Seventeen Questions on the Regulation of Stablecoin Issuers in Hong Kong

Mobile Payment Network News: Recently, the Hong Kong Monetary Authority has officially released the "Regulatory Guidelines for Licensed Stablecoin Issuers" (referred to as the "Guidelines"). As one of the core supporting documents of the "Stablecoin Ordinance", the "Guidelines" aim to regulate the operations of stablecoin issuers, prevent financial risks, and ensure the protection of investor rights and the stability of the financial system.

The Hong Kong Monetary Authority previously announced a draft of the "Guidelines" and sought industry opinions, receiving a total of 28 feedback submissions. After summarizing the various opinions, the Hong Kong Monetary Authority formed the consultation conclusions of the "Guidelines." Based on the consultation conclusions, the main concerns of the industry and the responses of the Hong Kong Monetary Authority can be understood.

Are the requirements for full reserves applicable only to the local reserve asset pool, or to the global overall reserve asset pool?

The Hong Kong Monetary Authority has clarified that whether adopting a single jurisdiction issuance arrangement or a multi-jurisdiction issuance arrangement, licensed institutions must ensure that the designated stablecoin achieves full reserves, including those stablecoins that have been frozen or blacklisted.

Can tokens of qualifying assets be regarded as reserve assets?

The Hong Kong Monetary Authority takes a technology-neutral approach in this regard, stating that it can accept tokens of eligible assets as part of the reserve assets.

However, the premise is that licensed institutions must be able to demonstrate to the Hong Kong Monetary Authority that these assets meet the relevant requirements of the Guidelines, and there must be no unresolved risks, including potential technical or operational risks.

Is currency mismatch allowed?

If such currency mismatches are required, licensed institutions should provide reasonable justifications and obtain prior approval from the Hong Kong Monetary Authority. In other words, the Hong Kong Monetary Authority may conditionally allow currency mismatches in certain cases.

Licensed institutions must demonstrate that they always possess the capability to maintain full redemption capacity, including under extreme and market stress conditions, while ensuring that any currency mismatch measures do not transfer risk to stablecoin holders.

In addition, licensed institutions must discuss and obtain approval from the Hong Kong Monetary Authority in advance before proposing plans for the composition and proportion of reserve assets, as well as risk management measures.

Is it feasible to store reserve assets outside of Hong Kong regarding the isolation and custody of reserve assets?

Licensed banks or other institutions recognized by the Hong Kong Monetary Authority in Hong Kong will be appointed as custodians for stablecoin reserve assets.

In fact, the Hong Kong Monetary Authority has not explicitly prohibited licensed institutions from keeping part of their reserve assets outside of Hong Kong, but licensed institutions must fully explain the reasons for this and the basis for selecting the corresponding custodians.

At the same time, licensed institutions must also demonstrate that the reserve assets held outside of Hong Kong are properly protected, and ensure that stablecoin holders can timely withdraw that portion of reserve assets when redemption requests are made.

Can I entrust an investment manager to manage the stablecoin reserve assets?

The Hong Kong Monetary Authority believes that licensed institutions can hire investment managers, but must ensure that the investment managers have the relevant qualifications and that this will not affect the level of protection for stablecoin holders.

What is a "valid redemption request"?

Some market institutions believe that the account opening process may take some time, which makes it difficult to handle redemption requests "within one business day."

The Hong Kong Monetary Authority explained that any additional time required should not be counted within the "one business day processing redemption" requirement if the prerequisite conditions (such as necessary account opening procedures) are not met.

In addition, any unresolved potential compliance issues (such as outstanding money laundering issues) may be regarded as a failure to meet the prerequisites, thereby rendering redemption requests invalid.

Of course, the Hong Kong Monetary Authority also added that licensees should ensure that the redemption conditions and time limits they set are reasonable.

Is it allowed to hire distributors outside of Hong Kong?

The Hong Kong Monetary Authority does not prohibit licensed institutions from hiring distributors outside of Hong Kong.

However, licensed institutions should conduct due diligence and risk assessments before hiring and continuously monitor throughout the process while adhering to relevant third-party risk management measures. Additionally, licensed institutions should pay particular attention to complying with local laws and regulations.

Is it necessary to hire a third-party institution to provide liquidity in the secondary market?

The Hong Kong Monetary Authority believes that stablecoin issuers typically hire "market makers" to provide secondary market liquidity for their stablecoins, which is also a common practice.

The Hong Kong Monetary Authority stated that this arrangement carries risks and may undermine the confidence of stablecoin holders in the stablecoin. For example, "market makers" may deliberately create a "decoupling" phenomenon in the secondary market or cause other conflicts of interest.

To this end, the "Guidelines" require that the issuance of designated stablecoins must be cautious and prudent, and that the hiring of "market makers" should properly manage related risks and potential conflicts of interest, for example, by signing specific contracts to regulate the corresponding responsibilities that "market makers" should assume.

Cooperating with "market makers" is not a mandatory requirement; licensed institutions should consider whether it is necessary to engage in such cooperation based on the purpose of the issuance of specific stablecoins, business model, and operational arrangements.

Should users be completely prohibited from using VPNs?

Some believe that users may use VPNs for privacy purposes and suggest that some risk management measures can be taken instead of a complete ban.

In this regard, the Hong Kong Monetary Authority believes that licensed institutions should establish an effective set of measures to ensure which groups are prohibited from accessing their services, with the identification of VPNs and subsequent activities being part of these measures.

Does ### set quantitative requirements for over-collateralization?

In terms of market risk management, there are views suggesting that the Hong Kong Monetary Authority could set quantitative requirements for over-collateralization.

The Hong Kong Monetary Authority responded that the range and composition of reserve assets held by different licensed institutions vary, and adopting an appropriate proportional approach is more beneficial for managing risks, while also minimizing unnecessary regulatory burdens.

Clearly, the Hong Kong Monetary Authority currently has no intention of setting specific requirements for over-collateralization in the "Guidelines," but it also stated that it will consider whether to provide relevant guidelines in the future based on circumstances. For example, to arrange the required level of over-collateralization according to the nature of various assets, maturity periods, and other factors.

Will stronger token risk management techniques be adopted?

In terms of technical risk management, there are suggestions to adopt layered issuance (setting different levels of authorization for different scales of issuance) and pre-issuance (pre-issuing designated stablecoins into the operating wallet and transferring them to customers when needed) to enhance the security of token management.

The Hong Kong Monetary Authority stated that it has no intention to regulate or arrange specific technologies for the issuance of stablecoins. However, the "Guidelines" have outlined relevant requirements and encourage the adoption of a tiered management security practice. For example, if a pre-mined method is used, the pre-mined stablecoins should, in principle, have full reserve support to prevent stablecoins without reserve support from entering the market due to wallet breaches.

Is it possible to outsource cloud-based Hardware Security Module (HSM) and private key management services to a third party?

The Hong Kong Monetary Authority pointed out that private key management is one of the important core businesses that affect the prudence and robustness of licensed institutions. Therefore, although the Hong Kong Monetary Authority has not prohibited certain technical arrangements or the outsourcing of private key management services, it will adopt a cautious and strict approach when assessing related risks.

Is the localization requirement for private key management canceled?

The Hong Kong Monetary Authority emphasizes that the private key management systems implemented by licensed institutions must be robust and secure, while localization requirements can ensure that regulatory work is carried out effectively.

Of course, the Hong Kong Monetary Authority also provides flexibility for licensed institutions to store and use private keys outside of Hong Kong, but it will adopt a prudent and rigorous approach when assessing the relevant arrangements.

What qualifications are required for third-party smart contract auditing?

Currently, the industry has not established relevant standards for smart contract auditing, nor has it clearly defined the qualifications required. Therefore, the Hong Kong Monetary Authority expects licensed institutions to consider factors such as professional competence, performance, and reputation when assessing the qualifications of third-party auditors, and to provide explanations to the regulatory authorities.

Is ### required for smart contract audits for all code changes, or only for major upgrades?

Given the importance of smart contracts for the prudence and robustness of licensed institutions' operations, the Hong Kong Monetary Authority believes that all code changes should undergo smart contract audits. Since changes to smart contract code are not frequent, this requirement will not impose too much burden on licensed institutions.

Can the Hong Kong regulation and other regional regulations discuss a mutual recognition mechanism?

The Hong Kong Monetary Authority pointed out that the feasibility of the mutual recognition arrangement depends on several factors, including the development of regulatory frameworks in other jurisdictions and international consensus. It will continue to pay attention to international developments and is willing to explore the possibility of mutual recognition in the future.

Of course, any mutual recognition arrangement cannot replace the obligation of the issuing institution to fulfill regulatory requirements in Hong Kong.

Is there a specific regulatory measure for systemically important stablecoins?

Currently, there are no arrangements, but the Hong Kong Monetary Authority has stated that the international regulatory environment is constantly evolving and will consider whether additional regulatory requirements are needed based on the international regulatory situation regarding systemically important stablecoins.