Hong Kong
In line with the Hong Kong government’s ambition to be a virtual asset hub, having introduced a regulatory regime for virtual asset exchanges, it is now inviting public comments on a regulatory regime for stablecoins. The announcement and consultation paper, issued 27 December 2023, can be found via the PDF.
Please see our previous client alert for more on the topic.
Below are some key features of this highly anticipated development.
Who is the regulator?
This will be the Hong Kong Monetary Authority (HKMA), Hong Kong’s de facto central bank, that currently regulates banks, stored value facilities (SVF) providers, certain payment systems and money brokers. This makes sense, as stablecoins share numerous common features with SVFs1 and the HKMA has had many years of experience regulating SVFs.
Definitions of stablecoin
- This is proposed to be defined as a cryptographically secured digital representation of value that, among other things:
- is expressed as a unit of account or a store of economic value;
- is used or intended to be used as a medium of exchange, for payment for goods or services, discharge of a debt and/or investment;
- can be transferred, stored or traded electronically;
- uses a distributed ledger or similar technology; and
- purports to maintain a stable value with reference to a specified asset or basket of assets.
- For now, the proposal is to regulate stablecoins referencing one or more fiat currencies (fiat-referenced stablecoins or FRS)2. Issuers of FRS will need a licence from the HKMA. In terms of compliance, issuers should expect a robust framework, covering the handling and segregation of reserve assets, committing to sufficient financial resources and internal controls and being subject to the HKMA supervision and investigation regime.
- The definition disregards the stablisation mechanism, so theoretically a stablecoin that derives its value from arbitrage or an algorithm is still caught. However, the HKMA has stated that such issuers are unlikely to meet the proposed licensing criteria, especially on reserves management. Unfortunately, this will be a disappointment to many stablecoin issuers.
Extra-territorial effect
An overseas issuer may be caught in the regulatory net if it issues a stablecoin referencing the HK dollar or actively markets its stablecoin to the public in Hong Kong.
What activities are caught?
This is wider than at first glance. As mentioned, overseas issuers and their distributors should be aware that they could be caught by the extra-territorial provisions.3
The licensing regime will provide that no person shall, unless it holds an FRS issuer licence from the HKMA:
- issue, or hold oneself as issuing, an FRS in Hong Kong;
- issue, or hold oneself out as issuing, a stablecoin that purposes to maintain a stable value with reference to the value of the Hong Kong dollar; or
- actively market its issuance of FRS to the public in Hong Kong.
It is also proposed that only Hong Kong-licensed entities, such as licensed FRS issuers and HKMA- or Securities and Futures Commission (SFC)-licensed entities,4 can offer FRS to retail investors in Hong Kong. Non-HK-licensed issuers should be able to offer their FRS to professional investors.5
Main requirements
It should be no surprise that the regime proposes robust controls around reserve assets and internal controls. Under the principle of “same activity, same risk, same regulation”, the HKMA is seeking to strike the right balance between investor protection and a proportionate and risk-based regulatory framework.
The main licensing criteria and conditions proposed are as follows:
- Stablecoin issuers must ensure that the value of reserves is equal to the par value of stablecoins6 in circulation at all times.
- Reserve assets must be of high liquidity with minimal market, credit and concentration risk and be held in the fiat currency7 referenced by the stablecoin.
- Reserve assets need to be held in segregated accounts with licensed banks or HKMA-approved custodians.8
- Internal controls must be established to protect and manage the reserve assets. In addition, the issuer must have sufficient risk management processes.9
- The total amount of stablecoins in circulation and the mark-to-market value and composition of reserve assets must be publicly and regularly disclosed.
- Stablecoin issuers cannot pay interest to holders of the coins.
- Minimum paid up capital is HK$25 million.
- Local presence: A Hong Kong incorporated company must be established and the senior management must be based in Hong Kong and exercise effective management control.
There has been some commentary that these requirements are too stringent. In particular, the local presence requirement may be challenging for issuers10 to meet.
What’s Next?
Overall, this is a regime that is in line with international standards, although it is slightly more robust with a focus on investor protection. There may be flexibility in relaxing some of the proposed requirements (possibly the localisation and the non-payment of interest requirements) so international issuers who are interested in obtaining a Hong Kong license take this opportunity to provide comments.
The HKMA will introduce a sandbox so that entities who are serious about FRS issuance can interact with and receive guidance from the HKMA. Details will be announced separately.
The proposed framework positions Hong Kong as a frontrunner jurisdiction for stablecoin issuance activities. Given the overlaps and similarities between this Hong Kong framework and the stablecoin regulatory regimes in jurisdictions such as Singapore11 and the European Union, issuers looking to domicile their activities in a reputable onshore jurisdiction are now likely to gravitate towards one of these locations, with the geographical target market likely being a determinative factor in their choice.
For further information, contact the author or any member of our On Chain team.
- Indeed, key regulatory aspects are similar.
- However, the HKMA will retain flexibility to expand the regulatory regime. Please also see the section on the extra-territoriality aspects of the proposed regime.
- Please see the section on the extra-territoriality aspects of the proposed regime.
- Banks, brokers, virtual asset trading platforms, etc. licensed by HKMA or SFC. It appears that such virtual asset trading platforms (VATPs) may still offer FRS such as USDC (if such issuer does not obtain a licence under the FRS regime) to professional investors.
- As defined in the Securities and Futures Ordinance.
- This would require the issuer to have good reserves management and monitoring systems.
- This may be varied on a case-by-case basis by the HKMA.
- Details have not yet been issued.
- Main controls and procedures would include liquidity risk management, handling of operational risk, data protection, having contingency measures and establishing good AML controls.
- Many established stablecoin issuers have their primary base of operations overseas.
- Singapore stablecoin regulation – MAS confirms its framework
Client Alert 2024-008
