Current regulatory regime in Hong Kong
The Securities and Futures Commission (SFC) in Hong Kong has been operating an opt-in regime for virtual asset (VA) service providers (VASPs) since November 2019. In December 2020, the SFC granted the first-ever cryptocurrency exchange platform license.
In May 2021, the Financial Services and the Treasury Bureau (FSTB) announced it had completed a public consultation on the VASP regime and would work towards an amendment bill in 2022. Cryptocurrency exchanges will likely continue to fall within the VASP regime as their activities are regulated.
The HKMA observed that the VASP regime is not primarily intended to regulate stablecoins, particularly those that function like stored value facilities (SVFs), which are currently subject to a mandatory licensing regime under the Payment Systems and Stored Value Facilities Ordinance (Cap. 584) (PSSVFO). Despite the PSSVFO, the HKMA considers that some stablecoins do not technically fit within the definition of an SVF, bringing about a regulatory ‘grey’ area. This may require the PSSVFO to be expanded or new legislation to be introduced.
The HKMA and the SFC intend to issue separate guidance to banks and other authorised institutions to protect Hong Kong investors in respect of crypto-asset related intermediary services.
In terms of global developments, the HKMA observed that different countries were at different stages in formulating their regulatory stance on crypto-assets. Hong Kong and Singapore tended to develop their regulations based upon existing regimes that cover a limited range of crypto-assets. Other countries, such as the United States and a number of EU member states, had more comprehensive plans to introduce new, bespoke legislation covering all types of crypto-assets.
Regulating stablecoins
One of the key priorities for the HKMA appears to be regulating stablecoins.
A stablecoin is a crypto-asset whose value is linked or referenced to an underlying asset, giving it relative stability compared to other crypto-assets. This stability gives rise to the potential for use in payments, which may lead to wider incorporation into Hong Kong’s mainstream financial system. The HKMA identified seven key areas of risk:
Financial stability: Will stablecoins impact economic activity and public confidence in Hong Kong’s financial system? Is there a risk to banks if more deposits are held as stablecoins?
Monetary stability: Is there a risk of currency substitution? Will there be any impact upon the supply of and demand for Hong Kong dollars?
Settlement: Is there a risk of stablecoin payments being altered or reversed by ‘forks’ in the blockchain?
User protection: Is there any legal or other recourse against operational disruptions related to stablecoins? Do users have access to sufficient and clear information about different stablecoins and crypto-assets?
Financial crime and cyber threats: Are stablecoins prone to cyber threats and could they be used for money laundering, terrorist financing or other illicit activities?
International compliance: Will Hong Kong be able to comply with internationally agreed standards and best practices?
Regulatory arbitrage: Will Hong Kong become a safe haven for crypto-assets because of under-regulation?
As for non-payment-related or unbacked crypto-assets, given they are highly speculative and volatile and many do not have any intrinsic value, the HKMA has stated it will continue to monitor their development. Banks and other authorised institutions are required to observe the guidance issued by the HKMA and the SFC from time to time on VA-related products and to notify the HKMA and the SFC in advance of the provision of investment services related to VAs.
Looking to the future
The HKMA’s discussion paper and recommendations provide critical insight into the regulator’s plans for the future of crypto-assets in Hong Kong.
The HKMA recommends an agile regulatory approach, and acting on the basis of risk and in a proportionate manner, when targeting stablecoin-related activities. The HKMA has stated that its initial focus will be on stablecoins that are asset-linked (e.g. linked to a single fiat currency) rather than algorithm-based. Specifically, seven types of activities are likely to become the subject of a licensing regime:
- Issuer minting and burning of stablecoins
- Managing reserve assets backing the value of stablecoins and providing custody or trust for such assets
- Authorising or verifying the validity of transactions and records
- Safe-keeping of keys used to digitally sign transaction instructions on behalf of stablecoin holders
- Facilitating stablecoin holders to redeem stablecoins for fiat currencies or other assets
- Ensuring correct and final settlement of transactions to minimise the risk of counterparty default
- Conducting transactions on behalf of others
Entities subject to the proposed licensing regime will likely be required to (a) be incorporated in Hong Kong; and (b) demonstrate compliance with high-level regulatory requirements to be implemented. Relevant aspects of existing legislation will be incorporated into the new regime to avoid regulatory arbitrage.
The new regime will likely be introduced in 2023/2024.
General remarks
As Hong Kong is a leading international financial centre, it is clear that the regulators will strive to maintain its financial and economic stability. Stablecoin regulation is a welcome and much-needed step in view of the fast-growing adoption and ongoing development of crypto-assets.
It is also consistent with the need for Hong Kong to align its supervisory approach with the regulatory policy recommendations of international bodies like the Financial Stability Board and the Bank for International Settlements, in order to prevent regulatory arbitrage in stablecoin-related activities. Policy approaches to the regulation of stablecoins (among other virtual assets) are under development in other key jurisdiction such as the European Union (which has proposed a Markets in Crypto-Assets Regulation), the United States (where a President’s Working Group report on stablecoins examining potential supervisory approaches was published recently) and Singapore (where the Monetary Authority of Singapore is reviewing the regulatory treatment of stablecoins).
Client Alert 2022-017
