The HKMA Published Conclusion on Crypto-assets and Stablecoins Discussion Paper

On 31 January 2023, the Hong Kong Monetary Authority (the “HKMA”) published a Conclusion of Discussion Paper on Crypto-assets and Stablecoins (the “Consultation Conclusion Paper”). This followed its earlier consultation by way of its discussion paper published on 12 January 2022 on the relevant proposals (the “Discussion Paper”) (see our news update on the Discussion Paper). Taking into account the feedback received, the HKMA will further proceed to bringing certain activities relating to stablecoins into the regulatory regime. The target implementation date of the regime will be by 2023/24 after considering various issues such as the volatility and risks of the stablecoins as well as the need to adopt the latest international recommendations and align Hong Kong’s regulatory regime in stablecoins with those in other major jurisdictions. ¹

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The Key Parameters of the Regulatory Regime

A. What to regulate

Having considered the responses received, the HKMA suggested that key activities relating to stablecoins will be subject to a mandatory licensing regime. The HKMA will take a risk-based approach by giving priority to regulating stablecoins that purport to reference to one or more fiat currencies at this stage. The focus of the regulation would be on the purported reference of a stablecoin regardless of their respective underlying stabilisation mechanism. That is, stablecoins that purports to reference to fiat currencies through algorithms or arbitrage mechanisms will be regulated. ²

Regarding the regime, the HKMA proposes that flexibility should be adopted to enable the authority to declare other stablecoin structure(s) for regulation under the regime in the future. The HKMA also acknowledges the need to exclude certain arrangements from the definition of stablecoins for certain reasons, for instance, the stablecoins which are already being subject to another financial regulatory regime. ³ As this issue has not been finalised yet, further analysis and additional consultation will be required for more information on decision making. While considering the regulation of other crypto-assets, the latest market situation and international discussion will be taken into account by the HKMA for future implementation.

B. Key activities to be regulated

As mentioned above, the key activities relating to an in-scope stablecoin will be regulated under the mandatory licensing regime, for instance: ⁴

Key activities

Governance Establishment and maintenance of the rules governing an in-scope stablecoin arrangement

Issuance Issuing, creation or destroying of in-scope stablecoins

Stabilisation Stabilisation and reserve management arrangements of an in-scope stablecoin (whether or not such arrangements are provided by the issuer)

Wallets Provision of services that allow the storage of users’ cryptographic keys which enable access to the users’ holdings of an in-scope stablecoin and the management of such stablecoins

It is noted that these activities might overlap and/or have interface with other financial regulatory regimes in Hong Kong such as the licensing regime for VASPs to be administered by the SFC. ⁵

For the other stablecoin-related activities that are not listed above, they may not be included in the proposed regulatory scope at this stage. Nevertheless, in order to scope in new types of regulated activities in the future, the HKMA aims to apply appropriate flexibility in the regulatory regime. This would also prepare the authority to tackle any risks associated with the unregulated stablecoin activities when such risks become concerning from a monetary and financial stability angle. ⁶

C. Entities that will require a license from HKMA

After the consultation, the HKMA concludes that the following types of entities will require a license from the authority:

Entities that:

(i) conduct a regulated activity in Hong Kong;
(ii) actively market a regulated activity to the public of Hong Kong;
(iii) conduct a regulated activity which concerns a stablecoin that purports to reference to the value of the Hong Kong dollar; or
(iv) the authority is of the opinion that should be so regulated, having regard to matters of significant public interest. ⁷

D. Key regulatory principles

When formulating the regulatory requirements, the HKMA will adopt a risk-based approach. To deal with the issue where there are multiple activities that may take place regarding a stablecoin arrangement, the authority tends to customise the appropriate requirements for each type of activities. ⁸

For the time being, the HKMA has provided the three principles of the regulatory regime: ⁹

Principle

Comprehensive regulatory framework The regulatory framework should cover a broad range of issues including but not limited to:

Ownership

Governance and management

Financial resources requirements

Risk management

AML/CFT

User protection

Regular audits and disclosure requirements.

Full backing and redemption at par
The value of the reserve assets of a stablecoin arrangement should meet the value of the outstanding stablecoins at all times.

The reserve assets should be of high quality and high liquidity.

Stablecoins that derive their value based on arbitrage or algorithm will not be accepted.

Stablecoin holders should be able to redeem the stablecoins into the referenced fiat currency at par within a reasonable period

Principle business restriction
The regulated entities should not conduct activities that deviate from its principle business as permitted under their relevant license.

For example, wallet operators should not engage in lending activities.

Authorised Institutions (“AI”) and Non-AI Issuers of Stablecoins

Following the consultation and considering the international standards, a risk-based, “same risk, same regulation” approach will be adopted by the HKMA, where the authority is of the view that both AIs and non-AIs should be allowed to issue stablecoins provided that the licensing and regulatory requirements could be satisfied. On the other hand, the final regulatory requirements applicable to the AI and non-AI will be calibrated according to risks of each type of issuers presents to the financial system. ¹⁰

Analysis and Takeaways

The significant potential in the use of crypto-assets in Hong Kong raises the need of investor protection and the regulation of the new financial instrument. With the introduction of the stablecoin and its regulatory parameters, the financial stability risks that may be posed by the stablecoin can be addressed for a safer crypto-asset ecosystem in Hong Kong. The proposed regulatory regime shows the initiative and determination of the regulators in Hong Kong to ensure monetary and financial stability amidst technological advancement.

Please contact our Partner Mr. Rodney Teoh for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

¹ Consultation Conclusion Paper p.21
² Consultation Conclusion Paper p.14
³ Consultation Conclusion Paper p.14
⁴ Consultation Conclusion Paper p.15-16
⁵ Consultation Conclusion Paper p.5
⁶ Consultation Conclusion Paper p.16
⁷ Consultation Conclusion Paper p.4
⁸ Consultation Conclusion Paper pp.17
⁹ Consultation Conclusion Paper pp.17-18
¹⁰ Consultation Conclusion Paper pp.22-23

Key activities
Governance	Establishment and maintenance of the rules governing an in-scope stablecoin arrangement
Issuance	Issuing, creation or destroying of in-scope stablecoins
Stabilisation	Stabilisation and reserve management arrangements of an in-scope stablecoin (whether or not such arrangements are provided by the issuer)
Wallets	Provision of services that allow the storage of users’ cryptographic keys which enable access to the users’ holdings of an in-scope stablecoin and the management of such stablecoins

Principle
Comprehensive regulatory framework	The regulatory framework should cover a broad range of issues including but not limited to: Ownership Governance and management Financial resources requirements Risk management AML/CFT User protection Regular audits and disclosure requirements.
Full backing and redemption at par	The value of the reserve assets of a stablecoin arrangement should meet the value of the outstanding stablecoins at all times. The reserve assets should be of high quality and high liquidity. Stablecoins that derive their value based on arbitrage or algorithm will not be accepted. Stablecoin holders should be able to redeem the stablecoins into the referenced fiat currency at par within a reasonable period
Principle business restriction	The regulated entities should not conduct activities that deviate from its principle business as permitted under their relevant license. For example, wallet operators should not engage in lending activities.