Stablecoins in Hong Kong - here's what you need to know
by Jill Wong
A RECENT public consultation on Hong Kong's proposed stablecoin regime received more than 100 responses, demonstrating enthusiastic international interest in Hong Kong's ambition to be a virtual asset hub.
It seems likely that a licensing regime for fiat-referenced stablecoin (FRS) issuers in Hong Kong will be in place within the next 12 months.
As FRS is seen as a method of payment, the regime will fall under the purview of the banking regulator, the Hong Kong Monetary Authority (HKMA). But what are the key features for stablecoin issuers considering the Hong Kong regime?
What is in scope?
The HKMA will prioritise a regime for FRS issuance. For now, other types of stablecoins such as commodity-linked or previous metal-linked stablecoins are not in scope.
The licensing regime will have extra-territorial effect. Overseas issuers who issue Hong Kong dollar-referenced stablecoins or who actively market any FRS to the public will need to be licensed.
We expect the HKMA to scrutinise overseas issuers who may rely on the reverse solicitation route, which is a risk management technique to show there is no “active marketing”).
The transitional non-contravention period is proposed to be six months, and this is conditional upon a licence application being submitted within the first three months of the commencement of the new regime.
Any issuer wanting first mover advantage should start preparing now. Indeed, there are already three aspiring issuers who have entered the HKMAs regulatory sandbox.
Reserve assets
It should be no surprise that, being an international financial centre with a reputation for robust regulation, that the same standards will apply to reserve assets.
Firstly, the stablisation mechanism requires that the stablecoins issued are fully backed by reserve assets of good quality and high liquidity, at any given point in time.
Examples provided include: (a) coins and banknotes, (b) deposits placed with licensed banks, (c) marketable securities representing claims on or guaranteed by governments, central banks or qualified international organisations with high credit quality, (d) overnight reserve repurchase agreements with minimal counterparty risk backed by these securities, and (e) tokenised versions of these assets. Stablisation mechanisms that use arbitrage or algorithms are unlikely to be allowed.
Secondly, reserve assets should be held in segregated accounts. Whilst the HKMA prefers that reserve assets are held with licensed banks in Hong Kong, it has indicated that it is open to approving assets held in other jurisdictions on a case-by-case basis.
The HKMA is also willing to allow USD-denominated reserve asserts (the Hong Kong dollar is pegged to the US dollar, with the HKMA managing the peg).
Other requirements
The minimum paid-up share capital remains at HKD25 million or 1% of the par value of FRS in circulation, whichever is higher, the percentage threshold having been lowered from 2% to 1%.
Unfortunately, in other areas the HKMA has stood firm. Stablecoin issuers must be locally incorporated and overseas entities will need to establish a Hong Kong subsidiary. Key senior management will need to be present in Hong Kong and meet “fit and proper” criteria.
FRS issuers must fulfil redemption requests within one business day in normal circumstances after the day on which a redemption request is received. This is relatively demanding, when compared to other jurisdictions.
Still working on it…
While the key features of the framework have been provided, there are still details that need to be worked out: not least the regulatory approach for private key storage and wallet services, guidelines on what amounts to issuing FRS in Hong Kong, disclosure of asset backing, requirements for AML and potential mutual recognition of FRS with other jurisdictions.
It is not unusual for Hong Kong regulators to take a phased approach to legislative initiatives. Ultimately, it is encouraging to see that Hong Kong is forging ahead and staking its position on stablecoins, for certainty for issuers, investors and the financial services industries.
Jill Wong, Partner and member of On Chain, Reed Smith
