How Hong Kong can re-establish itself as a global digital assets hub

With the inclusion of retail investors in its new regulatory regime, Hong Kong is becoming known as a digital-asset-friendly jurisdiction
To become a true hub, it must continue to regulate effectively, recognise the specific tech requirements and include emerging retail and institutional use cases

Amy Zhang

Published: 4:15pm, 29 May 2023

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The recent announcement by the Hong Kong Securities and Futures Commission (SFC) that individual investors can from June 1 buy and sell digital assets – such as bitcoin or ethereum – has shifted the spotlight back on the city. While regulators around the world are clamping down on digital assets, Hong Kong seeks to re-establish its position as a global financial hub for digital asset innovation.

But it is not just digital asset companies that will be supported by this new regulatory regime – financial institutions and corporations are beginning to produce distributed-ledger technology to increase efficiencies, reduce costs and offer new services to clients. This regime might just be the catalyst to spur further innovation in Hong Kong and drive the adoption of digital assets.

With the oversight of the SFC, the Hong Kong Monetary Authority and the new regulatory guidance, financial institutions will have more incentive to explore the incorporation of blockchain technology, including tokenising traditional assets and offering digital asset trading using secure and flexible wallet technology.

Tokenisation – a digital representation of a traditional asset that can be stored, transferred and settled over blockchain – allows for a common platform for traditional and digital assets to interact. This next phase in the evolution of digitisation will drive down transaction processing times, improve end-to-end transparency and attract a larger investor base.

Tokenisation is being used across multiple asset classes, including commodities, debt securities, equity securities and real estate.

In February, the Hong Kong government issued HK$800 million (US$102 million) of tokenised green bonds – the first to be issued by a government globally. In this case, tokenisation creates greater efficiencies in the bond life cycle by digitising coupon payments, settlement of secondary trading and maturity redemption, allowing the government to sell these bonds with ease.

A mural featuring the bitcoin logo in seen in Hong Kong on December 21, 2022. From June 1, individual investors can buy and sell digital assets such as bitcoin and ethereum. Photo: Bloomberg

Late last year, Singapore’s Monetary Authority completed its first tokenisation industry pilot under “Project Guardian”, where foreign exchange and government bond transactions were executed against liquidity pools comprising tokenised Singapore government securities bonds, Japanese government bonds, the yen and Singapore dollar.

Two more industry pilot projects are set to be conducted for trade finance and wealth management by some of Singapore’s biggest banks, including Standard Chartered, HSBC and United Overseas Bank, showcasing the government’s belief in the potential of distributed-ledger technology to transform capital markets.

Hong Kong’s multifaceted regulatory licensing structure, led, managed and supervised by the SFC, allows for the safe operation of digital asset exchanges in Hong Kong through principle- or rules-based guidelines. These licensing requirements give institutional and retail investors confidence that they are engaging with mature and regulated operators.

With the virtual-asset trading platform licence, Hong Kong has created regulatory clarity for digital asset exchanges to operate inclusive of retail investors, rather than imposing a blanket ban. The new licensing rules require retail digital asset exchanges to implement enhanced protective measures around their trading and custody operations. This includes onboarding steps that assess users’ risk profiles, strict token due diligence criteria, and robust operational governance controls that mitigate against internal fraud and protect against external attacks.

With the virtual-asset trading platform licence, Hong Kong has created regulatory clarity for digital asset exchanges. Photo: Shutterstock

Furthermore, it is encouraging to see that the SFC recognises the importance of the safe custody of clients’ virtual assets and requires that virtual-asset trading platforms have a direct regulatory handle over the companies exercising control of clients’ virtual assets.

Between July 2021 and July 2022, the digital asset trading volume in Singapore was just over US$100 billion, compared with US$74 billion in Hong Kong. But the tide could turn in favour of Hong Kong, especially as new entrants decide to operate under the new licensing regime and explore new use cases within digital assets.

Additionally, Hong Kong is urging banks to provide critical services to licensed digital asset companies, further easing digital asset business operations and establishing its position as a digital-asset-friendly jurisdiction.

Further progress should be expected with the development of Hong Kong’s central bank digital currency – the e-HKD saw its pilot programme launch earlier this month – stablecoin, asset property rights and non-financial tokenisation in the coming months.

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To become a true digital assets hub, Hong Kong needs to effectively regulate these assets, recognise the technological requirements that differentiate digital assets from traditional assets, and it must be inclusive of emerging retail and institutional use cases.

It also needs to think beyond the buying and selling of digital assets, and consider how to manage the risks arising from decentralised finance. For an instructive model, Hong Kong should turn towards the Middle East, specifically the Abu Dhabi Global Market’s Registration Authority, which has proposed a legal framework for distributed-ledger technology, targeting disclosures, liquidation and governance structures.

Finally, the SFC needs to urge Hong Kong’s digital asset operators to use enterprise-grade technology, such as multiparty computation (MPC) custody solutions. MPC mitigates the risk involved with storing private keys and other sensitive data in one location, enabling stronger governance processes within organisations, ensuring the right level of operational oversight and risk mitigation.

Furthermore, infrastructure that guards against operational errors and internal fraud will be critical as these operators scale up their teams and increase their transaction workflows.

It might take a while to achieve harmonisation and a globally coordinated regulatory approach but, for now, Hong Kong has the opportunity to drive regulatory clarity that balances both innovation and consumer protection.

Amy Zhang is vice-president of Asia-Pacific sales at digital asset platform Fireblocks