Hong Kong, on its way towards establishing itself as a crypto hub, is going to press ahead with establishing a new licensing scheme for stablecoin issuers in the city.
The Hong Kong Monetary Authority (HKMA) published on July 17, jointly with the Financial Services and the Treasury Bureau (FSTB), a consultation conclusions paper on a proposed regulatory framework for fiat-referenced stablecoin (FRS) issuers.
An FRS is defined by the regulators as stablecoins that aim to maintain a stable value with reference to a specified asset or a pool of basket of assets, and are issued, transferred, stored and traded on distributed ledgers or a network using similar technology.
This would be a second major licensing scheme in the Special Administrative Region’s (SAR) virtual asset space, after the Securities and Exchange Commission (SFC) introduced last June a framework for virtual asset trading platform (VATP) operators.
Once the new regime takes effect, only licensed FRS issuers, authorised institutions, licensed corporations and licensed VATPs would be able to offer FRS in Hong Kong or actively market such an offering to the Hong Kong public, the HKMA stated in the paper.
The authorities are now preparing a bill to implement the proposal, which is planned to be introduced into the legislative council later this year. A full implementation is expected in 2025.
HKMA’s proposed framework will require applying stablecoin issuers to build a local presence in Hong Kong, which would include the incorporation of key management personnel in the city; to obtain monthly attestation from an independent auditor; and to prepare a stablecoin whitepaper that should be disclosed publicly, among many other proposed measures to ensure security.
Despite receiving concerns over costs and inconvenience from market players during the consultation period, the HKMA maintained in the conclusions that these requirements are necessary.
Changes to note in the conclusions, according to market sources, include a lowered threshold for minimum paid-up share capital from 2% of par value of FRS in circulation to 1%; and a recognition of tokenised assets as reserve assets to back up FRS issuance, which demonstrated the city’s support and commitment in bringing traditional financial instruments on chain.
Traditional use cases
A focus on stablecoin adoption in cross-border payments is one of the HKMA’s focuses – it underlined that stablecoins bear a greater potential of being widely recognised and accepted in payments.
Shortly after the conclusions release, the regulator announced a first batch of participants in its sandbox, which include several potential stablecoin issuers. The participants have been testing with stablecoin business plans and operations since March.
Alvin Kwock, founder of digital insurer OneInfinity by OneDegree, pointed out to FinanceAsia that compared to other global legislations, where most of the rules are designed around crypto-native players, Hong Kong has a greater focus towards the connection with traditional financial services sectors.
“We can see traditional banks, payment players and supply chain players participating in the sandbox,” Kwock said. “The objective is to explore different use cases in the city.”
Peter Brewin, partner at PwC Hong Kong and greater China, said that having HKMA-regulated stablecoin issuers will “totally change the market”.
“It means that the businesses that we interact with on a daily basis will have the trust to explore use cases for these new forms of payment that until now have been considered too risky,” he furthered.
“Tokenised payments have the potential to open up new opportunities that are not currently well served including international payments and remittances, providing an instant settlement mechanism for tokenised financial assets and providing programmable payments.”
On the other hand, regulators in Hong Kong are trying to avoid incidents such as the Terra Luna collapse in May 2022, which ended up wiping out an estimated $60 billion in the global crypto market. Terra Luna was connected with TerraUSD (UST), an algorithmic stablecoin that tried to maintain pricing with the $ but ultimately failed due to market volatility.
Rocky Mui, partner at law firm Clifford Chance, which was involved in the drafting and consultation processes, told FA that financial stability, anti-money laundering and investor protection were three major priorities when deciding the scope of regulation.
Andre Da Roza, counsel at Clifford Chance, added that the scheme not only covers Hong Kong-licensed stablecoins, but also provides details around the “offering” or “active marketing” of stablecoin products and services, thereby ensuring guardrails around certain activities where non-Hong Kong related stablecoins are involved.
“For example, if you are not licensed and if you are actively marketing into Hong Kong, there will be restrictions and extra territorial application of the regulatory regime,” he explained.
He also suggested that the licensing regime proposal draws on a lot of the concepts from other existing regimes, bringing in familiarity, which will help ensure a level of certainty. For example, the concept of “actively marketing” appeared in the existing Securities and Futures Ordinance (SFO).
“Hong Kong is taking the lead in terms of proposed stablecoin regulatory schemes, as such frameworks are either still in early stages of development or don’t yet exist in a lot of jurisdictions,” Mui commented.
Custody pitfall
The HKMA pointed out that FRS in circulation should be fully backed by reserve assets at all times, and that such assets should be kept separately from an issuer’s own assets.
Meanwhile, flexibility is offered – the HKMA does not “currently see a need” either to introduce a separate licensing regime for custody of reserve assets, or to include custodians into the proposed framework. The regulator is also open to options to place these assets outside of Hong Kong, despite a recommendation of keeping them with licensed banks in Hong Kong.
When it comes to custody of virtual assets, FA reported late last year that fragmentation exists.
There are currently no designated rules or frameworks guiding virtual asset custody in Hong Kong, aside from a Trust or Company Service Provider (TCSP) licensing scheme under the Companies Registry for trust providers, introduced in 2018. A key point to note here is that TCSP licensees are registered instead of being regulated.
This, in the crypto space, would lead to relatively higher prevalence of first-party custody, where entities such as crypto exchanges keep assets in custody with themselves.
The involvement of a third-party custodian is crucial for virtual asset security, according to Rex Zhang, chief operating officer at digital insurer OneInfinity by OneDegree.
He explained that working with a third-party custodian ensures segregation of various wallets and keys to them, which in turn avoids a mix of funds across functions such as exchange, custody and margin-generating services.
In places such as Dubai, virtual asset custody services are incorporated as one of the regulated activities as part of the licensing regime under its Virtual Assets Regulatory Authority (VARA).
“The HKMA will review how reserve assets will be or are proposed to be managed, as part of the license application assessment process,” the Hong Kong regulator noted in its conclusions. Adding that the government and the financial regulators are exploring regulatory approaches for activities, such as the storage of private keys.
