The Financial Services and the Treasury Bureau (FSTB) and the Hong Kong Monetary Authority (HKMA) today (December 27) jointly published a public consultation paper to solicit views on the legislative proposals on the regulation of stablecoin issuers.
In response to the important role of stablecoins in the Web3 and virtual asset ecosystem, and the increasingly close connection between the traditional financial system and the virtual asset market, the government believes that it is necessary to establish a regulatory system for issuers of fiat stablecoins. As virtual assets become more popular, regulating fiat stablecoin issuers in a risk-based and flexible manner can appropriately manage potential monetary and financial stability risks and provide transparent and appropriate regulations.
The legislative proposals have taken into account the market and public views collected in the Discussion Paper on Crypto-Assets and Stablecoins published by the HKMA last year, ongoing discussions with stakeholders, local market conditions and needs, and relevant international standards. The highlights are as follows:
(a) Implement a licensing system by introducing new legislation, requiring all eligible fiat stablecoin issuers to obtain a licence issued by the Monetary Authority;
(ii) requiring that only designated licensed institutions can provide services for purchasing legal tender stablecoins, and that only legal tender stablecoins issued by licensed issuers can be sold to retail investors;
(III) Prohibition of promotion:
(i) Issuance of fiat stablecoins by unlicensed issuers;
(ii) Services for purchasing legal tender stablecoins provided by non-designated licensed institutions;
(iv) empowering authorities to adjust the scope of regulated stablecoins and activities in response to rapid changes in the virtual asset market;
(V) Providing transitional arrangements to facilitate the smooth implementation of the regulatory system.
The HKMA will also launch a "sandbox" arrangement to convey regulatory expectations and provide compliance guidance to issuers who intend to and have concrete plans to issue fiat stablecoins in Hong Kong, while collecting their opinions on the proposed regulatory requirements to facilitate the implementation of the subsequent regulatory system and ensure that the system is in line with regulatory objectives. Details of the "sandbox" will be announced separately.
Secretary for Finance and the Treasury, Mr Hui Ching-yu, said: “With the implementation of the licensing regime for virtual asset trading platforms in June this year, the legislative proposal to regulate fiat stablecoin issuers is another important step to promote the development of Hong Kong’s Web3 ecosystem. The implementation of the relevant licensing, regulatory and enforcement arrangements can properly manage the actual and potential risks associated with the development of stablecoins in Hong Kong and be consistent with international standards.”
HKMA Chief Executive Eddie Yue said: "While we support financial innovation, we also believe that necessary regulatory limits and standards need to be put in place to promote the long-term, sustainable and responsible development of the virtual asset ecosystem. Therefore, while launching the public consultation, we will also launch a 'sandbox' arrangement as a channel for the HKMA to exchange views with market participants who are interested in conducting stablecoin issuance business in Hong Kong, so as to facilitate the implementation of the regulatory system."
Legislative method
1. After weighing the options of introducing the proposed regulatory regime by amending the Anti-Money Laundering Ordinance, the Payments Ordinance and enacting new legislation, the Treasury and the HKMA proposed enacting new legislation based on the following considerations:
(a) Stablecoins and stored value facilities may have different characteristics. Therefore, it is more appropriate to enact separate legislation to regulate issuers of fiat currency stablecoins than to incorporate the relevant regulatory regime into the Payment Ordinance.
(b) It seems more appropriate to use new legislation to deal with an area that is still in its infancy, such as stablecoins. If necessary, the new legislation can also serve as a basis for expanding the regulatory regime to other virtual asset activities in the future.
2. It is now proposed to first bring fiat stablecoin issuers under the HKMA’s regulatory scope. As the market and international regulatory discussions continue to evolve, the Government will continue to work with other financial regulators to assess the risks of other virtual assets and activities and consider their need to be brought under regulation.
3. The Treasury and the HKMA also note that under the proposed regulatory regime for fiat currency stablecoin issuers, the regulated issuance activities may overlap with other financial regulatory regimes in Hong Kong. In order to avoid subjecting fiat currency stablecoin issuers to multiple regulatory regimes, it is now proposed that the issuance of fiat currency stablecoins by licensed issuers will be excluded from certain regulatory regimes, such as the regulatory regimes applicable to securities (including collective investment schemes) and stored value payment instruments.
Regulatory framework for issuers of fiat stablecoins
1. Licensing system for issuers of legal currency stablecoins
1.1 It is proposed that under the new licensing regime for fiat stablecoin issuers, unless a company holds a licence granted by the Monetary Authority, no person shall:
(1) Issue or indicate that it issues legal tender stablecoins in Hong Kong;
(2) issuing or holding itself out as issuing a stablecoin that claims or purports to maintain a relatively stable value relative to the Hong Kong dollar;
(3) Actively promote the issuance of its fiat stablecoin to the Hong Kong public.
2. Licensing Criteria and Conditions
2.1 Reserve Management and Stabilization Mechanisms
(a) Full Reserve Backing: Fiat stablecoin issuers must ensure that the total value of the reserve assets of the fiat stablecoin is at least equal to the face value of the fiat stablecoin in circulation at all times. Given the fundamental difficulty of maintaining a robust stability mechanism for issuing fiat stablecoins whose value is derived by arbitrage or algorithmically in the absence of valuable reserve assets, such issuers will not be licensed.
(b) Investment restrictions: Reserve assets must be high quality, highly liquid and involve only minimal market, credit and concentration risks. The currency of denominated reserve assets should correspond to the currency to which the fiat stablecoin is referenced, and appropriate flexibility will be allowed in individual cases approved by the Monetary Authority. When deciding on the allocation of reserve assets, the issuer of a fiat stablecoin should consider the liquidity needs of the relevant assets and how to ensure that such needs are met when managing the reserve assets and making relevant investments. The Monetary Authority must be able to ensure that the types of assets and allocations proposed by the issuer of a fiat stablecoin are appropriate. Therefore, issuers need to formulate investment policies and review their investment policies as the fiat stablecoin business gradually develops.
(c) Segregation and custody of reserve assets: Fiat stablecoin issuers should establish effective trust arrangements to ensure that reserve assets are kept separate from other assets and used to meet redemption requests, as well as to ensure users' legal rights and priority claims to reserve assets in the event of the issuer's insolvency. Issuers must maintain separate accounts with licensed banks or other custodians under arrangements satisfactory to the Monetary Authority to manage reserve assets. As part of their internal controls and procedures, issuers must establish effective internal controls and procedures to protect reserve assets from operational risks (including the risk of theft, fraud and misappropriation).
(d) Risk management and control procedures: The fiat stablecoin issuer must develop sound policies, guidelines and controls to properly manage all investment risks related to the management of reserve assets and ensure that there are sufficient funds and liquid assets to meet redemption requests for the fiat stablecoins in circulation. The issuer must adopt comprehensive liquidity risk management measures, which clearly specify the strategies and implementation tools to deal with large-scale redemptions (i.e. bank runs or liquidity stress scenarios). The issuer should also conduct regular stress testing to monitor the adequacy and liquidity of reserve assets.
(e) Disclosure and reporting: Issuers of fiat stablecoins must disclose to the public on a regular basis the total amount of fiat stablecoins in circulation, the market value of their reserve assets and the composition of their reserve assets. Issuers must, after consulting the Monetary Authority, appoint a qualified independent auditor to certify: (i) the composition and market value of their reserve assets; (ii) the denomination of fiat stablecoins in circulation; (iii) whether their reserve assets are sufficient to fully support the value of their fiat stablecoins in circulation and have sufficient liquidity as of the last business day of the certification period; and (iv) whether they have fully complied with the conditions set by the Monetary Authority for the management of their reserve assets. It is recommended that issuers disclose the total amount of fiat stablecoins in circulation and the market value of their reserve assets at least daily, the composition of their reserve assets at least weekly, and that the relevant certification be conducted by a qualified independent auditor at least monthly.
(f) Prohibition of interest payments: Any income or loss from reserve assets, including but not limited to interest, dividends or capital gains or losses, belongs to the issuer. With reference to international regulatory practices, fiat stablecoin issuers are not allowed to pay interest to fiat stablecoin users.
(g) Effective stabilization mechanism: Regardless of whether the specific operating procedures of the stabilization mechanism of the fiat currency stablecoin are executed by a third party, the issuer must bear the ultimate responsibility for the effective operation of the stabilization mechanism of the fiat currency stablecoin it issues.
2.2 Redemption Requirements
2.2.1 Fiat stablecoin users should have the right to redeem their fiat stablecoins at par from the fiat stablecoin issuer and have a claim on the reserve assets (and on the issuer if the issuer fails to meet its redemption obligations). Redemption requests must be processed without unreasonable fees and within a reasonable time. The issuer may not impose unreasonable conditions on redemptions (such as very high minimum threshold amounts). Redemption fees must be clearly communicated to users and should be proportionate and not so high as to discourage users from redeeming. The issuer must pay in the fiat currency or currencies to which it refers when fulfilling redemption requests.
2.2.2 When fiat stablecoin users are unable to redeem fiat stablecoins into one or more fiat currencies through other channels (for example, due to obstruction of intermediary or infrastructure operations), the issuer must ensure that redemption is provided directly to users at face value within a reasonable time.
2.2.3 Issuers must develop and maintain contingency plans to enable users to redeem fiat stablecoins in an orderly manner in the event that they are unable to fulfill redemption requests (including when the issuer’s license is suspended or revoked).
2.3 Restrictions on Business Activities
2.3.1 The issuer of a fiat currency stablecoin must obtain the approval of the Monetary Authority before commencing any new business. The issuer must also conduct a risk assessment and prove that it has sufficient resources to invest in the issuance of a fiat currency stablecoin and maintain its operation, that the new business will not bring it additional risks, and that there are risk control measures to ensure that the new business activities will not affect its ability to perform its functions as an issuer.
2.3.2 Issuers may obtain approval to conduct activities ancillary or incidental to the issuance of legal tender stablecoins, such as providing wallet services for their issued legal tender stablecoins to facilitate the issuance and redemption process. When providing such wallet services, issuers should formulate corresponding policies and procedures for the segregation and custody of user assets, as well as the deposit and withdrawal of user assets.
2.3.3 For the avoidance of doubt, the Issuer should not engage in money lending and financial intermediation activities and should not carry out other regulated activities such as those listed under the Securities and Futures Ordinance (Cap. 571), the Mandatory Provident Fund Schemes Ordinance (Cap. 485) or the Insurance Ordinance (Cap. 41).
2.4 Have a physical company and office in Hong Kong
The fiat stablecoin issuer must be a company established under Hong Kong law and have a registered office in Hong Kong. Its CEO, senior management team and key personnel must be based in Hong Kong and exercise effective control over the issuance of its fiat stablecoin and related activities. This requirement will enable the Monetary Authority to effectively supervise such entities.
2.5 Financial resource requirements
2.5.1 The issuer of a fiat currency stablecoin must have sufficient financial resources to operate the fiat currency stablecoin issuance business, including meeting the minimum paid-up share capital requirement. The purpose of this requirement is to ensure that the issuer has sufficient financial resources to maintain the issuer's operations and serve as a buffer for losses. With reference to international regulatory practices, we recommend that the minimum paid-up share capital be HK$25,000,000, or a fixed percentage of the denomination of the fiat currency stablecoin in circulation, whichever is higher. We recommend that the fixed percentage be set at 2%.
2.5.2 If the Monetary Authority considers it necessary, he may also impose higher paid-up capital requirements on issuers through licensing conditions under the regime.
2.6 Disclosure Requirements
2.6.1 The issuer of a fiat stablecoin must publish a white paper to disclose general information about the issuer, the rights and responsibilities of users of the fiat stablecoin, the stabilization mechanism of the fiat stablecoin, the reserve asset management arrangements, and the technology and risks used. The issuer must notify the Monetary Authority before publishing the white paper and other related publications.
2.6.2 Issuers of fiat stablecoins must disclose their redemption policies, clearly specifying the redemption procedures, redemption time limits, applicable fees, and the rights of fiat stablecoin users regarding redemption.
2.7 Governance, knowledge and experience
The controllers, CEOs and directors of the fiat stablecoin issuers must be fit and proper persons, and the appointment of such persons, as well as changes in the ownership or management of the issuer, must be approved in advance by the Monetary Authority. In addition, the issuer must establish a comprehensive control system for the appointment of senior management and a robust corporate governance structure, with personnel who have the necessary knowledge and experience to perform their duties effectively.
2.8 Risk Management Provisions
Fiat stablecoin issuers must establish appropriate risk management procedures and measures for their operations. These measures include adequate security and internal control measures to ensure the security and integrity of data and systems; effective fraud monitoring and detection measures; technology risk management measures; robust contingency arrangements to deal with disruptions in business operations; and other operational and security measures commensurate with the scale and complexity of the business. The issuer should also conduct risk assessments regularly (at least once a year) to ensure that internal control measures, risk management and governance procedures are sound and effective.
2.9 Auditing Requirements
Fiat stablecoin issuers must submit audited financial statements to the Monetary Authority every year. If required by the Monetary Authority, the issuer must submit a report prepared by an external independent auditor and assessor to confirm the effective management and sound operation of the fiat stablecoin issuance business, such as whether the issuer has adequate control systems in terms of reserve asset management, network security, and the robustness of "smart contracts".
2.10 Anti-money laundering and terrorist financing regulations
Issuers of fiat currency stablecoins must ensure that the design and implementation of the issuance of fiat currency stablecoins are equipped with a sound and appropriate control system to prevent and combat activities that may involve money laundering and terrorist financing. The issuer must have a sound and appropriate control system to ensure that the company complies with the applicable provisions under the Anti-Money Laundering Ordinance and the measures published by the Monetary Authority in the form of rules, regulations, guidelines or other forms to prevent, combat or detect money laundering or terrorist financing. The relevant requirements include but are not limited to adequate customer due diligence measures, transaction monitoring and relevant wire transfer requirements ("transfer rules") for customers when issuing and redeeming fiat currency stablecoins in order to comply with the standards of the Financial Action Task Force and the requirements under the Anti-Money Laundering Ordinance.
3. Other licensing matters
3.1 Eligibility for applying for a license
It is now recommended that all entities that meet the licensing criteria and conditions are eligible to apply for a Fiat Stablecoin Issuer License. Applicants for a license need to go through a rigorous vetting process, which requires them to demonstrate compliance with the licensing criteria and conditions, including but not limited to those set out above.
Taking into account that licensed banks are already subject to strict prudential regulatory requirements and are subject to ongoing comprehensive supervision by the Monetary Authority, we propose that the licensing criteria (c) restriction on business activities, (d) having a physical company and office in Hong Kong and (e) financial resources requirements should not apply to fiat stablecoin issuers that are licensed banks, as licensed banks are already subject to the banking regulatory regime in these aspects.
3.2 Continuing Licensing Conditions
In addition to establishing licensing criteria, we propose to give the Monetary Authority the power to set, modify or cancel the ongoing licensing conditions for issuers of fiat stablecoins. The Monetary Authority will set such conditions as necessary. For example, such conditions may include requirements for reserve assets and restrictions on the types of services that issuers can provide.
3.3 Issuing more than one fiat stablecoin
We propose that fiat stablecoin issuers need to obtain the approval of the Monetary Authority before issuing any new fiat stablecoins under their license. The purpose of this provision is to ensure that new fiat stablecoins do not affect the operation of existing fiat stablecoins.
3.4 Open license
We propose to make the fiat stablecoin issuer license an open license, which means that the licensed issuer will remain valid as long as it continues to operate and its license has not been revoked by the Monetary Authority (for example, due to non-compliance or cessation of operation by the issuer).
3.5 Register of Licensees and Licence Fees
We recommend that fiat stablecoin issuers must display their licence number on any advertising material and any software applications provided to customers to inform the public of their licensing status. The Monetary Authority will maintain a central register of licensees for public inspection.
We propose to give the Monetary Authority the power to impose an annual licence fee on fiat stablecoin issuers (including licensees that are themselves licensed banks).
4. Custody and purchase services of legal currency stablecoins
Some stakeholders believe that virtual asset custody and purchase services should be subject to specific regulation. The Treasury, the HKMA and the SFC will work closely to assess the appropriate regulatory model for such services.
As for the provision of services for the purchase of fiat stablecoins, we believe that the risks involved in fiat stablecoins issued by unlicensed issuers are not transparent and therefore the above-mentioned fiat stablecoins are not suitable for use by the general public. To protect the users of fiat stablecoins, it is now recommended that only licensed fiat stablecoin issuers, authorized institutions, licensed corporations and licensed virtual asset trading platforms can provide services for the purchase of fiat stablecoins in Hong Kong, or actively promote the relevant services to the public in Hong Kong. When providing such services, authorized institutions, licensed corporations and licensed virtual asset trading platforms may only sell the relevant fiat stablecoins to professional investors if they are issued by unlicensed issuers, and must clearly state that the fiat stablecoins are not issued by licensed fiat stablecoin issuers.
5. Violations and sanctions
The proposed criminal sanctions mechanism can deter similar violations of the Ordinance by industry participants. Relevant crimes include issuing or showing oneself to issue fiat currency stablecoins in Hong Kong without a license, issuing or showing oneself to issue Hong Kong dollar stablecoins, actively promoting the issuance of its fiat currency stablecoins to the Hong Kong public, and issuing advertisements to promote the issuance of fiat currency stablecoins by non-licensed issuers, refusing to produce documents upon request by the Monetary Authority, providing false information to the Monetary Authority or making false entries in documents, and violating other conditions issued by the Monetary Authority for the licensing system for fiat currency stablecoin issuers. According to our current proposal, only licensed institutions listed in Section 7 can provide services for purchasing fiat currency stablecoins in Hong Kong. Therefore, unless it is a licensed institution listed in Section 7, it is illegal to provide services for purchasing fiat currency stablecoins in Hong Kong, and it is also illegal to issue advertisements to promote services for purchasing fiat currency stablecoins that are not provided by licensed institutions listed in Section 7. In determining the amount of fines and imprisonment terms applicable to relevant offences under the proposed regulatory regime, we will refer to the relevant provisions of the Anti-Money Laundering Ordinance, the Banking Ordinance, the Payments Ordinance and the Securities and Futures Ordinance.
In addition, we believe that a range of civil and regulatory sanctions should be introduced into the proposed regulatory regime to implement a penalty system, allowing the Monetary Authority to consider appropriate penalties based on the severity and duration of the breach. The proposed civil and regulatory sanctions include the following:
(a) issuing a warning, caution, reprimand or order to take specified action; regulatory sanctions include temporary suspension of licence, revocation of licence, cancellation of licence or a combination of these measures;
(b) a fine of not more than HK$10,000,000 or 3 times the amount of profit gained or loss avoided as a result of the breach, whichever is the higher; or (c) a combination of the above measures.