Hong Kong

Understanding Hong Kong’s Stablecoin Issuer Licensing System in One Article

Posted on by Aiying
Understanding Hong Kong’s Stablecoin Issuer Licensing System in One Article
26
June
In July 2024, the Hong Kong Monetary Authority (“Hong Kong Monetary Authority”) and the Financial Services and the Treasury Bureau (“Treasury Bureau”) published a report on the results of a consultation on legislative proposals for implementing a regulatory regime for stablecoin issuers in Hong Kong (“Consultation Results Report")1. The HKMA and the Treasury Department stated that they are preparing specific implementation bills in accordance with such regulatory requirements and plan to submit the bill to the Legislative Council for approval later this year. The industry expects that the stablecoin issuer licensing system may officially come into effect in 2025. The HKMA recommends setting up a 6-month "non-violation period" after the licensing system takes effect, so that relevant issuers can take necessary measures to comply with the licensing requirements. We note that the licensing system and regulatory requirements listed in the "Consultation Results Report" are consistent with the Stablecoin Consultation Paper ("Stablecoin Consultation Paper") jointly issued by the HKMA and the Treasury Department in February 2024.Consultation Document")2The requirements in the Consultation Paper are roughly the same, but the Consultation Report further explains the reasons for the relevant requirements and the specific details of the relevant requirements. For the specific content of the Consultation Paper and the sandbox arrangement launched by the HKMA, please refer to our earlier article "Stablecoin issuers can start applying to join the Hong Kong Monetary Authority Sandbox Arrangement".

The highlights of this Consultation Report are as follows:

  • The HKMA has provided further guidance for license applications. When reviewing license applications, the HKMA will carefully review the applicant's business plan and the application scenarios of the fiat-pegged stablecoins it issues.
  •  The HKMA noted the need to conduct further research on some areas related to stablecoin business, such as the storage of wallet private keys, the provision of wallet services for storing stablecoins, and combating money laundering and terrorist financing. They said they would maintain communication with the industry and stakeholders and would issue regulatory guidelines at an appropriate time to facilitate relevant parties to further understand and comply with relevant regulatory requirements.
  • For the first time, the HKMA clearly stated that it can accept tokenized forms of high-quality and highly liquid assets as the issuer's reserve assets.
  • Regarding the issue of prohibiting the introduction of interest, which has attracted widespread attention, the Monetary Authority of Singapore explained the difference between paying interest and providing promotional discounts.
  • The HKMA said it has flexibility for certain specific regulatory requirements and will consider the individual circumstances of each license applicant.

We also note that the HKMA has announced the first three companies to enter the stablecoin issuer sandbox arrangement.3This article aims to introduce to readers the key contents of the stablecoin issuer licensing system and regulatory requirements listed in the Consultation Results Report.

 

1. Types of regulated stablecoins

(1) Applicable blockchain types

  • The HKMA and the Treasury Department clearly stated in the Consultation Report that the stablecoin issuer licensing system only applies toStablecoins issued “operated on a decentralised distributed ledger or similar technology”.
  • “A distributed ledger operating in a decentralized manner” means that no person has the power to unilaterally control or substantially change the function or operation of the ledger.

We note that based on the above restrictions, stablecoins issued on private chains or consortium chains do not seem to fall within the regulatory scope of the stablecoin issuer licensing system.

(2) Definition of Fiat-Referenced Stablecoin

  • As in the Consultation Paper, the HKMA believes that fiat-pegged stablecoins have a greater chance of developing into a widely accepted means of payment than other types of stablecoins (such as stablecoins that maintain a relatively stable value against commodities or precious metals), and therefore pose a higher and more imminent risk to monetary and financial stability. The HKMA insists on its recommendation to give priority to the regulation of fiat-pegged stablecoins, namelyThe licensing system for stablecoin issuers applies to the issuance of stablecoins whose pegged assets are single or multiple fiat currencies..
  • With regard to fiat-pegged stablecoins pegged to multiple fiat currencies, the HKMA further stated that it will formulate requirements commensurate with the complexity of the issuer’s business operations to ensure that the issuer can adequately address the relevant risks.For example, such issuers must consider whether the market can supply high-quality and highly liquid assets in the relevant currencies and demonstrate their ability to properly manage reserve assets denominated in multiple currencies. Therefore, for issuers of stablecoins pegged to multiple fiat currencies, they may be subject to more regulatory requirements in terms of the composition and management of reserve assets.

Taking into account the nascent nature of the virtual asset sector and the rapidly evolving market, the HKMA said it would retain flexibility to potentially expand the scope of regulated stablecoins in the future.

 

2. Regulated Stablecoin Activities

According to the Consultation Report, unless licensed by the HKMA, no person may:

  • at Hong KongissuedOrShow self-issuedFiat-pegged stablecoins (“Issuing stablecoins in Hong Kong”);
  • issuedOrDisplay self-issued claimsOr it seems to be a stablecoin that maintains a relatively stable value with the Hong Kong dollar (“发Hong Kong dollar pegged stablecoin");or
  • To the Hong Kong publicActive promotionThe issuance of its fiat-pegged stablecoins (“Actively promote stablecoin issuance in Hong Kong").

(1) Issuing stablecoins in Hong Kong

  • Based on the feedback from the industry on the Consultation Paper, the HKMA clarified in the Consultation Report that “issued” Definition of stablecoin.The HKMA stated that what activities would constitute the “issuance” of a fiat-pegged stablecoin would generally require individual consideration based on the relevant facts and circumstances..The HKMA said it will provide further guidance on the matter.
  • In addition, the HKMA stated whether the issuerat Hong KongIssuing a stablecoin pegged to a fiat currency also requiresIndividual consideration will be given based on relevant facts and circumstances. The HKMA will generally consider whether the issuer of a fiat-pegged stablecoin is registered in Hong Kong, has its business location, provides customer services in Hong Kong, and uses a Hong Kong bank account to process issuance and redemption requests..
  • In addition to the "issuance" activities, the HKMA also agrees that issuers of fiat-pegged stablecoins have the responsibility to maintain a strong and effective stability mechanism for the fiat stablecoins they issue, including proper management of reserve assets. The HKMA will review the issuer's reserve asset management mechanism during the license application process, but will not introduce an independent licensing system for reserve asset management activities.
  • in addition,The HKMA also noted the importance of private key storage and wallet services in risk management and investor protection, and said the government is exploring regulatory approaches for such activities and will seek opinions from the public and stakeholders..

(2) Issuing a Hong Kong dollar-pegged stablecoin

As issuers of HKD-pegged stablecoins are likely to target the Hong Kong public as one of their primary targets and HKD-pegged stablecoins may have an impact on Hong Kong’s financial and monetary stability, the HKMA insisted in its Consultation Result Report thatEven if the HKD-pegged stablecoin is issued outside Hong Kong, it will regulate the issuers of such stablecoins, who must have a subsidiary in Hong Kong and management resident in Hong Kong..

(3) Actively promote the issuance of stablecoins in Hong Kong

The HKMA responded to public inquiries in the Consultation Results Report and further clarified the meaning of “active promotion”.The HKMA said it would consider a number of factors when determining whether someone is “actively promoting” a fiat-pegged stablecoin to the Hong Kong public, including:

(a) the language used in promotional information;(b) whether the message is targeted at people residing in Hong Kong; and

(c) whether its website uses a Hong Kong domain name.

We note that the above considerations are consistent with the Securities and Futures Commission of Hong Kong (“Securities Regulatory CommissionThere is some overlap in the factors considered by the Securities and Futures Ordinance (SFO) when considering whether a person is “actively promoting” the operation of a virtual asset trading platform business to the Hong Kong public under section 115 of the SFO and section 53ZRB of the Anti-Money Laundering Ordinance.4The HKMA further clarified:

(a) Anyone who promotes the issuance of an unlicensed stablecoin will be guilty of a crime, but (b) anyone who actively promotesLicensed EntityAgents or intermediaries involved in the issuance of fiat-pegged stablecoins will not be considered to be issuing fiat-pegged stablecoins and therefore do not need to apply for a stablecoin issuer license.

In addition to the above three items, the Consultation Report clearly states:Licensed fiat-pegged stablecoin issuers can issue more than one fiat-pegged stablecoin with their existing licenses without having to set up a separate entity or apply for a new license, but must obtain the HKMA’s prior consent before issuance.

 

3. Reserve Asset Requirements

(1) Amount of reserve assets

The HKMA reiterated in its Consultation Report that at all times, licensed issuers must ensure that the stablecoins they have issued and are in circulation are backed by reserve assets.Full supportThe licence applicant needs to demonstrate to the HKMA that it has measures in place to comply with this requirement, such asSuperReserve(over-collateralisation) mechanism.

(2) Types of reserve assets

The HKMA further clarified in its Consultation Report that its requirementsHigh-quality and highly liquid reserve assets include:

(a) coins and banknotes; (b) deposits with licensed banks; 

(c) high credit quality securities representing claims on or guaranteed by governments, central banks or eligible international organizations; 

(d) overnight reverse repurchase agreements with minimal counterparty risk using such securities as collateral; and 

(e) Tokenised Versions of the above assets.

We are pleased to see tokenized assets included in the above list of high-quality and highly liquid reserve assets. Based on the HKMA’s recognition, we look forward to more institutions in the Hong Kong tokenized asset market launching products and services in related fields such as tokenized bank deposits.

(3) Currency of denominated reserve assets

  • According to the Consultation Report, the HKMA requires licensed issuers to holdReserve assets should be the same as the currency in which the fiat-pegged stablecoin is denominated, and they are required to obtain the HKMA's prior approval for currency mismatches. In such cases, the HKMA may impose additional requirements, such as excess reserves, to mitigate the associated foreign exchange risk, depending on the actual circumstances.
  • One thing worth noting is that the HKMAAllow issuers of HKD-pegged stablecoins to hold USD-denominated reserve assetsConsidering the abundance of dollar-denominated reserve assets in the market, we believe this measure will be welcomed by the industry.

(4) Isolation and safekeeping of reserve assets

  • The HKMA believes that the licensed issuer's reserve assets areLicensed Banks in Hong KongCustody can provide greater protection for users. However, the HKMA is open to licensed issuers' proposal to store reserve assets in other regions and will consider it on a case-by-case basis, provided that the issuer can prove that there is a need to make relevant arrangements to ensure that additional risks are properly handled and the rights and interests of users of fiat-pegged stablecoins are not affected.
  • In addition, the HKMA requires licensed issuers to effectively segregate their own assets from reserve assets. In terms of asset segregation, the HKMA considers acceptable practices to include:Appoint an independent trustee or enter into a trust statement for reserve assetsHowever, before making the relevant arrangements, the issuer should submit the relevant draft trust deed and draft independent legal opinion for review by the HKMA.
  • The HKMA also requires issuers toFormulate sound, appropriate and proportionate reserve management policies, to address the financial and operational risks that arise in the reserve management process.

To comply with the requirements of the HKMA, we speculate that license applicants will at least need to prepare internal policy systems such as investment policies, risk management policies, business continuity plans, and reserve management policies to ensure the adequacy and high liquidity of their reserve assets.

 

4. Operational requirements

(1) Redemption time limit requirements

  • The HKMA further clarified in its Consultation Report that:Licensed issuers must redeem stablecoins within one business day of receiving a redemption requestIssuers should seek prior approval from the HKMA if they anticipate that it will be difficult to fulfil redemption requests within one business day (e.g. in the event of unexpected market stress).
  • We note that based on the one business day time requirement, issuers may need to allocate more highly liquid asset types in their reserve assets to meet this requirement.

(2) Restrictions on business activities

The HKMA requires licensed issuers toCannot engage in providing loans or financial intermediation services.

(3) Established in Hong Kong

Despite the industry's objections, the HKMA believes it is necessary to requireThe licensed issuer is a company established in Hong KongExcept for authorized institutions under the Banking Ordinance, overseas companies that intend to apply for a stablecoin issuer license need to set up a subsidiary in Hong Kong.The HKMA also requires that key management personnel of licensed issuers, including the CEO, must be based in Hong Kong.

(4) Reduced minimum paid-up share capital requirements

In response to industry feedback, the HKMA has adjusted the minimum paid-up share capital requirement for licensed issuers toHKD 2,500 million or 1% of the nominal value of the stablecoin in circulation, whichever is higher. However, the HKMA has the right to impose additional capital requirements if necessary. We note that the original requirement under the Consultation Paper was 2% of the par value of its stablecoin circulation.

(5) Suitability of senior management

The HKMA will consider whether the senior management of the license applicant meets the suitability requirements as a whole, including their qualifications, asset levels and educational background.

(6) Risk Management Provisions

Regardless of the size of the business and the risk level of the fiat-pegged stablecoin operation,Licensed issuers should conduct risk assessment at least once a yearIts incident management work should include, but is not limited to, the formulation of incident management policies, monitoring mechanisms and incident response plans, so that the issuer can initiate recovery actions and report incidents to the HKMA in a timely manner.

(7) Anti-money laundering and counter-terrorist financing

  • The HKMA reiterated that licensed issuers should take appropriate measures to mitigate and manage the risks of money laundering and terrorist financing arising from the issuance of fiat-pegged stablecoins based on the relevant risks, including communicating with relevant intermediaries within the ecosystem.
  • The HKMA said it would issue separate guidance on anti-money laundering and counter-terrorist financing requirements in accordance with international standards set by the Financial Action Task Force.

(8) Disclosure and reporting

The HKMA reiterated in its Consultation Report that:Licensed issuers must employ a qualified independent auditor to certify their reserve assets on a monthly basis, in order to build public confidence.Agree to reduce the number of public disclosures of the circulation of fiat-pegged stablecoins and the market value and composition of reserve assets(The Consultation Paper requires issuers to disclose at least daily the total amount of fiat-pegged stablecoins in circulation and the market value of reserve assets, and at least weekly the composition of reserve assets) to strike a balance between the operational burden and transparency of issuers. The HKMA will formulate more detailed disclosure requirements.

(9) Audit requirements

The HKMA requires licensed issuers to consider a series of criteria when appointing auditors, including the auditor’s knowledge, expertise, resources and independence in conducting the audit or review in the relevant areas.

 

5. Application scenarios, business plans, white papers

(1) Application scenarios and business plans

  • The HKMA notedAppropriate and feasible application scenarios are crucial for the sustainable operation of fiat-pegged stablecoin issuersTherefore, the HKMA specifically stated in the Consultation Result Report that when reviewing the license application, it will consider the stablecoin that the applicant intends to issue.Application scenarios and business plans.
  • We note that the HKMA further emphasized the importance of stablecoins in its article on the first batch of participants in the sandbox arrangement for stablecoin issuers.ApplicationThe importance of and requirements for applicants(1) Propose specific application scenarios for stablecoins, and (2) Ensure that application scenarios can help solve pain points in economic activities and create value and new opportunities for economic and financial services.
  • Therefore, for applicants who intend to apply for a stablecoin issuer license (including the sandbox program), we recommend that they start considering the application scenarios of the stablecoins they issue as early as possible and include the details of such application scenarios in their business plans to meet the regulatory requirements of the HKMA. Applicants need to consider what is special about the application scenarios of the stablecoins they issue compared to other stablecoins, such as how they can uniquely solve the pain points or needs of the market, or how they can enhance the efficient operation of the market, or what new value or opportunities they can create.

(2) White Paper

The HKMA also reiterated that applicants should have prepared the fiat-pegged stablecoins to be issued when submitting their license applications.White Paper, including:

  • General information about the issuer of the fiat-pegged stablecoin;
  • Redemption mechanism and procedures;
  • The rights and interests of potential fiat-pegged stablecoin users; and
  • The applicable conditions and fees for redemption, etc.

Issuers are required to notify the HKMA before publishing the white paper.

 

6. Prohibition of interest payments vs. provision of promotional offers

In its Consultation Report, the HKMA reiterated its position on interest payments and promotional offers by licensed issuers:

Interest Payment
Promotional Offers
× Arrangements with third parties toProviding interest to users of fiat-pegged stablecoins× Interest payments are generally based on:

o the length of time that the user holds the fiat-pegged stablecoin; and/or

o Any profits, income or other returns distributed in proportion to the size of the fiat-pegged stablecoin held by the user

√ Promotional offers allowed√ Issuers should ensure that their promotional activities do not constitute interest payments

 

7. Offer a Fiat-pegged Stablecoin

The HKMA reiterated that, in general,Only licensed fiat-pegged stablecoin issuers, authorized institutions, licensed corporations and licensed virtual asset trading platforms can "provide" fiat-pegged stablecoins. The HKMA will also consider (after the Virtual Asset OTC (VA OTC) licensing regime comes into effect) allowing licensed virtual asset OTC service providers to sell fiat-pegged stablecoins. The HKMA also stated that it will consider whether SVF license holders can sell fiat-pegged stablecoins after further evaluating the business model and related risks of SVF license holders. The HKMA further clarified that "sale" means communicating information to the public in any form or medium, providing sufficient information on the terms and channels of sale of the relevant fiat-pegged stablecoins so that individuals can decide whether to purchase the relevant fiat-pegged stablecoins.

 

8. Sales of fiat-pegged stablecoins issued outside Hong Kong

According to the licensing system and requirements listed in the Consultation Result Report, the HKMA does not allow the sale of fiat-pegged stablecoins issued by unlicensed issuers (including fiat-pegged stablecoins issued outside Hong Kong, such as USDC, which has a large circulation in the market) to retail investors. However, the HKMA expressed its understanding of the cross-border nature of fiat-pegged stablecoins and their potential value in various application scenarios. The HKMA will consider establishing a formal regulatory cooperation mechanism, such as mutual recognition or "passporting" arrangements, and continue to actively participate in and pay attention to international discussions, maintain close communication with other regulators, and pay attention to regulatory developments in other jurisdictions. We expect that the HKMA's approach of granting flexibility to overseas issuance of stablecoins will be welcomed by the market.

 

Conclusion

Blockchain technology innovation has provided us with more and more new tools. What matters is how we use them. Stablecoin is a good example. We expect that under the supervision of the HKMA, more compliant stablecoins will be used in various practical scenarios such as cross-border payments, bringing more improvements to our real lives.

 

 

 

 

Article Source: Junhe Law Review

Article author: Qiao Zheyuan, Cheng Xiaoyu, etc.

Aiying