Billion-level business opportunities: an in-depth analysis of the prospect of "Security Tokens" in Hong Kong

Produced｜Okey Cloud Chain Research Institute

作宇｜Hedy Bi

"Digitalization is blurring the boundaries of traditional industries, which is a real financial revolution."

As early as 2017, McKinsey described the digital wave in its "Competing in a Borderless World" report. As global acceptance of virtual assets grows, the potential behind them has sparked discussions among regulators. **When tokens are considered financial instruments, security tokens have become the focus of regulators in various countries, including Hong Kong's Securities and Futures Commission (SFC). **

Since the beginning of this year, Okey Cloud Chain Research Institute has participated in the Hong Kong government's suggestion on the virtual asset platform and continued to conduct in-depth exchanges with all walks of life in Hong Kong.

Looking back at Hong Kong's "Policy Declaration on the Development of Virtual Assets in Hong Kong" released on October 31, it reiterated the potential and prospects of tokenization. In addition, just last month, Huang Lexin, head of the financial technology department of Hong Kong SFC, said that security tokens and Real World Assets (RWA) will no longer be included in the “complex” product definition, mentioning that there may be a new version of Security Token Offering (STO) regulations.

**The issuance and trading of financial assets are usually subject to strict supervision, among which securities are the most representative. **Security tokens are similar to traditional securities, so exploring the regulation of security tokens is one of the types of tokens that regulators can most easily expand the scope of supervision.

Hong Kong regulation is running up

The author believes that SFC has a "run-up" attitude towards security tokens. The specific points are as follows:

1. 1+7** license plate**

**Hong Kong regulators have different requirements for licenses depending on whether the trading services provided are security tokens or not, and the nature of the institution itself. **Specifically, virtual asset trading platforms that provide or actively promote security token trading services in Hong Kong need to obtain Type 1 regulated business (securities trading) and Type 7 regulated business ( Provide automated trading services) license. Platforms that provide non-security tokens also need to obtain a VASP license.

Any person or organization that promotes and distributes security tokens (whether in Hong Kong or to Hong Kong investors) is subject to Type 1 regulation under the SFO unless an applicable exemption is granted. Regulatory activities (dealing in securities) are licensed or registered.

2. Remove 12-month post-release track record requirement

Security tokens no longer require a 12-month post-issuance track record. However, licensed platform operators need to comply with the General Token Inclusion Guidelines under the "Guidelines for Virtual Asset Trading Platforms", as well as the Security Token Distribution Guidelines issued by the China Securities Regulatory Commission in due course in the future.

**3.**Reasonable Due Diligence

Platform operators are ultimately responsible for conducting reasonable due diligence on security tokens** proposed to be traded on the platform**. At the same time, platform operators also need to ensure that internal monitoring measures, systems, technologies, etc. can support any specific risks.

Transactions are on the chain, and compliance is also on the chain

When financial institutions are faced with the issuance and trading of such high-speed and round-the-clock financial instruments, in addition to the first step in their business development, relevant parties such as platform operators, dealers, and brokers should conduct self-internal monitoring and risk management measures, and put the most emphasis on anti-money laundering and counter-terrorism financing (AML&CFT). **

According to public information statistics, the total amount of anti-money laundering (AML) fines last year was nearly 5 billion US dollars. Most of the penalties are related to poorly implemented identity verification and Know Your Customer (KYC) solutions or inadequate internal policies and risk management systems. And in December last year, the Legislative Council passed the "Anti-Money Laundering and Terrorist Financing (Amendment) Bill 2022" to complete the regulatory framework, and only then did Hong Kong make great strides into Web3.

Source：Sumsub

**When the transaction is "on the chain", AML compliance also needs to be "on the chain". **According to the recommendations of the internationally recognized Financial Action Task Force (FATF), **AML&CFT focuses on customer identification and risk assessment, continuous monitoring and reporting, and control measures and needs to be adjusted accordingly .

Taking security tokens as an example, during the issuance stage, virtual asset trading platforms, dealers, brokers, etc. require transaction parties to provide KYC, which is an off-chain information collection for customer identification. This step is a routine measure in traditional financial compliance. When an investor provides an account address (wallet) on the chain and trades with his assets on the chain, KYC should also continue to be identified on the chain, as shown in the figure below It can be seen that the comprehensive identification of customer identity runs through the whole process.

Source: ResearchGate

When security tokens can circulate freely without relying on intermediaries, KYA** (Know Your Address, know your address, note 1) and KYT (Know Your Transaction, know your transaction) on the **chain , Note 2) becomes particularly important.

This is different from traditional securities. **Securities are based on a centralized structure, and the compliance of inter-institutional transactions is ensured by KYC at all levels of institutions. The most effective way for financial institutions is to use chain compliance tools such as OKLink, Chainalysis, Elliptic and other chain compliance tools to track customers' virtual asset movements on the chain, so as to conduct whole-process supervision and full-chain tracking, aiming at In the prevention of money laundering where accounts (addresses on the chain) are out of touch with real identities. **

The following figure will illustrate how financial institutions use on-chain compliance tools to carry out risk management and control throughout the life cycle, so as to achieve mutual cooperation between on-chain and off-chain:

Financial institutions like Barclays Bank of the United Kingdom have tried to use on-chain compliant financial tools to identify risks and prevent risks brought about by AML & CFT as early as 2015. Not only that, financial institutions including financial technology companies such as banks and payments have invested in on-chain compliance tools. According to public information statistics, the largest round of investment has reached 60 million US dollars, while on-chain compliance tools The valuation of leading companies on the track is also as high as nearly 10 billion US dollars.

"We have been cultivating on-chain data for many years, and our ultimate goal is to become an on-chain navigator in this intricate new digital world. With the continuous acceptance of virtual assets by the global and Hong Kong governments, OKLink's launch of Onchain AML will provide financial Institutions and participants provide reliable compliance guidance." Nick Xiao, product director of OKLink, said.

Security Tokens, New Representatives of Ownership

At the end of the day, security tokens represent ownership such as equity, real estate, etc. The biggest difference between them and securities is that each asset is built on the blockchain in the form of tokens (according to the latest IMF article, tokens are units formulated by entries in digital ledgers that use encryption technology) of. Similar to the securities market, the issuance and trading of security tokens need to comply with financial regulatory regulations and norms.

As a new representative of ownership, security tokens also mean that **Web3 is breaking the boundaries of the securities industry with the digital form of its tokens, through global accessibility, high liquidity, high security and transparency, and automation and intelligence. characteristics, constantly broadening the boundaries of the traditional securities industry. **Liang Hanjing, Director of Finance, Finance and Financial Technology of the Hong Kong Investment Promotion Agency, said in June this year that from the Hong Kong government level, asset tokenization (including security tokens) is regarded as a multi-trillion-level business opportunity.

Combining traditional financial tools with blockchain technology is an eternal topic in the global financial industry. At the same time, this has put forward new requirements for the technical regulatory capabilities of regulatory agencies, but this does not affect the introduction of global regulation of securitization tokens and its positioning. In addition to Hong Kong SFC, Okey Cloud Chain Research Institute sorted out the regulatory status of securities tokenization in major countries around the world, as shown in the table below.

The original nature of future business will not change. When the transaction is on the chain, this "trillion-level business opportunity" will be opened. Only after the compliance is ensured and it is included in the operation of the chain, is this the time when the mainstream truly recognizes a new technology.