Hong Kong is taking significant strides towards establishing a comprehensive regulatory framework for stablecoin issuers. The Financial Services and the Treasury Bureau (“FSTB”) and the Hong Kong Monetary Authority (“HKMA”) jointly issued a consultation paper on 27 December 2023 on the proposed regulatory regime for stablecoin issuers in Hong Kong (“Consultation Paper”) and jointly published the consultation conclusions on 17 July 2024 (“Consultation Conclusions”) following the end of the two-month consultation period.

This article summarises the key aspects of the legislative proposal, including the scope and coverage of the proposed regulatory regime, the licensing criteria and conditions and the powers granted to the HKMA.

Scope and Coverage

Definitions of “stablecoin” and “fiat-referenced stablecoin” (“FRS”)

In the Consultation Paper, “stablecoin” is defined as a cryptographically secured digital representation of value that, among other things, —

1. is expressed as a unit of account or a store of economic value;
2. is used, or is intended to be used, as a medium of exchange accepted by the public, for the purpose of payment for goods or services; discharge of a debt; and/or investment;
3. can be transferred, stored or traded electronically;
4. uses a distributed ledger or similar technology that is not controlled solely by the issuer; and
5. purports to maintain a stable value with reference to a specified asset, or a pool or basket of assets.

“FRS” is defined as a stablecoin where the specified asset is one or more fiat currencies.

The respondents to the Consultation Paper generally agree to the proposed definitions. The proposed exclusion of certain financial instruments that are already covered by existing regulatory regimes (such as deposits, authorised collective investment schemes, authorised structured products, float stored in stored value facilities, etc.) from the definition of “stablecoin” has also received broad consensus.

Considering that the proposed regulatory regime intends to primarily focus on representations of value which rest on ledgers that are operated in a decentralised manner, it is concluded in the Consultation Conclusions that limb (d) of the definition of “stablecoin” will be amended to specify that the stablecoins subject to the proposed regulatory regime are those “operated on a decentralised distributed ledger or similar technology”. A “decentralised distributed ledger” refers to a distributed ledger in which no person has the unilateral authority to control or materially alter its functionality or operation.

Scope of regulated activity

It is proposed in the Consultation Paper that the regulatory regime will prioritise regulation of FRS issuance activity, considering that FRS has a higher potential to be used as a commonly acceptable means of payment, as compared with other types of virtual assets. A significant majority of respondents agree with this approach.

With regard to what constitutes an “issuance” activity, it is clarified in the Consultation Conclusions that it is generally decided on a case-by-case basis with respect to specific facts and circumstances. Further guidelines will be issued upon the implementation of the regulatory regime to provide further guidance to the industry.

Regulatory Framework

In the Consultation Paper, it is proposed that under the proposed licensing regime for FRS issuers, no person shall:

1. issue, or hold oneself out as issuing, an FRS in Hong Kong;
2. issue, or hold oneself out as, issuing a stablecoin that purports to maintain a stable value with reference to the value of the Hong Kong dollar; or
3. actively market its issuance of FRS to the public of Hong Kong;

unless it is a company that holds an FRS issuer licence granted by the HKMA.

“Actively market” may include frequently calling on members of the Hong Kong public and marketing their services and running a mass media programme or Internet activities targeting the Hong Kong public, etc.

The proposed scope of the regulatory regime is generally agreed. On the question of how to determine whether a person is “actively marketing” an issuance of FRS to the Hong Kong public, it is clarified in the Consultation Conclusions that the HKMA will take into account multiple factors such as the language used in the marketing messages, whether the messages are targeted at people that resides in Hong Kong and whether a Hong Kong domain name is used for its website, etc.

Licensing Criteria and Conditions

Under the proposed regulatory regime, any person who issues FRS in Hong Kong will be required to obtain a licence from the HKMA.  Some of the key licensing criteria and conditions as proposed in the Consultation Paper (and modified in the Consultation Conclusions, if applicable) are broadly summarised below:

• Full backing: The FRS issuer must ensure that the value of the reserve assets backing an FRS is at least equal to the par value of the FRS in circulation at all times.
• Investment limitations: The reserve assets must be of high quality and high liquidity with minimal market, credit and concentration risk.
• Segregation and safekeeping of reserve assets: The FRS issuer must ensure that the reserve assets are segregated from other assets and are available to satisfy FRS holders’ redemption as well as their legal right and priority claim of the reserve assets in the event of the FRS issuer’s insolvency.
• Risk management and controls: The FRS issuer must formulate adequate policies, guidelines and controls for the proper management of all investment activities associated with the management of the reserve assets. …READ FULL ARTICLE
  

Author: Sam Wu at YYC Legal LLP