Summary of consultation conclusions - Proposed regime for stablecoin issuers in Hong Kong

The Hong Kong Monetary Authority (HKMA) and the Financial Services and the Treasury Bureau (FSTB) recently (in July 2024) published their conclusions on the proposed regulatory regime for stablecoin issuers in Hong Kong (per consultation paper from last December).?

The regime aims to regulate fiat-referenced stablecoins (FRS). Particular defined terms to note:

• FRS - digital representations of value that are cryptographically secured, used as a medium of exchange, and maintain a stable value with reference to a specified currency or pool of currencies.
• Issuing FRS - creating or minting FRS and distributing them to users, or facilitating the creation or minting of FRS by users.?

Key features of proposed regime

??FRS issuers will be required to obtain a license from the HKMA and comply with various requirements - e.g. reserve asset management, disclosure, redemption, governance, and anti-money laundering and counter-terrorist financing.

???It will regulate FRS issuers that issue FRS in Hong Kong, reference the Hong Kong dollar, or actively market their FRS to the Hong Kong public.

??Certain types of stablecoins will not be regulated - including those that are: (1) not operated on decentralized distributed ledgers, (2) backed by commodities or other assets, and (3) issued by authorized institutions or licensed corporations.

??Further to (3) - certain licensed entities, such as banks, licensed virtual asset service providers, and licensed virtual asset over-the-counter service providers will (subject to their separate regulatory requirements) be able to offer FRS in Hong Kong without obtaining an additional license from the HKMA.

??There will be transitional period of six months for existing FRS issuers to apply for a license and comply with the new framework.

??FRS issuers are required to submit a license application to the HKMA, which will include information such as the FRS issuer's business plan, use case, white paper, reserve asset policy, risk management policy, AML/CFT policy, and key personnel.? The HKMA will assess the license application based on the FRS issuer's fitness and propriety, financial soundness, operational readiness, and compliance with the regulatory requirements.

Key restrictions

???FRS issuers cannot pay interest to FRS users, engage in certain business activities that may pose conflicts of interest or systemic risks, or issue FRS that are not fully backed by qualified reserve assets.

??Unless otherwise approved by HKMA - FRS issuers will be required to hold reserve assets in the same currency as the FRS and to safekeep them with licensed banks in Hong Kong.

??FRS issuers will be required to maintain minimum financial resources at HK$25 million or 1% of the par value of FRS in circulation, whichever is higher.

??The regime will limit the offering of FRS issued by non-licensed entities to professional investors only, and require clear disclosure of the non-licensed status of the FRS issuer.

Similarities with SVF regime

??The proposed regime for FRS issuers is similar to the existing regime for stored value facility (SVF) operators in Hong Kong, which also requires a license from the HKMA and compliance with regulatory requirements such as reserve asset management, disclosure, redemption, governance, and AML/CFT. There are also similarities re: the scope of licensing, the exclusions, the transitional period, and the offering regime.

???Additional requirements to the SVF regime (mostly specific to stablecoins) include the reserve asset eligibility and safekeeping, the financial resources requirements, and the interest payment prohibition.

Next Steps

??The HKMA has launched a stablecoin issuer sandbox in March 2024, which allows FRS issuers to test their business models and regulatory requirements within a limited scope and under the HKMA's close supervision.? The first batch of three participants was admitted to the sandbox on 18 July 2024, with use cases involving payments, supply chain management, and capital markets.

???????In the meantime and as part of Hong Kong's push towards developing a comprehensive virtual assets regime - the HKMA and FSTB are also conducting consultations on other aspects related to virtual assets, including: storage of private keys and provision of wallet services; frequency of public disclosure regarding FRS in circulation and market value and composition of reserve assets; SVF licensees' and VA OTC service providers' ability to offer FRS; considering establishing “passporting” arrangement or entering into mutual recognition agreements; and scope of stablecoins to be regulated.

What do you need to know?

When will the bill be passed? The HKMA and the FSTB are drafting the regulatory proposal into a bill, which is expected to be introduced to the Legislative Council later in the year 2024.?The HKMA will also issue licensing and supervisory guidelines to assist applicants and licensees in understanding and complying with the regulatory requirements - including how to determine whether an FRS is issued in Hong Kong; what would qualify as an “issuance” activity; scope of audit; and regulatory AML/CFT requirements consistent with international standards, covering transaction monitoring and compliance with travel rule.

There are some uncertainties - for example, there is no concrete timing for the proposing or passing of the above-referenced bill, and we will need to see further details regarding how any new rules for FRS issuers will integrate with Hong Kong's current licensing and regulatory frameworks for virtual assets service providers.

What about now? Given the above - payment industry intermediaries should consider either acquiring an existing licensed corporation or obtaining a license from the Commission, given currently only certain licensed corporations and VA trading platforms, are currently permitted to offer FRS to the public in Hong Kong.

Note - the HKMA does not plan to regulate activities related to stablecoins, such as managing reserve assets or providing wallet services, under the new licensing regime.

What about the other regulatory frameworks in HK? In Hong Kong, there are three main categories of payment service providers in the Virtual Asset (VA) payment sector:

• Money services operators - who provide “money services” (i.e., a money changing service and/or remittance service) will be expected to obtain a licence with the CCE under the AMLO, unless exempted from the licensing requirements (e.g. authorised institutions and insurers, SVF issuers).
• Stored value facility issuers - who issue a facility to be used for (a) storing the value of an amount of money that is paid into the facility and (b) making payments for goods or services under an undertaking given by the issuer or for making payments to another person under an undertaking given by the issuer.
• Clearing and Settlement Systems - These systems must operate within Hong Kong and accept transfer orders that are denominated in Hong Kong dollars for clearing or settlement. The HKMA's oversight ensures that the clearing and settlement processes are conducted securely and efficiently, maintaining the stability and integrity of the financial system.
• Retail Payment Systems - These systems, which also operate within Hong Kong, are subject to HKMA's oversight if they accept transfer orders for transfer, clearing, or settlement in any currency or any declared medium of exchange. Retail payment systems are crucial for everyday financial transactions, and their oversight by the HKMA is aimed at safeguarding consumer interests and promoting confidence in the financial transaction process.