Hong Kong Fintech Week drew to a close on Friday 11 November with the Hong Kong Monetary Authority (HKMA) hosting its Fintech Day, an all-day event comprising panel discussions and presentations on the state of Fintech in Hong Kong, with a particular focus on the banking industry. The event kicked-off with a speech by Norman Chan, the Chief Executive of the HKMA, who announced the publication by the Hong Kong Applied Science and Technology Research Institute (ASTRI) of a whitepaper presenting ASTRI’s initial research findings of the application of distributed ledger technology (DLT) to financial services in Hong Kong.

The whitepaper was commissioned by the HKMA and, while the HKMA welcomes the potential applications of blockchain in the financial services industry, the white paper is relatively conservative in its initial findings, emphasizing that many legal, regulatory and other issues need to be considered and assessed before there can be widespread adoption and acceptance of the technology.

Howard Lee, a Senior Executive Director at the HKMA, identified the following regulatory issues that have been identified in relation to DLT:

  • the ability of regulators to keep up with the rapid developments of DLT;

  • some DLT models may involve activities or participants outside the financial services regulatory perimeter, thereby limiting the ability of regulators to respond to regulatory issues;

  • the need for collaboration between multiple regulators in relation to cross-border DLT models;

  • the possibility of regulatory arbitrage arising from inconsistent regulatory requirements across jurisdictions; and

    ensuring that customers are adequately protected.

Mr. Lee also drew attention to a series of legal issues relating to the use of DLT in financial services, including the following:

  • cross-border DLT models without a single entity responsible for their operation require guidance on the applicable laws, cross-border data flow, enforceability, liability and dispute resolution mechanisms;

  • difficulty in identifying the point of finality in DLT for payment and settlement of financial transactions, which would be crucial in an enforcement context and also in relation to taking and enforcing security interests over the relevant assets;

  • the legal status of digital assets and documents (e.g., smart contracts);

  • the potential for DLT to be used for financial crime such as money laundering, the sale of illegal goods and ransomware payments; and

  • data privacy issues, such as potential data leakage in a decentralized environment, disclosure of personal data to unauthorized participants, data mining by nodes on separate databases, and data retention (given the perpetual nature of DLT).

Having identified the above regulatory and legal issues, Mr Lee called upon regulators and the legal profession to assist the HKMA by providing legal guidance and opinions on the applications of DLT to the banking industry; reviewing DLT models and smart contracts (to the level of computer code in some cases); increasing resources to handle the increasing demand of DLT implementation; and collaborating across jurisdictions in respect of cross-border DLT models.

Overall, the HKMA’s preliminary view is that further studies of DLT and its applications to the financial services industry are required before the HKMA considers issuing formal guidance in relation to the use of DLT within the banking sector. Consistent with this approach, ASTRI is continuing its research into DLT and a second whitepaper is expected in the second half of 2017. In the panel discussion following Mr. Lee’s presentation of the whitepaper, panelists identified several areas where the application of DLT would be particularly valuable: (i) know-your-customer (KYC) processes; (ii) payments; (iii) clearing; (iv) trade financing; and mortgage applications.

Indeed, Bank of China (Hong Kong) Limited (BOCHK) and ASTRI presented a live demonstration of a DLT solution in the context of property valuation. Typically, when a property purchaser applies for a mortgage from a bank, the bank requires a valuation report from a surveyor, which acts as a safeguard for the bank in the situation that the mortgage is unpaid and recovery of the property’s value is required. Under a DLT system, the surveyor uploads the valuation report to the distributed ledgers. A network node generates a full report hash value and stores the most significant information such as address and price on the distributed ledgers. The bank retrieves the information from the network and uses the hash value to verify the report, a more efficient process which potentially obliterates the need for surveyors to value the same property repetitively and substantially removes the related back-office paperwork that is required.

We eagerly await the second whitepaper, which will cover the regulatory implications of DLT and the general control principles for DLT for the banking and payments industry.