Hong Kong’s Proposed Stablecoin Regulatory Regime: key takeaways from consultation conclusions

Government will introduce a new stablecoin legislative framework in Hong Kong

The HKMA:

• is preparing a bill to implement the proposed regulatory regime for issuers of fiat-referenced stablecoins (FRS)
• plans to introduce the bill into the Legislative Council later in 2024
• will in due course issue licensing and supervisory guidelines to facilitate licence applicants’ understanding of, and compliance with, the relevant regulatory requirements
• will continue to work with other regulators with a view to maintaining a coherent virtual assets (VA) regulatory framework in Hong Kong, thereby avoiding regulatory arbitrage.

Triggers for the FRS issuer licensing requirement and related questions

Which FRS are in scope?

• The HKMA clarifies that stablecoins subject to the proposed regulatory regime are those “operated on a decentralised distributed ledger or similar technology”, whereby 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
• The HKMA does not intend to prescribe the scope of reference currencies of FRS under the regulatory regime
• Key aspects of the FRS regulatory regime are similar to the stored value facility (SVF) regulatory regime in Hong Kong 

What constitutes “issuing” FRS?

• The question of what constitutes an “issuance” activity will generally be decided on a case-by-case basis
• The HKMA will provide further guidance by issuing guidelines upon implementation of the licensing regime

What constitutes “issues in Hong Kong”?

• Under the proposed regulatory regime, any person who issues FRS in Hong Kong will be required to obtain a licence from the HKMA
• The question of whether an FRS is “issued in” Hong Kong will depend on the facts and circumstances of each case
• The HKMA will consider factors such as the FRS issuer’s place of incorporation, the location of its operations, provision of subsequent customer service to FRS users and whether a Hong Kong bank account is used to process issuance and redemption requests
• The HKMA will provide further guidelines on this issue.

What constitutes “actively marketing” an issuance of FRS to the Hong Kong public?

• Referencing a similar approach and the well established principles adopted by the Securities and Futures Commission of Hong Kong (SFC), factors in determining whether a person is “actively marketing” an issuance of FRS to the Hong Kong public includes  the language used in marketing messages, whether messages are targeted at a group of people that reside in Hong Kong and whether a Hong Kong domain name is used for the website
• Agents or intermediaries actively marketing a licensed entity’s FRS issuance generally will not be considered as issuing FRS themselves and thus will not require a stablecoin issuer licence
• However, any person (including issuers, agents and intermediaries) promoting unlicensed FRS issuance will commit an offence.

Importance of viable FRS use cases and business plans in assessing licence applications

• The HKMA noted that viable and proper use cases are crucial to the sustainability of operations of FRS issuers
• The HKMA considers it appropriate to take into account the use cases and business plans of prospective FRS issuers when reviewing their licence applications.

Can one FRS licensee issue multiple FRS?

• An FRS issuer can issue more than one FRS under its existing licence, without the need to set up a separate entity or go through a separate application process
• However, the FRS issuer should provide the rationale, justify the use cases and seek the HKMA’s prior consent before issuing a new FRS.

Where should FRS issuers display their licence numbers?

• The HKMA expects FRS issuers to display their licence numbers in a prominent place on advertising materials, and in accessible locations on their websites and mobile applications
• This would ensure that users can easily distinguish the FRS issued by a licensed FRS issuer and those issued by an unlicensed entity.

What constitutes “offering” an FRS?

• Separate from the proposed FRS issuer licensing regime, the Consultation Paper introduces an FRS offering regime under which only licensed FRS issuers, authorized institutions (AIs), licensed corporations and licensed virtual asset trading platforms can offer FRS in Hong Kong or actively market such offering to the public of Hong Kong  
• ·The HKMA clarifies that “offer”, in relation to an FRS, means communication to the public in any form, or by any means, presenting sufficient information on the term of the offer and channels through which the FRS is to be offered so as to enable a person to decide whether to acquire the FRS
• The HKMA has been working closely with other relevant authorities on the possibility of allowing licensed VA over-the-counter (OTC) service providers to offer FRS
• In terms of offering FRS issued outside Hong Kong, the HKMA considers formal regulatory cooperation mechanisms with other jurisdictions as and when equivalent regimes are established, such as mutual recognition or “passporting” arrangements.  However, the timeline for putting in place such arrangements would largely depend on the progress of international regulatory developments.   

Reserve asset requirements and redemptions

Full reserve asset backing for FRS and further HKMA guidance on policy and regulatory expectations for reserve asset management and stabilisation mechanisms

• An FRS must be fully backed by qualified reserved assets to meet on-going redemption requests
• The HKMA will adopt a risk-based approach in assessing the eligibility of reserved assets backing an FRS.  An FRS issuer is required to segregate its reserved assets from its own assets, and safekeep such reserved assets with eligible custodians through effective trust arrangements
• To manage the HKMA’s policy and regulatory requirements, an FRS issuer applicant must formulate specific policies regarding its management of reserved assets, including:
  • investment policies
  • liquidity management policies
  • reserve management policies

• To satisfy the asset segregation requirement, an FRS issuer licence applicant must submit a draft of the relevant trust deed, supported by an independent legal opinion for the HKMA’s review.  This is consistent with similar practices under the SVF regime.

Reserve asset requirements: how to satisfy the requirement that the amount of FRS issued must be fully backed by qualified reserve assets “at all times”?

• A licensed FRS issuer must demonstrate to the HKMA’s satisfaction that it has put in place measures (e.g. over-collateralisation of qualified reserved assets) to comply with the “at all times” requirement.

What constitutes high quality and highly liquid reserve assets?

• In general, reserved assets backing an FRS should be of “high-quality and highly liquid with minimal market, credit and concentration risks”. Importantly, the HKMA will take into account the classification of high-quality liquid assets in banking regulations[1]and other applicable international standards[2].
• Generally, high quality and highly liquid assets include:
  • coins and banknotes
  • deposits placed with licensed banks
  • marketable securities representing claims on or guaranteed by governments, central banks or qualified international organisations with high credit quality
  • overnight reverse repurchase agreements with minimal counterparty risk backed by these securities
  • tokenised versions of those assets (in other words, tokenised assets may constitute reserve assets)
• On the same day that the consultation conclusions were published, the Basel Committee on Banking Supervision (Basel Committee) also finalised its revised criteria for stablecoins to qualify as so-called ‘Group 1b cryptoassets’, which enjoy favourable bank regulatory capital treatment under the Basel cryptoasset standards.[3]  The additional guidance in the HKMA Consultation Conclusions about what constitutes eligible reserve assets are similar to the Basel Committee’s revised criteria.  For example, the Basel Committee clarified that certain short-term reverse repurchase agreements can qualify as eligible reserve assets. 

What about foreign exchange mismatches between reserve assets and the FRS’ referenced currency?

• FRS issuers must obtain prior approval from the HKMA for any currency mismatch between the FRS’ referenced currency and its reserve assets
• The HKMA may impose additional requirements, such as over-collateralisation, to mitigate the associated foreign exchange risks as appropriate
• For HKD-referenced stablecoins, the HKMA intends to allow FRS issuers the flexibility to include USD-denominated reserve assets (presumably because of the USD peg).

Regulatory expectations on where reserve assets should be held

• According to the HKMA, safekeeping reserve assets with licensed banks in Hong Kong could provide greater user protection in case of business disruptions or failures
• The HKMA is open to considering proposals from licensed FRS issuers on placing the reserve assets in other jurisdictions on a case-by-case basis.

Frequency of public disclosures about reserve assets

• The HKMA is inclined to reduce the frequency of public disclosures regarding FRS in circulation as well as the market value and composition of reserve assets
• The HKMA will further engage with the industry and the public as it develops more detailed disclosure requirements.

Paying interest to FRS users is prohibited, but marketing incentives are generally permissible

• An FRS issuer may offer marketing incentives to promote its FRS, but is prohibited from offering any interest payment to FRS users by itself or through any third party
• The HKMA clarified that “interest payment” can generally be considered as the distribution of any profit, income or other returns that are proportionate to the length of period during which a user holds the FRS, and/or the size of FRS held by an FRS user
• FRS issuers that wish to offer marketing incentives should ensure that their promotional activities do not amount to payment of interest.

FRS users must be able to redeem their FRS on a “timely” basis – what does “timely” mean?

• The HKMA will require FRS issuers to fulfil redemption requests within 1 business day in normal circumstances after the day on which a redemption request is received
• FRS issuers should seek the HKMA’s prior approval if they foresee any difficulty in fulfilling redemption requests within 1 business day (e.g. an unforeseen market stress scenario).

Other key requirements under the FRS regulatory regime

Physical presence in Hong Kong requirement for licensed FRS issuers

• The HKMA plans to keep the local incorporation requirement
• Non-Hong Kong incorporated companies, other than AIs incorporated outside Hong Kong, intending to apply for an FRS issuer licence must establish a subsidiary in Hong Kong.

Relaxation of minimum financial resources requirements

• The Consultation Paper originally proposed a minimum paid-up share capital requirement for a licensed FRS issuer equal to the greater of 2% of the total FRS in circulation and HKD25 million
• This minimum requirement will be reduced to the greater of 1% of the total FRS in circulation and HKD25 million
• However, the HKMA will retain flexibility and power to impose additional paid-up share capital requirements as licensing conditions where necessary.

White paper requirements

• The white paper for a prospective FRS should be ready when the licence application is submitted to the HKMA
• The FRS issuer should publish its white paper on its website.

Auditing requirements

• The HKMA will provide further guidance on the scope of required audits.

AML/CFT requirements

• The HKMA will take into account feedback received from market participants through ongoing engagements as well as the participants in the Stablecoin Issuer Sandbox when formulating specific AML/CFT compliance requirements.

Where can I learn more about stablecoins and related issues?  Come speak to us

We have advised issuers and platforms on stablecoins over many years, including bank-issued stablecoins, algorithmic stablecoins, trust-based stablecoins and many other similar instruments and arrangements.  We also have extensive experience assisting SVF providers and virtual banks with their HKMA licensing applications, ever since those licensing regimes were first introduced in Hong Kong.  We have advised numerous clients on trust arrangements and related documentation under the SVF regulatory regime.

More generally, KWM’s bilingual financial regulatory, financial markets, structured products and international funds teams have extensive experience in advising financial institutions, fund houses and fintech companies on a broad range of regulatory licensing, advisory and transactional matters related to stablecoins, tokenisation, digital assets and emerging fintech. 

We are familiar with the unique and nuanced commercial and legal issues faced by financial institutions, asset managers and fintech companies in the fast-evolving regulatory landscape in Hong Kong, China Mainland, Australia, Europe and the United States.

We can provide a range of support for your stablecoin and digital assets-related projects, including initial structuring strategy, advice on licensing and product authorisation requirements as well as the preparation and negotiation of product offering documents, transaction documents, reserve asset trust arrangements, reserve asset management policies and related documentation (such as derivatives agreements to hedge foreign exchange mismatch risk and reverse repurchase agreements that constitute eligible reserve assets).  

Come speak to us - we would be pleased to share our further insights with you. 

Our articles and other resources on digital assets in Asia are available at kwmdigital.asia  

This alert is provided for general information purposes only and does not constitute legal advice.

*In this article, “Hong Kong” or “HK” means the “Hong Kong Special Administrative Region of the People’s Republic of China”, and “PRC” or “China Mainland” means the People’s Republic of China, excluding Hong Kong, Macao Special Administrative Region and Taiwan.