"Digitalization is blurring the boundaries of traditional industries. This is a real financial revolution." McKinsey described the digital wave in this way as early as 2017 in its "Competing in a World without Borders" report. As global acceptance of virtual assets increases, regulators are beginning to discuss their potential.
When tokens are viewed as financial instruments, security tokens become the focus of regulatory agencies around the world, including the Hong Kong Securities and Futures Commission (SFC). Security tokens are similar to traditional securities, so it is relatively easy for regulators to extend their regulatory scope to such tokens.
Security tokens refer to virtual assets that meet the definition of securities, whose value depends on the enterprise, project or asset associated with them, and which are traded among investors. Similar to traditional securities, security tokens may involve financial instruments such as equities, bonds, funds, etc. Regulators are generally concerned about the issuance, trading and investment activities of security tokens because they are inherently related to investment and investment returns.
Looking back at the "Policy Declaration on the Development of Virtual Assets in Hong Kong" issued by Hong Kong on October 31, which reiterated the potential and prospects of tokenization, 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 classified as a “complex” product definition, and it was mentioned that there may be a new version of the Security Token Offering (STO) regulations. In this process, it can be seen that SFC has a "run-up" attitude towards security tokens.
Financial institutions face high-speed, all-weather issuance and trading of security tokens. In addition to obtaining relevant licenses, relevant parties such as platform operators, dealers and brokers should also carry out internal monitoring and risk management measures, and focus on countermeasures. Money laundering and counter-terrorism financing (AML&CFT).
According to public information statistics, the total amount of global anti-money laundering fines last year was close to US$5 billion. Most penalties arise from poor implementation of identity verification and know-your-customer (KYC) solutions, or from inadequate internal policies and risk management systems. In December last year, the Hong Kong Legislative Council passed the "Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022" to complete the regulatory framework. This is the important step Hong Kong has taken in the Web3 field.
When transactions are on-chain, AML compliance also needs to be on-chain. According to the recommendations of the internationally recognized Financial Action Task Force (FATF), AML&CFT should focus on the adjustment of three aspects: customer identification and risk assessment, continuous monitoring and reporting, and control measures.
For the issuance stage of security tokens, virtual asset trading platforms, dealers, brokers, etc. will require transaction participants to provide KYC information, which is an off-chain information collection used for customer identification. This step is routine in traditional financial compliance. When investors provide their on-chain account addresses (wallets) and conduct transactions using on-chain assets, KYC should be extended to the chain to fully identify customers.
When security tokens can circulate freely and do not rely on intermediaries, KYA (Know Your Address) and KYT (Know Your Transaction) on the chain become particularly important. Different from traditional securities, which are mainly centralized structures, compliance transactions rely on KYC by layers of institutions.
As early as 2015, financial institutions such as Barclays Bank began to try to use on-chain compliant financial tools to identify risks and prevent AML & CFT risks. In addition, financial institutions, including fintech companies such as banks and payments, are investing in on-chain compliance tools. According to public information statistics, the largest round of investment reached US$60 million, and the valuation of the leading company in the field of on-chain compliance tools is even close to US$10 billion.
These on-chain compliance tools can identify high-risk transactions and suspicious activities by analyzing the transaction chain and the on-chain behavior of participants, and provide more automated and efficient compliance solutions. They take advantage of the characteristics of blockchain technology to extend KYC and AML&CFT measures to the chain, thus enhancing compliance and regulatory capabilities.
Ultimately, security tokens represent ownership rights, 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 a token. 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 using the digital form of its tokens to break the boundaries of the securities industry. Through features such as global accessibility, high liquidity, high security and transparency, and automation and intelligence, Continuously broaden the boundaries of the traditional securities industry. Leung Han-king, head of finance and fintech at Invest Hong Kong, 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.
Summarize
In short, combining traditional financial instruments with blockchain technology is an eternal topic in the global financial industry. At the same time, this has put forward new requirements for regulatory agencies in terms of their technical supervision capabilities, but this does not affect the introduction and positioning of global regulations on securitization tokens. At the same time, in the process of developing security tokens, it is also necessary to comply with the financial regulatory regulations and compliance requirements of various countries. This helps ensure the stable operation of the market, the legitimate rights and interests of investors, and the effective management of financial risks.