institutional investors in tokenised securities.

Future Developments

The SFC has indicated that it will continue to develop its regulatory framework for tokenised securities as the market evolves. Key areas for future regulatory development include the authorisation of additional VATPs for security token trading, the development of Hong Kong-based tokenisation infrastructure, and the establishment of standards for cross-border interoperability of tokenised securities.

The Hong Kong Monetary Authority (HKMA) has also been active in the tokenised securities space, particularly in relation to tokenised deposits and central bank digital currency (CBDC) initiatives that could facilitate the settlement of tokenised securities transactions.

Conclusion

Tokenised securities represent one of the most exciting developments in Hong Kong's financial markets. The SFC's thoughtful and detailed regulatory framework provides a solid foundation for the market to develop, while ensuring that investor protection standards are maintained. As the technology matures and the regulatory environment stabilises, Hong Kong is well positioned to become a leading centre for tokenised securities in the Asia-Pacific region.

Alan Wong LLP's digital assets team advises issuers, fund managers, and investors on all aspects of tokenised securities in Hong Kong, from regulatory structuring and SFC engagement to smart contract legal review and investor documentation. We combine deep expertise in securities law with a thorough understanding of the technology to provide practical, commercially focused advice.