Prepare for a New Era: Hong Kong Monetary Authority Issues Conclusions on Cryptoassets and Stablecoin Regulation

On January 31, 2023, the Hong Kong Monetary Authority (the HKMA) published its conclusions (the Conclusions) on a discussion paper on cryptoassets and stablecoins, which set out the HKMA’s thoughts on the development of a regulatory framework for stablecoins that has the potential to develop into a widely acceptable means of payments.

This is the second publication made by an authoritative body in Hong Kong in the past three months. In October 2022, the Hong Kong government issued its Policy Statement on Development of Virtual Assets in Hong Kong, setting out its policy stance and approach toward regulating virtual assets. In addition, amendments to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance introducing a new statutory licensing regime for virtual asset service providers will become effective on April 1, 2023.

It is clear from all these developments that the regulators in Hong Kong are ramping up their efforts to regulate virtual assets and stablecoins, not least in the wake of unfavorable events that have unfolded in this space in recent years.

While it remains to be seen how the Conclusions will be implemented, it is now an apt time for market players to review the Conclusions to better understand the regulatory expectations of the HKMA and get prepared.

What types of stablecoins will be regulated?

The HKMA’s priority would be stablecoins that purport to reference to one or more fiat currencies, regardless of whether references are made through algorithms or arbitrage mechanisms, and whether the stablecoins are predominately used for retail, wholesale, or cryptoasset transactions. The reason given for prioritizing these stablecoins is that they are more likely to be used in payments and therefore potentially pose higher and more imminent monetary and financial stability risks.

The HKMA indicated that it would consider whether to exclude certain arrangements from the definition of stablecoins, for example, if they are already subject to another financial regulatory regime or used within a well-confined environment outside the reach of the general public.

What activities concerning stablecoins will be regulated?

The HKMA will focus on regulating the following functions:

• establishment and maintenance of rules governing an in-scope stablecoin arrangement
• issuance, creation, or destruction of in-scope stablecoins
• stabilization and reserve management arrangements of an in-scope stablecoin
• provision of services that allow the storage of users’ cryptographic keys that enable access to the users’ holdings of an in-scope stablecoin and management of such stablecoins

The HKMA has stated that it is inclined to develop different categories of licenses targeting each type of activity rather than a single type of license covering multiple types of activity.

In addition, the HKMA has indicated that those who market regulated activities to the public of Hong Kong should hold a relevant license. Any entity conducting a “stablecoin-related activity” in which the stablecoin concerned purports to reference its value to the Hong Kong dollar would also need a relevant license and be subject to regulatory requirements, regardless of whether the relevant regulated activity is conducted in Hong Kong or actively marketed to the general public of Hong Kong.

What type of regulatory requirements should be expected?

The HKMA has proposed that the regulatory requirements should cover a broad range of issues including ownership, governance and management, financial resources requirements, risk management, anti-money-laundering, user protection, and regular audits and disclosure requirements.

It is clear that the HKMA places emphasis on the reserve assets of a stablecoin arrangement in that the value of such reserve assets should meet the value of the outstanding stablecoins at all times. The HKMA also proposes that the reserve assets should also be of “high quality” and “high liquidity.” Stablecoins that derive their value based on arbitrage or algorithm will not be accepted. Stablecoin holders should also be able to redeem stablecoins into the referenced fiat currency at par value within a reasonable period.

Who can issue stablecoins?

The HKMA made clear that entities other than authorized institutions under the Banking Ordinance would also be allowed to issue stablecoins, so long as the entity can satisfy the relevant licensing and regulatory requirements.

The HKMA is also of the view that imposing a local incorporation requirement is highly conducive to enabling it to effectively supervise the licensed entities and enforce the regulatory requirements, particularly for ensuring that the company’s assets and liabilities will be appropriately segregated from the rest of the group and to facilitate seizure of assets where necessary for the purpose of user protection in case of failure of business.

Accordingly, overseas stablecoin issuers wishing to expand their business to Hong Kong should plan for how they should organize or reorganize their business structure.

Next Steps

While we would expect further clarification and details on the requirements in the course of implementation, the Conclusions shed important light on what market players and the general public should expect of the regulation of stablecoins. It is not surprising to see that the proposals raised by the HKMA are geared toward minimizing risks and sustaining Hong Kong’s financial and monetary stability. This is also the common theme of the stored value facility and banking regimes that the HKMA also administers. We would expect the stablecoin framework to bear considerable resemblance to those other frameworks. This is certainly a space to watch in 2023 and beyond.