Financial experts have called for issues like cybersecurity, privacy and traceability to be addressed as city makes strides toward e-HKD. Oswald Chan reports from Hong Kong.

The Hong Kong Monetary Authority — the city’s banking regulator — is to conduct a joint feasibility study with the Bank for International Settlements Innovation Hub Centre in Hong Kong on developing a digital Hong Kong dollar or e-HKD as a central bank digital currency for retail transactions, similar to the Chinese mainland’s digital renminbi or e-CNY that has drawn interest from global financial companies.

The preliminary findings, which are expected to be ready in the coming year, will cover aspects such as consumer demand, privacy protection, anti-money laundering measures, system security, and legal concerns, to mitigate potential risks. Issues will include how to strike a balance between protecting individual privacy in using the e-HKD to buy daily products, and how to curb illegal practices like money laundering.

As the digital currency relies more on internet stability, financial regulators should develop the e-HKD as cautiously as possible to thwart cybersecurity threats, experts say.

The e-HKD will just be an electronic version of a bank note, and the mechanism of issuing the digital currency will be the same as that for physical bank notes under the currency peg system, without affecting the monetary base. The existing Hong Kong dollar peg with the US dollar will remain in place, according to the HKMA.

The e-HKD, which may be issued by the HKMA or the three note-issuing banks — HSBC, Standard Chartered Hong Kong and Bank of China (Hong Kong) — is expected to have limited impact on current deposits at commercial banks as only part of the deposits will be used as e-HKDs, banking experts said. As the digital currency will probably not pay any interest and will be mainly used in the retail sector, members of the public and enterprises will still deposit money at banks as savings and for other purposes.

Cheng Shi, chief economist, managing director and head of research department at ICBC International, said that the digital Hong Kong dollar has potential in other business scenarios.

“Initially, the e-HKD will only be tested in making retail payments, but digital currency has a strong expandability. Theoretically, it could also improve payment efficiency and reduce intermediary risks in wholesale use cases. The HKMA has accumulated rich experience. This would also provide technological support for the e-HKD’s future expansion to improve financial services, apart from retail payments,” he said.

The e-HKD initiative is not related to the cross-border central bank digital currencies program the HKMA has been working on. The HKMA has teamed up with the Bank of Thailand, the Central Bank of the United Arab Emirates, the People’s Bank of China and the BIS Innovation Hub Centre in Hong Kong to work on the “m-CBDC Bridge” project — a CBDC scheme for cross-border payments.

The project will further explore the capabilities of distributing ledger technology by developing a proof-of-concept prototype to facilitate real-time cross-border foreign exchange payment-versus-payment transactions in a multi-jurisdictional context and on a 24 hours a day and seven days a week basis. This could alleviate the pain points in making cross-border payments, such as inefficiencies, high costs and complex regulatory compliance.

The HKMA hopes that the participating central banks will take into account the prototype work to determine whether it can be applied in cross-border fund transfers, international trade settlement and capital market transactions.

Increasing readiness

“The HKMA needs time to evaluate and balance the costs and benefits in terms of consumer demand, privacy protection, system security and legal issues. It is more about increasing the city’s readiness in using CBDCs. Even if the e-HKD is issued, it may mainly be used domestically in the initial stages,” said OCBC Wing Hang Bank Economist Li Ruofan.

“Unlike the Chinese mainland where online payment tools are popular, there are retailers, like Hong Kong’s wet markets, that do not support any e-payment method due to cost concerns. As such, the issuance of e-HKD may be a supplement rather than a threat to other online payment tools,” Li added.

Developing the e-HKD will herald a new chapter in Hong Kong’s financial technology landscape, Cheng said.

“Once the digital Hong Kong dollar is launched, all the banking system has to face is an important infrastructure upgrade. This will be a powerful external stimulus for commercial banks as well as other financial institutions,” he reckoned.

Distinct from decentralized cryptocurrencies, such as Bitcoin, a CBDC is a digital bank note issued by a central bank, whose legal tender status is established through government regulation or law. It could be used by individuals to pay each other, companies and shops, or by institutions to settle transactions in financial markets.

A BIS report in January revealed that 86 percent of 65 central banks surveyed have been actively conducting CBDC research, with 60 percent experimenting with the technology and 14 percent having started pilot projects.

There are many reasons for global central banks to consider issuing CBDCs, including enhancing financial inclusion, cutting transaction costs, making monetary and fiscal policies more efficient, fighting money laundering and terrorist financing, as well as tracking money flows.

According to the BIS, many central banks in emerging markets are interested in exploring CBDCs for financial inclusion purposes. Globally, 1.7 billion people remain unbanked, according to the Global Findex Database from the World Bank. Even in the developed world, such as the United States, there are still about 14 million people unbanked and 50 million underbanked, making them unable to access the full range of financial services, according to HSBC Global Research.

Trimming costs

Regarding trimming transaction costs, a report by the Federal Reserve Bank of Kansas City in the United States shows that retail payment costs are estimated to absorb 0.5 percent to 0.9 percent of the annual gross domestic product in many countries.

In October, the Bahamas launched the world’s first CBDC, the Sand Dollar, striving to improve financial inclusion, slash service delivery costs and increase transactional efficiency in an archipelago of 700 islands scattered across the Atlantic Ocean. The archipelago spans more than 800 square kilometers, with a relatively well-off, scattered population with high mobile penetration. The Sand Dollar is backed 1:1 to the Bahamian dollar which, in turn, is pegged to the US dollar.

Apart from the Bahamas, global central banks are gearing up for the CBDC race. Although there is still no timetable for the official launch of the e-CNY, China is tipped, along with Sweden, to launch its CBDC by the end of this year. The US Federal Reserve, the European Central Bank and Bank of Japan are also showing interest.

China has been at the forefront of the CBDC experimentation since 2014 in a bid to alleviate money laundering, tax evasion and terrorist financing, while promoting financial inclusion and digital footprint sharing.

Pilot tests for the e-CNY have been carried out in several regions, such as Xiong’an New Area in Hebei province, which is adjacent to Beijing and at locations for the 2022 Beijing Winter Olympic Games. The tests are expected to be gradually expanded to Shanghai, Changsha, Hainan, Qingdao, Dalian and Xi’an.

The total value of transactions using the e-CNY had reached 34.5 billion yuan (US$5.32 billion) involving 1.32 million payments made by the end of June, according to PBOC data. The total number of transactions stood at 70.75 million, spread among almost 21 million personal wallets and 3.5 million enterprise wallets.

The HKMA said it will continue to collaborate with the PBOC in supporting technical testing for the e-CNY in the special administrative region to facilitate convenient cross-border payments for Hong Kong and mainland residents. Both monetary institutions will also discuss the technical aspects of cross-border usage of the digital currency.

World central banks, however, will have to beware of the downsides involving digital currencies, such as possible digital bank runs and political opposition to their use. It is feared that governments could exert greater social control through CBDCs by increasingly overseeing citizens’ spending behavior, or if CBDCs are seen as a step toward banning cash transactions.