The financial landscape is evolving rapidly around the world, alongside technological innovation. The HKMA is supportive of financial innovation and has been keeping up with the fast-evolving developments. For example, in 2016 we commissioned a whitepaper on distributed ledger technology (DLT). In 2019, the HKMA and the Bank of Thailand jointly initiated Project Inthanon-LionRock (later renamed as the mCBDC Bridge Project) to study the potential of wholesale central bank digital currency for cross-border payments, which was further expanded in February 2021 to include the Central Bank of the United Arab Emirates and the Digital Currency Institute of the People’s Bank of China, with strong support from the Bank for International Settlements Innovation Hub Centre in Hong Kong. Last year, we announced our “Fintech 2025” strategy to drive fintech development in Hong Kong.
Along this journey, while embracing the benefits of financial innovation, we are cognizant of the need to monitor and tackle possible risks, a topical one being the significant growth of crypto-assets and their increased interlinkages with the financial system. On this front and in line with international standards, we will adopt a risk-based, “same risk, same regulation” approach1 to regulate the relevant entities and activities from angles including monetary and financial stability, user and investor protection, and possible fraud and money laundering activities. Let me share more details of our thoughts below.
Rapid growth of crypto-assets
There is no universal definition for crypto-assets which have a wide range of variation in terms of structure, nature and usage. They are sometimes referred to as virtual assets, and some critics already cast doubt on whether they should be labelled as assets since some of them actually do not have intrinsic value. The broad spectrum of these products covers investment-related tokens, stablecoins, utility tokens and non-fungible tokens, just to name a few.
In recent years, we have witnessed significant growth in the market capitalisation of crypto-assets (estimated to be around US$2.2 trillion), as well as increasing focus on this asset class by institutional and retail investors, which suggest its rising interconnectedness with the mainstream financial system. In Hong Kong, the Government has announced that a virtual asset service provider (VASP) licensing regime would be implemented for crypto-asset activities conducted on exchanges by amending the Anti-Money Laundering and Counter-Terrorist Financing Ordinance.
As for the HKMA, in discharging our functions to maintain monetary and banking stability and having regard to international standards, we are currently focusing on addressing the implications of crypto‑assets from three dimensions, namely stablecoins that may be used in payments, investor protection relating to crypto-assets, and Authorized Institutions (AIs)’ interface with crypto-assets.
Stablecoins, as a subset of crypto-assets, are gaining market traction in recent years. Unlike other types of crypto-assets which are largely unbacked, stablecoins are generally linked or referenced to underlying assets such as securities or fiat currencies. Due to the lack of regulation or disclosure of their operational arrangements, there could be limited transparency about their backing arrangements.
International bodies and standard-setters such as the Financial Stability Board (FSB) are increasingly focused on stablecoins in the regulatory discussion, especially payment-related stablecoins, i.e. stablecoins that may be used for payment of goods, services or other financial transactions. This is because with their nature and intended usage for payment, this type of stablecoins will likely have relatively broad and frequent interconnection with the mainstream financial system and day-to-day commercial, financial and economic activities. Hence, the risks that they may pose to the financial system are more direct and imminent. For instance, operational issues undermining users’ or investors’ confidence in such assets could bring disruption to the functioning of our payment and financial systems.
In view of the above, it is crucial to ensure that the relevant arrangements and activities of payment-related stablecoins are safe and sound. As observed in the market, payment-related stablecoins and their wallets may perform functions similar to those of stored value facilities. Therefore, based on the “same risk, same regulation” principle, the HKMA has been reviewing the need to adjust the existing regulatory framework e.g. under the Payment Systems and Stored Value Facilities Ordinance to ensure that payment-related stablecoins are properly regulated in Hong Kong.
As part of the aforesaid efforts, we issued the Discussion Paper on Crypto-assets and Stablecoins earlier today to share our thoughts on the regulatory framework for payment-related stablecoins, and look forward to receiving feedback from stakeholders by 31 March 2022. We aim to introduce the new regime no later than 2023/24.
As mentioned above, some crypto-assets may have no intrinsic value and are subject to significant price fluctuations. This prompts questions such as whether these products are suitable for retail investors and how their selling process should be regulated. There is a clear need to promote investor education and enhance product disclosures on this front. The HKMA and the Securities and Futures Commission are working together to set out our supervisory expectations on the investor protection aspects of AIs’ provision of intermediary services to customers related to crypto-assets.
AIs’ interface with crypto-assets
The HKMA is also deliberating its regulatory approaches regarding AIs’ growing business interface with crypto-assets. Depending on the form of AIs’ engagement with crypto-assets and the underlying structure and nature of such assets, the key supervisory issues are wide ranging and include user protection, credit risk, market risk, operational risk, financial crime risk including fraud and money laundering/terrorist financing risk (ML/TF), as well as prudential treatment of any direct exposures of AIs to such assets according to relevant international standards recommended by the Basel Committee on Banking Supervision. The Financial Action Task Force has also updated its Recommendations to take account of the ML/TF risks of virtual assets, including stablecoins. AIs should critically evaluate their exposures to different types of risks and put in place appropriate risk-mitigation measures before establishing their relationship with crypto-asset service providers. The HKMA will soon issue a circular to provide more detailed regulatory guidance on these issues.
The HKMA is committed to striking the right balance between maintaining a safe and efficient financial system in Hong Kong and supporting financial innovation. Our issuance of the Discussion Paper on Crypto-assets and Stablecoins today marks an important milestone of our engagement with stakeholders on the relevant issues. We will closely monitor the evolving landscape, stay open-minded and remain agile in drawing up the details of our regulatory framework. We are also actively participating in the relevant international discussion. Among others and as a member jurisdiction of the FSB, we are expected to have a plan in establishing a new, or adjusting the existing, regulatory framework, in line with FSB recommendations by July 2022. Last but not least, we will continue to keep an ongoing dialogue and closely coordinate with other regulators along our journey to contribute to the coordinated efforts internationally and locally.
Hong Kong Monetary Authority
12 January 2022
1 This means that authorities should focus on the functions performed and risks posed by an activity, and apply the appropriate regulatory framework in the same manner as they would apply it to entities performing the same functions or activities, and posing the same risks.