Hong Kong Central Bank’s Risk-Based Approach to Crypto-Assets and Stablecoins

Most recently in April 2022, UK regulators have also planned regulatory reform with regard to stablecoins. With the growth of crypto-related activities in the Hong Kong SAR, it is time to reflect on the recent efforts of the Hong Kong SAR authorities to bring this issue into the regulatory perimeter.

Current regulatory landscape

The Hong Kong Monetary Authority (“HKMA”) and the Securities and Futures Commission (“SFC”) act as supervisory and regulatory authorities for financial activities in the Hong Kong SAR, where the HKMA acts as than central bank.

Earlier this year, the HKMA released a discussion paper (34-page / 976KB PDF) on crypto assets and stablecoins. This discussion paper sheds light on the HKMA’s current tilt and attitude towards crypto-assets. It also provides an overview of the authority’s priorities in light of the evolution of the crypto market and the developing global regulatory framework.

Over the past few years, the HKMA and SFC have taken a relatively passive approach to the regulation of crypto-assets and virtual assets in general. Recent efforts include establishing a voluntary membership scheme for platforms to obtain a license to offer virtual asset trading services with securities features. Since the launch of the voluntary opt-in regime, several crypto-related consultations have also been conducted.

It is apparent from the current regulatory regime that the primary concern of authorities is with the substantive transactions of crypto-related activities, such as whether the relevant transactions involve regulated activities or securities transactions. The current approach focuses on applying the principles of the existing regulatory framework to crypto-related activities, rather than formulating a new framework specifically for crypto or virtual assets.

The Discussion Paper

This discussion paper is the most recent attempt, and appears to be the most elaborate, to clarify and expand the Hong Kong SAR regulatory regime.

Although the opinions expressed in the discussion paper are not conclusive and are subject to change, the issues discussed will serve as practical starting points for market participants and potential investors to better assess the future regulatory framework.

The HKMA is expected to take a risk-based approach to moving things forward. As mentioned in the discussion paper, the HKMA will continue to monitor the development of crypto assets and maintain close dialogue with various stakeholders, including other financial regulators and relevant international standard-setting bodies, to avoid regulatory arbitrage. .

Given the rapid development of crypto and the changing global regulatory landscape, investors and market participants who appreciate the potential of the crypto market are encouraged to keep a close eye on the HKMA’s development approach. .

Takeaways from the Discussion Paper

Regulating stablecoins

One of the top priorities for the HKMA seems to be the regulation of stablecoins. Stablecoins are generally considered a subset of crypto assets, where their values ​​are tied or referenced to an underlying asset, allowing them to maintain a relatively stable value compared to other crypto assets. Due to this relative stability, there is a general perception and expectation that these stablecoins could easily become an acceptable means of payment or store of value, and gradually integrate into the mainstream financial system globally and local.

Risks and Regulatory Concerns

As the central bank of the Hong Kong SAR financial system, the main objective of the HKMA is to ensure the stability of the Hong Kong dollar and its banking system. Against this background, the HKMA has identified a few key areas of concern in the discussion paper.

Essentially, the HKMA is very concerned about the potential contagion risks of crypto-assets and stablecoins. The HKMA recognizes that while stablecoins are to be part of the mainstream financial system, any collapse or operational disruption of these coins could potentially compromise the stability and integrity of the financial system, which should be considered by the HKMA when formulation of its own regulations. frame.

Even though virtual assets are gaining popularity in some parts of the world, the global regulatory landscape remains uneven. The HKMA is aware of the time pressure and the issue of regulatory arbitrage. The evolving nature of this crypto market makes it very difficult for regulators to introduce a consistent approach to managing crypto-related activities.

Objectives and Guiding Principles

In line with the HKMA’s long-standing risk-based supervisory approach to banking supervision, the HKMA also intends to take a risk-based approach to regulating stablecoin-related activities.

The HKMA offers a more agile regulatory approach to remain agile while ensuring that the local regulatory regime can adapt to changing market conditions. The HKMA also intends to take a proportionate approach to regulating stablecoins by prioritizing areas that present a higher degree of risk while allowing room for financial innovation.

Moving Forward: Political Tilt

The HKMA also expressed its initial views on various aspects related to establishing a regulatory regime for stablecoins. These early views, while subject to change, offer a good overview of how crypto-asset regulation will evolve in the future:

Aspects First sights of HKMA
Proposed activities that may be regulated

The HKMA has proposed that the following activities may need to be regulated, either by expanding the scope of current legislation or by introducing new legislation:

1. issue, create or destroy stablecoins

– stablecoin minting and burning issuer activity

2. manage reserve assets to ensure stablecoin value stabilization

– the activity of managing reserve assets that back the value of stablecoins and the custody or trust of those assets

3. validate transactions and records

– the activity of authorizing or verifying the validity of transactions and records

4. store private keys giving access to stablecoins

– the custody activity of the keys used to digitally sign transaction instructions on behalf of stablecoin holders

5. facilitate the redemption of stablecoins

– the activity of assisting stablecoin holders to exchange stablecoins for fiat currencies or other assets

6. remittance of funds

– the activity of ensuring the correct and final settlement of transactions in order to minimize the risk of counterparty default

7. execute transactions in stablecoins

– the activity of carrying out transactions on behalf of others

Requirement for a company incorporated in the Hong Kong SAR
  • HKMA proposed that if an entity wishes to carry on or market the regulated activities in the Hong Kong SAR, the entity must be incorporated in the Hong Kong SAR and hold an appropriate license granted by the HKMA.
  • In other words, if a foreign company or group intends to conduct, as a business, regulated crypto-related activities in the Hong Kong SAR or actively markets such activities to the local public, this foreign company will have to incorporate a company under the laws of the Hong Kong SAR. The company incorporated in the Hong Kong SAR would then be the entity to apply to the HKMA for a license and hold that license if and when granted.
  • A mere branch or office of a foreign company in the Hong Kong SAR is deemed not to meet the “Hong Kong incorporated entity” requirement.
Regulatory plans for unsupported crypto assets such as bitcoin
  • HKMA recognized the need to continue to monitor the various risks associated with these unbacked crypto-assets and take necessary action.

Co-written by Sara Chan of Pinsent Masons.

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