Hong Kong consultation on regulatory regime for stablecoin issuers

The Financial Services and the Treasury Bureau of the Hong Kong government and the Hong Kong Monetary Authority (HKMA) conducted public consultations in December 2023 on a proposed regulatory regime for stablecoin activities in Hong Kong that would be effected by new legislation.

Scope of proposed regime

The proposed regime covers any fiat-referenced stablecoin (FRS), which is defined as a cryptographically secured digital representation of value that purports, among its features, to maintain a stable value with reference to one or more fiat currencies, except for items already covered by other regulatory regimes, such as deposits. This definition also excludes stablecoins that are referenced to precious metals or other assets.

The two types of activities to be regulated are:

1. FRS issuance, including: (i) issuing an FRS in Hong Kong; (ii) issuing an FRS with reference to the value of the Hong Kong dollar (regardless of whether the issuance is in Hong Kong); and (iii) active marketing of an FRS issuance to the Hong Kong public; and
2. FRS offering, including: (i) offering an FRS in Hong Kong; and (ii) active marketing of the offering to the Hong Kong public.

Engaging in such regulated activities without the relevant licence or authorisation will constitute a criminal offence. The HKMA will administer the proposed FRS-issuer licensing and regulatory regime.

FRS issuance

It is proposed that all FRS issuers be licensed by the HKMA. The licensing requirements would include:

• The value of the reserve assets backing the FRS must be always at least equal to the par value of the FRS in circulation. Issuers that derive FRS value from arbitrage or algorithms will not be granted licences.
• The reserve assets (normally in the referenced currency) must be of high quality and high liquidity, with minimal market, credit and concentration risks.
• An effective trust arrangement is required such that the reserve assets of the FRS are segregated from the issuer’s other assets, put in segregated accounts maintained with licensed banks in Hong Kong, or placed under other custodial arrangements approved by the HKMA, and are available to satisfy FRS redemptions.
• The FRS issuer must have adequate policies, guidelines and controls for managing all investment activities of the reserve assets to ensure funds are available to satisfy redemption requests.
• Any income for or loss from the reserve assets (e.g. interest payments, dividends or capital gains or losses) must be attributed to FRS issuers, but FRS issuers must not pay interest to FRS holders.
• An FRS issuer must be a company incorporated in Hong Kong. Its chief executive, senior management team and key personnel must be based in Hong Kong, and exercise effective management and control of the company’s FRS issuance and related activities.
• An FRS issuer’s minimum paid-up share capital is either HKD25 million (USD3.2 million) or 2% of the par value of FRSs in circulation, whichever is higher. The HKMA may impose a higher level of paid-up share capital requirement.
• FRS holders should have the right to redeem their FRS at par value in the relevant currency referenced by the FRS on a timely basis, without having to pay undue costs and without being subject to unreasonable redemption conditions (e.g. a very high minimum threshold amount).
• Appropriate risk management processes and measures must be in place, e.g. adequate security and internal controls to safeguard the integrity of data and systems, effective fraud monitoring and detection measures, technology risk-management measures, and robust contingency arrangements to address operational disruptions.
• Adequate and appropriate systems of control must be in place to prevent and combat possible money laundering and terrorism financing.
• The FRS issuer must seek the HKMA’s approval before commencing any new line of business. In any event, it should not carry on lending and financial intermediation, or conduct other Hong Kong regulated activities.
• It must publish a white paper to disclose general information about itself, FRS holders’ rights and obligations, a stabilisation mechanism, reserves management arrangements, the underlying technology, risks and redemption policies and processes.
• The total amount of the FRS in circulation, the mark-to-market value of reserve assets and the composition of reserve assets must be disclosed regularly to the public.
• The FRS issuer must submit audited financial statements to the HKMA annually.

FRS offering

FRS can be offered in Hong Kong only by licensed FRS issuers and other regulated entities, such as licensed corporations regulated by the Hong Kong Securities and Futures Commission, authorised institutions licensed by the HKMA, and licensed virtual asset trading platforms. Where the FRS is not issued by a licensed FRS issuer, the offering can be made only to professional investors.

Features of regulatory regime

This regime proposed by the Hong Kong regulators will provide adequate protection to FRS holders and address potential monetary and financial stability risks posed by FRSs. Certain locality elements are proposed (e.g. the FRS issuer must be a Hong Kong company with locally based senior management) to allow the HKMA to exercise effective supervision over such entities and persons. To protect the Hong Kong public, it fences Hong Kong retail investors off from being offered FRSs not issued by licensed FRS issuers.

This may be onerous to certain international FRS issuers, but it is an important step for Hong Kong to maintain its status as an international financial centre while developing a healthy stablecoin ecosystem at the same time.

Rossana Chu is a partner at Yang & Yang Solicitors