How is Hong Kong preparing for stablecoin regulation?

At the end of January, the Hong Kong Monetary Authority (HKMA) indicated that it may require companies to maintain their core business and have a local entity in Hong Kong if they wish to obtain stablecoin licenses, according to its consultation conclusions.

HKMA’s current position is that stablecoins should be fully backed by high-quality liquid assets (which HKMA has yet to detail) and exchangeable for their fiat currencies referred to at par. Under this system, algorithmic coins and arbitrage are virtually not allowed.

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

Hong Kong stablecoin regulations may be rolled out as early as this year. The proposed system would cover entities if they actively market or operate in Hong Kong. It will also increase the number of licenses an issuer will need.

CoinDesk has reached out to HKMA to ask if non-Hong Kong stablecoin issuers such as Tether will be regulated under its upcoming regulation.

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

“We will continue our ongoing discussions with the industry with the aim of adopting a risk-based, pragmatic and agile approach to regulating stablecoins,” said the representative, adding that the regulator will “consult further consultations on the finer details.”

Wallet service providers now have a “Trust or Company Service Provider” license, but under the new system they will likely need a stablecoin wallet license.

Issuers of widely used stablecoins such as Tether (USDT) may have to create an incorporated entity locally.

CoinDesk has reached out to stablecoin issuers Tether, Circle, and Paxos for comment. When this article was published, none of them had responded to questions about whether they would be interested in applying for regulation under the proposed stablecoin system.

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

Crypto companies were not the only ones to participate in the consultations. It’s no surprise, then, that traditional banks and virtual banks, which have been vying to sign off on retail customers and companies involved in cross-border trade payments, have all given feedback to the regulator.

There is also the question of “how stablecoins can be used to facilitate the next era of payments,” said Ken Lu, Head of Strategy at HKbitEX, pointing to the city’s strength in commercial and wholesale banking.

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

“If they want to do something industry-friendly, they shouldn’t have this requirement that the issuer has to be incorporated in Hong Kong,” said Wong. He said registering as a non-Hong Kong company in Hong Kong is a simple one.

Requiring foreign entities that have already issued stablecoins to establish an entity in Hong Kong and then issuing stablecoins from that entity will introduce complications.

Legally, investors who own stablecoins issued by a Hong Kong entity will only be able to go after that entity, not its other entities, Wong said.

Liquidity may also be an issue. Jason Chan, senior associate at Dechert, said that if a small market uses the stablecoin issued by the Hong Kong issuing entity, it could also affect trading pairs.

HKMA’s current situation may mean that exchanges will have to separate their virtual asset business from their stablecoin business.

Under the severance clause, companies will face additional costs. “Every time you want to trade, let’s say 0.1 bitcoin, you have gas fees that go back and forth to the keepers,” said Tim Byun, OKX’s global government relations officer.

Bion said there are other ways to keep the focus on protecting consumers and ensuring that exchanges don’t run a partial reserve system where they lend customers money.

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

“Just quickly moving the entire cryptocurrency industry into the traditional world of securities is like driving a square peg into a round hole,” Bion said.