Compliance Considerations for Asset Tokenization Projects

Recently, our team has received a large number of inquiries regarding asset tokenization projects. The underlying assets involved in these projects vary widely, ranging from agricultural products to real estate, from precious metals to some purely conceptual projects.

It is worth noting that under the current regulatory policies, apart from projects that are strictly reviewed and issued under regulation through the Hong Kong regulatory sandbox, other types of asset tokenization projects carry higher risks, especially those targeting residents of mainland China.

In order to help industry professionals better understand this field, we will provide a detailed explanation of which mainland assets can be used in the Hong Kong sandbox and which assets are not suitable for use. This not only facilitates more efficient business operations but also saves unnecessary consulting fees.

Basic Understanding and Judgment Criteria of Asset Tokenization in Mainland China

First, it is necessary to clarify that assets located in mainland China and primarily operated for mainland residents can be tokenized, which has been confirmed by previous successful cases.

However, there are indeed some restrictions on issuing mainland assets in the Hong Kong sandbox. Based on practical experience, the following three types of assets are not suitable for tokenization:

1. Assets that do not comply with the laws and regulations of the Hong Kong region.
2. Assets that do not comply with the laws and regulations of mainland China
3. The current stage is not suitable for the issuance of assets in Hong Kong.

Mainland assets issued in Hong Kong must comply with the "dual compliance principle"

Considering that the assets are on the mainland, but the tokenized assets are sold and operated in Hong Kong, the entire financing chain spans across both locations, thus it is necessary to adhere to the "dual compliance principle"—the underlying assets must be compliant both on the mainland and in Hong Kong.

Hong Kong Compliance

As a major region for asset tokenization and financial operations, Hong Kong requires special attention to the regulatory laws and regulations related to financial supervision that govern the requirements for underlying assets when issuing financial products, such as the Securities and Futures Ordinance, the Banking Ordinance, the Insurance Ordinance, and the Anti-Money Laundering and Counter-Terrorist Financing Ordinance.

Although Hong Kong has not yet issued clear normative legal documents regarding the issuance and regulation of asset tokenization and is still in the exploratory stage, understanding the consistent regulatory principles for financial assets in Hong Kong and referencing the specific issuance rules for similar financial products can greatly enhance the project's success rate.

Hong Kong adopts a "substantive regulatory principle" for financial assets, which means determining compliance based on the substance of the asset rather than its appearance. Specific regulations need to be assessed according to the regulatory rules applicable to the physical assets corresponding to the tokenization.

Mainland Compliance

Due to the underlying assets being located in the mainland, it is necessary to focus on the legality of the assets themselves as well as the legality of the operational methods.

The legitimacy of the asset itself can be judged by its circulation, which is divided into circulating objects, restricted circulation objects, and prohibited circulation objects. Assets suitable for tokenization should be "circulating objects" or "restricted circulation objects" that are permitted for circulation.

In terms of operations, due to Hong Kong's cash flow requirements for tokenization projects' underlying assets, the operation of the underlying assets must also comply with Chinese legal regulations, stay away from regulatory red lines, and obtain the necessary business licenses.

The current stage is not suitable for issuing assets in Hong Kong.

Although certain assets may comply with the "dual compliance principle", they may not be suitable for issuance in Hong Kong at this stage. The types of underlying assets currently recommended in Hong Kong are mainly those with "high-tech" or "clean and green" attributes.

In addition, some assets that are difficult to generate good cash flow, such as real estate with low economic value, are unlikely to change the reality of their gradually decreasing market value even through the new concept of "empowerment". The possibility of tokenization for such assets is very low.

Specific Types of Mainland Assets Not Suitable for Tokenization

Jewelry and Cultural Artifacts

Jewelry and cultural artifacts are a category with a large volume of inquiries but also the most difficult to provide clear legal opinions on. This is mainly because there are many types of jewelry and cultural artifacts, and the relevant regulations are scattered across various laws and regulations. Overall, it is currently not recommended to use jewelry and cultural artifacts as the underlying assets for tokenization.

The assets in the following situations are not suitable for tokenization:

1. Gem products with gambling nature
2. Processed jewelry and gemstones
3. Biopharmaceuticals banned by the country
4. Low-quality or processed jadeite or imitations
5. Precious metals such as pure gold and pure silver that are restricted or prohibited from circulation by the country.

Intellectual Property

Although there have not yet been successful cases of intellectual property tokenization in Hong Kong, we believe this is not an unexploitable direction. If a certain intellectual property truly has significant commercial value, it can be attempted to apply for tokenization after regulatory norms are clarified.

Agriculture and agricultural products

For agricultural and agricultural product projects, if they meet the standards of scientific and technological ethics review, have a high technological content and research value, and also possess good commercial prospects, they can attempt to apply after regulatory norms are clarified.

Pure Conceptual Project

It is important to clarify that asset tokenization is not crowdfunding. For purely conceptual projects, we usually give a direct veto.

Conclusion

It is worth mentioning that for underlying assets that are neither in the mainland nor in Hong Kong, can they be tokenized in Hong Kong? We believe that there are currently no strict regulations regarding the geographical location of assets. From the perspective of Hong Kong's positioning as an "international financial center," the geographical location of the assets should not be a hindrance; the key lies in whether the assets themselves are genuine, trustworthy, compliant, and have investment value.