The Hong Kong Monetary Authority (HKMA) and the Financial Services and the Treasury Bureau (FSTB) released a consultation paper on a proposed regulatory regime for stablecoin issuers in Hong Kong. Written comments for this consultation are due on or before February 29, 2024.
● The proposed regulatory regime refers specifically to fiat-referenced stablecoins (“FRS”).
● Entities issuing FRS to retail investors must be licensed by the HKMA, potentially limiting international issuers to operate in Hong Kong.
● It is highly unlikely that algorithmic stablecoin issuers will meet the proposed licensing criteria, particularly regarding reserves management.
● Reserve assets should be high quality and liquid, and held in the referenced currency–with flexibility on a case-by-case basis subject to HKMA approval.
● The FRS issuer can provide wallet services but cannot engage in regulated activities such as lending or financial intermediation.
● In line with international regulatory practices, any income or loss from the reserve assets must be attributed to the FRS issuer. In other words, natively yield-bearing stablecoins will not be allowed.
The paper’s definition of a “stablecoin” refers specifically to fiat-referenced stablecoins (or “FRS”), which purport to maintain a stable value with reference to one or more fiat currencies. Among other points, the paper’s definition of a “stablecoin” includes the use of a distributed ledger or similar technology that is not controlled solely by the issuer.
The definition of FRS explicitly excludes floats in stored value facilities (“SVF”) or SVF deposits that are overseen by the HKMA’s Payment Systems and Stored Value Facilities Ordinance. It also excludes from the definition deposits (including tokenized deposits), securities or futures contracts, CBDCs, and other digital representations of value with a limited purpose.
All FRS issuers will be subject to the same regulatory treatment regardless of the stabilization mechanism. However, it is “highly unlikely” that algorithmic stablecoin issuers will meet the proposed licensing criteria–particularly regarding reserves management.
FRS can only be offered by specified licensed entities in Hong Kong, especially those that will be offered to retail investors. Entities that are not licensed by the HKMA may only offer FRS products to professional investors. Standalone legislation for FRS issuers is recommended and will abide by the “same activity, same risk, same regulation” principle.
Licensed FRS issuers will require consent from the HKMA before issuing any new FRS. These licenses will be open-ended and subject to revocation if found non-compliant. The FRS issuer will be required to display its license number on any marketing materials or consumer-facing interfaces.
To facilitate the transition to the new regulations, pre-existing FRS issuers with a meaningful and substantial presence in Hong Kong prior to the commencement date of the regulatory regime may continue to operate for six months, if they have submitted a license application to the HKMA within the first three months of the new regime. Those who do not submit a license application within the first three months will be required to close their business by the end of the fourth month.
The FRS issuer is responsible for ensuring that the stablecoin’s reserve assets are at least equal to the par value of the FRS in circulation at all times, and that they are of high quality and high liquidity with minimal market, credit, and concentration risk. Reserve assets should be held in the referenced currency, but there is flexibility on a case-by-case basis subject to HKMA approval.
The investment policy of the FRS issuer’s reserve assets should be reviewed on a “sufficiently frequent” basis. The FRS issuer should also ensure that the reserve assets are properly segregated from other assets to satisfy redemption rights, as well as claims in the event of an insolvency. The segregation must be done with accounts at licensed banks or in arrangements with asset custodians deemed satisfactory by the HKMA.
The FRS issuer must also have comprehensive liquidity risk management practices with processes to address large scale redemptions, including runs or liquidity stress scenarios. Periodic stress testing and monitoring is expected.
Attestation and Reporting
A qualified and independent auditor should perform regular attestations on i) the composition and market value of the reserve assets, ii) the par value of the FRS in circulation, iii) the liquidity and adequate backing of reserve assets to the FRS in circulation, and iv) fulfillment of the HKMA’s reserve management conditions.
The paper proposes that the total FRS in circulation and value of reserve assets should be disclosed at least daily, the composition of reserve assets should be disclosed weekly, and independent audits should be conducted monthly.
There should not be unreasonable conditions on redemption (such as a high minimum threshold amount). The FRS issuer is allowed to provide wallet services and other activities ancillary or incidental to the issuance of FRS. However, it should not conduct other regulated activities such as lending and financial intermediation.
The FRS issuer must be a company incorporated in Hong Kong and have an office in Hong Kong. The minimum paid-up share capital is proposed to be the higher of either HKD 25 million or 2% of the par value of the FRS in circulation.
The FRS issuer is required to publish a white paper to disclose general information, including information about the company, the rights and obligations of FRS users, the FRS stabilization mechanism, reserve management arrangements, as well as the underlying technology and their accompanying risks.
Governance and control
Any changes in the ownership or management of the FRS issuer requires prior consent of the HKMA. FRS issuers must additionally have adequate CDD measures in line with standards set by the FATF and requirements under the AMLO.
CCI’s Take: Comparing to other jurisdictions
While Hong Kong’s proposed regime follows recommendations issued by global standard-setters, the city’s rules seem slightly more stringent in certain ways than Singapore’s, such as the minimum paid-up capital requirement of at least HK$25 million (US$3.2 million). There are also concerns that major stablecoins such as USDT and USDC could face potential challenges operating in Hong Kong, especially given the set limits aimed to prevent unlicensed firms from offering stablecoin trading to individual and retail investors. Hong Kong’s proposed regime is also significantly different from Japan’s revised Payment Services Law, published in June 2023, in which the legislation authorizes only banks, trust companies and funds transfer operators to issue stablecoins.