Author | Leung Fung-yee, Chief Executive Officer of the Hong Kong Securities and Futures Commission
Original link:
https://www.sfc.hk/-/media/TC/files/COM/Speech/Chinese-Speech---CEO-at-Greenwich-Economic-Forum_4-Jun_final.pdf?rev=3084b27cc551423aa31db1a410f201d4&hash=A9C6C36339EC1E43ED997CB4FDEC92DD
Good afternoon, everyone. It is my honor to speak here today.
Here we are gathered together with elites from the financial industry, business, academia and public institutions from all over the world. I believe everyone will agree that technology is changing all aspects of life, and the financial market is no exception.
The smartphone is a great example of this - it is one of the greatest inventions of the 21st century, a small but versatile device that has become an indispensable part of our lives. Although we still call it a "phone", it is a camera, wallet, music player, video store, social media, e-book reader, and even keys.
Gone are the days when business people relied on fixed-line phones, fax machines, pagers, electronic notebooks, traditional mobile phones and BlackBerrys. Behind this digital revolution, many consumer brands that were once household names have been forgotten by the times or are undergoing a long transformation.
The lesson of history is that today’s innovators may soon become obsolete. If companies rest on their laurels, they may have to pay a heavy price, even industry leaders.
Leveraging the power of technology, focusing on distributed ledger technology (DLT)
Many financial elites are hotly discussing whether the changes brought by DLT to financial services will be as earth-shaking as consumer electronics. At present, DLT has been applied in global financial fields such as virtual assets and trade finance, and has achieved remarkable results. In terms of efficiently and securely transferring physical assets, DLT as the underlying technology is developing rapidly, which means that financial activities and transactions conducted on traditional infrastructure will be moved to the blockchain. But are we already at this turning point? Is delivering all financial services on the blockchain the future of finance?
DLT is applied to virtual assets in financial markets. If you ask central bankers and economists whether virtual assets such as Bitcoin and Ethereum have intrinsic value, most of them will deny it, and I do not disagree with their position. Although all parties are still arguing about the issue of intrinsic value, the fact is that Bitcoin has experienced many cycles of rise and fall in the past 15 years, which is enough to prove its viability as an alternative asset. What is more certain is that as the underlying technology of Bitcoin, DLT will stand the test of time.
The potential benefits of DLT are clear, as the technology can improve the efficiency of distribution, clearing, settlement and custody of physical assets while reducing costs. A wide chasm has emerged between areas such as non-fungible tokens (NFTs), the metaverse and physical assets. In the art industry, for example, digital artworks now available in the form of NFTs can be divided into multiple parts, which are more affordable, revolutionizing the ownership and transfer of artworks and making them more accessible to more people. On the other hand, Ethereum and stablecoins have become a medium of payment for buying and selling tokenized comic book images. A well-known example of NFT is Bored Ape Yacht Club (BAYC), which was a hit when it was launched in 2021, but its recent reserve price and trading volume have plummeted. Naturally, many people regard NFTs as speculative commodities.
The NFT craze may have faded, but the technology is increasingly being used in the physical asset world. Advocates have increasingly talked about how decentralized finance (DeFi) has breathed new life into physical assets in recent years. Physical assets are increasingly being tokenized, such as airline tickets, Andy Warhol works, art, collectibles, and even real estate. The potential benefits of tokenizing physical assets include:
· The first is financial inclusion, because physical assets can be divided into multiple parts, with lower barriers to entry, giving more investors the opportunity to share in the pie.
· Second, both parties to a transaction can enjoy greater transparency and privacy. To achieve this goal, financial institutions can use encryption technology to share ownership and transaction records in a confidential manner.
· The third is to improve settlement efficiency and reduce costs, and tokenization may indeed help achieve atomic settlement. In the trading and settlement process of securities, tokenization can reduce the number of counterparties, shorten confirmation and reconciliation time, and expand the scope of application of delivery-versus-payment arrangements at a lower cost.
· Fourth is transferability. For example, if you consider Claude Monet’s Water Lilies or Sunrise as alternative assets, why would a collector lend these paintings to a museum? Obviously, it is very expensive to store paintings at home for appreciation due to the high cost of insurance and home security systems. For investment and safekeeping purposes, Monet paintings can be stored in a secure place like an auction house warehouse through tokenization, and the tokens can be bought, sold, owned, and even used as collateral for loans.
In summary, tokenization can facilitate financial inclusion, asset fractionalization, custody arrangements, and ownership, all of which can occur on the blockchain.
Transfer traditional financial services and products to blockchain
The financial services sector can also benefit from the potential benefits and efficiency gains mentioned above. For example, the initial issuance, secondary market trading, custody and collateral of traditional assets such as bonds and money market funds can all be completed on the blockchain, which is our vision for the future of the financial industry. Although some markets are moving towards T+1 or even T+0 settlement cycles, most existing financial infrastructure and cross-border payment system processes still use T+2, so the blockchain model is particularly attractive.
Today, this is still a vision, and there is still a long way to go. First, the DLT ecosystem needs to be expanded, enhanced, and improved to support institutional-level financial services. This mainly involves blockchain interoperability across financial institutions and regions, as well as settlement finality, cross-border settlement, and legal conflicts. Blockchain interoperability is particularly important for the development of the third-generation Internet (Web3), which ideally should securely connect all blockchains.
Hong Kong is gradually building a Web3 ecosystem. Following the issuance of the world's first digital government green bonds last year, the SAR government continued its efforts in February this year and issued the second batch of bonds on a private blockchain. The initial issuance, transaction settlement, coupon payment and maturity redemption of the bonds were all carried out on a private blockchain. Supported by Hong Kong's legal and regulatory framework, the issuance of green bonds with a total value of HK$6.8 billion was very successful, attracting subscriptions from a wide range of institutional investors around the world.
The number of digital products on the market is increasing day by day. The Securities and Futures Commission (SFC) has previously approved the first tokenized investment product available for retail trading in Hong Kong. This gold token allows investors to purchase a portion of the ownership of physical gold, and the token is recorded on the issuing bank's internal private permissioned ledger using DLT. Each token represents 0.001 troy ounce of local London gold stored in the bank's vault. Although investors cannot trade in the secondary market, they can subscribe or redeem the token online at any time.
In order to promote the development of the exchange-traded fund (ETF) ecosystem in Hong Kong, the SFC has approved the first batch of virtual asset spot ETFs in Asia for retail investment. The six ETFs began trading at the end of April and have been trading in an orderly manner since then. As of May 31, the total market value of these ETFs reached US$301 million, and since listing, they have recorded a good average daily turnover of US$5.8 million.
Regulatory system promotes financial technology innovation
As a regulator, I often hear that “innovation and regulation are mutually exclusive”. In fact, the Commission firmly believes that these two forces should complement each other. One of the Commission’s strategic priorities for the next three years is to lead the transformation of financial markets through technology.
We maintain a technology-neutral stance and adopt the principle of "same business, same risks, same rules". Investor protection is a top priority for the Commission. As early as 2018, when the global regulatory environment for virtual assets was still unclear, we introduced a comprehensive policy response to virtual asset-related activities, focusing on investor protection, becoming one of the pioneers among major global financial regulators. We support tokenization and regard it as a digital tool for traditional financial products such as stocks, bonds and funds. In November last year, we issued a circular to clarify the Commission's expectations for virtual asset issuers and distributors, at least in line with the requirements for the securities industry.
In fact, the Commission has established additional safeguards to address the risks associated with emerging technologies, which is an area where regulators can provide clarity and consistency in supervision. We believe that the responsible use of innovative technologies will drive efficiency improvements in the financial industry and help Hong Kong build a sustainable Web3 ecosystem.
However, I would like to clarify that our support for the Hong Kong Web3 ecosystem does not mean an endorsement of the asset class of virtual assets. As things stand, virtual assets are obviously highly speculative and their prices fluctuate greatly. Therefore, we have ensured that extensive investor protection measures are in place while meeting investor needs. In terms of virtual asset spot ETFs, we require that the relevant virtual asset transactions must be conducted on virtual asset trading platforms licensed by the SFC, and the relevant virtual assets must be kept by these platforms or banks that meet the relevant standards. We also require fund management companies to warn investors of the risks. At the same time, we also remind investors to pay attention to the sharp fluctuations in this asset class.
Hong Kong’s Web3 ecosystem is taking shape
Hong Kong is gradually building a responsible and sustainable Web3 ecosystem. In June last year, the Commission's regulatory regime for central trading platforms came into effect. In view of the risks of fraud and money laundering in over-the-counter virtual asset trading, the Government had consulted the public on the licensing regime for over-the-counter service providers earlier this year. The measures will complement the work of creating a robust and transparent regulatory environment for virtual asset trading.
The scope of virtual asset regulation will also be further extended to stablecoins, and a new regime for regulating fiat stablecoins is being prepared. As we all know, stablecoins are generally issued by non-bank institutions and may be used for payment. Therefore, regulating the issuers of stablecoins will help protect their holders. The Hong Kong Monetary Authority (HKMA) recently completed a consultation on the proposed regime, which includes requiring issuers to ensure that stablecoins are fully backed by high-quality and highly liquid reserve assets.
In terms of products, the SFC has provided guidance on the recognition of tokenized investment products and the trading ethics of licensed companies, and the HKMA has also issued guidance on banks operating digital asset custody services. The next stage of tokenization is scale-up, an important part of which is the Ensemble project launched by the HKMA in March. The SFC is a member of the project's framework working group, which aims to work with the industry to support the development of Hong Kong's tokenization market.
This new wholesale central bank digital currency project will initially focus on tokenized deposits, which are digital forms of bank deposits issued by commercial banks that can be used to trade tokenized assets. The core work of the Ensemble project is to unify blockchain standards to achieve interoperability, which is key to promoting secondary market trading and staking activities. A sandbox related to the project will be launched to test tokenized use cases, covering the buying, selling and settlement of tokenized products such as green bonds and voluntary emission reductions.
Embracing the digital age
Finally, I believe that everyone here today will agree that technological innovation has brought about earth-shaking changes to the financial market. Will the provision of traditional financial services on traditional infrastructure be replaced by smart contracts and DLT one day? And when will it happen? These are still unknown. Market participants who are interested in trying should actively test relevant use cases, and our responsibility as regulators is to provide a clear, certain and consistent regulatory framework to promote the market to expand use cases in an environment that protects investors.
You may have heard: If you think technology is disruptive, then you may not be ready for big change. As I said at the beginning, the fall of those well-known consumer brands is a wake-up call, reminding us to keep up with the pace of the digital age, otherwise we may be eliminated by the innovation wheel of the era.
Promoting responsible innovation and building a fintech ecosystem is not a quick process, but we are all united in our efforts to prepare for the future of finance. If the financial market is to move to the next level, traditional finance and decentralized finance must work together, and as regulators, we are facilitating this integration. The future is now, and now is the critical moment to seize new opportunities.
Thank you all.
