Hong Kong Monetary Authority's Stablecoin Regulatory Framework: Requires Licensing, Recognizes Only Fully Reserve-Backed Stablecoins

The Hong Kong Monetary Authority (HKMA) will prioritize regulating stablecoins that are pegged to fiat currencies and may be used for payments. The regulatory requirements include that stablecoins should be fully backed and allow for face value redemption, reserve assets should be highly liquid, and stablecoins that derive value from arbitrage or algorithms will not be accepted. Holders of stablecoins should be able to redeem them at face value for the reference fiat currency within a reasonable timeframe. Additionally, regulated entities are not allowed to engage in activities that differ from their licensed primary business, for example, wallet operators should not engage in lending activities.

Compiled by: Karen, Foresight News

Key Information Overview

1. On January 12, 2022, the Hong Kong Monetary Authority issued a discussion paper on crypto assets and stablecoins, inviting stakeholders to provide feedback. The paper outlined the HKMA's thoughts on prioritizing the development of a regulatory framework for stablecoins used in payments, believing they have the potential to become widely accepted payment methods while providing flexibility in the system.

2. Subsequently, the crypto asset market continued to evolve. However, following the collapse of TerraUSD, the stablecoin market experienced significant volatility and adjustments in May 2022. Some cryptocurrency exchanges also faced challenges and crises, such as the FTX collapse in November 2022. Against this backdrop, authorities called for more comprehensive regulation of stablecoins to address potential financial stability risks they may pose. International regulatory bodies, the International Standards Setting Bodies (SSBs), and some major jurisdictions have already put forward more specific policy recommendations and regulatory measures or proposals concerning stablecoins.

3. More jurisdictions are prioritizing the regulation of stablecoins claiming to be pegged to fiat currencies, as regulators believe these stablecoins are more likely to be used for payments and have connections to the traditional financial system. Compared to other types of stablecoins or crypto assets, they are seen as posing more urgent monetary and financial stability risks. Major jurisdictions also noted the importance of establishing appropriate flexibility in regulatory frameworks to adjust the scope of regulation to cope with rapidly changing markets and international regulatory developments.

4. By the end of the feedback period on March 31, 2022, the HKMA received a total of 58 submissions. Respondents generally expressed support for the HKMA's proposal to include stablecoins in the regulatory scope. Taking into account the latest international recommendations and feedback received, the HKMA will further work on establishing the regulatory framework. The key proposed parameters of the relevant system are summarized as follows:

What is regulated?

Key activities related to stablecoins will be subject to a mandatory licensing regime. Specifically, the HKMA will use a risk-based approach to determine the scope of stablecoin structures for regulation under the proposed system. Given the potentially higher and more urgent monetary and financial stability risks stablecoins may bring, the HKMA will prioritize regulating stablecoins claiming to reference one or more fiat currencies. Subsequently, the authorities will establish flexibility to regulate other stablecoin structures in the future.

Which key activities are regulated?

• Governance: Establishing and maintaining rules for stablecoins within the governance scope (in-scope, referring to stablecoins pegged to fiat currencies and potentially used for payments);
• Issuance: Issuing, creating, or redeeming relevant stablecoins;
• Stability: Stabilizing and reserve management arrangements of stablecoins within the relevant scope (whether provided by the issuer or not);
• Wallets: Providing services that allow storing user encryption keys (allowing users to access and manage such stablecoins).

Which entities need HKMA licenses?

• Engaging in regulated activities in Hong Kong;
• Actively marketing regulated activities to the Hong Kong public;
• Engaging in regulated activities involving stablecoins claiming to reference the value of the Hong Kong dollar;
• Involving matters of significant public interest (which the authorities deem should be regulated as such).

Key Regulatory Principles

Comprehensive regulatory framework: Appropriate regulatory requirements will be developed 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 and disclosure requirements.

Full backing and redemption at face value for stablecoins: The reserve asset value of stablecoins should always match the value of unredeemed stablecoins. Reserve assets should be of high quality and high liquidity. Stablecoins obtained value through arbitrage or algorithms will not be accepted. Stablecoin holders should be able to redeem stablecoins at face value for the reference fiat currency within a reasonable period.

Primary business restrictions: Regulated entities must not engage in activities different from their licensed primary operations. 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 system.

5. The HKMA will provide more detailed consultations at the appropriate time to further offer detailed information on the regulatory system.

6. Regarding the broader field of crypto assets, according to the Hong Kong SAR Government's policy statement on developing virtual assets issued on October 31, 2022, the HKMA will continue to engage in ongoing discussions with the Hong Kong SAR Government, other stakeholders in the financial regulatory institutions, 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.

7. The HKMA pointed out that the proposed regulatory activities for stablecoin systems may overlap or intersect with other financial regulatory systems in Hong Kong, such as the licensing regime for Virtual Asset Service Providers (VASPs) managed by the Securities and Futures Commission (SFC). The HKMA will conduct further assessments and collaborate with other stakeholders in the Hong Kong SAR Government, local financial regulatory institutions, etc., to avoid regulatory arbitrage, address duplicate regulation or regulatory gaps, and mitigate risks arising from different activities.

Next Steps

1. The HKMA stated that after reaching broad consensus on the proposed regulatory scheme, it intends to establish a flexible, risk-based regulatory framework for stablecoins. This will help ensure monetary and financial stability, protect users, and minimize regulatory arbitrage risks.

2. The HKMA will consider the responses received, refer to relevant international discussions to formulate the details of the regulatory system, continue to monitor market developments, engage with the industry, and collaborate with other stakeholders in the Hong Kong SAR Government and other financial regulatory institutions.

3. Detailed consultations will be conducted at an appropriate time to provide more information on the regulatory system, with the aim of finalizing a legislative draft covering key parameters. Additionally, the HKMA will further assess certain issues, such as whether to introduce new legislation or amend existing laws to implement the proposed regulatory system, how to minimize potential duplicate regulation, how to address risks posed by associated entities offering multiple or bundled financial services, and local registration requirements.

4. The HKMA will closely cooperate with other stakeholders to implement the regulatory system through appropriate legislative activities. The envisioned legislative draft will clarify key issues such as i defining structures and activities subject to regulation or not under the legislation; ii the scope of powers to be granted to the HKMA for implementing regulation, balancing regulatory effectiveness and proportionality; iii major regulatory requirements; iv the scope of powers to be granted to the authorities (and related frameworks) to promptly update the regulatory system to cover additional structures or activities; v relevant guiding factors for the authorities in exercising the powers related to iv above.

This article is authorized reprint from Foresight News，Foresight News is a Chinese content platform in the Web3 vertical sector, upholding the basic principles of "objectivity and neutrality" and dedicated to creating a Chinese gateway to the Web3 world.