Regulation
Hong Kong publishes proposed stablecoin legislation – Ledger Insights
The Financial Services and Treasury Bureau (FSTB) and the Hong Kong Monetary Authority (HKMA Research Institute) worked for two months Stablecoin Consultation at the beginning of the year with 108 responses. Today they published a legislative proposal including responses to issues raised in the consultation. They plan to introduce a bill to the Legislative Council later this year.
“In addition to the existing regulatory regime for VA (virtual asset) trading platforms, the establishment of a licensing regime for FRS (fiat-referenced stablecoin) issuers will further strengthen the VA regulatory framework in Hong Kong in line with international standards and effectively mitigate potential financial stability risks associated with FRS issuance activities,” said Secretary for Financial Services and Treasury, Mr Christopher Hui.
Today’s document has clarified several points, although there have been only a few changes since the original consultation. One amendment concerned capital. The original proposal was that stable currency Issuers must have the greater of 2% of stablecoin issuance or HKD25 million ($2.9 million) of equity. They have reduced the percentage to 1%, but this is a minimum and the HKMA can specify a higher amount on a case-by-case basis.
When they published the consultation, we highlighted the key points which we reproduce below with the addition of today’s clarifications.
Who can issue stablecoins?
Licensing requirements apply to issuers issuing a stablecoin in Hong Kong or referencing the Hong Kong dollar. Additionally, any stablecoin issuer that “actively markets” to Hong Kong users must apply for a license. Any issuer not licensed by the HKMA may only offer stablecoins to professional investors.
One conclusion to draw from this and other stablecoin regulations such as the EU MiCAR is that stablecoins that want to have global reach will likely need to have a physical presence in most countries.
The marketing of stablecoins will not be limited to issuers specializing in stablecoins. Hong Kong also allows cryptocurrency exchanges, regulated banks and some securities firms that have cryptocurrency licenses to offer stablecoins to customers, but the restriction for professional investors applies to unlicensed stablecoins.
One of the issues debated by the authorities was whether to adapt the existing regulations on electronic money (called stored value structures (SVF)). However, they decided that standalone regulations were more appropriate. The regulations also exclude CBDCs but notably do not mention the topic of tokenized deposits.
Stablecoin reserves and interest ban
Stablecoins cannot pay interest to holders. The HKMA said today that issuers can offer marketing incentives. But the incentive must not be related to the amount of stablecoins held and how long the user holds the balance. The issuer also cannot make arrangements with third parties to provide interest to users.
The original proposals did not provide specific details on the management of capital reserves. In today’s document, the HKMA said that the issuer should have made this clear during the application process. As for the separation of assets from those of the issuer, the HKMA prefers the creation of a trust based on comments in the consultation response.
Reserve assets must be “high quality” and “highly liquid”. Today, the HKMA clarified that this includes:
- Cash
- bank deposits
- Marketable securities issued by governments, central banks or qualified international organizations with high credit quality
- Overnight reverse repo contracts with minimal counterparty risk and the same quality of support
- Tokenized versions of the above assets.
There is a requirement that the assets must match the currency of the stablecoin, but the HKMA will allow some exceptions, provided the issuer obtains prior approval. Given the Hong Kong dollar (HKD) peg to the US dollar, the HKMA has stated that it intends to allow stablecoin issuers to include USD-denominated reserve assets. We would note that if the HKD ever abandons the US dollar peg, there is a risk that a stablecoin could lose its peg.
The reporting on the valuation and composition of the capital reserves was quite specific. The amount of stablecoins in circulation should be reported daily, the composition of the reserves weekly, and the auditors’ statements monthly.
There was some resistance in the consultation on monthly attestations. The HKMA did not concede on this, but said it could reduce the frequency of unverified public disclosures. This is surprising, given that we hope internally generated public disclosures will be automated. It is the attestations that are expensive.
Other requirements for stablecoins
Redemption requests for stablecoins must be handled in a timely manner. Today, the HKMA clarified that this means one business day under normal circumstances. The issuer may seek authorization from the HKMA for a longer period if there is a market stress scenario.
The consultation states that AML procedures should cover “issuance and refund, transaction monitoring and transfer requirements (‘travel rule’)”. Regarding transaction monitoring, does this refer to all transactions, not just those in which the issuer is directly involved?
The HKMA must authorize any additional stablecoins. It is unclear whether this applies exclusively to new brands or currencies or whether this also refers to the same brand issued on a different blockchain.
Issuers can provide wallet services and any other activity would require a license. However, an issuer cannot lend money or conduct other regulated activities.
There will be transitional rules, but current stablecoin issuances must be implemented within three months of the regulations coming into force. Otherwise, they must close.
Meanwhile, in March the HKMA launched a stablecoin sandbox.