Prospective Hong Kong Fiat-Referenced Stablecoin Issuers’ Insight into Hong Kong Monetary Authority’s Supervisory Authority

August 13, 2024

摘要

The Financial Services and the Treasury Bureau and the Hong Kong Monetary Authority (HKMA) jointly published the consultation conclusions on the legislative proposal to implement a regulatory regime for fiat-referenced stablecoin (FRS) issuers in Hong Kong. The conclusions indicate that a draft bill will be introduced later in the year. This Update¹ summarizes the HKMA’s intended supervisory authority over FRS issuers in Hong Kong and FRS issuers of HKD-referenced stablecoins that would likely target members of the Hong Kong public. Though the proposed legislation only covers issuers (but not firms that distribute or trade FRS), the update intends to provide some navigation points to prospective FRS issuers ahead of legislation enactment and non-issuers with a foretaste of Hong Kong’s upcoming regulatory regime relating to stablecoins.

Following the proposed introduction of a new licensing regime for “fiat-referenced” stablecoin (FRS) issuers under the purview of the Hong Kong Monetary Authority (HKMA), what does it mean to market participants venturing into this new facet of the monetary system?

Traditionally, as a bank regulator, the HKMA is empowered under the Banking Ordinance (BO) and is responsible for the

authorization (including suspension and revocation), regulation and supervision of banking business (covering licensed banks, restricted banks and virtual banks) and the business of taking deposits conducted by deposit-taking companies in Hong Kong
approval and supervision of money brokers operating in the interbank foreign exchange and deposit markets in Hong Kong
licensing and supervision of stored value facilities (SVFs), including e-wallets and prepaid cards, and the designation and oversight of retail payment systems (RPSs) in Hong Kong

Under the HKMA’s supervisory authority vested in it by the BO, the HKMA’s principal function is to “promote the general stability and effective working of the banking system.” On this mission, the HKMA has established a comprehensive regulatory framework in line with international standards in supervising the banking sector and adopted a risk-based supervisory approach.

Essentially, this approach is based on a policy of “continuous supervision” of banking institutions through on-site examinations, off-site reviews, prudential meetings, cooperation with external auditors, and information sharing and collaborative efforts with other local and overseas supervisor authorities, for example, the Securities and Futures Commission (SFC) and the Insurance Authority (IA).

The HKMA has had experience venturing into the authorization arena relating to fintech and innovation upon the introduction of its authorization regime for virtual banks. Virtual banks are expected to

deliver retail banking services through the internet or other forms of electronic channels
offer a new kind of customer experience
promote financial inclusion as they normally target small and medium-size enterprises in the retail segment

Subject to adhering to the risk-based and technology-neutral approach while taking into consideration the business models of virtual banks, the same supervisory approach and regulatory requirements apply equally to virtual banks and traditional banks. The supervisory requirements are embedded among published guidance in the form of supervisory policy manuals, guidelines, and circulars.

In addition to virtual banks, the HKMA is also the supervisory authority empowered under the Payment Systems and Stored Value Facilities Ordinance (PSSVFO) to oversee the operations of SVFs and RPSs. The regulatory regime for SVFs issuers similarly adopts a licensing regime administered by the HKMA. Through the publication of guidelines and practice notes setting out the HKMA’s supervisory requirements and the use of regulatory tools, such as on-site examinations, off-site reviews, independent assessments, review of auditors’ reports and management meetings with SVFs, the HKMA exercises its supervisory authority over SVFs on a continuous basis. Notably, under the PSSVFO, the HKMA is empowered to impose sanctions, including pecuniary penalties, and to take disciplinary actions against SVFs.

HKMA as the regulator for FRS issuers

As set out in the consultation conclusions on the proposed regulatory regime for FRS issuers published on July 17, 2024, the HKMA and the Financial Services and the Treasury Bureau (FSTB) concluded as follows with regards to aspects of the HKMA’s supervisory authority.

Salient features of the HKMA’s intended supervisory authority over FRS issuers

HKMA’s proposed powers	What the HKMA may do	Why the HKMA may exercise such powers
Modification of the regulatory regime Note: Referencing experience of the Virtual Asset Service Provider regime	Adjust the parameters of in-scope stablecoins and activities.	This power is intended to ensure the regime is sufficiently flexible to allow for adjustments to adapt to changes in the operating landscape with respect to FRS.
Supervision Note: In line with other regimes administered by the HKMA (i.e., under the BO and PSSVFO)	1. Intervention in operations of FRS issuer require the licensee to do any act relating to the licensee’s affairs, business, or property, as considered necessary by the HKMA, including restricting the licensee’s business of issuing FRS give directions to the licensee to seek advice on the management of its affairs, business, and property from an adviser appointed by the HKMA give directions that a licensee’s affairs, business, and property must be managed by a managed appointed by the HKMA	In circumstances where the FRS issuer has become or is likely to become insolvent or unable to meet its obligations; is carrying on its business in a manner detrimental to the interests of its users or its creditors; or has contravened any of its licensing conditions or provisions of the licensing regime.
2. Requirement for prior consent for changes in ownership/management	Prior consent from the HKMA to be required where there is/are amalgamation, including any arrangement or agreement for the sale or disposal of all or part of the business of the FRS issuers persons becoming or being “controllers” (majority shareholder controller, minority shareholder controller, and indirect controller) and sale of shares appointment of chief executives and directors
d. Gathering information from FRS issuers Empowered to request information or documents, without limitation to reports prepared by internal and external auditors and books, accounts, and transactions between the licensee and its subsidiaries Empowered to conduct on-site examinations at the premises of the licensees	The authority to request information and conduct site visits is to empower the HKMA to regularly monitor compliance with the regulatory regime.
e. Providing directions for compliance Empowered to direct licensees to take necessary action to bring the licensee into compliance with statutory obligations	The authority to provide directions is a power to require nonconforming licensees to take compliance steps.
f. Making supporting regulations Empowered to make regulations under the licensing regime, e.g., specific requirements in relation to the issuance and redemption of FRS, reserves management, and risk management.	The authority to make regulations is to ensure that the legislative regime is able to operate effectively.
g. Issuing guidelines and circulars Empowered to issue guidelines regarding the manner in which the HKMA expects to perform its functions under the new licensing regime licensees’ compliance with the proposed regulatory regime practical guidance to assist licensees in complying with statutory requirements	The HKMA would commonly prepare guidelines and circulars to inform licensees on practical applications of the regime and set expectations of compliance.
Investigation Note: Similar to investigation powers under the PSSVFO and Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO)	Conducting investigations; compelling disclosure of evidence related to potential misconduct and breaches of statute; reviewing documents; and applying for and executing search warrants. Empowered to conduct investigations where it has reasonable cause to believe that an offense under the intended regulatory regime may have been committed.For example, the HKMA may direct an investigator to conduct an investigation compel provision of evidence from persons relevant to the suspected contravention by way of producing documents, providing explanations, or attending interviews inspect documents procured during the investigation apply to a magistrate for search warrants and seizures	Investigative powers are a substantive aspect of the HKMA’s ability to take enforcement action against noncompliance with the statutory or regulatory requirements. The proposed powers to be vested in the HKMA are in line with other similar legislation.
Sanction, Disciplinary, and Appeal Mechanism Note: Reference made to the AMLO and other financial regulations	1. Pursuing criminal offenses and sanctions issuing an FRS in Hong Kong, issuing a Hong Kong dollar-referenced stablecoin, or actively marketing one’s own issuance of FRS to the public of Hong Kong without a licence advertising the issuance of FRS of an unlicensed issuer failing to produce documents as required by the HKMA giving false information to the HKMA making false entries in documents contravening other conditions required by the HKMA in relation to the licensing regime	The HKMA may pursue criminal proceedings against FRS issuers who are violating the offense provisions within the proposed legislation. Fines and imprisonment may be imposed upon conviction. This is to deter FRS issuers from acting outside of the regime.
2. Pursuing civil and supervisory sanctions issuing a caution, warning, reprimand, or order to take specified actions and issuing supervisory sanctions, including temporary suspension, suspension, or revocation of license (or a combination of the above), or imposing a pecuniary penalty not exceeding HK$10,000,000 or three times the amount of profit gained or loss avoided as a result of the contravention, whichever is higher, or any combination of the above.	The HKMA may pursue civil proceedings and impose supervisory sanctions against FRS issuers who are in breach of regulatory requirements or licensing conditions. This is to encourage FRS issuers to comply with the regulatory requirements under the regime and penalize those who fail to do so.
3. Appeal mechanism Set up an appeal tribunal mechanism (Tribunal) for appeals against the HKMA’s decision in relation to the implementation of the licensing and supervisory requirements. Dissatisfied persons with a decision of the Tribunal may appeal to the Court of Appeal against the determination of a point of law. Appealable decisions include refusal to grant licences for FRS issuance attachment of conditions to licenses attachment of conditions to an exemption granted to an issuer revocation and suspension of licenses objection to controllers, directors, and key personnel of licensees (e.g., the chief executive) imposition of civil and supervisory sanctions	The appeal mechanism would be made available to allow an aggrieved party to appeal a decision of the HKMA, as appropriate.

HKMA’s proposed powers

What the HKMA may do

Why the HKMA may exercise such powers

Modification of the regulatory regime

Note: Referencing experience of the Virtual Asset Service Provider regime

Adjust the parameters of in-scope stablecoins and activities.

This power is intended to ensure the regime is sufficiently flexible to allow for adjustments to adapt to changes in the operating landscape with respect to FRS.

Supervision

Note: In line with other regimes administered by the HKMA (i.e., under the BO and PSSVFO)

1. Intervention in operations of FRS issuer

require the licensee to do any act relating to the licensee’s affairs, business, or property, as considered necessary by the HKMA, including restricting the licensee’s business of issuing FRS
give directions to the licensee to seek advice on the management of its affairs, business, and property from an adviser appointed by the HKMA
give directions that a licensee’s affairs, business, and property must be managed by a managed appointed by the HKMA

In circumstances where the FRS issuer

has become or is likely to become insolvent or unable to meet its obligations;
is carrying on its business in a manner detrimental to the interests of its users or its creditors; or
has contravened any of its licensing conditions or provisions of the licensing regime.

2. Requirement for prior consent for changes in ownership/management

Prior consent from the HKMA to be required where there is/are

amalgamation, including any arrangement or agreement for the sale or disposal of all or part of the business of the FRS issuers
persons becoming or being “controllers” (majority shareholder controller, minority shareholder controller, and indirect controller) and sale of shares
appointment of chief executives and directors

d. Gathering information from FRS issuers

Empowered to request information or documents, without limitation to reports prepared by internal and external auditors and books, accounts, and transactions between the licensee and its subsidiaries
Empowered to conduct on-site examinations at the premises of the licensees

The authority to request information and conduct site visits is to empower the HKMA to regularly monitor compliance with the regulatory regime.

e. Providing directions for compliance

Empowered to direct licensees to take necessary action to bring the licensee into compliance with statutory obligations

The authority to provide directions is a power to require nonconforming licensees to take compliance steps.

f. Making supporting regulations

Empowered to make regulations under the licensing regime, e.g., specific requirements in relation to the issuance and redemption of FRS, reserves management, and risk management.

The authority to make regulations is to ensure that the legislative regime is able to operate effectively.

g. Issuing guidelines and circulars

Empowered to issue guidelines regarding
- the manner in which the HKMA expects to perform its functions under the new licensing regime
- licensees’ compliance with the proposed regulatory regime
- practical guidance to assist licensees in complying with statutory requirements

The HKMA would commonly prepare guidelines and circulars to inform licensees on practical applications of the regime and set expectations of compliance.

Investigation

Note: Similar to investigation powers under the PSSVFO and Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO)

Conducting investigations; compelling disclosure of evidence related to potential misconduct and breaches of statute; reviewing documents; and applying for and executing search warrants.

Empowered to conduct investigations where it has reasonable cause to believe that an offense under the intended regulatory regime may have been committed.For example, the HKMA may
- direct an investigator to conduct an investigation
- compel provision of evidence from persons relevant to the suspected contravention by way of producing documents, providing explanations, or attending interviews
- inspect documents procured during the investigation
- apply to a magistrate for search warrants and seizures

Investigative powers are a substantive aspect of the HKMA’s ability to take enforcement action against noncompliance with the statutory or regulatory requirements. The proposed powers to be vested in the HKMA are in line with other similar legislation.

Sanction, Disciplinary, and Appeal Mechanism

Note: Reference made to the AMLO and other financial regulations

1. Pursuing criminal offenses and sanctions

issuing an FRS in Hong Kong, issuing a Hong Kong dollar-referenced stablecoin, or actively marketing one’s own issuance of FRS to the public of Hong Kong without a licence
advertising the issuance of FRS of an unlicensed issuer
failing to produce documents as required by the HKMA
giving false information to the HKMA
making false entries in documents
contravening other conditions required by the HKMA in relation to the licensing regime

The HKMA may pursue criminal proceedings against FRS issuers who are violating the offense provisions within the proposed legislation. Fines and imprisonment may be imposed upon conviction. This is to deter FRS issuers from acting outside of the regime.

2. Pursuing civil and supervisory sanctions

issuing a caution, warning, reprimand, or order to take specified actions and issuing supervisory sanctions, including temporary suspension, suspension, or revocation of license (or a combination of the above), or
imposing a pecuniary penalty not exceeding HK$10,000,000 or three times the amount of profit gained or loss avoided as a result of the contravention, whichever is higher, or
any combination of the above.

The HKMA may pursue civil proceedings and impose supervisory sanctions against FRS issuers who are in breach of regulatory requirements or licensing conditions. This is to encourage FRS issuers to comply with the regulatory requirements under the regime and penalize those who fail to do so.

3. Appeal mechanism

Set up an appeal tribunal mechanism (Tribunal) for appeals against the HKMA’s decision in relation to the implementation of the licensing and supervisory requirements.
Dissatisfied persons with a decision of the Tribunal may appeal to the Court of Appeal against the determination of a point of law. Appealable decisions include
- refusal to grant licences for FRS issuance
- attachment of conditions to licenses
- attachment of conditions to an exemption granted to an issuer
- revocation and suspension of licenses
- objection to controllers, directors, and key personnel of licensees (e.g., the chief executive)
- imposition of civil and supervisory sanctions

The appeal mechanism would be made available to allow an aggrieved party to appeal a decision of the HKMA, as appropriate.

HKMA’s overarching concerns

Drawing on the analogy of the HKMA’s authorization powers over virtual banks and SVFs, let’s be reminded of what underpins the HKMA’s exercise of its powers:

risk posed to the monetary and financial stability of Hong Kong
risk posed to the functioning of Hong Kong as an international financial center
matters of significant public interest

The HKMA has indicated that these criteria and factors related to financial stability risks and of public interests would be considered in exercising powers under other financial regulatory regimes in Hong Kong (i.e., in its capacity as the supervisory authority of FRS issuers).

FRS issuers’ navigation points

Against the HKMA’s overarching concerns, we highlight various key signposts to help market participants in navigating the HKMA’s new supervisory authority over FRS issuers:

(1) Familiarity with HKMA’s regulatory supervisory protocol

Given that the proposed legislative proposal has indicated that the HKMA will be the supervisory authority with powers to grant licenses to FRS issuers, familiarization with the HKMA’s prevailing regulatory supervisory protocol and the proposed licensing criteria and conditions that may apply, spanning, for example, management of reserves and stabilization mechanism, segregation and safekeeping of reserve assets, risk management, and financial resources would provide a head start to payment services providers keen to become FRS issuers.

(2) Investigation and sanction approach to be similar to PSSVFO and AMLO

It is anticipated that the HKMA’s intended enforcement approach against FRS issuers will be consistent with its current practices in taking investigative, disciplinary, and civil/criminal court actions against service providers breaching the PSSVFO and AMLO, as appropriate. As with any other enforcement steps conducted by Hong Kong regulators, FRS issuers are strongly advised to cooperate with the HKMA on the one hand and to seek professional assistance to navigate the investigation process in order to mitigate associated risks (i.e., reputation or otherwise) arising from this process.

(3) Growing regulatory engagement and cooperation

With regard to the imposition of criminal offenses and sanctions, the HKMA and FSTB have stated there would be further discussions with the Department of Justice to ensure that the proposed offenses and sanctions would be sufficient and appropriate to bring about a deterrent effect. Regardless, regulatory cooperation is a growing trend as licensing and/or regulatory regimes intertwine among different regulators and asset classes in the increasingly technology-affected financial markets.

Hong Kong regulators including the HKMA, the SFC, and IA have joined forces recently on various cases of mutual concern to investigate and discipline regulated entities and/or their personnel for misconduct². These cases illustrate the increased level of cooperation between Hong Kong regulators through sharing of actionable evidence and intelligence obtained through one regulator’s investigations, which then facilitates the enforcement actions of another regulator. The regulators have notably commented that this approach is to foster a compliance culture in the financial industry, ensure there is accountability, and uphold the integrity of Hong Kong’s financial markets.

(4) Watchful eye on HKMA alerts

In addition to familiarizing with the HKMA’s prevailing regulatory supervisory protocol under the BO, AMLO, and PSSVFO, individuals should also increase their awareness of potential joint regulatory actions undertaken by regulators. The HKMA has also emphasized that it will continue to issue press releases alerting the public to suspicious FRS issuers and websites. Emphasis will be placed on the importance of exercising caution and vigilance in relation to dealing with suspicious FRS issuers and marketing campaigns launched on suspicious websites. This follows the existing practice of the HKMA and also the SFC’s practice in issuing warnings to the public of suspected VA-related frauds and lists of suspicious investment products since the introduction of the VA service provider licensing regime.

¹ https://www.sidley.com/en/insights/newsupdates/2024/08/hong-kong-tokenization-buzz-2024-hk-proposes-regulatory-regime-for-stablecoin-issuers
² Joint press release co-issued by the SFC and the IA on July 26, 2024: https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=24PR128 and joint press release co-issued by the IA and HKMA on January 10, 2024: https://www.hkma.gov.hk/eng/news-and-media/press-releases/2024/01/20240110-3/

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