Submission to the Financial Services and the Treasury Bureau and the Hong Kong Monetary Authority in Response to the Consultation on the Legislative Proposal to Implement the Regulatory Regime for Stablecoin Issuers in Hong Kong

1. The Consumer Council (the Council) is pleased to submit its views with respect to the consultation paper issued by the Financial Services and the Treasury Bureau (FSTB) and the Hong Kong Monetary Authority (HKMA) on the legislative proposal to implement a regulatory regime for stablecoin issuers in Hong Kong (the proposed regulatory regime).

The Council’s Overall Stance

2. Recognising the growing acceptance and popularity of virtual assets (VA) among retail investors and their high-risk nature, the Council is in principle supportive of introducing a new legislation to implement the proposed regulatory regime in Hong Kong that strengthens consumer safeguards in the VA market.  As mentioned in the executive summary of the consultation paper, the collapse of TerraUSD, a stablecoin claimed to be relatively low-risk and less fluctuant, is a case in point evidencing the imminent need for heightened consumer protection to stablecoin activity. 

3. Noting the proposal to define a “stablecoin” as a cryptographically secured digital representation of value that, among other things, is used or intended to be used as a medium of exchange accepted by the public for payment for goods and services, the Council welcomes the proposed regulatory regime that aims to regulate fiat-referenced stablecoin (FRS) issuers, and regards it as an appropriate and necessary step to protect FRS users the majority of whom are expected to be ordinary consumers under the aforesaid scope.  The Council supports making a clear demarcation that only FRS licensed by the HKMA can be offered to the general public and FRS not issued by a licensed FRS issuer is only for professional investors.

4. In the following parts, the Council puts forward its responses to the consultation questions and comments/suggestions for optimising the proposed regulatory regime from a consumer protection perspective.

Responses to Consultation Questions

Proposed Approach of Introducing a New Piece of Legislation to Implement the Regulatory Regime for FRS issuers (Consultation Question 3)

5. The Council supports the introduction of a new piece of legislation to implement the regulatory regime for FRS issuers, taking into account the reasons stated in section 5.1 of the consultation paper including the uniqueness and nascent nature of stablecoins.  This new regulatory regime can serve as the foundation for extension of the local regulatory regime for other VA-related activities as necessary and appropriate in the future. 

Exclusion of Issuance of FRS from Certain Regulatory Regimes to Avoid Overlap (Consultation Question 4)

6. The Council agrees that excluding issuance of FRS from certain regulatory regimes could avoid subjecting FRS issuers to multiple regulatory regimes and hence reduce the compliance costs of FRS issuers as well as regulatory costs of responsible authorities.  Nevertheless, the Council emphasises that while keeping a single regime for the issuance of FRS, its regulatory stringency and requirements should be on par with regimes that regulate other types of financial activities or tools (such as stored value facilities and VA exchanges).  It is also important to avoid any regulatory arbitrage or loopholes that might exist between different regimes and be abused by unscrupulous market players.

Licensing Regime for FRS Issuers and Licensing Criteria and Conditions (Consultation Questions 5 and 6)

7. The Council notes the licensing criteria and conditions put forward in sections 6.2-6.3 of the consultation paper.  While acknowledging the comprehensiveness of the proposed regulatory framework for FRS issuers, the Council deems that the following areas could be optimised to provide further protection to FRS users.

Disclosure and reporting related to reserves (6.2(a), at paragraph 6.2.5) and disclosure requirements (6.2(f))

8. Information transparency is of high importance to consumers; therefore, the Council strongly agrees that FRS issuers must disclose the specified information of its FRS and reserve assets on a regular basis to the public, and publish a white paper to disclose general information about itself and other critical information.  However, the Council notes that specific requirements for disclosure channels are not covered and thus suggests that relevant guidance should be provided for FRS issuers’ reference to ensure easy accessibility of such information to the public.  Meanwhile, a clear disclosure timetable should also be made available to the public.  

9. To strengthen the safeguards of consumers, the Council further opines that the obligations of FRS issuers should not be limited to information disclosure but extend to proactive notification to FRS users in case of significant events or updates, such as major staff movement, changes in redemption process, and large fluctuations in the buying and selling (major dumps).  The Council considers that FRS issuers should be held responsible for sending notifications in a timely manner via the preferred means of FRS users so that they could be alerted easily and have reasonable and sufficient time to take the necessary action accordingly.  

Stress testing (6.2(a), at paragraph 6.2.4)

10. The Council notes that the FRS issuers will be expected to conduct periodic stress testing to monitor the adequacy and the liquidity of the reserve assets, as proposed in paragraph 6.2.4 of the consultation paper.  While the Council understands that there are FRS issuers of different scales, modes of operation and risk levels such that it may not be desirable to set the frequency of stress testing across the board, it is important to fine-tune the meaning of “periodic” such as by providing more specific timeframes to serve as guidance.  In the long run, the frequency of stress testing could be prescribed so as to provide certainty and to ensure that stress testing will be carried out adequately.

Redemption requirements (6.2(b))

11. As proposed in paragraph 6.2.8 of the consultation paper, FRS issuers must process redemption requests without undue costs on a timely basis and not impose unreasonable conditions on redemption.  While agreeing with these requirements in principle, the Council suggests that more concrete instructions could be provided.  For example, the Monetary Authority of Singapore suggested in its proposed stablecoin regulatory approach that redemption should be completed in five business days_[1].  Such practice provides consumers with a higher level of certainty and is hence worth referencing.  Apart from the redemption time span, the HKMA could also consider specifying other requirements such as the limit or proportion of service charges and threshold amount of redemption.  Separately, there should also be a robust mechanism to oversee the introduction of major changes in redemption policies so as to safeguard the interests of FRS users.  The level of monitoring should depend on the nature of the change and the degree of potential impact on FRS users.  Also, proper notification of major changes should be issued to FRS users in advance of the change.

12. The Council agrees with the proposal in paragraph 6.2.10 of the consultation paper that the FRS issuer must draw up and maintain a contingency plan to enable orderly redemption when the FRS issuer is unable to meet redemption requests.  In addition, the FRS issuer should be required to ensure that the contingency plan will be timely and easily accessible to the public.

Risk management requirements (6.2(h))

13. Given the dynamic nature of the VA (including FRS) market, the Council welcomes the proposed risk management requirements in paragraph 6.2.20 of the consultation paper to mandate FRS issuers to perform risk assessments regularly.  The Council is of the view that the FSTB and the HKMA should also regularly review the requirements in accordance with the latest development of the FRS market to keep abreast of the challenges and risks and provide up‑to‑date consumer protection.   There should also be a robust mechanism to require timely issuance of report and alert to the public once risks are identified.

Audit requirements (6.2(i))

14. The Council supports the requirements that the FRS issuers engage qualified and independent auditors to conduct regular attestation (at least monthly) and submit annual audited financial statements to the HKMA.  These requirements provide important bases, which might give the FRS users and the public a clearer picture of the financial conditions of the FRS issuers.  Auditors play a key role in ensuring audit quality.  However, when there is a change of auditors, the reasons (e.g. disagreement with company management on certain audit issues) leading to the resignation and its potential impact on the concerned FRS issuer’s financial reporting and accounts should not be taken lightly.  The Council therefore suggests imposing disclosure requirement on the FRS issuers to promptly inform the HKMA and the public about the change in auditors, thereby enhancing market transparency, which is in line with the practice of Hong Kong listed companies in disclosing the replacement of auditors.

Other licensing matters (6.3) – advertising requirements

15. While noticing that the FRS issuer is mandated to display its licence number on any advertising materials and consumer‑facing interface of its software applications (paragraph 6.3.6 of the consultation paper), the Council suggests that the HKMA should consider including more holistic advertising requirements in the proposed regulatory regime.

16. In spite of the growing popularity of VA (including FRS) investment over the recent years, many consumers only have a smattering of knowledge about the VA market.  For instance, according to a survey conducted by the Hong Kong University of Science and Technology in 2023, more than 50% of the respondents agreed with the statement that VA traded on licensed exchanges in Hong Kong are approved by regulators, but it is in fact a misconception_[2].  Therefore, the Council deems it important to regulate advertising activities of FRS issuers to make sure consumers would not be baited or misled.

17. To enhance consumer protection, the Council suggests the following requirements for consideration:

• Providing an advisory message in advertising of any form to warn consumers of the potential risks and remind them to conduct basic research and/or consult professionals before any investment;
• Not using any terms or claims that imply or relate to interest paying (on par with the prohibition on paying interest in paragraph 6.2.6 of the consultation paper);
• Not containing information that is false, disparaging, misleading or deceptive (in line with the VA licensing regime by the SFC_[3]); and
• Not posting any advertisement in connection with a specific VA trading platform.

18. Some of the above suggested requirements might be applicable to other entities offering or marketing FRS in the future when the relevant regulatory regime becomes more comprehensive and mature.

Other licensing matters (6.3) – complaint handling and monitoring requirements

19. Moreover, the Council opines that the HKMA should include complaint handling and monitoring requirements in the proposed licensing criteria and conditions, and suggests the following requirements for FRS issuers:

• To periodically submit a report of consumer complaints to the HKMA for monitoring and early detection if there is any systematic issue of concern;
• To provide consumers with reasonable channels to submit claims, make complaints and seek redress; such channels should be accessible, fair, accountable, timely and efficient, and should not impose unreasonable cost, delays or burdens on consumers; and
• To acknowledge, resolve or provide a response to complainants within a reasonable time; among other requirements.

20. Besides, the Council notes that the Financial Conduct Authority of the UK proposed to apply similar requirements on regulated stablecoin issuers to those in traditional finance regarding complaint handling in its discussion paper on "Regulating cryptoassets Phase 1: Stablecoins" in November 2023_[4].   The Council shares the same view. 

Transitional Arrangements (Consultation Question 14)

21. The Council understands the need for a transitional arrangement that allows pre-existing FRS issuers to continue to operate under a non‑contravention period of six months as long as they have submitted a licence application within the first three months of the commencement of the Proposed Regime.  In light of the rapid evolving VA market, the Council considers that the HKMA should step up its monitoring efforts during the transitional period and alert the public immediately if it discovers problematic practices amongst FRS issuers.  

Other Comments/Suggestions

22. In addition to the above responses to specific consultation questions, the Council provides further comments/suggestions below for the enhancement of the proposed regulatory regime and intensification of consumer protection.

Safety Net for FRS Users

23. As specified in paragraph 4.3 of the consultation paper, FRS could potentially be developed into a commonly acceptable means of payment, and it might have more interconnection with the mainstream financial system and daily transactional activities.  Considering the importance of maintaining the stability of the financial system and protection of FRS users, the Council is of the view that the FSTB, the HKMA and related authorities may consider the provision of financial safety net to FRS users, e.g. measures similar to the deposit protection scheme in the banking industry, and the investor compensation fund to compensate investors who suffer losses due to an agent default.

Public Education

24. Given the novelty and complexity of VA (including FRS), and the insufficient knowledge of consumers as mentioned above, it is of paramount importance to continuously carry out education and publicity efforts to raise public awareness of this type of financial product.  Topics could include (i) opportunities and risks, (ii) ways to navigate the risks, (iii) current relevant regulatory regimes, (iv) channels to check the lists of licensed FRS issuers and VA trading platforms, etc. 

25. While noting that the Investor and Financial Education Council has been putting effort in public education in this area, the Council believes the FSTB, the HKMA, FRS issuers and VA exchanges also play an important role in driving the public’s understanding of VA such as FRS.  The Council foresees that with the collaborative efforts of these parties, public education would be implemented more efficiently, and consumers would thus be able to acquaint themselves with VA before engaging in VA-related activities.

26. To further empower consumers, the HKMA may consider developing a tool for the public to perform preliminary self-assessment of their financial position, risk tolerance level, etc. before they engage in VA-related activities.

Know‑your‑client Requirements

27. Know-your-client (KYC) requirements are commonly found in financial services, including banking, various investment products and services, as well as for VA trading platforms.  The FSTB and HKMA may consider clarifying whether KYC requirements are necessary for the FRS issuers when they offer FRS directly or indirectly via trading platforms to individuals/consumers.

Keeping Abreast of International Movement and Exploring Overseas Cooperation

28. The Council appreciates the FSTB and the HKMA’s forward-looking action of suggesting the proposed regulatory regime.  Nonetheless, given the rapid development of VA (including FRS), the Council considers it imperative for both authorities to pay close attention to international developments, engage in active dialogue with their counterparts in other jurisdictions and reference their experience so as to ensure that the consumer protection in Hong Kong can keep up with the times and its status as the world’s premier international financial centre. 

Conclusion

29. The Council hopes that the FSTB and the HKMA will take into consideration the above responses and comments/suggestions in the implementation of the proposed regulatory regime for better consumer safeguards.