The Fintech Association of Hong Kong has filed recommendations on stablecoin regulation in response to a call by the Hong Kong Monetary Authority for comments from the industry.
The Association authors argue the monetary authority does not need to write regulation that is too broad and general, which risks driving out blockchain-finance companies.
[Disclosure: DigFin’s Jame DiBiasio is a member of the board of FTAHK. He did not participate in the Association’s consultation paper.]
HKMA released its views on stablecoins – digital assets that are meant to be pegged to an underlying fiat currency or asset – in a January discussion paper. It noted their “pegged” nature opens the possibility of stablecoins being used for payments or to store value, and thereby becoming incorporated into mainstream financial systems – and possibly becoming a vector of risk.
Current regulation in Hong Kong covers cryptocurrencies including stablecoins within the framework of exchanges or “virtual asset service providers” (regulated by the Securities and Futures Commission”), and within compliance regulations (such as anti-money laundering rules).
Other areas of regulation do not cover stablecoins, such as the stored-value facility rules for e-money wallets, which has a framework for the likes of Octopus (the city’s transportation wallet) or AliPay, but not crypto.
HKMA therefore expressed some of its views and requested feedback. These views include:
- A need to regulate asset-linked stablecoins, such as those pegged to the US dollar, rather than the niche area of algorithmically backed stablecoins
- That a variety of activities will require a HKMA license or legislative changes, including issuing, creating or destroying stablecoins; managing their reserve assets; validating transactions and records; storing the private keys that provide access to the stablecoins; and other actions
- Depending on the degree of risk, HKMA would regulate stablecoin management; prudential arrangements including liquidity and capital; the fitness of stablecoin controllers and senior managers; reserves; system controls; and other features such as compliance, safety, and settlement operations
- That any stablecoin issuer marketing these to Hong Kong investors must have a locally incorporated entity
Put together, these suggestions would require major changes by stablecoin operators, including the industry leader, Bitfinex, which operates USDT, also known as Tether.
Tether has served as the major liquid gateway for Asia-based crypto holders, who have prized its peg to the US dollar to provide stability against the vagaries of Bitcoin and other crypto coins. But Tether’s fines by US authorities over false statements and inadequate disclosure over reserve backing makes it hard to see how, under the proposed regulation, Bitfinex could operate in Hong Kong or market Tether to local investors.
This may be HKMA’s intent, although it did not single out any operators or coins in its paper.
The response by FTAHK, although largely supportive of HKMA regulating the space, does raise industry concerns about a few important aspects, as per an executive summary it published on its website.
The Association calls for authorities to regulate activities, rather than design regulation around categories of business.
“We believe the HKMA should modify the laws to regulate stablecoins, but use a narrow lens,” said Kat Kukreja, co-chair of the FTAHK’s blockchain committee. “We argue for substance over form: look at the activity.”
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Antony Morris, a board member at FTAHK and payments specialist, says authorities should make the distinction between a stablecoin that operates like a stored-value facility, versus one that takes investors’ money and lends them out, in which case the stablecoin then resembles a commercial bank that lends out a portion of customer deposits.
While an Octopus or AliPay-like SVF is merely a store of value, with no risk to payments or capital markets, a stablecoin acting like a commercial bank injects risk into the financial system.
Going for precision
FTAHK agrees that stablecoins ought to be regulated, as either stored value facilities or as banks – but the nature of regulation should make this distinction.
This implies that some parts of the HKMA’s statement on stablecoins, such as virtual asset exchanges’ facilitating trades of stablecoins, would replicate aspects of existing SFC jurisdiction. Similarly, the use of collateral and nature of the stablecoin could mean stablecoins should fall under the SFC, such as if they pegging to a basket of currencies – at which point it looks like the kind of structured products created by investment banks.
On the other hand, regulation is needed for stablecoins as either stored-value facilities, or as commercial banks.
The other point raised by FTAHK’s paper, in its mantra of “substance over form”, is looking at the activities HKMA is proposing it should regulate. While the Association agrees that basic aspects demand regulation, such as issuing and burning coins, and managing reserves, the authors say HKMA risks overreach if it also insists on regulating secondary activities such as validating nodes and storing private keys.
This is the role of custodians, which are already regulated to handle these duties, said Kukreja. “Otherwise they will face additional regulation just for one asset class,” she said.
There is also a question of whether HKMA’s proposals, such as to regulate activities such as node validation, would be practical without other major monetary regulators following suit.
The third area the FTAHK addresses is the need for a stablecoin operator to have a locally licensed business. Global stablecoin operators running US-dollar linked instruments are unlikely to go through the expense of opening a physical office in Hong Kong just to market to the city’s residents.