Overview of Key Information on the Latest Proposed Regulatory Framework for Stablecoins in Hong Kong
Stablecoin holders should be able to redeem stablecoins at face value for the reference fiat currency within a reasonable period. In addition, regulated entities must not engage in activities that are different from the main business activities permitted by their relevant licenses.Source: Karen, Foresight News
The Hong Kong Monetary Authority (HKMA) today released a 36-page discussion document on "Cryptocurrency and Stablecoins Conclusions", which broadly outlines the proposed regulatory framework parameters based on feedback from the previous discussion document. The focus will be on regulating stablecoins that reference fiat currencies and may be used for payments, with detailed introductions to regulatory activities, implementation timelines, licensing, regulatory principles, and more.
Some key regulatory requirements include that stablecoins should be fully backed and allow for redemption at face value, reserve assets should have high liquidity, and stablecoins that derive value from arbitrage or algorithms will not be accepted. Stablecoin holders should be able to redeem their stablecoins at face value for the reference fiat currency within a reasonable timeframe. Additionally, regulated entities must not engage in activities that differ from their licensed core business, for example, wallet operators should not engage in lending activities.
Key Information Overview
On January 12, 2022, the HKMA published a discussion document on cryptocurrency and stablecoins and invited stakeholders to provide feedback. The discussion document outlined the HKMA's thoughts on prioritizing the establishment of a regulatory framework for payment-related stablecoins, believing that such stablecoins have the potential to develop into widely accepted payment methods while also providing institutional flexibility.
Since then, the cryptocurrency market has continued to evolve. However, it is noteworthy that after the collapse of TerraUSD, the stablecoin market experienced significant volatility and adjustments in May 2022. Some cryptocurrency exchanges also faced difficulties and crises, such as the FTX collapse in November 2022. Against this backdrop, authorities have called for more comprehensive regulation of stablecoins to address the financial stability risks they may pose. International regulatory bodies, standard-setting bodies (SSB), and some major jurisdictions have proposed more specific policy recommendations and regulatory measures for stablecoins.
An increasing number of major jurisdictions are prioritizing the regulation of stablecoins that claim to reference fiat currencies, as regulators believe these stablecoins are more likely to be used for payments and are connected to the traditional financial system, thus posing more urgent monetary and financial stability risks compared to other types of stablecoins or cryptocurrencies. Major jurisdictions have also recognized the importance of establishing appropriate flexibility within the regulatory framework to adjust the scope of regulation in response to rapidly changing markets and international regulatory developments.
By the end of the feedback period on March 31, 2022, the HKMA had received 58 submissions. Respondents generally expressed support for the HKMA's proposal to include stablecoins within the regulatory scope. Considering the latest international recommendations and the feedback received, the HKMA will further work on establishing a regulatory framework. The proposed key parameters of the relevant framework are summarized as follows:
What will be regulated?
Key activities related to stablecoins will be subject to a mandatory licensing regime. Specifically, the HKMA will adopt a risk-based approach to determine the scope of stablecoin structures for regulation under the proposed framework. Given that stablecoins may pose higher and more urgent monetary and financial stability risks, the HKMA will prioritize the regulation of stablecoins that claim to reference one or more fiat currencies. Subsequently, authorities will establish flexibility to regulate other stablecoin structures in the future.
What key activities will be regulated?
- Governance: Establishing and maintaining rules for stablecoins within the scope (in-scope, referring to stablecoins that reference fiat currencies and may be used for payments);
- Issuance: Issuing, creating, or destroying relevant stablecoins;
- Stability: Stability and reserve management arrangements for stablecoins within the scope (whether provided by the issuer or not);
- Wallets: Providing services that allow users to store their cryptographic keys (enabling users to access and manage such stablecoins).
Which entities need to obtain a license from the HKMA?
- Conducting regulated activities in Hong Kong;
- Actively marketing regulated activities to the public in Hong Kong;
- Engaging in regulated activities involving stablecoins that claim to reference the value of the Hong Kong dollar;
- Involving matters of significant public interest (as deemed necessary by the authorities).
Key Regulatory Principles
Comprehensive regulatory framework: Appropriate regulatory requirements will be established in areas such as ownership, governance and management, financial resource requirements, risk management, anti-money laundering and counter-terrorism financing (AML/CFT), user protection, and regular supervision.
Stablecoins should be fully backed and allow for redemption at face value: The value of the reserve assets for stablecoins should always match the value of the outstanding stablecoins. Reserve assets should be of high quality and high liquidity. Stablecoins that derive value from arbitrage or algorithms will not be accepted. Stablecoin holders should be able to redeem their stablecoins at face value for the reference fiat currency within a reasonable timeframe.
Core business restrictions: Regulated entities must not engage in activities that differ from their licensed core business. For example, wallet operators should not engage in lending activities.
Target implementation date: 2023/2024
Legislative approach: The HKMA is weighing the pros and cons of introducing new legislation and amending existing laws to implement the regulatory framework.
The HKMA will conduct more detailed consultations at the appropriate time to provide further information regarding the regulatory framework.
Regarding the broader cryptocurrency sector, based on the policy statement on "Developing Virtual Assets in Hong Kong" released by the Hong Kong SAR government on October 31, 2022, the HKMA will continue to engage in ongoing discussions with the Hong Kong SAR government and other stakeholders in the financial regulatory sector, and actively participate in relevant international forums. The HKMA supports financial innovation and encourages institutions to explore the potential of distributed ledger technology (DLT) to support the development of Hong Kong's virtual asset ecosystem.
The HKMA noted that the proposed regulatory activities for stablecoins may overlap or intersect with other financial regulatory frameworks in Hong Kong, such as the licensing regime for virtual asset service providers (VASP) managed by the Securities and Futures Commission (SFC). The HKMA will conduct further assessments and continue to collaborate with other stakeholders in the Hong Kong SAR government and local financial regulatory bodies when formulating the details of the framework to avoid regulatory arbitrage and address issues of duplicate regulation or regulatory gaps, and to mitigate risks arising from different activities.
Next Steps
The HKMA stated that after achieving broad consensus on the proposed regulatory framework, it intends to establish a flexible, risk-based regulatory system for stablecoins. This will help ensure monetary and financial stability, protect users, and minimize the risk of regulatory arbitrage.
The HKMA will consider the responses received and reference relevant international discussions to develop the details of the regulatory framework, while continuing to monitor market developments, engage with the industry, and collaborate with other stakeholders in the Hong Kong SAR government and other financial regulatory bodies.
More detailed consultations will be conducted at the appropriate time to provide further information regarding the regulatory framework, with the aim of finalizing the key parameters that the legislative draft will cover. Additionally, the HKMA will conduct further assessments on certain issues, such as whether to introduce new legislation or amend existing laws to implement the proposed regulatory framework, how to minimize potential duplicate regulation, how to address risks that may arise from related entities providing multiple or bundled financial services, and local registration requirements.
The HKMA will also work closely with other stakeholders to implement the regulatory framework through appropriate legislative activities. The envisioned legislative draft will clarify key issues, such as (i) defining structures and activities that will be regulated or not regulated under the legislation; (ii) the scope of powers to be granted to the HKMA for implementing regulation, while considering regulatory effectiveness and proportionality; (iii) key regulatory requirements; (iv) the scope of powers to be granted to the authorities (and the relevant framework) to timely update the regulatory framework to cover additional structures or activities; (v) relevant guiding factors that authorities should consider when exercising powers related to point (iv) above.
