How Hong Kong Is Gearing Up to Regulate Stablecoins

At the end of January, the Hong Kong Monetary Authority (HKMA) indicated it may require firms to keep to their principal business and have a locally incorporated entity in Hong Kong if they want to obtain stablecoin licenses, according to its consultation conclusions.

The HKMA’s current stance is that stablecoins must be fully backed by high-quality liquid assets (which HKMA has yet to detail) and be redeemable to their referenced fiat currencies at par. Under this regime, algorithmic and arbitrage coins are effectively not allowed.

The collapse of Terraform Labs and the algorithmic UST stablecoin last year prompted regulators worldwide to focus on regulating stablecoins.

Stablecoin regulations in Hong Kong may be coming in as soon as this year. The proposed regime will cover entities if they actively market or operate in Hong Kong. It will also increase the number of licenses an issuer will need.

CoinDesk reached out to the HKMA to ask whether non-Hong Kong stablecoin issuers like Tether will be regulated under its upcoming regime.

A representative from the HKMA said that “regulatory treatment for different types of virtual assets would depend on, among other things, their actual structures and operational details.”

“We will continue our ongoing discussion with the industry with a view to adopting a risk-based, pragmatic and agile approach to regulate stablecoins,” the representative said, adding that the regulator will “conduct further consultation on the granular details”.

Wallet providers now obtain a “Trust or Company Service Provider” license, but under the new regime, they are likely to need a stablecoin wallet license.

Issuers of widely used stablecoins like tether USDT$0.9985 might have to set up a locally incorporated entity.

CoinDesk reached out to stablecoin issuers Tether and Paxos for comment. On the publication of this article, they had not responded to questions on whether they were interested in applying to be regulated under the proposed stablecoin regime.

A spokesperson for Circle did not respond directly to a query on whether the company would be interested in obtaining stablecoin licenses in Hong Kong, but said that it had “been in discussions with regulators globally on stablecoin regulatory developments.”

How firm is its stance?

There is a chance the HKMA will relax its stance because the city is trying to welcome talent and keep its position as an international financial center.

The HKMA is focused on ensuring the stability of Hong Kong’s financial system but it also has another role in promoting the economy.

Crypto companies were not the only ones to participate in consultations. No surprise, then, that traditional banks and virtual banks, which have been competing to sign retail customers and companies involved in cross-border trade payments all gave feedback to the regulator.

HKbitEX Chief Strategy Officer Ken Lo said there’s also the question of “how stablecoins can be used to facilitate the next era of payment,” pointing to the strength of wholesale and commercial banking in the city.

Michael Wong, partner at law firm Dechert, said that judging from previous discussions with the HKMA over the private equity fund regime, the regulator will take a commercially friendly stance to “make it work for both the industry and also from the investor protection perspective.”

Locally incorporated entity

“If they want to do something which is friendly to the industry, they shouldn't really have this requirement that the issuer has to be incorporated in Hong Kong,” Wong said. Registering as a non-Hong Kong company in Hong Kong is a simple registration, he said.

Requiring foreign entities that have already issued stablecoins to set up an entity in Hong Kong then issue stablecoins out of that entity would create complications.

Legally, investors holding stablecoins issued from the Hong Kong entity would only be able to go after that entity, not its other entities, Wong said.

Liquidity might also be an issue. If only a small market used the stablecoin issued from the issuer’s Hong Kong entity, it might also affect trading pairs, Jason Chan, senior associate at Dechert, said.

Principal business

HKMA’s current position would mean that exchanges would have to segregate their virtual asset business from their stablecoin business.

Under the segregation requirement, companies will face additional costs. “Every time you want to trade, let's say 0.1 bitcoin, you have gas fees going back and forth to the custodians,” Tim Byun, global government relations officer at OKX, said.

Byun said there are other ways to keep the focus on protecting consumers and ensure exchanges aren’t operating a fractional reserve system where they lend out customers’ funds.

He pointed to OKX’s use of Merkel trees and its commitment to go for an audit this year.

“To quickly just move the entire crypto industry into the traditional securities world is like pushing a square peg into a round hole,” Byun said.

Update (Feb. 22, 2023 11:56 UTC): Adds response from Circle.