HKMA sets new guidelines for digital asset custody and tokenization

The Hong Kong Monetary Authority (HKMA) issued comprehensive guidelines on February 20, targeting the tokenization and custody of digital assets by authorized institutions (AIs). This development underscores HKMA’s commitment to aligning the operations of AIs with international standards and practices, ensuring a robust regulatory framework for the evolving landscape of digital finance.

Setting new standards for digital asset custody

The HKMA’s directive comes in two letters addressed to the heads of AIs, outlining the regulatory expectations and standards for engaging in digital asset custody and tokenization activities. The first letter emphasizes the importance of establishing a solid governance framework and risk management practices for AIs involved in the custody of customer assets. It highlights the necessity for senior management and staff responsible for custodial activities to possess adequate knowledge, skills, and expertise, ensuring they can fulfill their duties effectively.

The standards detailed in the annex of the letter cover eight critical areas, including governance and risk management, asset segregation, outsourcing, disclosure, and compliance with Anti-Money Laundering and Counter-Financing of Terrorism regulations. These guidelines are designed to apply regardless of whether the AIs offer standalone custodial services or integrate these services into other financial activities. AIs are required to engage in discussions with the HKMA before offering these services, demonstrating their compliance with the outlined standards and requirements.

HKMA guides on tokenized product distribution

The second letter issued by the HKMA addresses the sale and distribution of tokenized products that fall outside the purview of the Securities and Futures Ordinance and are 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 counterparts, given the similarity in terms, features, and associated risks.

However, the letter distinguishes stablecoins, slated for a separate licensing regime per a consultation paper released by the HKMA and other regulatory bodies in December. The HKMA also points out that the tokenization structure could alter the asset’s nature, with fractionalized interests in an asset potentially qualifying as a collective investment scheme. The letter elaborates on the due diligence, disclosure, risk management, and custodial services necessary for dealing with tokenized products, indicating the HKMA’s supportive stance towards AI initiatives in tokenization and acknowledging the industry’s progress in this area.

Implications for the financial industry

The HKMA’s recent directives clearly indicate its proactive approach to regulating the digital asset space, ensuring that Hong Kong’s financial institutions remain competitive while adhering to high standards of consumer protection and financial stability. By setting out these guidelines, the HKMA aims to foster innovation in 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 reflects the HKMA’s commitment to maintaining the integrity of Hong Kong’s financial system. As the digital asset market continues to evolve, these guidelines will play a crucial role in shaping the practices of AIs, ensuring they are well-equipped to navigate the complexities of this emerging sector.

The HKMA’s initiative is expected to pave the way for further developments in digital finance, with authorized institutions now having a clear roadmap for integrating tokenization and digital asset custody into their service offerings. As the industry moves forward, adherence to these standards will be instrumental in promoting a safe, reliable, and innovative financial landscape in Hong Kong.