The Hong Kong Monetary Authority (HKMA) issued a discussion paper on 12 January 2022 in which it sets out its views on how to expand Hong Kong’s regulatory framework for crypto-assets. The discussion paper joins a number of papers that regulators across the world have issued on the subject of crypto-assets and has been prompted by the region witnessing significant growth in the market capitalisation of crypto-assets, as well as increasing investment in and/or usage by institutional and retail players. The discussion paper in particular considers stablecoins, which are generally considered a sub-set of crypto-assets, and have also been the focus of discussion across the international regulatory fora.
Sections 4 and 5 are the key sections in the discussion paper where the HKMA provides an overview of where it stands in respect of crypto-assets and stablecoin regulation. It also sets out in these sections the key risks posed by stablecoins, the guiding principles of a contemplated regulatory regime, and puts forwards the HKMA’s thoughts on how to expand the regulatory framework for such assets.
Payment related stablecoins
One of the key points made by the HKMA is that it feels that there is a perception that some stablecoins may be developing into a widely acceptable means of payment, i.e. payment-related stablecoins. The HKMA’s concern is that these payment-related stablecoins have a higher potential for being incorporated into the mainstream financial system or even day-to-day commercial and economic activities (by being a means of payment). In light of these concerns, the HKMA is considering expanding the scope of the Payment Systems and Stored Value Facilities Ordinance (PSSVFO) or introducing new legislation to focus on activities relating to these types of stablecoins.
The types of stablecoin-related activities that would fall within regulatory scope are further described in the HKMA’s response to discussion question 2 (page 26), and these include issuing, creating or destroying stablecoins, managing reserve assets to ensure stabilisation of the stablecoin value, and storing the private keys providing access to stablecoins
The HKMA’s attention will focus on asset-linked stablecoins (e.g., to a single fiat currency) rather than algorithm-based stablecoins at this stage, noting that (i) currently, existing stablecoins are mostly asset-linked and predominantly pegged to USD; and (ii) compared to algorithm-based stablecoins, asset-linked stablecoins appear to be more prevalent in the market and more likely to be perceived as having the potential to develop into a widely used and acceptable means of payment. However, the HKMA does not rule out the possibility of regulating other types of stablecoins, including but not limited to algorithm-based ones in the future (e.g., having regard to the risks that they may pose to the monetary and financial stability of Hong Kong).
In terms of the regulatory requirements to be put in place for the stablecoin arrangements, the HKMA states that it proposes a risk based approach on the basis that it is common for multiple entities to be involved in different parts of a stablecoin arrangement. Such entities would be subject to part or all of the requirements. Such requirements include authorisation, maintaining adequate financial resources and liquidity requirements, maintenance and management of reserves of backing assets, and proper implementation of anti-money laundering rules.
Significantly, the HKMA states that a foreign company or group cannot carry out, as a business, the proposed regulated activities in Hong Kong or actively market to the public of Hong Kong such activities. Instead, they will need to incorporate a company under Hong Kong law, and the Hong Kong incorporated company would be the entity to apply to the HKMA for a licence and hold that licence if and when granted. A mere Hong Kong branch or office of a foreign corporation will be regarded as not meeting the requirement of being “an entity incorporated in Hong Kong”. This requirement aims to enable the HKMA to exercise effective regulation on the relevant entities.
Non-backed crypto assets
Another area of focus concerns non-backed crypto-assets such as security crypto-assets. The HKMA’s concern is that these kinds of crypto-assets are highly speculative and volatile, and that these risks are not reasonably likely to be understood by retail investors. Hence, such products are likely to be considered as complex products. The HKMA refers to the circular that the Securities and Futures Commission (SFC) issued to all intermediaries in November 2018 regarding regulatory requirements and expected standards and practices in relation to the distribution of virtual asset funds. It states that both it and the SFC will continue to keep in view the evolving regulatory landscape, and the evolution of different types of investment products and investment activities in the market. In addition, the HKMA states that certain types of virtual asset activities will be brought under the virtual asset service provider licensing regime that was announced in May 2021.
Separate guidance for AIs
Please note that the HKMA is also considering its regulatory approach regarding Authorized Institutions’ (i.e., the financial institutions it supervises) interface with and provision of intermediary services to customers related to crypto-assets, and further guidance will be issued soon.
The deadline for comments on the discussion paper is 31 March 2022.
The HKMA will take into account the feedback and consider next steps, including assessing the need to issue further documents on specific aspects of the regulatory framework in 2022/23. It aims to introduce the new regime no later than 2023/24.