The regulator fields a last discussion paper before implementing a regime for coins referencing fiat currencies. But behind all the business-friendly talk lies a strict, ironclad regulatory framework. 

The key messages about an impending framework for stablecoins by the authorities in Hong Kong seem all warm and fuzzy, full of talk about the importance of Web3 and the virtual asset ecosystem – the «rising interconnectedness» between traditional finance and the digital world.

But behind the joint announcement put out Wednesday by the Hong Kong Monetary Authority (HKMA), and the Financial Services and (the) Treasury Bureau lies an unambiguously severe licensing regime. As finews.asia has argued at length before, it will turn virtual asset providers into little more than de facto, barely profitable banks.

Comments Welcome

This new consultation paper, probably the last before this first set of very specific stablecoin rules come into force, is fielding written comments from the public and market participants by way of email and snail mail until the end of next February.

Although emails have already started to drip down the PR grapevine about providers, including banks, eagerly anticipating, even warmly welcoming the new framework, the truth is that all may have not yet read the fine print of what is being proposed.

Very Specific

For one, this regime is only for issuers of stablecoins that reference one or more fiat currencies and not tokenized, float, or deposited stored value facilities. It also doesn’t include those so-called fiat-referenced stablecoins (FRS) that derive value from arbitrage or algorithms given the view that these would be «highly unlikely» to meet licensing criteria, particularly when it comes to reserves.

So after jumping through all the administrative hoops, what is left?  As a first step, the authorities suggest introducing a new wide-ranging ordinance to serve as a foundation for all future regulation of such products, with all issuers FRS issuers to be brought into the remit of the HKMA’s work.

1-to-1 Reserves

So far, so good. But then we get into the more problematic aspects, at least from the point of providers. If they issue those kinds of virtual asset products in Hong Kong, they will have to make sure they keep reserves that are always at least equal in value to the par value of FRS in circulation.

Those reserves need to be of high enough quality and liquidity while showing «minimal» market, credit, and concentration risk.

No Zhaos or Sam Bankman-Frieds

The authorities also seem interested in making sure that reserve assets are properly segregated in trust arrangements, seemingly learning the painful lessons from FTX’s collapse and the more recent ructions at Binance, as finews.asia has extensively reported on.

«The FRS issuer must establish segregated accounts for reserve assets with licensed banks or, under arrangements satisfactory to the MA (SIC: HKMA) with other asset custodians,» the proposal indicates.

Ample Control Framework

Beyond that, any issuer must have a full complement of policies, guidelines, and controls that make sure any investment activity related to the reserves is properly managed in a way that allows for full redemption of FRSs.

«The FRS issuer must have comprehensive liquidity risk management practices that clearly set out the strategy and tools for addressing large-scale redemptions, i.e. run scenarios or scenarios of liquidity stress. The issuer will be expected to conduct periodic stress testing to monitor the adequacy and the liquidity of the reserve assets,» the proposal foresees.

Daily Disclosures

Moreover, the public must be in the know at all times about the state of the issuer. Under the proposal, there will be compulsory regular disclosures of the total amount of FRS in circulation as well as the mark-to-market value or reserve assets and their composition.

As such, these will have to be attested by independent, qualified auditors. Clear timeframes will also be set for all of the above. The total amount of FRS in circulation and the value of reserves will have to be publicized daily, the composition of reserves weekly, and the independent audits at least monthly.

JPEXers Take Note

The regulators also seem to have taken heed of the recent crypto scandal that took place far closer to home than FTX or Binance did – that of JPEX, which we commented on in early October.

That cryptocurrency platform was ostensibly forced to shut down in Hong Kong after a police probe and the arrest of several famous local television actors after users experienced significant difficulties in making withdrawals.

Right to Redeem

Given what happened, the paper now suggests that FRS users should have «the right» to redeem assets at par value from the issuer and have a claim on reserves.

Taking a page from the exact events as they unfolded, they added that redemption requests needed to be processed «without undue costs» in a timely fashion while the issuer could not impose «unreasonable conditions» or high threshold amounts on redemption.

Much Propriety

Although much of the other stuff in the paper is mostly basic, familiar hygiene for the banking system - it still makes for a very long list of to-dos for FRS issuers.

They must be incorporated in Hong Kong and have a registered office in the city. Management also needs to be based here and seen as fit and proper. All need adequate controls, contingency arrangements, and a robust corporate governance structure.

Getting Punished

The HKMA is also not shying away from intervening when things go wrong, given what it says in the executive summary of the proposal are ostensible lessons from 2022’s TerraUSD collapse.

As at authorized institutions, it will be able to conduct on-site examinations to monitor compliance while being able to enact criminal, civil, and supervisory sanctions for any future offenders - basically, the powers the embattled Swiss regulator Finma would dearly like to have just for banks in wake of Credit Suisse's collapse.

Out by Sundown

Once this new framework is implemented, any companies currently offering such products in Hong Kong will be allowed to continue operating for six months afterward, but only if they apply for a license within three months.

If they don’t, they will have to cease operations and be out of here by the end of the fourth month.

No Profit, No Cry

There are some positives, or loopholes in the proposal. Authorized institutions in Hong Kong will be able to offer FRS that are not licensed under the future local regime, but only to professional investors, and not the wider public. That, however, will have to be clearly set out and labeled on the products sold and distributed.

As we have argued before, it will be hard to make a good business case given all the reserve and policy requirements - not to mention the hiring of specialists and qualified leadership.

Final Shape

But it will be interesting to watch all the comments roll in and what the final shape of the framework will be next year. 

It does not look like a question of the survival of the fittest, but that of the most compliant. Still, by this point next year, we are very likely going to know who has run this extensive administrative and licensing gauntlet and made it through.