At the end of December Hong Kong launched a consultation on legislative proposals related to stablecoin issuers. The consultation is jointly run by the Hong Kong Monetary Authority (HKMA) which will be the stablecoin regulator and the Financial Services and the Treasury Bureau (FSTB). It runs until the end of February. Additionally, the HKMA plans to launch a regulatory sandbox for the same purpose.
One of the concerns is that stablecoins are a source of interconnectedness between the traditional financial (TradFi) system and cryptocurrencies. Hence, they present a potential financial stability risk that the authorities want to manage. The consultation explicitly mentioned the 2022 Terra UST collapse.
Additionally, the move is seen as a step in maintaining Hong Kong’s status as an international financial center. Other objectives include protecting stablecoin users and fostering a sustainable cryptocurrency (virtual asset) ecosystem in Hong Kong.
“We are supportive of financial innovation and believe that it is essential to put in place the necessary regulatory guardrails and standards to enable the long-term, sustainable and responsible development of the virtual asset ecosystem,” said Mr Eddie Yue, CEO of the HKMA.
Who can issue stablecoins?
Licensing requirements apply to issuers who issue a stablecoin in Hong Kong or reference the Hong Kong dollar. Additionally, any stablecoin issuer that “actively markets” to Hong Kong users needs to apply for a license. Any issuers not licensed by the HKMA can only offer stablecoins to professional investors.
However, the marketing of stablecoins will not be restricted to specialist stablecoin issuers. Hong Kong also envisages crypto exchanges, regulated banks and certain securities firms that have crypto authorizations being able to offer stablecoins to clients, but the professional investor restriction applies to unlicensed stablecoins.
One of the issues the authorities debated was whether to adapt existing e-money regulations (referred to as stored value facilities (SVF)). However, it decided standalone regulations were more appropriate. The regulations also exclude CBDCs but notably don’t mention the topic of tokenized deposits.
What’s unusual is that Hong Kong’s proposals cover algorithmic stablecoins. However, such digital currencies aren’t likely to receive licenses because it requires at least one-for-one backing for the stablecoin reserves.
Some of the stablecoin requirements
Stablecoins cannot pay interest to holders.
Some of the requirements are currently quite broad brush while others are detailed. Reserve assets must be ‘high quality’ and ‘highly liquid’. Redemption requests should be dealt with in a timely manner without prescribing how long.
In contrast, reporting on the valuation and composition of reserve assets is more specific. The stablecoin amount in circulation should be reported daily, the composition of reserves weekly, and auditor attestations monthly. However, the regulations are not static, meaning other topics could become more prescriptive.
Another area that isn’t entirely clear relates to anti money laundering (AML). The consultation states that AML procedures should cover “issuance and redemption, transaction monitoring and wire transfer (“travel rule”) requirements”. Concerning transaction monitoring, does that relate to all transactions, not just ones in which the issuer is directly involved? We suspect it might.
The HKMA must authorize any additional stablecoins. It’s unclear if this purely applies to new brands or currencies or whether that also relates to the same brand being issued on a different blockchain.
Issuers can provide wallet services and any other activities would require authorization. However, an issuer cannot lend money or conduct other regulated activities.
Issuers have to be based in Hong Kong and have a capital of at least HK$ 25 million ($3.2m) or 2% of the stablecoin issuance, whichever is higher.
There will be transitional rules, but existing stablecoin issues must apply within three months of the regulations coming into force. If not, they have to shut down.
