CSRC Enters the Tokenized Fund Market Traditional Finance Steps into Hong Kong’s Web3 Innovation Era

CSRC Ventures into the Tokenized Fund Market Traditional Finance Embraces Hong Kong's Web3 Innovation Age

Author: Jason Jiang

Financial institutions of all kinds are showing increasing interest in the tokenization of traditional financial instruments.

According to Bloomberg on November 23rd, Harvest Global Investments is cooperating with Meta Lab to tokenize one of its fund products and has already notified the Hong Kong Securities Regulatory Authority. This is the first tokenized fund launched by Chinese financial institutions in Asia, and it is another important practice in the industry after the Hong Kong Securities and Futures Commission issued a letter on tokenization.

This article will analyze the tokenized fund launched by Harvest Global Investments from three perspectives: target audience, investment objects, and technical features, and will combine with the latest letter issued by the Hong Kong Securities and Futures Commission to analyze the regulatory trend of tokenized securities in Hong Kong.

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Is tokenized fund limited to professional investors?

The tokenized fund launched by Harvest Global Investments in cooperation with Meta Lab this time is for professional investors. “Limited to professional investors only and investing in mature financial products such as US bonds, the probability and efficiency of tokenized fund obtaining approval from the Securities and Futures Commission will be much higher,” said an informed person participating in tokenization practice.

Due to regulatory compliance restrictions, tokenized funds sold directly to retail investors are rare worldwide. Either they are offered for sale based on private chains or permissioned consortium chains within a specific scope. Even tokenized funds on public chains are mostly open to specific groups or professional investors through whitelist addresses. The tokenized fund launched by Harvest Global Investments is based on public chains and is only open to professional investors.

However, the letter “Intermediaries Dealing in Tokenized Securities Activities” issued by the Hong Kong Securities and Futures Commission in early November released a positive signal, that is, the issuance of tokenized securities is not limited to professional investors only. This means that under the premise of meeting regulatory requirements, Hong Kong is currently allowing the public sale of tokenized funds and other products to retail investors.

However, according to informed sources, due to factors such as investor protection and risk control, tokenized funds targeting retail investors will not appear in Hong Kong in the short term. Although tokenization can improve liquidity, this relies on sufficient market demand, effective price discovery mechanisms, and frequent trading. Currently, the market’s understanding of tokenization is not high, and token liquidity and market manipulation face challenges, so “many tokenized funds do not have a secondary market and it is difficult to be approved for trading on virtual asset trading platforms.”

In the long run, we believe that Hong Kong will still introduce tokenized funds targeting retail investors at the appropriate time. The important criterion for this timing is that intermediaries can effectively address the risks brought by tokenization, such as ownership, technical network security, and anti-money laundering, while meeting traditional securities regulation.

As the CEO of the Hong Kong Securities and Futures Commission, Ashley Alder, previously mentioned, “Using new technology definitely comes with new risks, so we must try to minimize those risks and have new tools to address them in order to enjoy the benefits that new technology brings to financial services.”

The Hong Kong Securities and Futures Commission has repeatedly emphasized the importance of blockchain analytics tools in the virtual asset space. In the process of regulating tokenized securities, compliance technology products such as blockchain analytics tools can also prove valuable: relevant institutions can quickly track on-chain addresses and transaction activities, and through analyzing transaction patterns, address connections, and fund flows, they can timely identify unusual transactions and identify potential risks, thus providing clues and decision support for regulatory agencies and tokenized service providers.

What are the investment objects of tokenized funds?

In the tokenized fund market, US bonds are one of the most common investment objects. The tokenized funds launched by CSOP International primarily invest in investment-grade US bonds.

US bonds are currently one of the fastest-growing areas in the global tokenized market, with a market size of over 770 million US dollars and expanding at a monthly growth rate of around 10%.However, under compliance conditions, whether it is traditional fund companies or DeFi protocols, they cannot directly tokenize US bonds. In most cases, they need to tokenize the fund shares or SPV (Special Purpose Vehicle) debt tokens holding US bonds to bring the income of US bonds into the blockchain. Franklin Templeton, Superstate, WisdomTree, and Ondo Finance are all tokenizing US bonds through fund shares.

According to public information, it is currently unclear whether CSOP International achieved tokenization through US bond fund shares or directly holding US bonds, and it is also unknown which aspects utilized DLT and related technologies. This is because, according to the circular, as long as a fund uses blockchain or other technologies in any stage of issuance, subscription, redemption, trading, transfer, settlement, etc., it falls into the category of tokenized funds and falls under the regulation of tokenized securities.

However, compared to traditional funds, the advantages of tokenized funds include:

(1) Simplifying the issuance and distribution process, changing the fund trading and settlement model, achieving 24/7 trading and atomic settlement;

(2) Providing lower operating costs, with the cost of Franklin’s tokenized funds reportedly only 1/10 of traditional funds’ costs.

(3) Increasing transparency, with fund transaction records and other key information recorded on the blockchain and difficult to tamper with, and available for relevant parties to access in a timely manner;

(4) Lowering the investment threshold and introducing more assets into the fund market and the Web3 world, such as US bonds.

“Penetration” technology, tokenization without changing the essence of funds

Looking at tokenized products through a “perspective” and breaking through technological barriers are key to promoting innovation in tokenized securities.

The Hong Kong Securities and Futures Commission pointed out that the essence of tokenized securities is traditional securities packaged in token form. Given this nature, the Hong Kong Securities and Futures Commission will regulate tokenized securities based on the underlying assets. The existing laws and regulations applicable to traditional securities and related activities also apply to tokenized securities.

This means that issuing tokenized funds in Hong Kong first needs to meet the regulatory requirements for traditional funds, and then meet additional requirements related to risk control, information disclosure, and investor protection specific to tokenization schemes based on the commission’s guidelines.

“One of the challenges in regulating virtual assets is the difficulty in defining their attributes, but the attributes of the underlying assets of tokenized products are relatively clear and can be regulated under the current legal framework. Therefore, the key to regulating tokenized securities lies in breaking through the ‘tokenization’ shell and discovering the essential characteristics of the underlying assets,” said a lawyer with years of compliance experience during a discussion with the European Blockchain Research Institute.

The European Blockchain Research Institute has also put forward a similar viewpoint: “For financial and regulatory institutions, the key to tokenization lies not in technology, but in the underlying assets.” This is partly because technology is not the barrier to tokenization at this stage; asset diversity is the key factor restricting its long-term development. It is also because how tokenized assets are operated and regulated ultimately depends on the types of underlying assets.

As the degree of tokenization of traditional financial instruments deepens, there will be a stronger demand in the market for compliance technology solutions such as blockchain analysis tools. As the European Blockchain Research Institute has repeatedly emphasized, in the Web3 era, it is not only important to put data and assets on the blockchain, but also to ensure compliance. Only with compliance can data and assets be securely and confidently put on the blockchain.

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