122 For consistency with the new BCBS framework, we propose to re-base the statutory limits in respect of (i) aggregate exposures to all connected parties who are individuals and (ii) aggregate exposures to all connected parties (including individuals and non-individuals) as a ratio of Tier 1 capital instead of the total capital base of AIs.
Moreover, taking into account the re-basing of these limits and the revisions to the definition of exposures, and subject to the quantitative impact study to be conducted, we also propose to correspondingly raise the respective limits to 10%
and 20% of Tier 1 capital respectively.
123 Furthermore, subject to the approach to be taken regarding the exclusion from the limit of advances, loans and credit facilities granted to individuals that are secured by real property collateral, we will consider whether and how the existing statutory limit of HKD 1m on the aggregate exposures to a single connected individual should be adjusted.
16 Limitation on Holding of Shares by AIs
124 Currently, pursuant to section 87 BO, a locally incorporated AI is prohibited from acquiring or holding any part of the share capital of any other company or companies to an aggregate value in excess of 25% of the AI’s capital base. While this has served as a useful and simple tool in limiting AIs’ concentration risk arising from holding of shares, it raises certain operational issues. It imposes a limit on holdings of shares but does not cover, for example, other types of capital instruments or derivatives which essentially carry the same risk as holdings of shares. The treatment of shares held through CIUs is also unclear. Furthermore, it does not allow short positions, or hedging positions, to be set off against long positions.
125 To keep pace with market developments, we propose to enhance the relevant provisions to cover a wider range of equity exposures and recognise an appropriate extent of netting. Conceptually, all instruments conveying the economic substance of equity interests should be covered, instead of just holdings of shares. To this end, the HKMA proposes to adopt the definition of equity exposures under section 145 BCR (extracted in Annex 1 for ease of reference) for the purpose of defining equity exposures that are subject to the statutory limit set by the new rules.
126 As regards positions that can be set off, the HKMA proposes that reference be drawn from section 185 BCR, which provides for the netting of positions under the simple risk-weight method of the market-based approach for calculating risk weights of equity exposures under the IRB Approach. Accordingly:
(i) an AI may set off a short position in an equity exposure against a long position in the same equity exposure if that short position:
• has been explicitly designated by the institution as a hedge of the long position in that equity exposure (for instance, short cash positions and derivative instruments are permitted to offset long positions in the same individual stocks provided that these instruments have been explicitly designated as hedges of specific equity holdings); and
• has a remaining maturity of not less than one year;
(ii) where the AI’s short position in an equity exposure has a residual maturity which is shorter or longer than the residual maturity of the AI’s long position in the same equity exposure, an AI should adjust, with all necessary modifications, the value of the AI’s short position in the equity exposure in accordance with section 103 BCR;
(iii) where a net short position remains after the set-off of the AI’s short position in an equity exposure against the AI’s long position in the same equity
exposure, an AI should treat the net short position as if it were a long position in that equity exposure; and
(iv) in relation to a short position in an equity exposure which is not permitted to set off a long position in the same equity exposure, an AI should treat the short position as if it were a long position in that equity exposure.
127 Subject to the quantitative impact study to be conducted, it is proposed that the resulting “equity exposures” should then not be more in aggregate than 25% of an AI’s Tier 1 capital.
128 Furthermore, the HKMA also intends to incorporate flexibility in the proposed new Exposure Limits rules to allow an AI, on a case-by-case basis, to exclude certain exposures if specific conditions are satisfied. Conceptually, the AI should demonstrate to the satisfaction of the HKMA that the risks arising from the relevant exposures are fully mitigated. It is expected that this flexibility will only be exercised on an exceptional basis, given that the rules would have already catered for a reasonable range of set-offs.
17 Other Corresponding Revisions
129 For consistency and ease of operation, the limitations under the existing sections 87A, 88 and 90 of the BO, are proposed to be re-based as a ratio of the Tier 1 capital instead of the total capital base of an AI. Having considered the operation of such provisions in the past and the actual positions reported by AIs through periodic returns, we propose to provide in the proposed new Exposure Limits rules that:
(i) an AI shall not acquire share capital of a company to a value of 5% or more of the AI’s Tier 1 capital unless the approval of the HKMA has been given;
(ii) an AI shall not purchase or hold any interest or interests in land of a value, or to an aggregate value, in excess of 25% of the AI’s Tier 1 capital;
(iii) the aggregate of exposures to connected parties, equity exposures and interests in land shall not exceed 80% of an AI’s Tier 1 capital.
130 For the provisions currently in sections 79, 79A, 82, 85, 86 and 91 BO, the HKMA considers that no changes are currently required, except for textual amendments and relocation from the BO to the proposed new Exposure Limits rules to be made as appropriate following the changes proposed above.