Out-Law / Your Daily Need-To-Know

Hong Kong central bank’s risk based approach to crypto-assets and stablecoins

Out-Law Analysis | 27 Jun 2022 | 2:06 am | 8 min. read

The recent collapse of a popular stablecoin has sent shockwaves across the crypto market. The crash may prompt authorities in the Hong Kong Special Administrative Region (SAR) to speed up regulations to bring crypto assets and stablecoins under supervision.

Very recently in April 2022, the regulators in the UK have also been planning for regulatory reform in relation to stablecoins. With the growth of crypto-related activities in Hong Kong SAR, it is a good time to revisit the recent efforts by the Hong Kong SAR authorities to bring this matter into regulatory perimeter.

Current regulatory landscape

The Hong Kong Monetary Authority (“HKMA”) and the Securities and Futures Commission (“SFC”) act as two supervisory and regulatory authorities of the financial activities in the Hong Kong SAR, where the HKMA acts as the 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 inclination and attitude towards crypto-assets. It also provides insight into the authority’s priorities in light of the evolving crypto market and the developing global regulatory framework.

For the past few years, the HKMA and the SFC have adopted a comparatively hands-off approach towards the regulation of crypto-assets and virtual assets in general. Recent effort includes putting forward a voluntary opt-in regime for platforms to obtain licence for offering trading services of virtual assets with securities features. Since the launch of the voluntary opt-in regime, several crypto-related consultations have also been carried out. 

It appears from the current regulatory regime that the authorities’ major concern is the substantive dealings of the crypto-related activities, as in whether the relevant dealings involve any regulated activities or dealings with securities. 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, and appears to be the most elaborate, attempt to clarify and expand the regulatory regime in the Hong Kong SAR.

While the views set out in the discussion paper are not conclusive and would be subject to change, the issues covered will serve as practical starting points for market players and potential investors to gain a better gauge of the future regulatory framework.

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

Given the speed of crypto development and the evolving global regulatory landscape, investors and market participants that are keen on the potential of the crypto market are encouraged to closely monitor the HKMA’s developing approach.

Takeaways from the discussion paper

Regulating stablecoins

One of the key priorities for the HKMA appears to be regulating stablecoins. Stablecoins are generally considered as a sub-set of crypto assets, where their values are linked or referenced to an underlying asset, allowing them to maintain a relatively stable value compared to other crypto assets. Because of this relative stability, there a general perception and expectation that these stablecoins could readily develop into an acceptable means of payment or store of value, and gradually integrate into the mainstream financial system globally and locally.

Risks and regulatory concerns

As the central bank of Hong Kong SAR's financial system, it is the HKMA’s primary objective 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 most concerned about the potential contagion risks of crypto assets and stablecoins. The HKMA recognises that if stablecoins are to become part of the mainstream financial system, any collapse or operational disruption of such coins would potentially undermine the stability and integrity of the financial system, which should be taken into account by the HKMA when formulating its own regulatory framework.

Even though virtual assets are becoming more popular in some parts of the world, the global regulatory landscape remains uneven. The HKMA is conscious of the time pressure and the issue of regulatory arbitrage. The evolving nature of this crypto-market makes it a very challenging task for regulators to introduce a consistent approach to deal with 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 adopt a risk-based approach to regulate stablecoin-related activities. 

The HKMA is proposing a more agile regulatory approach to stay nimble whilst making sure the local regulatory regime could accommodate the evolving market. The HKMA also intends to adopt a proportionate approach to regulate stablecoins by giving priority to areas that pose higher degree of risks while allowing room for financial innovation.

Moving forward: Policy inclination

The HKMA has also expressed its initial views on various aspects relating to establishing a regulatory regime for stablecoins. These initial views, although subject to change, offer great insight into the future regulatory development on crypto-assets:


Aspects HKMA’s initial views 
Proposed activities likely to be regulated 

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

1. issuing, creating or destroying stablecoins

-  the activity of the issuer minting and burning of stablecoins

2. managing reserve assets to ensure stabilisation of the stablecoin value

-  the activity of managing the reserve assets that are backing the value of the stablecoins and providing custody or trust for these assets

3. validating transactions and records

-  the activity of authorising or verifying the validity of transactions and records

4. storing the private keys providing access to stablecoins

-  the activity of safe-keeping of keys used to digitally sign transaction instructions on behalf of stablecoin holders

5. facilitating the redemption of stablecoins

-  the activity of facilitating stablecoin holders to redeem stablecoins for fiat currencies or other assets

6. transmission of funds

-  the activity of ensuring the correct and final settlement of transactions to minimise default risk of counterparties

7. executing transactions in stablecoins

-  the activity of conducting transactions on behalf of others

Requirement for a Hong Kong SAR-incorporated company 
  • HKMA has proposed that if an entity would like to carry out or market the regulated activities in Hong Kong SAR, the entity has to be incorporated in Hong Kong SAR and hold a relevant licence granted by the HKMA.
  • In other words, if a foreign company or group intends to carry out, as a business, any regulated crypto-related activities in Hong Kong SAR or actively markets to the local public such activities, such foreign corporation will need to incorporate a company under the laws of the Hong Kong SAR. The company incorporated in Hong Kong SAR would then be the entity to apply to the HKMA for a licence and hold that licence if and when granted.
  • A mere Hong Kong SAR branch or office of a foreign corporation is regarded as not meeting the requirement of “an entity incorporated in Hong Kong”.
Plans to regulate unbacked crypto assets such as bitcoin
  • HKMA has recognised that there is a need to continue monitoring the various risks associated with these unbacked crypto-assets and take actions as necessary. 

Co-written by Sara Chan of Pinsent Masons.

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