Direct hit, Hong Kong stablecoin legislation is coming, a detailed explanation of the issuer regulatory system and sandbox arrangements

Author: Xiao Za Lawyer

In July 2024, the Hong Kong Financial Services and the Treasury Bureau released the "Consultation Summary on Legislative Proposals for Implementing a Regulatory Regime for Stablecoin Issuers in Hong Kong," clarifying the importance of fiat-pegged stablecoins in the Web3 and cryptocurrency ecosystem and releasing a sandbox list (our old e-commerce friend JD is among them, indeed quietly doing big things). It can be seen that the Hong Kong government recognizes both the risks of crypto assets and their symbiotic relationship with the traditional financial system and capital markets, which complement and promote each other.

Today, the Za Jie team will clarify the current regulatory measures regarding stablecoins in Hong Kong and help partners understand how to properly ride the financial express of Hong Kong's stablecoins.

01 Detailed Explanation of Current Regulatory Measures for Stablecoins in Hong Kong

According to the Hong Kong Monetary Authority's definition, a stablecoin is a virtual asset designed to maintain a relatively stable value against certain assets (usually currencies). Due to the increasing interconnectedness between the traditional financial system and the virtual asset market, the Monetary Authority is developing a regulatory regime for stablecoin issuers in Hong Kong.

1 Regulation of Stablecoin Issuers

Currently, Hong Kong has not yet legislated to regulate stablecoins, but the subsequent legislative approach is likely to remain broadly consistent with previous consultation documents. We refer to the "Legislative Proposals for Implementing a Regulatory Regime for Stablecoin Issuers" released by the Financial Services and the Treasury Bureau (FSTB) and the Monetary Authority (HKMA) in December 2023 to briefly interpret the regulatory measures Hong Kong intends to take regarding stablecoin issuers and the conditions for applying to become a stablecoin issuer.

1. Licensing Regulation

Hong Kong's regulatory measures for stablecoin issuance follow the licensing regulatory model of traditional financial institutions: all eligible fiat stablecoin issuers must obtain a license issued by the Financial Commissioner. In other words, only licensed entities can issue stablecoins. Additionally, from the consultation document, it appears that there may be two types of licenses for issuing stablecoins in Hong Kong (or one type of license with different scopes of permission, commonly referred to as "big and small licenses"). The consultation document specifies: (1) only licensed entities can provide services to the public for purchasing fiat stablecoins; (2) only fiat stablecoins issued by licensed stablecoin issuers can be sold to ordinary investors. In the future, some "coin merchants" may only have administrative licenses to "sell" fiat stablecoins.

Moreover, the consultation document also clarifies that a suitable "transition period" will be provided for existing stablecoin issuers and coin merchants to adapt to the new regulatory requirements. Referring to the Hong Kong Securities and Futures Commission's circular on the transitional arrangements for the VATP licensing regime last year, we expect the transition period for stablecoin issuers and coin merchants to be around 12 months. Note that stablecoin issuers and coin merchants that can enjoy the transition period will likely need to meet the condition of "operating a genuine business and having a genuine business presence." According to the VATP transition arrangements, considerations for "genuine business" and "genuine business presence" include: whether there is a legitimate Hong Kong entity; whether there is a Hong Kong office; whether the entity is managed and controlled by Hong Kong employees; whether key personnel are based in Hong Kong; whether there are independent clients in Hong Kong and actual transaction volume, etc.

2. Requirements for Applying for a Stablecoin Issuer License

We first need to clarify that the Hong Kong government does not impose strict requirements on the entities that can apply for a license; essentially, "all eligible entities can apply for a license," but whether they can obtain a license depends on the specific business and compliance of the platform. In short, in the emerging industry of crypto assets, the Hong Kong government values not "who you are," but "what you intend to do."

According to the consultation document, the Hong Kong government has proposed the following compliance requirements for entities issuing stablecoins:

3. Other Matters

The consultation document clarifies that the stablecoin issuance license is a continuously valid license; in other words, once issued, the license will remain valid unless revoked. In terms of business operations, the current consultation document believes that, from a risk control perspective, licensed stablecoin issuing institutions can provide stablecoin purchasing services in Hong Kong and do not emphasize that they must sell to professional investors, which means that stablecoins issued by licensed institutions are likely to be sold to the general public.

02 How to Play with the Stablecoin Sandbox?

On March 12, 2024, the Hong Kong Monetary Authority released the "Hong Kong Stablecoin Sandbox Arrangement," officially launching the regulatory sandbox system for stablecoins in Hong Kong. According to the Monetary Authority's information, the purpose of establishing the "sandbox" is to test the business processes of stablecoin issuers and assess how they can operate compliant and sustainable stablecoin businesses in Hong Kong. Therefore, applicants entering the "sandbox" need to demonstrate detailed and feasible business and "sandbox" plans.

1. How to Apply to Join the Stablecoin Sandbox?

Currently, there is only one application channel (quite old school): express your intention to join the stablecoin regulatory sandbox to the Monetary Authority via the official email stablecoin_sandbox@hkma.gov.hk and wait for the Monetary Authority to contact you. The Monetary Authority may also request more information from the applicant. The time taken by the Monetary Authority to process applications is uncertain and depends on the complexity of the applicant's business model, the sufficiency and quality of the data provided by the applicant, and the applicant's responsiveness and thoroughness to subsequent questions and requirements from the Monetary Authority.

Currently, the main factors considered in evaluating applications are as follows:

1. Whether the applicant can demonstrate a genuine intention and reasonable plan to issue fiat stablecoins in Hong Kong.

2. Whether the applicant can demonstrate a specific plan for participating in the "sandbox."

3. Whether the applicant can provide reasonable expectations that meet the proposed regulatory requirements.

2. Entities Already Joined the Stablecoin Regulatory Sandbox

Currently, according to the Monetary Authority's information, three individual or joint entities have successfully joined the stablecoin sandbox, among which our very familiar e-commerce giant JD from mainland China is also listed, along with two other equally powerful entities. According to information obtained by the Za Jie team, JD has already put the plan to issue a cryptocurrency stablecoin pegged to the Hong Kong dollar at a 1:1 ratio on the agenda, tentatively named "JD Stablecoin." Technically, this is a cryptocurrency issued on a public chain, with a price pegged to the Hong Kong dollar (HKD) at a 1:1 ratio. The underlying assets have not been disclosed, but according to JD's blockchain technology company, the underlying assets consist of highly liquid and trustworthy assets, securely stored in independent accounts held by licensed financial institutions, and can be strictly verified for the integrity of reserves through regular disclosures and audit reports. Upon inquiry, the issuing entity JD Blockchain Technology has obtained licenses from the Hong Kong Securities and Futures Commission for Type 1 (Securities Trading), Type 4 (Advising on Securities), and Type 9 (Asset Management).

3. Sandbox Does Not Equal Already Licensed

It is important to note that entering the sandbox does not mean that a license to issue cryptocurrency stablecoins has already been obtained. Taking JD as an example, if the stablecoin licensing system is improved and JD's sandbox test results are good (high stability, good compliance, capable of generating significant economic value), JD will still need to apply for a license from the regulatory authority, but can use the results of the sandbox test directly as a basis for applying for a licensed entity, greatly increasing the probability of obtaining a license. From this perspective, entering the sandbox means seizing the initiative in the wave of stablecoins in Hong Kong.

In Conclusion

Partners familiar with Hong Kong's financial system know that since 1983, the Hong Kong Monetary Authority has established a "linked exchange rate system" pegging the Hong Kong dollar to the US dollar, delegating the currency issuance rights to three note-issuing banks: HSBC, Bank of China, and Standard Chartered. For every 7.8 Hong Kong dollars issued, the note-issuing banks must pay 1 US dollar to the Monetary Authority and receive a liability certificate before they can start printing money. When the note-issuing banks want to withdraw banknotes, they must present the liability certificate to the Monetary Authority to exchange back for US dollars and then exchange for Hong Kong dollars from the market. However, although the three banks have the right to issue currency, they do not have the "minting rights." The three banks only submit the designed banknote styles and the quantity of currency to the Hong Kong Note Printing Company, which then issues them uniformly. This is why, except for the 10 Hong Kong dollar note, all other Hong Kong dollars are printed with the words "Payable on Demand," meaning that the Hong Kong dollars issued by the note-issuing banks are essentially a type of "voucher."

Many partners should now realize that the traditional financial system in Hong Kong actually has multiple similarities with the issuance logic of stablecoins, and it is not unreasonable to view stablecoins as a type of fiat "voucher." Therefore, the Za Jie team believes that Hong Kong has an inherent advantage in regulating stablecoins, which also means that the issuance of fiat stablecoins in Hong Kong faces relatively low resistance. From a historical perspective, obtaining a license for the issuance of fiat stablecoins is likely to signify sustained prosperity for any entity in the next century.