Introduction
The Hong Kong Monetary Authority (HKMA) on 12 January 2022 issued a discussion paper on Crypto-assets and Stablecoins.1 The HKMA received over 50 responses from the public and issued its "Conclusion on Discussion Paper on Crypto-assets and Stablecoins" on 31 January 2023 (Consultation Conclusions),2 which proposes the introduction of a new stablecoin license (Stablecoin Licence) and associated regime (Stablecoin Licence Regime).
While acknowledging the interconnection between other types of crypto-assets and the mainstream financial system, the HKMA makes clear that it will prioritise the development of a regulatory framework for "payment-related stablecoins". This OnPoint will focus on the proposed Stablecoin Licence Regime set out in the Consultation Conclusions.
Scope of Stablecoins
Initially, the HKMA intends to regulate stablecoins that purport to reference one or more fiat currencies, regardless of whether the stablecoins are backed by assets or reference fiat currencies through algorithms or arbitrage mechanisms (In-Scope Stablecoins).
Interestingly, the HKMA notes that algorithmic stablecoins will be unlikely to meet the regulatory requirements under the Stablecoin Licence Regime (see the section “Key Features of the Proposed Stablecoin Licence – Key Regulatory Principles” below) – it appears that while the stablecoins will be in scope of the regulatory regime, the service providers of these algorithmic stablecoins will unlikely be granted a licence under the current regime. This could be taken to mean that the service providers of these algorithmic stablecoins may not conduct the proposed regulated activities in Hong Kong.
The HKMA intends to build a Stablecoin Licence Regime that has the flexibility to bring other stablecoin structures into the scope of regulation in the future.
Key Features of the Proposed Stablecoin Licence
Although the HKMA is still working on the final details of the Stablecoin Licence and associated Stablecoin Licence Regime, we have set out below some of the key features:
Gaps in the Proposed Stablecoin Licence Regime
While the above provides sets out very helpful guidelines for crypto-related businesses who are developing their regulatory strategy plan, there are still some gaps in the proposed Stablecoin Licence Regime, including (but not limited) to the following:
Local Incorporation Requirement: The HKMA acknowledges that amongst the responses it received to its discussion paper, there were mixed views as to whether the Stablecoin Licence Regime should impose a local incorporation requirement. The HKMA’s view is that imposing a local incorporation requirement would help it effectively supervise the licensed entities and enforce the regulatory requirements. The HKMA is in the process of evaluating different options, such as whether certain mitigation measures could be adopted instead of the local incorporation requirement while still upholding the necessary level of robustness and ensuring the effectiveness of the regulatory regime.
Legislative Approach: The HKMA has not finalised how it will implement the Stablecoin Licence Regime. It notes that while amending the Payment Systems and Stored Value Facilities Ordinance of Hong Kong may bring In-Scope Stablecoins into the regulatory remit from the payment perspective, there may be merit in introducing new stand-alone legislation. The stand-alone legislation could focus on the regulation of In-Scope Stablecoins to start with but may be extended to bring other segments of the crypto-asset market in scope of such legislation in the future.
Existing Stablecoins: We note that entities that issue, stabilize and govern the In-Scope Stablecoin arrangements will be required to obtain a Stablecoin Licence from the HKMA under this new regime. However, many stablecoins have already been issued, and are governed and stabilized by non-Hong Kong incorporated entities. While it is clear that under a Stablecoin Licence Regime these entities will have to licensed by the HKMA, the HKMA may need to consider how to deal with this issue when formulating the details and effectiveness of the new regulatory regime. Of specific importance will be how the HKMA develops the regime bearing in mind the local incorporation requirement, as well as the Hong Kong Government's policy stance to develop a vibrant virtual asset sector and ecosystem. Other questions that may need to be considered include the following:
- Will existing stablecoin service providers be willing to obtain a Stablecoin Licence in Hong Kong to service Hong Kong users?
- Will existing stablecoin issuers be required to, and if so, be willing to, form a new Hong Kong entity to issue a Hong Kong-specific stablecoin – one that is segregated from the existing stablecoins that they have already issued - to satisfy any licence requirements?
- Will the HKMA provide exemptions or "fast-track applications" for stablecoin service providers that already obtained equivalent licences from regulators of comparable recognized jurisdiction, similar to other existing regulatory regimes?
Wallets: Operators of wallets holding In-Scope Stablecoins will be required to obtain a Stablecoin Licence from the HKMA. This would bring many global online wallets that hold stablecoins that may be used by Hong Kong users into scope of the Stablecoin Licence Regime. However, bearing in mind the way the crypto ecosystem works, such wallets may not have been actively marketed to Hong Kong users. As a consequence, crypto wallet providers may have to exclude Hong Kong users from using their services in relation to the In-Scope Stablecoins to ensure they stay outside the Stablecoin Licence Regime, which therefore may affect the adoption of these In-Scope Stablecoins.
Principal Business Restriction: It is not immediately clear how far the principal business restrictions will extend. The example given by the HKMA, i.e. that wallet operators should not engage in lending activities, is a clear cut example. However, what is not clear is whether the wallet operator will be required to segregate (and if so, to what extent do they have to segregate) the wallet business of In-Scope Stablecoins from the wallet business of other crypto-assets. This may not be viable operationally nor commercially to wallet operators.
Timeline and Next Steps
Having considered the volatility and risks of stablecoins as well as the need to adopt the latest international recommendations and align Hong Kong’s regulatory regime for stablecoins with those regimes in other major jurisdictions, the HKMA will work towards putting in place the regulatory regime by 2023/24. The proposed timeline will also allow the HKMA to conduct further assessment and work with other stakeholders in the HKSAR Government, local financial regulators as well as other relevant entities when formulating the details of the regime. This collaboration will help to avoid regulatory arbitrage, identify and address regulatory overlaps or gaps and mitigate the risks arising from different activities (in particular the existing crypto-related regulatory framework, including the upcoming virtual asset service provider licensing regime under the recently effective amended Anti-Money Laundering and Counter-Terrorist Financing Ordinance).
In conclusion, while there are still much to be developed and confirmed for this Stablecoin Licence Regime, the proposals for a Stablecoin Licence Regime represents a significant and encouraging step in furthering Hong Kong's aim to become Asia's virtual asset hub.
Footnotes
1) https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2022/20220112e3a1.pdf
2) https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2023/20230131e9a1.pdf
