The good news: the Hong Kong Securities and Futures Commission’s CEO, Ashley Alder, announced a path to license funds investing in digital assets, as well as their distribution.
He also announced that trading venues can be considered for the regulator’s sandbox, meaning there is the potential – and the intent – to regulate these as well.
For proponents of institutionalizing decentralized finance, this is welcome. Some exchanges and financial groups have been self-regulating, in the expectation that regulation will come to cryptoland, and that only the most robust businesses – those able to meet the compliance requirements of a traditional financial service – will survive.
This will bring much-needed transparency and accountability to digital-asset exchanges, many of which have inflated their stated volumes by making their own trades. Low-quality exchanges playing this game will have to leave Hong Kong or clean up their act.
Enabling a fund or a distributor to operate under SFC supervision will also lend those players credibility. Given the way the bubble market for bitcoin and other tokens has popped, and the ongoing stream of hacks and chicanery, serious players will want the trust that being regulated can provide.
The SFC’s move by itself may not have a major impact on institutional investors’ decision to enter crypto: that has more to do with practical issues such as custody and market demand.
There is a downside to Alder’s approach. Hong Kong’s Securities and Futures Ordinance makes it illegal to offer equity crowdfunding to retail or unaccredited investors. Changing the law – any law – is politically difficult. So the only crowdfunding businesses that operate in Hong Kong are those that only admit wealthy investors.
The same principle is now being applied to securities tokens. Anything deemed a security token falls under the SFO. Therefore funds dealing in securities tokens are subject to SFC regulation and require a Type 1 license, for securities dealing.
Tokens deemed utilities (or anything that’s not a security, such as a currency) remain out of the SFC’s remit. The SFC has no legal mandate or capacity to deal with these. Therefore such activities, while legal, will not be licensed or regulated.
The SFC’s objective is to protect consumers. It notes there have been lots of hacks and scams involving ICOs and crypto exchanges. Therefore it is drawing a line and protecting retail consumers by denying them the opportunity to invest in regulated crypto funds. This effectively leaves moms and pops to the wolves of the unregulated space, but the SFC won’t care because small investors won’t, at least, be getting fleeced in the securities world.
Although the SFC will point to the SFO and say its hands are tied, this approach is putting in place legal precedent and habit that says digital assets are only for rich people.
Maybe that’s no big deal today, while tokens remain fringe. But what about as the industry develops and we have securities-backed tokens, and tokens representing fractionalized units in real assets, such as buildings, or in intangibles such as intellectual property rights?
The potential for tokenization to vastly expand the supply of investible assets is vast. But for now, at least, the SFC is building a system whereby only rich people can avail themselves of this opportunity.
It is a sad irony that such walls are being built the week of the 10thanniversary of Satoshi Nakamoto’s white paper. Democratizing finance and making it fair are foundational motives behind that landmark achievement.
To be fair to the SFC and Alder, this could just be a stepping stone. Authorities can adjust the rules as the industry develops. Establishing licensed funds and distributors, and ultimately regulated exchanges, will help put the industry on a solid footing. It will also guarantee to some extent that the crypto industry remains in Hong Kong, creating jobs and paying taxes.
But it’s also important to maintain a story around financial inclusion and ensuring that everyone can participate in the benefits of innovation. It’s important to vocalize the need to update the SFO. Because if Hong Kong doesn’t do this, and a credible jurisdiction does lay out a path for retail to participate in a regulated environment, then the SFC may have also set the stage for the city’s role in digital assets to stagnate.