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 they have 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 Terra 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 might have to set up a locally incorporated entity.
CoinDesk reached out to stablecoin issuers Tether, Circle and Paxos for comment. On the publication of this article none of them had responded to questions on whether they were interested in applying to be regulated under the proposed stablecoin regime.
How firm is its stance?
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-up 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 who have already issued stablecoins to set up an entity in Hong Kong then issue stablecoins out of that entity would throw up 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, senior associate at Dechert Jason Chan, said.
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 that there's 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.