FSTB AND HKMA JOINTLY PUBLISHED A CONSULTATION PAPER ON REGULATORY REGIME FOR STABLECOIN ISSUERS

• A “stablecoin” is 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 is intended to be used, as a medium of exchange accepted by the public, for the 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 that is not controlled solely by the issuer; and
  • purports to maintain a stable value with reference to a specified asset, or a pool or basket of assets.
  • The following are excluded from the definition of “stablecoin”:
    • deposits, including its tokenised or digitally represented form;
    • certain securities or futures contracts (e.g., authorised collective investment schemes, authorised structured products);
    • float stored in SVFs or SVF deposit;
    • digital representations of fiat currencies issued by or on behalf of central banks; and
    • certain digital representation of value that has a limited purpose.

Definition of FRS

• FRS is defined as a stablecoin where the specified asset is one or more fiat currencies
• Issuance of an FRS would be a regulated stablecoin activity under the proposed new legislation

Scope of Regulation

• Unless it is a company that holds an FRS issuer licence granted by the HKMA, no person shall:

(i)               issue an FRS in Hong Kong;

(ii)              issue a stablecoin that purports to maintain a stable value with reference to the value of the Hong Kong dollar (“Hong Kong dollar-referenced stablecoin”); or

(iii)            actively market their issuance of FRS to the public of Hong Kong, should be licensed by the HKMA

• All FRS issuers will be subject to the same regulatory treatment, regardless of the stabilisation mechanism of the FRS concerned and the underlying backing assets

• Full backing: FRS issuer must maintain a reserve of assets that is equal to or greater than the par value of the FRS in circulation at all times
• Investment limitations: Reserve assets must be of high quality and liquidity with minimal market, credit, and concentration risk
• Segregation and safekeeping of reserve assets: FRS issuer must establish effective trust arrangements to segregate the reserve assets from other assets and ensure their availability for redemption, reserves should be held in segregated accounts with licensed banks or with asset custodians under arrangements satisfactory to the HKMA
• Risk management and controls: FRS issuer must have adequate policies, guidelines, and controls for managing investment activities and liquidity risks associated with the reserve assets, periodic stress testing should be conducted to monitor the adequacy and liquidity of the reserve assets
• Disclosure and reporting: Regular disclosure of the total amount of FRS in circulation, mark-to-market value, and composition of reserve assets should be made to the public
• Prohibition on paying interest: Any income or loss from the reserve assets should be attributed to the FRS issuer, interest payments to FRS users are prohibited in line with international regulatory practices
• Effective stabilisation: FRS issuer holds ultimate responsibility for ensuring the proper functioning of the stabilisation mechanism, even if third parties are involved in carrying out stabilisation activities

Redemption Requirements

• FRS users have the right to redeem their FRS at par value with the issuer and have a claim on the reserve assets
• Redemption requests should be processed promptly and without undue costs, FRS issuer must not impose unreasonable conditions on redemption, such as high minimum threshold amounts
• Any fees for redemption must be clearly communicated to users, proportionate, and not set at levels that discourage redemption
• FRS issuer must maintain a contingency plan for orderly redemption in case they are unable to meet requests, including in situations like license suspension or revocation
• If channels for exchanging FRS into fiat currency become unavailable, the FRS issuer must ensure direct redemption for all users in a reasonably timely manner

Restrictions on Business Activities

• FRS issuer must obtain the HKMA’s approval before engaging in any new lines of business
  • A risk assessment should be conducted, and sufficient resources be dedicated to FRS issuance and maintenance
  • New business activities should not introduce significant risks or impair the issuer’s ability to function as an FRS issuer
  • FRS issuer is allowed to conduct ancillary or incidental activities related to FRS issuance, such as providing wallet services for the FRS it issues to facilitate the issuance and redemption processes
  • Lending, financial intermediation, and other regulated activities under the Securities and Futures Ordinance (Cap. 571), Mandatory Provident Fund Schemes Ordinance (Cap. 485), or Insurance Ordinance (Cap. 41) are prohibited

Physical Presence in Hong Kong

• FRS issuer must be a locally incorporated company with a registered office in Hong Kong
• Its chief executive, senior management team, and key personnel must be based in Hong Kong, ensuring effective management and control of FRS issuance and related activities

Financial Resources Requirements

• FRS issuer must have adequate financial resources, including a minimum paid-up share capital, to support its FRS issuance business and absorb potential losses
• The minimum paid-up share capital is proposed to be either HKD25,000,000 or 2% of the par value of FRS in circulation, whichever is higher
• The HKMA has the discretion to impose a higher paid-up share capital requirement as a licensing condition if deemed appropriate

Disclosure Requirements

• FRS issuer must publish a white paper disclosing general information about itself, user rights and obligations, the stabilisation mechanism, reserves management, underlying technology, and risks, prior notification to the HKMA is required
• FRS issuer must disclose redemption policies that outline the redemption process, timeframe, applicable fees, and the right of FRS users to redemption

Governance, Knowledge and Experience

• Controllers, chief executives, and directors of an FRS issuer must be fit and proper individuals; prior consent from the HKMA for their appointment is required

Risk Management Requirements

• FRS issuer must implement appropriate risk management processes and measures, among other things:
  • adequate security and internal controls to ensure the safety and integrity of data and systems;
  • effective fraud monitoring and detection measures;
  • technology risk management measures;
  • robust contingency arrangements to address operational disruptions; and
  • other operational and security safeguards which are commensurate with the scale and complexity of the business.
  • Risk assessments should be conducted at least annually to evaluate and ensure the adequacy and effectiveness of internal controls, risk management, and governance processes

Audit Requirements

• Audited financial statements must be provided to the HKMA annually
• Upon request by the HKMA, the FRS issuer must submit reports from external auditors and assessors to validate the management and operational soundness of FRS issuance

Anti-Money Laundering and Counter-Financing of Terrorism

• FRS issuer must establish and implement adequate systems of control to prevent and combat money laundering and terrorist financing
• FRS issuer must comply with the relevant provisions of the AMLO and any measures issued by the HKMA

• Only licensed FRS issuers, authorised institutions, licensed corporations and licensed Virtual Asset Trading Platforms (“VATPs”) can offer FRS in Hong Kong or actively market such offering to the public of Hong Kong
• Authorised institutions, licensed corporations and licensed VATPs can offer FRS issued by entities not licensed by the HKMA only to professional investors, and must indicate clearly such FRS is not issued by a licensed FRS issuer

• The regulatory regime will be designed with flexibility, allowing authorities to adjust the parameters of stablecoins and activities that fall within its scope, having regard to:

(i)      the risks posed to the monetary and financial stability of Hong Kong;

(ii)    the risk posed to the functioning of Hong Kong as an international financial centre; and

(iii)  matters of significant public interest.

Powers of the HKMA

• Powers will be provided to the HKMA for supervising and administering the licensing regime, and conducting investigations to enforce the regime

• Criminal sanctions would deter industry participants from committing offenses
• Proposed offenses include:
  • issuing an FRS in Hong Kong without a license
  • issuing a Hong Kong dollar-referenced stablecoin without a license
  • actively marketing unlicensed FRS issuance to the public
  • advertising unlicensed FRS issuance
  • failure to produce required documents
  • providing false information or making false entries
  • contravening the HKMA’s conditions for the licensing regime
  • Only specified licensed entities will be allowed to offer FRS in Hong Kong, it will be illegal to offer FRS or advertise FRS offerings without a license

Civil and Supervisory Sanctions

• The HKMA will be empowered to impose a range of civil and supervisory sanctions, including:
  • issuing a caution, warning, reprimand, order to take specified action(s); and supervisory sanctions including temporary suspension, suspension or revocation of licence, or a combination of the above;
  • a pecuniary penalty not exceeding HKD10,000,000 or 3 times the amount of profit gained or loss avoided as a result of the contravention, whichever is higher; or
  • any combination of the above.

Appeals

• A proposed appeal tribunal mechanism will be established to allow for appeals against the HKMA’s decisions regarding the licensing and supervisory requirements of the regulatory regime
• Decisions that can be appealed against include:
  • refusal to grant FRS issuance licenses
  • imposition of license conditions
  • conditions on exemptions granted to issuers
  • license revocation or suspension
  • objections to controllers, directors, and key personnel
  • imposition of civil and supervisory sanctions
  • If dissatisfied with the Tribunal’s decision, a person may further appeal to the Court of Appeal on a point of law

• Pre-existing FRS issuers with significant presence in Hong Kong before the commencement date of the regulatory regime may continue operations for 6 months, if a license application to the HKMA is submitted within the first 3 months
• FRS issues who fail to submit a licence application within the first 3 months must orderly close their business by the end of the fourth month after the commencement of the regime
• In evaluating whether the FRS issuer has a meaningful and substantial operations in Hong Kong, the HKMA will take into consideration the following factors:
  • whether it is incorporated in Hong Kong;
  • whether it has a physical office in Hong Kong with staff exercising central management and control over the FRS issuance; and
  • whether the FRS it issues has been circulated to independent FRS users (i.e., not limited to its own associated entities).