On 27 December 2023, the Hong Kong Financial Services and the Treasury Bureau (FSTB) and the Hong Kong Monetary Authority (HKMA) jointly issued a consultation paper1 (the Consultation) proposing regulatory regime for fiat-referenced stablecoin (FRS)2 issuers in Hong Kong. The Consultation aims to establish licensing, supervision, and enforcement measures that align with global standards to effectively control the existing and potential risks linked to the development of stablecoins in Hong Kong. The HKMA plans to launch a "regulatory sandbox" for potential issuers to facilitate the observation of stablecoins at the regulatory level in a controlled environment and will shortly be announcing the details of the arrangement.
The Consultation, which closes to comments on 29 February 2024, seeks feedback from relevant market stakeholders to facilitate the effective implementation of the proposed regulatory framework for FRS.
The Consultation proposes the following key changes to implement a licensing regime for FRS issuers:
Licensing of FRS issuers
In Hong Kong, FRS issuers would need to be licensed by the HKMA, which include complying with the requirements relating to financial resources, type of stablecoin to be issued and the assets and mechanisms supporting the stablecoins' stability. Obtaining an FRS issuer license would be required when issuing an FRS in Hong Kong, issuing any FRS referencing the Hong Kong dollar (irrespective of location) or actively marketing3 FRS issuance to the Hong Kong public.
FRS issuers would need to be Hong Kong-based companies4 meeting financial requirements to maintain a stabilization mechanism, and comply with governance, risk management, and anti-money laundering and counter terrorist financing (AML/CFT) measures. All circulating stablecoins would need to be fully backed by reserves matching their par value, and reserve assets must be segregated and secured. In addition, disclosure and regular reporting would need to prerequisite5 for an HKMA license. Given the challenge of maintaining a strong stabilization mechanism without backing assets of inherent value, the Consultation emphasizes that issuers of FRS deriving their value from arbitrage or algorithm will not be licensed.
Restrictions on offering and marketing of FRS
In Hong Kong, only specific regulated entities would be able to offer6 FRS or actively promote them to the public. Advertising of FRS issuance by unlicensed entities and non-specified license entities offering FRS is prohibited. FRS would need to be licensed by the HKMA to be offered to retail investors. FRS not issued by licensed issuers could only be offered to professional investors. Entities offering such FRS would need to explicitly state that the FRS issuer is not licensed. HKMA-licensed FRS issuers would only be permitted to offer their own FRS. SFC-licensed corporations offering FRS would need to hold a Type 1 license (for securities dealing) and be permitted by the Securities and Futures Commission (SFC) to carry out dealing in virtual assets.
Some key features of the proposal set out in the Consultation to highlight:
AML/ CFT requirements
An FRS issuer will need to ensure that it has in place adequate and appropriate systems and controls to prevent money laundering and terrorist financing. The FRS issuer will need to ensure its AML/CFT measures comply with the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO), any measures promulgated by the HKMA standards whether in the form of rules, regulations, guidelines or otherwise, and Financial Action Task Force (FATF) guidelines. This would include but not be limited to adequate customer due diligence measures in relation to the FRS issuance and redemption, transaction monitoring and, the wire transfer (“travel rule”) requirement.
Risk management requirements
An FRS issuer will need to implement risk management frameworks, including data and system safety controls, fraud detection, technology risk measures, contingency plans for disruptions, and other safeguards suitable for its business. The FRS issuer will need to perform risk assessments on a sufficiently frequent basis (at least annually) to ensure the effectiveness of internal controls, risk management, and governance processes.
Proposed transitional arrangements for existing FRS issuers
The new licensing and regulatory regime for FRS issuers will start one month after the new legislation is gazetted. Existing FRS issuers with a significant presence in Hong Kong will be able to continue operations for six months following the start of the new regime, provided they apply for a license within three months of the legislation's commencement. The HKMA will assess the issuer's presence based on factors like incorporation, physical office, and FRS circulation. Issuers failing to apply within the timeframe must orderly close their FRS business by the fourth month post-commencement.
Conclusion
Hong Kong has established itself as a conducive regulatory hub for cryptocurrencies, reflecting the government's active approach in promoting financial innovation and reasserting importance of a risk-based regulatory approach through continuous regulatory updates. With a reliable regulatory environment, the growing influx of cryptocurrency-related firms in the region is anticipated to continue.
Footnotes
1) Legislative Proposal to Implement the Regulatory Regime for Stablecoin Issuers in Hong Kong.
2) The Consultation Paper provided definition of an FRS as “a cryptographically secured digital representation of value that, among other features, purports to maintain a stable value with reference to one or more fiat currencies, with the exception of items that are already covered by other regulatory regimes, such as deposits.”
3) Include regularly contacting and marketing services to the Hong Kong public, conducting mass media programs aimed at the Hong Kong public, or engaging in internet activities targeting the Hong Kong public.
4) Stablecoin issuers will also be required to set up a registered office in Hong Kong, staffed with a chief executive, senior management team, and other essential personnel.
5) The HKMA can impose additional conditions and will administer the new regime, with powers similar to those under the Banking Ordinance. New offenses, sanctions and appeal mechanism will be introduced.
6) “Offer” refers to “the act, as a principal or an agent, of providing a channel for a person to acquire FRS, which includes but is not limited to distribution, providing trading or brokerage services for acquiring FRS, etc.”
