Legal Update – HKMA Consultation Conclusions on Crypto-assets and Stablecoins

On 31 January 2023, the Hong Kong Monetary Authority (the “HKMA”) issued the consultation conclusions to its discussion paper published on 12 January 2022 (the “Consultation Conclusions”). The Consultation Conclusions provide critical insights into the shape of the HKMA plans for stablecoin regulation in Hong Kong.

Regulation of fiat-linked stablecoins

Unsurprisingly, the HKMA proposes to bring certain activities relating to stablecoins into its regulatory perimeter under a mandatory licensing regime. The HKMA will regulate stablecoins that derive their value by referencing one or more fiat currencies. This type of stablecoin is more likely to be used for payments, and will be more closely linked to the traditional financial system. The HKMA perceives this as potentially posing more imminent monetary and financial risk.

The trigger for regulation will be the reference of the stablecoin to fiat currencies, and will be agnostic to the stabilisation mechanism deployed. This will provide more flexibility to the HKMA to decide if other types of stablecoins should be brought within its regulatory ambit.

The HKMA will exclude certain arrangements from the definition of stablecoins. This is intended to avoid regulatory overlap with regulatory regimes for virtual asset service providers and stored value facilities, in particular. The HKMA also expressed it would take account of the international environment in which stablecoins are used, and would consider international practice and standards in its regulatory approach.

Key activities to be regulated

The key activities that will be subject to the licensing regime are:

1. Governance: Establishment and maintenance of the rules governing a regulated stablecoin arrangement;
   
    
2. Issuance: Issuance, creation or destruction of regulated stablecoins;
   
    
3. Stabilisation: Stabilisation and reserve management arrangements of regulated stablecoins (whether or not the arrangements are provided by the issuer); and
   
    
4. Wallets: Provision of services that allow the storage of users’ cryptographical keys enabling access to the users’ holdings and management of regulated stablecoins.

The HKMA may include new types of regulated activities in future regulation.

The licensed entity performing regulated activities must retain ultimate control, even if certain activities are outsourced. More guidance on this and other aspects of the licensing regime will be elaborated in future guidelines.

Who will need to be licensed?

The following entities will need to be licensed by the HKMA:

1. Entities conducting a regulated activity in Hong Kong concerning a regulated stablecoin;
   
    
2. Entities actively marketing regulated activities in respect of a regulated stablecoin to the public of Hong Kong; and
   
    
3. Entities conducting stablecoin-related activities in which the stablecoin concerned purports to reference its value to the Hong Kong dollar (regardless of location or marketing to the public of Hong Kong).

The HKMA will be able to supplement these categories according to circumstances.

The HKMA considers that both authorised institutions and non-authorised institutions should be allowed to issue stablecoins, so long as they comply with licensing and regulatory requirements. The licensing conditions and regulatory approach will be calibrated to the risk each type of issuer presents.

Key regulatory principles

The HKMA will not have a single licence type for all activities. It will customise regulatory requirements to specific types of activities involving stablecoins. The HKMA will adopt these regulatory principles:

Comprehensive regulatory framework: We can expect regulations to cover:

1. ownership;
    
2. governance and management;
    
3. financial resources requirements;
    
4. risk management;
    
5. anti-money laundering and counter-terrorist financing;
    
6. user protection; and
    
7. regular audits and disclosure requirements

Full backing and redemption at par: The value of the reserve assets of a stablecoin arrangement should meet the value of the outstanding stablecoins at all times. The reserve assets should be of high quality and high liquidity. Stablecoins that derive their value based on arbitrage or algorithm will not be accepted. Stablecoin holders will have the right to convert stablecoins into the reference referenced fiat currency at par within a reasonable period of time.

Principal business restriction: Regulated entities will not be permitted to conduct activities other than its principal business under the relevant licences

Steps from here

The HKMA aims to put in place the regulatory regime for stablecoins by 2023/2024.

The draft legislation will cover key issues such as:

1. defining the arrangements and activities that will be subject to regulation;
    
2. the licensing, rulemaking and enforcement powers be granted to the HKMA; and
    
3. the key regulatory requirements.

The HKMA Consultation Conclusions in full is available on this link.

Pádraig Walsh & Raymond Li

If you would like to discuss any of the matters raised in this article, please contact:

Pádraig Walsh
Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.