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Hong Kong’s CBDC pilot is going multi-currency

A pilot for cross-border digital currencies is going multilateral and blending with retail versions.



One of the world’s most advanced projects for central-bank digital currencies (CBDCs) is making the jump from bilateral cross-border tests to ones involving multiple jurisdictions and multiple currencies.

An experiment of using digital currency to settle cross-border transactions between Hong Kong and Thailand is being expanded. Two places mentioned at a conference today include the United Arab Emirates and mainland China.

During a discussion at the Asian Financial Forum, an annual gathering hosted by the Hong Kong government, panelists discussing CBDCs mentioned the UAE will join the Inthanon-LionRock project combining research into cross-border CBDC payments from the Hong Kong Monetary Authority and Bank of Thailand.

The original study was done in early 2020, but last year the two central banks began to involve more currencies and central banks, said Benedicte Nolens, head of the Hong Kong innovation hub for the Bank of International Settlements. BIS is involved in the project along with ConsenSys and PwC. She mentioned the UAE in that context.

(The UAE also has a bilateral CBDC project with Saudi Arabia.)

A BIS report will be published in the coming months that looks primarily at digital currencies at the wholesale level in cross-border payments, although BIS is also doing research on their use for trading on overseas stock exchanges.

China connection

“The HKMA has been proactive in building local financial infrastructure for a multi-currency, multi-dimensional platform to link our payment system with those of our neighbors to facilitate faster, safer cross-border payments,” said Joseph Chan, undersecretary at the Financial Services and the Treasury Bureau (FSTB) for the Hong Kong administration.

The People’s Bank of China is also working with HKMA on integrating its (retail) CBDC with Hong Kong, suggesting the HKMA is now working with at least three other partners as a hub of CBDCs.

Ba Shusong, managing director and chief China economist at Hong Kong Exchanges and Clearing (as well as at the China Banking Association), said embedding China’s digital currency into Hong Kong’s system can help internationalize the renminbi.

International v. capital controls

China, like some other Asian markets, has capital controls. But the nature of a digital currency is that it is programmable and traceable. Therefore, Ba suggests, the PBoC could leverage Wealth Connect, a brand-new channel to sell mutually recognized mutual funds between the Hong Kong and mainland stock exchanges.

COVID-19 has accelerated the desire to integrate Hong Kong better into the “Greater Bay Area” of 11 cities in Guangdong Province and Macau. For example, for a Hong Kong insurance company or investment advisor to sell a product to a mainland person requires that person to physically visit a branch to satisfy KYC (know your customer) rules.

But with a digital renminbi that works across the mainland-Hong Kong border, its traceability means regulators on both sides can have confidence in verifying how renminbi are used abroad. For example, any eCNY a mainland person or business uses to invest in Hong Kong can be programmed to comply with Beijing’s capital controls: the money can be designed to be unable to transfer outside of Hong Kong, or allowed only to be invested in permitted instruments, such as locally domiciled bonds.

“If we can use eCNY, and it is programmable and traceable, then we can solve problems that cannot be solved under the existing framework,” Ba said.

Big use cases

The advent of CBDCs could have a major impact on financial markets and institutions.

FSTB’s Chan says CBDCs are a form of digital currency issued or backed by governments or central banks that bring several benefits.

First, CBDCs can make payments more efficient by eliminating layers of processes now done by correspondent banks, thus allowing for real-time cross-border payments.

Second, they can be designed to help the underbanked gain better access to financial services.

Third, CBDCs can also be traced down to the dollar (or whatever unit) which helps authorities combat tax evasion and money laundering.

eCNY can solve problems that cannot be solved under the existing framework

Ba Shusong, HKEX

But the advent of CBDCs also creates challenges to financial stability and monetary policy.

Within that context, CBDCs come in two flavors, wholesale and retail. Wholesale is for large-volume, low-frequency transactions. The current banking infrastructure for cross-border payments and settlements is slow, cumbersome, and expensive. In this context, a wholesale CBDC would either replace today’s correspondent banking infrastructure or transform it radically.

The retail CBDC is a replacement of physical banknotes with a system that will need to be just as trusted by the general public. Here too the first use cases may be cross-border, targeting remittances, where the average remittance charge is still at 7 percent, says Henri Arslanian, partner at PwC.

Design questions

The HKMA has looked at a retail CBDC but for the time being has decided Hong Kong’s existing real-time gross settlement infrastructure, as well as its faster-payments system for retail transactions, is adequate. It is focusing on wholesale cross-border payments.

Yet the addition of the eCNY could change this equation. China’s eCNY is a retail CBDC. The experiments with HKMA are now focusing on retail needs, so that a Hongkonger could make payments in the mainland with the digital currency, or mainlanders can pay and settle for Hong Kong funds and securities in digital RMB.

At the same time, Ba from HKEX says adding the PBoC to the Lion Rock project will help advance the renminbi’s internationalization – effectively leveraging Hong Kong to make the retail eCNY into a wholesale tool.

Nolens adds that working with the eCNY will give Hong Kong experience in building CBDC rails involving parties with capital controls, which will allow it to scale Lion Rock to other Asian markets.

These projects are still being tested. Most CBDC pilots are national in character. Going cross-border creates a lot of challenges, especially as these projects become multilateral.

First, do the different parties try to link their existing (but not always compatible) real-time gross settlement systems? Or do they build a new network that’s digital native?

Second, other aspects of the traditional system also need to be incorporated into any new framework, such as foreign exchange, liquidity management, and compliance – matters today handled by banks.

Third, regulators will have to find a balance between traceability and privacy; in the U.S., for example, proponents of a digital dollar would like to ensure transactions below $10,000 remain completely anonymous, as is the case with cash payments today.

Fourth, there will arise questions of how to integrate CBDCs with private developments such as cryptocurrencies and corporate stablecoins such as Facebook’s Diem project.

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