January 18, 2022
Introduction
On 12 January 2022, the Hong Kong Financial Authority (HKMA) released a Dialogue Paper on the enlargement of the Hong Kong regulatory framework to stablecoins (e.g. crypto-assets pegged to fiat currencies). The Paper considers the adequacy of the present regulatory framework in mild of the rising use of stablecoins and different sorts of crypto-assets in monetary markets, and the challenges posed by this enhance of their prevalence. It additional poses eight questions for consideration by the business, together with the scope of a proposed new regulatory regime to cowl what the HKMA describes as “payment-related stablecoins”.
This consumer alert supplies an outline of the HKMA’s views on crypto-assets and stablecoins as outlined within the Paper, discusses the implications for gamers within the stablecoin ecosystem if the proposed adjustments are carried out, and urged subsequent steps for events.
The HKMA has requested responses to the Paper by 31 March 2022, and has indicated that it intends to introduce this new stablecoin regulatory regime by 2023-2024.
HKMA’s views on crypto-assets and monetary stability
The Paper supplies a invaluable perception into the HKMA’s views on crypto-assets normally, and stablecoins particularly, together with their linkages to the normal monetary system and ramifications on monetary stability.
In introducing its proposal to control cost associated stablecoins, the HKMA has made it clear that whereas the present dimension and buying and selling exercise of crypto-assets globally could not pose an speedy risk to the soundness of the worldwide monetary system from a systemic standpoint, it does take into account the growing prevalence of crypto-assets to have the potential to influence monetary stability. Specifically, the HKMA has flagged that it considers the rising publicity of institutional buyers, in addition to sure segments of the retail public, to such belongings as a substitute for, or to enhance conventional asset lessons, signifies rising interconnectedness with the mainstream monetary system.
Additional, as famous by the HKMA, it understands that whereas Hong Kong authorised banks (Authorised Establishments or AIs) at the moment undertake solely restricted actions in relation to crypto-assets, AIs are eager about pursuing these actions additional, provided that they face growing demand from prospects for crypto-related services. That is according to what we perceive is a gentle enhance in excessive web wealth buyers hungry for yield demanding entry to crypto-assets by their personal wealth managers, in addition to an uptick in demand from retail buyers in Hong Kong keen for a similar publicity to upside. To this finish, the HKMA has flagged that it’ll quickly present AIs with extra detailed regulatory steerage in relation to their interface with and provision of companies to prospects in relation to crypto-assets.
Lastly, the HKMA has additionally famous its issues that the convenience of nameless switch of crypto-assets could make them vulnerable to the chance of illicit and cash laundering / terrorist financing actions.
The HKMA’s views on stablecoins
The Paper additionally flags the HKMA’s view that stablecoins are more and more considered as a ‘extensively acceptable technique of cost’ and that this, alongside the precise enhance of their use, has elevated the potential for his or her incorporation into the mainstream monetary system. Within the HKMA’s opinion, this in flip raises broader financial and monetary stability implications and has resulted within the regulation of stablecoins turning into a key precedence for the HKMA, which has acknowledged within the Paper that it needs to make sure that such cash “are appropriately regulated earlier than they function in Hong Kong or are marketed to the general public of Hong Kong”.
The Paper goes on to establish quite a few potential dangers which will come up in relation to using stablecoins, together with, in abstract:
- Fee integrity dangers the place stablecoins are generally accepted as a method of cost and operational disruptions or failures happen in relation to the stablecoins;
- Banking stability dangers if banks had been to extend their publicity to stablecoins, significantly if stablecoins had been considered as an alternative to financial institution deposits;
- Financial coverage dangers in relation to the difficulty and redemption of HKD-backed stablecoins, which might have an effect on interbank HKD demand and provide; and
- Person safety dangers the place a consumer could haven’t any or restricted recourse in relation to operational disruptions or failures of a stablecoin.
Given these potential dangers, the HKMA has acknowledged within the Paper that it considers it acceptable to develop the regulatory perimeter to cowl payment-related stablecoins within the first occasion, though it has not dominated out the potential of regulating different types of stablecoins as nicely.
The HKMA’s dialogue questions for business consideration
The HKMA has famous within the Paper that it considers ‘the necessity to regulate [stablecoins] is nicely justified and the device to control…[can] be determined at a later stage’. Nevertheless, it has indicated that it needs for suggestions from the business and the general public on the scope of the regulatory regime relevant to stablecoins, and to this finish has set out eight dialogue questions for business consideration. A abstract of the important thing questions posed by the HKMA, in addition to the HKMA’s views on these questions, is about out under.
| Query 1: Ought to we regulate actions referring to all sorts of stablecoins or give precedence to these payment-related stablecoins that pose greater dangers to the financial and monetary programs whereas offering flexibility within the regime to make changes to the scope of stablecoins which may be topic to regulation as wanted sooner or later? |
In posing this query, the HKMA has famous that it intends to take a risk-based strategy targeted initially on payment-related stablecoins at this stage given their predominance available in the market and better potential to be included into the mainstream monetary market (as mentioned above). Nevertheless, the HKMA has famous that it intends to make sure that no matter regime is launched is sufficiently versatile that it might prolong to different sorts of stablecoins sooner or later. As such, issuers and merchants of different sorts of stablecoins mustn’t anticipate to keep away from regulatory scrutiny perpetually.
| Query 2: What sorts of stablecoin-related actions ought to fall below the regulatory ambit, e.g. issuance and redemption, custody and administration, reserves administration? |
The HKMA has proposed regulating a broad vary of stablecoin-related actions, together with:
- Issuing, creating or destroying stablecoins;
- Managing reserve belongings to make sure stabilisation of stablecoin worth;
- Validating transactions and information;
- Storing personal keys used to supply entry to stablecoins;
- Facilitating the redemption of stablecoins;
- Transmission of funds to settle transactions; and
- Executing transactions in stablecoins.
This broad record relies on a listing of actions in relation to stablecoins revealed by the Monetary Stability Board[1] and as such could also be considered as consistent with worldwide requirements. Nevertheless, as mentioned under in relation to Query 5, the breadth of this regime could elevate issues relating to the diploma of overlap between this regime and others proposed by Hong Kong regulators, together with the proposed VASP regime to be administered by the Securities and Futures Fee (SFC) (see our alert here).
| Query 3: What sort of authorisation and regulatory necessities can be envisaged for these entities topic to the brand new licensing regime? |
The HMKA has urged that it considers that entities topic to the brand new stablecoin licensing regime can be topic to the next necessities:
- authorisation and prudential necessities, together with sufficient monetary sources and liquidity necessities;
- match and correct necessities in relation to each administration and possession;
- necessities referring to the upkeep and administration of reserves of backing belongings; and programs; and
- controls, governance and danger administration necessities.
Additional, provided that it’s common for a number of entities to be concerned in numerous elements of a stablecoin association, the HKMA has famous that such entities may very well be topic to half or the entire necessities, relying on the companies they provide.
If necessities in relation to those issues are finally carried out by the HKMA, the stablecoin regime would cowl among the necessities of the proposed VASP regime, except for necessities of reserves of backing belongings, which can presumably solely be utilized to stablecoins given their nature.
| Query 4: What’s the meant protection as to who wants a licence below the meant regulatory regime? |
The HKMA has signalled that it believes that solely entities included in Hong Kong and holding a related licence granted by HKMA ought to perform regulated actions, to allow the HKMA to train efficient regulation on the related entities. As such, it has acknowledged within the Paper that it expects that overseas firms / teams which intend to supply regulated actions in Hong Kong or actively market these actions in Hong Kong to include an organization in Hong Kong and apply for a licence to the HKMA below this regime.
If carried out, this is able to have important ramifications for these international crypto-exchanges at the moment providing buying and selling in stablecoins to Hong Kong customers from offshore. These companies can be confronted with a alternative between both incorporating in Hong Kong and looking for a licence, or discontinuing their buying and selling for Hong Kong customers.
| Query 5: When will this new, risk-based regime on stablecoins be established, and would there be regulatory overlap with different monetary regulatory regimes in Hong Kong, together with however not restricted to the SFC’s VASP regime, and the SVF licensing regime of the PSSVFO? |
The HKMA has acknowledged that it’ll collaborate and coordinate with different monetary regulators when defining the scope of its oversight and can search to keep away from regulatory arbitrage, together with in relation to areas which ‘could also be topic to regulation by multiple native monetary authority’.
Nevertheless, an HKMA-administered regime of the breadth proposed above would create a state of affairs through which an trade endeavor transactions in non-stablecoin crypto-assets can be regulated by the SFC below its proposed new VASP regime whereas being regulated by each the SFC and the HKMA below its stablecoin regime. On this respect, we word that the proposed definition of ‘digital asset’ below the proposed new VASP regime ‘applies equally to digital cash which can be secure (i.e. the so-called “stablecoins”)’.[2] Whereas the HKMA and SFC share regulatory accountability for Registered Establishments (i.e. Authorised Establishments that are individually licensed by the SFC to undertake securities and futures enterprise), that shared regulatory accountability issues distinctly several types of actions. In distinction, we take into account that from an trade’s perspective, the act of executing transactions in stablecoins is considerably much like executing transactions in non-stablecoin crypto-assets. As such, this strategy could result in pointless and undesirable regulatory inefficiencies if exchanges are required to be licensed below each the SFC and HKMA regimes to undertake transactions in crypto-assets.
| Query 6: Stablecoins may very well be topic to run and turn into potential substitutes of financial institution deposits. Ought to the HKMA require stablecoin issuers to be AIs below the Banking Ordinance, much like the suggestions within the Report on Stablecoins issued by the US President’s Working Group on Monetary Markets? |
Whereas not expressly stating that it’ll not require stablecoin issuers to be regulated as AIs below the Banking Ordinance, the HKMA has indicated that it expects that the necessities relevant to stablecoin issuers will as a substitute borrow from Hong Kong’s present regulatory framework for saved worth amenities (SVF). Nevertheless, the HKMA has signalled that sure stablecoin issuers could also be topic to greater prudential necessities than SVF issuers the place they challenge stablecoins of systemic significance.
| Query 7: [Does] the HKMA even have plan[s] to control unbacked crypto-assets given their rising linkage with the mainstream monetary system and danger to monetary stability? |
The HKMA has not expressly dominated out regulating unbacked crypto-assets, and has acknowledged that it’s essential to proceed monitoring the dangers posed by this asset class. In stating this, the HKMA has additionally pointed to the VASP regime, suggesting that the HKMA’s strategy to this space is more likely to depend upon the success of that regime as soon as carried out.
| Query 8: For present or potential events and entities within the stablecoins ecosystem, what ought to they do earlier than the HKMA’s regulatory regime is launched? |
The HKMA has suggested present and potential gamers within the stablecoin ecosystem to supply suggestions on the proposals set out within the Dialogue Paper, and has famous that within the interim, it would proceed to oversee AIs’ actions in relation to crypto-assets and implement the SVF licensing regime pending implementation of this new regime.
Conclusion
The Dialogue Paper supplies a invaluable perception into the HKMA’s plans for the way forward for stablecoin regulation in Hong Kong. Whereas some issues exist as to the potential overlap between the HKMA’s new proposed regime and the SFC’s VASP regime, it’s clear that the HKMA intends to make sure that it’s considered the first regulator of stablecoins going ahead, and that it sees the regulation of this asset class as intently linked to its key goal of making certain monetary stability.
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[1] See Financial Stability Board, Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Final Report and High-Level Recommendations, https://www.fsb.org/wp-content/uploads/P131020-3.pdf, web page 10.
[2] See Financial Services and the Treasury Bureau, Public Consultation on Legislative Proposals to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (Consultation Conclusions), https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf, paragraph 2.8.
Gibson Dunn’s attorneys can be found to help in addressing any questions you could have relating to these developments. For those who want to focus on any of the issues set out above, please contact any member of Gibson Dunn’s Crypto Taskforce (cryptotaskforce@gibsondunn.com) or the Global Financial Regulatory group, together with the next authors in Hong Kong:
William R. Hallatt (+852 2214 3836, whallatt@gibsondunn.com)
Emily Rumble (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun (+852 2214 3838, apun@gibsondunn.com)
Becky Chung (+852 2214 3837, bchung@gibsondunn.com)
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