Hong Kong's "Digital Hong Kong Dollar" layout has begun to appear

Considering many practical conditions such as privacy protection and anti-money laundering requirements, Digital Hong Kong Dollar may adopt the idea of "centralized management" and "distributed bookkeeping" to achieve sound and efficient coordination as much as possible. What is the appeal of Hong Kong's more mature payment market?

As a new electronic form of central bank currency, the Digital Hong Kong dollar will not only bring a series of benefits to Hong Kong's monetary and financial stability and status as an international financial center, but also mean risks and challenges. The picture shows the recent Central Financial District of Hong Kong. Caijing reporter Jiao Jian/photo

| Caijing sent Hong Kong correspondent Jiao Jian

Edit | Su Qi

Actively studying and promoting the "Digital Hong Kong Dollar" to cope with the impact of the gradual popularization of new financial technologies such as electronic payment is becoming one of the important means for the Hong Kong Special Administrative Region of China to achieve its goal of "Digital International Financial Center". With the recent release of the "Digital Hong Kong Dollar" policy document by the Hong Kong Monetary Authority, the evolution map related to its launch has been roughly outlined.

The so-called "digital Hong Kong dollar" is essentially a digital version (Chinese mainland referred to as the "digital version") Hong Kong dollar cash. Local research processes are often referred to as "e-HKD" or "CBDC (Central Bank Digital Currency)" depending on the context. Under the Monetary Authority (GAT) system, the Hong Kong Monetary Authority (HKMA), the central banking institution of the Hong Kong Special Administrative Region of the People's Republic of China, announced in late September that preparations for a possible future "Digital Hong Kong dollar" will take a gradual "three-track" approach.

The more cautious attitude is not surprising. In many places around the world where relevant research is conducted, the promotion of central bank digital currency is a systematic project that needs to consider multiple factors and solve multiple difficulties. For example, wholesale (limited to use between central banks and financial institutions) or retail (public-oriented, also known as general targeting) or both.

The phased significance of this framework to analyze the new trend of "digital Hong Kong" can be seen: Hong Kong, China previously prioritized the application of CBDCs at the wholesale level. Affected by the epidemic prevention and control and other factors, the demand for improving cross-border payments and remittances has increased, so Hong Kong has launched a retail-level study. The hierarchy is also gradually evolving from high-level technical design to whether and how to support the development of related markets. Hoping to accelerate the paving of the way will prepare Hong Kong to launch it when the time is right.

The launch of the Digital Hong Kong dollar is believed to be conducive to promoting faster cross-border payment solutions, etc., thereby adding new advantages to Hong Kong and ensuring its status as the "first brother" of Asian finance; However, at the practical level, the application scenarios of the new currency are not clear and efficient, the cost advantages are not obvious, and the problems involving the revision of existing laws in related fields such as issuance, the protection of privacy and the improvement of efficiency are still difficult to balance, and it still takes a certain amount of time from gestation to flowering.

In this regard, the Chief Executive of the HKMA, Mr Yu Wai Man, recently told the outside world, "The HKMA will do its best to prepare for the development of digital currency, and will also provide suitable soil for innovative ideas to sprout and grow, so as to ensure that Hong Kong can continue to play a leading role in the field of global finance." ”

"Three tracks" advance

As an international financial center, it has the world's largest offshore RMB market, a mature and well-established exchange and international investor base, as well as investment and financing channels such as Shanghai-Shenzhen-Hong Kong Stock Connect and Bond Connect, which constitute the framework foundation for Hong Kong to promote the digitization of the Hong Kong dollar.

A noteworthy phenomenon is the decline in the attractiveness of the Hong Kong dollar in recent years. According to the Society for Global Banking and Financial Telecommunication (SWIFT), as of August 2021, the Hong Kong dollar accounted for about 1.28% of international payments, ranking 7th, and its year-on-year share fell to 1.48%. In January 2022, that percentage slipped to 1.13% again, falling to 8th place.

To catch up with a range of new trends in areas such as cross-border payments, Hong Kong has been exploring CBDCs since 2017. Central bank money in the traditional sense includes two forms: paper money and central bank reserves. The former is the physical currency available for use; Central bank reserves are electronic money and are only available to eligible financial institutions with settlement accounts at the central bank. CBDCs are both electronic forms and publicly accessible (i.e. electronic versions of coins and banknotes) and offer a range of new applications and features (e.g. smart contracts and encryption).

Previous relevant research reports of the Bank for International Settlements show that the use of central bank digital currency for cross-border payments can reduce at least half of the cost of intermediaries, and the payment time has been reduced from the original 3 days to 5 days to 2 seconds - 10 seconds.

From an evolutionary point of view, as the retail payment market in Hong Kong has developed relatively maturely, the application of CBDCs at the wholesale level has been regarded as a priority area, and the "LionRock" project was subsequently carried out to study the application of CBDCs at the wholesale level in dealing with large-value payments and settlement of goods and banks; In 2019, the HKMA launched the "Inthanon-LionRock" project in partnership with the Bank of Thailand. With the addition of institutions such as the People's Bank of China Digital Currency Research Institute, the project has been renamed the "Multi-Central Bank Digital Currency Cross-Border Network", the mBridge Project.

At the retail level, Hong Kong began conducting research and carrying out related projects to promote high-level technical design in 2021. Affected by the COVID-19 pandemic and the active crypto asset market, the HKMA announced in June of that year the launch of a retail-level digital HK$19 under the "FinTech 2025" strategy. In October of the same year, a technical white paper was published. In April this year, a policy discussion paper was published.

Compared with the Hong Kong dollar, the RMB digitization process is relatively advanced, and Chinese mainland has launched a number of digital RMB pilots. In addition, Hong Kong, China has also launched a pilot project on cross-border payment of digital yuan in Hong Kong and guided Hong Kong residents to use digital yuan in the mainland.

The exploration of the digital yuan provides experience for the study of the digital Hong Kong dollar. In October 2021, the HKMA proposed in the relevant technical white paper that the design of the CBDC system is basically the same as the mechanism design of the digital yuan, and both adopt a two-tier operation system. According to the analysis of Li Dazhi, Vice President of the HKMA, the digital Hong Kong dollar starts from the wholesale level, hoping to make the cross-border payment process faster, cheaper and more convenient. The design of the wholesale system needs to be able to match the technical basis of different design options at the retail level in the future, without major modifications.

In contrast to other crypto assets issued by the private sector, CBDCs are issued and supported by central bank institutions. It is generally believed that the former is more anonymous due to decentralization, but the price volatility is strong, and it is not suitable for use as storage value, accounting unit, etc. At the retail level, the potential benefits of CBDCs include improving the supply and availability of central bank money, addressing the challenges posed by new currencies, promoting digital economy innovation and meeting future payment needs, and strengthening monetary policy transmission.

According to the analysis of Caijing reporters by a number of Hong Kong financial researchers: considering the balance of user privacy protection and anti-money laundering requirements and many other practical conditions, the design concept of digital Hong Kong dollar and digital yuan should be roughly the same, that is, to abandon the idea of decentralization of overseas virtual currency, similar to "centralized management" plus "distributed accounting". While having a fiat currency credit endorsement, it has the advantages of non-forgery tampering, traceability, etc., "try to achieve a harmonious and efficient and not biased." ”

Hong Kong adopts a banknote issuing system, and the Hong Kong dollar is currently issued by three banknote issuers. Relevant persons of the HKMA have repeatedly stressed in recent days that the digital Hong Kong dollar will not replace the existing banknotes and coins. Issuers are temporarily inclined to use the current "coin scheme" framework for issuing Hong Kong dollar coins and 10 yuan banknotes (bank payments in US dollars to digital Hong Kong dollars), i.e. issued by the bureau and then distributed to users through banks; Another viable option is the "banknote scheme" (bank payment of dollars in exchange for a certificate of liability) that follows the current banknotes (except for the $10 notes), i.e. issues them through the issuing banknote. On this basis, the options currently under discussion also include a third option for banks to exchange the existing summary balance for the Digital Hong Kong dollar, which also has certain advantages.

Of the three potential issuance mechanisms, the banknote scheme and the coin scheme are considered to be more appropriate than the summarization scheme. Further, for example, when comparing banknote schemes with coin schemes, the HKMA prefers to adopt the latter as it issues the Digital HK$ entirely by a single institution and retains the advantage of having the correspondent bank handle all the customer-facing work related to the distribution of the Digital HK$. From an operational point of view, this scheme is relatively simple and can avoid possible differences in the form of digital Hong Kong dollars issued by different designated banks, which is not easy to cause confusion.

"Different issuance methods roughly correspond to the different issuance modes of central bank digital currency, that is, demand-driven mode or supply-driven mode." From a further micro point of view, according to the principles of Hong Kong's Currency Issuance Bureau, all changes in the monetary base must be fully matched by the corresponding movements of the US dollar assets held by the Exchange Fund. Banks are required to reserve a corresponding amount of US dollars as a backing asset before providing digital Hong Kong dollars to customers. The potential demand for retail CBDCs is actually quite uncertain, such as potential holders may need to mobilize funds in deposit accounts in exchange for retail level CBDCs, which will affect the balance sheets of commercial banks and, when the situation is widespread, lead to the disintermediation of banks. Hong Kong economic commentator Bo Yu told Caijing reporter that "in response to the corresponding scenario, banks may retain deposits at higher interest rates, or seek higher-cost alternative funds to make up for the loss of funds, which will increase the overall cost of funds." In addition, in the event of a financial crisis, CBDCs at the retail level may theoretically expose banks to higher risk of crowding. ”

In analysing the above possibilities in the relevant documents, the HKMA pointed out that to further mitigate these adverse effects, the issuing authorities could introduce safeguards and design options such as maximum account balance, daily conversion and transaction limits to the retail level CBDCs. The Authority may also set up a mechanism whereby the excess amount is automatically transferred to the payee's bank account once the limit is exceeded. "As long as there is an appropriate holding cap, the 'deposit substitution' effect is controllable. Given that the Digital HKD is intended for the instant settlement of small retail payment transactions, these relatively loose holding caps will not deter the general public from using the Digital HKD. ”

The launch of the retail CBDC will involve the revision of legal and regulatory rules, financial stability, and interaction with current payment methods, so in terms of the launch timetable, Digital HKD will adopt a "three-track" system to promote: the first track will mainly lay the technical and legal foundation to make the Digital HKD a legal tender; The second track revolves around the application, execution and design of the Digital HK$; The third track is related to the official launch of the Digital Hong Kong dollar and sets a timetable for the launch.

From the fourth quarter of 2022, the aforementioned tracks I and II will be carried out simultaneously. According to the HKMA's plan, overall progress "will depend on the actual progress of Tracks 1 and 2, as well as the pace of development in the local and international markets." ”

Issues that remain to be solved

Considering the special monetary policy system, payment environment and other policy factors in Hong Kong, China, the Digital Hong Kong dollar, as a new electronic form of central bank currency, will not only bring a series of benefits to Hong Kong's monetary and financial stability, as well as its status as an international financial center (development of financial infrastructure, etc.), but also means risks and challenges.

In terms of revenue, the application prospects of digital Hong Kong dollar are analyzed in light of the current payment environment in Hong Kong: the current more mainstream local electronic payment systems include Octopus, FPS Express, Alipay and WeChat Pay originating from the mainland, etc., and these platforms or channels require certain intermediary fees and support offline payment scenarios are limited. In short, with the exception of Octopus, which has become the second cash (offline payment, completely anonymous, but limited in quota and recharge means), there are many inconveniences in the rest of the means.

Starting with the issuance of electronic consumption coupons from 2021, Hong Kong hopes that this process will not only promote the popularization of new electronic payment methods among the public, but also become a test for the issuance and use of analog digital fiat currency. However, judging from the results, there have also been phenomena such as failure to receive consumption coupons or excessive waiting time due to problems such as filling in incorrect data.

Ideally, a digital Hong Kong dollar with a balance of privacy and data protection that is therefore "programmable" may largely avoid similar embarrassments. The application of the digital yuan can also provide reference for the digital Hong Kong dollar, such as the installation of legal digital wallets, the issuance of transportation allowances and bill payments for the public. In this way, the government can clarify the purpose and duration of subsidies, so that the "sugar distribution" can be carried out quickly, accurately and almost at no cost.

In addition, programmable retail-level CBDCs have a number of other scenarios in terms of fostering innovation: for example, they can support smart contracts (i.e. they are automatically executed if certain conditional agreements are met), and facilitate automated payments (e.g., travel insurance, where passengers are automatically awarded compensation in the event of flight delays when certain pre-conditions are met and confirmed by a designated external data source).

Along with the benefits comes risk. In addition to general considerations such as protecting privacy, the vulnerability of the entire system will increase once the data source is compromised because the execution of smart contracts requires the reliance on external data sources. For example, if a smart contract is erroneous or maliciously attacked, it may also lead to financial losses and legal problems.

Other legal issues include the fact that Hong Kong dollar cash as a digital version should have legal tender status, but this will involve amendments to existing laws (current fiat currency provisions do not include currencies issued in digital form) to ensure that all forms of Hong Kong currency are issued on a consistent legal basis, and the complexity may also make it longer necessary to study.

In order to resolve the corresponding issues, the relevant departments in Hong Kong conducted two rounds of consultations on major policy and design matters and received multiple responses. In addition to the above-mentioned corresponding issues, the attention of the digital Hong Kong dollar also focuses on its degree of interconnection and convertibility. That is, the interconnection between the Digital Hong Kong dollar and the Digital RMB, as well as the compatibility with existing payment systems (e.g. FPS, etc.) and the realization of offline payments, to help promote their use.

For the application scenario of the former, the HKMA has previously envisaged in the public document: including cooperating with the mainland to develop dual-currency e-currency wallets, and in line with national policies, first trial within the Guangdong-Hong Kong-Macao Greater Bay Area to promote financial interconnection and capital flows. Ideally, the Digital Hong Kong dollar would provide convenient cross-border payment services for residents of Hong Kong, China and Chinese mainland, which would not only facilitate local e-commerce, but also further strengthen Hong Kong's financial market links with the mainland.

However, for Hong Kong residents who do not have cross-border use of funds, the popularity of digital Hong Kong dollars may still need to further consider its attractiveness, that is, how to complement the shortcomings of existing retail electronic payments, solve pain points, or be more convenient than existing electronic payment methods.

"This may be the key to the digital Hong Kong dollar being able to occupy a certain position in the blossoming Hong Kong retail payment ecosystem." In the course of several rounds of discussions, the relevant departments in Hong Kong also pointed out that when physical cash continues to circulate, the advantages of strengthening monetary policy transmission through the digital Hong Kong dollar are not obvious under the premise that interest is not determined or not. At present, it is also difficult to determine its specific use scenarios, it is okay to say that the current positioning is slightly embarrassing, and it is also possible to prepare for the future. The analyst also admitted.

"We believe that with the rapid evolution of the digital economy, there may be changes in the future, and there may soon be a use case for the digital Hong Kong dollar." The relevant departments in Hong Kong also pointed out that "in response to the rapid digitalization of the market and the increasing integration of the global payment environment, we will focus more on the new use cases that may arise and make comprehensive preparations for this." ”