Introduction

The Hong Kong Monetary Authority (the “HKMA”) announced in June 2021 its “Fintech 2025” strategy for driving the fintech development of Hong Kong. As one of its strategic directions, the HKMA has commenced a study on the prospect of issuing retail Central Bank Digital Currency (“rCBDC”) in Hong Kong i.e. e-HKD, and has carried out two rounds of market consultation on the subject. On 20 September 2022, the HKMA published a positional paper “e-HKD – Charting the Next Steps”, summarizing the response to the earlier market consultations and setting out the initial views of the HKMA on the future development of e-HKD.

Various legal issues will arise in the development of e-HKD, including its legal status, privacy and data protection, compliance with AML/CFT requirements and cross-border transactions with other CBDCs. This article summarizes the legal issues involved in the future development of e-HKD, including the suggestions given in the response and the stance of the HKMA on these issues.

Legal status of e-HKD

The HKMA states that the legal mandate underpinning the status of any e-HKD, as essentially digital version of Hong Kong dollar cash, should align with that of existing Hong Kong currency/bank notes (issued under the Legal Tender Notes Issuance Ordinance, Cap 65) and coins (issued under the Coinage Ordinance, Cap 454).

The HKMA further preliminarily opines that e-HKD shall have the status as legal tender, in light of the vision that e-HKD shall be the digital equivalent of existing HKD fiat currency. A legal tender status means that absent any contractual term to the contrary, e-HKD as legal tender, would by law be regarded as a valid and legal means of tendering payment for an incurred debt.

A point to note is that in a commercial transaction, parties can always contractually determine for themselves what terms upon which they will transact, including what means of payment they will accept. Accordingly, as is the case presently with bank notes and coins, the law would not compel parties to accept e-HKD despite its future status as legal tender.

To implement the above ideas, amendment of the existing ordinances, the consolidation of all existing currency-related ordinances or enactment of a new stand-alone ordinance to include all provisions relating to e-HKD are all possible options to be implemented.

Further, alongside with introducing the e-HKD as legal tender, technology-based measures and criminal law protection should be introduced to secure the authenticity of and restrict any “double-spending” of e-HKD.

Privacy and data protection

The HKMA recognizes the importance of privacy and data protection in planning the e-HKD arrangement. In order for e-HKD to be generally accepted and used by the public, the consideration of privacy and data protection should be embedded in the system design and operation of e-HKD. In particular, the e-HKD system should at all times comply with the Personal Data (Privacy) Ordinance (Cap 486) and relevant codes of practice, guidelines and best practices issued by the Office of the Privacy Commissioner for Personal Data from time to time.

Two key aspects of e-HKD’s system design and operation would affect the privacy and data protection of e-HKD.  The first is whether it should be token-based or account-based. The token-based approach would rely on the ability of the payee to verify the validity of the payment object. This could allow more anonymity in payments between different parties (e.g. customers, merchants) and such privacy could protect against abuse of individual data by commercial entities, but at the same time may risk facilitating illegal activities. The account-based approach would require the recording of balances and transactions of e-HKD holders. This approach would rely on the ability to verify the identity of the account holder, and could help comply with AML/CFT requirements.

Nonetheless, either token-based or account-based approaches could be structured to trace users, as both are in digital forms and require a ledger. Hence, another aspect is what parties should have access to what degree of information such as user identity, transaction history, in particular the degree of anonymity vis-à-vis the central bank.

To maintain anonymity vis-à-vis the central bank and for other potential benefits, the HKMA in its technical whitepaper states that it prefers a two-tier rCBDCs model. In this model, the central bank focuses on maintaining the core and foundational infrastructure of e-HKD, guaranteeing the stability of its value and overseeing the system’s security. Majority of operational tasks and consumer-facing activities can be delegated to private sector intermediaries. The private sector intermediaries are also responsible for keeping detailed records of retail transactions and balances. If a high level of privacy protection is to be accorded to the e-HKD arrangements, those records may not be shared with the central bank.

However, this arrangement is not without drawbacks. Should an intermediary become insolvent, the central bank could lack information to honour claims on the e-HKD itself or as the backing assets from the general public.

Balancing the need for data protection and AML/CFT control

Another undesirable consequence for complete anonymity is the central bank’s inability to fulfil its responsibilities in ensuring that e-HKDs transactions comply with AML/CFT requirements and guarding against illicit transactions and tax evasion. In short, AML/CFT requirements mean the requirements to comply with the relevant Anti-Money Laundering and Counter-Financing of Terrorism provisions in Hong Kong that include customer due diligence (checking and verifying identities; checking source of funds and wealth; keeping records etc).

There is a need to strike a balance between personal data protection and AML/CFT control. One suggestion is to adopt a tiered wallet approach. Under this approach, a greater degree of anonymity is allowed for wallets with a lower maximum holding and transaction limit.

One example is e-CNY, which follows the principle of “anonymity for small value and traceable for high value”. The People’s Bank of China has come up with a tiered design of e-CNY wallet with different caps on transactions and balances for different types of e-CNY wallets. The lowest-tier wallet has lower transaction and balance caps but users are able to make payments in an anonymous manner. The upper-tier wallets have higher transaction and balance caps but require the registration of a Chinese identity card to ensure compliance with AML/CFT requirements.

From the positional paper and the earlier consultation, it can be observed that the HKMA does not prefer complete anonymity for e-HKD in the future. A tiered wallet approach may be implemented in the future.

Cross-border transactions

The HKMA states that currency, including e-HKD, legally issued in one jurisdiction should normally be recognized in other jurisdictions. Hence, issues related to cross-border transactions of e-HKD should be similar to those encountered with existing cross-border transfers.

Nevertheless, new issues may arise, including potential restrictions or limits placed in other jurisdictions on holding of CBDCs or markedly different data protection laws between jurisdictions. These and other issues will emerge as the market develops, will merit further consideration and discussion with stakeholders.

Conclusion

The development of e-HKD is still in a pre-mature stage and many details are yet to be confirmed. However, such development will bring a tremendous impact and numerous business opportunities to Hong Kong, so it is better to approach and understand it in an early stage to prepare for the future reform. We understand that compliance and legal considerations in relation to a newly developed financial technology might be too complicated to understand, it is advised that business should seek professional and legal advice to understand more about the legal issues involved in those areas.

 

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2022