2.1 Rule 3 provides as follows:
The resolution authority, by written notice served on a classifiable entity, may identify a resolution strategy as the preferred resolution strategy covering the entity.
2.2 Under the FIRO, resolution can only be initiated in respect of an AI (or holding company or affiliated operational entity of an AI) when the AI meets the three conditions set out in section 25, the third of which is that (a) the non-viability of the AI poses risks to the stability and effective working of the financial system of Hong Kong, including to the continued performance of critical financial functions; and (b) resolution will avoid or mitigate those risks.10
2.3 All AIs are within the scope of the FIRO. However, it is neither practical nor desirable that detailed ex ante resolution planning be conducted for all such entities. The resolution authority therefore applies a proportionate, risk-based approach for the purposes of prioritising resolution planning. It is only where ex ante it is anticipated that the non-viability of a particular AI would be likely to pose a risk to the stability and effective working of the financial system of Hong Kong, including to the continued performance of critical financial functions, that the resolution authority would prioritise the development of a resolution strategy that relates to that AI.
Determining which AIs should be prioritised for resolution planning
2.4 In determining how best to prioritise AIs for resolution planning, including the development of resolution strategies, the resolution
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authority has given consideration to developing a framework that specifically takes into account a range of characteristics that may be relevant, including total assets, total volume of deposits, total number of depositors and other factors. However, the resolution authority’s view is that developing a detailed framework that references multiple characteristics, each of which would have to be appropriately weighted, would lead to increased complexity without necessarily capturing all relevant institution-specific idiosyncrasies.
2.5 The resolution authority has therefore concluded that the better approach in prioritising the development of resolution strategies is to establish a framework that sets a threshold for developing resolution strategies that is based on a simple measure of the size of AIs, and allows for deviations from that threshold with reference to institution-specific factors.
2.6 In the resolution authority’s judgement, the non-viability of any Hong Kong incorporated AI with total consolidated assets of more than HK$150 billion would be likely to pose a risk to the stability and effective working of the financial system of Hong Kong, including to the continued performance of critical financial functions. The resolution authority’s approach is therefore to set the framework threshold at HK$150 billion, so that for any Hong Kong incorporated AI with total consolidated assets11 above HK$150 billion, the resolution authority will, for the purpose of securing orderly resolution of the AI, expect to devise a resolution strategy that covers such AI.
2.7 In calibrating the threshold at HK$150 billion, the resolution authority has paid careful attention to the extent to which the non-viability of an AI would be likely to pose a risk to the continued performance of critical
11 As reported in return MA(BS)24 Return of Information for Assessment of Systemically Important AIs.
Where reporting on a consolidated basis is not available, reporting on a combined or Hong Kong office basis will be used.
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financial functions, in particular taking into account the extent of deposit-taking activities.
2.8 However, it does not follow that every AI that is prioritised for resolution planning should necessarily be subject to LAC requirements, not least as requiring an AI to meet LAC requirements is likely to impose additional costs on the AI. The resolution authority’s planning assumption is that where a Hong Kong incorporated AI’s total consolidated assets exceed HK$300 billion, the AI (and possibly any HK holding company and/or HK affiliated operational entities of the AI) should be subject to LAC requirements. Where an AI’s total consolidated assets are less than HK$300 billion, the resolution authority’s current planning assumption is that it will not be subject to LAC requirements.
2.9 The resolution authority’s view is that setting the total consolidated asset threshold at the level of HK$300 billion for identifying AIs to be subject to the imposition of LAC requirements strikes a reasonable balance between (i) ensuring that AIs the non-viability of which would be likely to pose a risk to the stability and effective working of the financial system of Hong Kong, including to the continued performance of critical financial functions, have sufficient loss-absorption and recapitalisation resources in place on their balance sheets;and (ii) avoiding, insofar as is prudent, the imposition of potentially onerous requirements on smaller institutions that are considered less likely to pose such a risk.
2.10 The resolution authority will keep these thresholds of HK$150 billion and HK$300 billion under review, but does not expect that growth in the size of Hong Kong’s economy and of AIs’ balance sheets should necessarily lead to these thresholds being raised as a matter of course.
In relation to this, the resolution authority notes that HK$300 billion
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should in fact be devised for any particular AI, the framework allows for departure from the threshold on the basis of institution-specific factors.In particular, setting the threshold for prioritisation for resolution planning at HK$150 billion does not imply that a resolution strategy should not be developed for an AI below that threshold. In considering whether or not a resolution strategy should be developed that covers a classifiable entity, the resolution authority will also take into account the institution-specific circumstances of the relevant AI,12 and the resolution authority’s assessment of the likely consequences of the relevant AI’s non-viability. A key issue for this assessment will be whether the nature and scale of the relevant AI’s deposit-taking activities are such that they constitute a critical financial function.
2.12 Accordingly, in making a determination on whether a resolution strategy should be devised that covers a classifiable entity, in addition to the total consolidated assets of the relevant AI, the resolution authority may take into account, among other things, metrics related to the relevant AI’s deposit-taking activities, such as number of depositors, volume of deposits, number of transactional accounts, 13 and number of depositors who have deposits at that AI which exceed the compensation limit under the Deposit Protection Scheme. Further, the resolution authority may exercise the resolution authority’s powers under section 158(1) of the FIRO to require the provision of other
12 Where a resolution entity, material subsidiary or classifiable entity is an AI, references in this chapter to “relevant AI” are references to that AI. Where a resolution entity, material subsidiary or classifiable entity is an HK holding company or an HK affiliated operational entity in respect of an AI, “relevant AI”
refers to that AI.
13 In a quantitative information survey issued to Hong Kong incorporated licensed banks in March 2018,
‘transactional account’ was defined as any account which had had more than twelve transactions (i.e.
deposits or withdrawals) in a specified three month period.
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information to the resolution authority, as described in the CI-1
‘Resolution Planning – Core Information Requirements’ chapter of the Code of Practice.14 That information may lead the resolution authority to conclude that a resolution strategy should be developed.
2.13 Note that when devising resolution strategies that relate to cross-border banking groups, the resolution authority would expect to co-ordinate where appropriate with other relevant resolution authorities (for example, through crisis management groups of global systemically important banks (“G-SIBs”), resolution colleges or bilateral engagement).
2.14 It should also be noted that the development of a resolution strategy for an AI will be informed by the resolution authority’s ex ante determination of the appropriate measures that are expected to be taken in addressing a future situation in which the AI reaches the point at which it has ceased, or is likely to cease, to be viable (the point of non-viability, or “PONV”). But these determinations should not be taken to imply that the indicated measures would necessarily be used. Should an AI reach the PONV, the resolution authority will determine the best course of action based on the prevailing circumstances without being in any way bound by earlier expectations, including any resolution strategy that has been devised.
2.15 As set out above, the resolution authority expects to prioritise resolution planning, which will include the development of a resolution strategy, for any Hong Kong incorporated AI with total consolidated assets above HK$150 billion. However, the formal identification of a preferred resolution strategy covering a classifiable entity under rule 3 is only required where that entity is to be classified as a resolution entity or a material subsidiary under the LAC Rules, and so be subject to LAC requirements. Further guidance on the development of preferred
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resolution strategies for resolution entities and material subsidiaries is set out in the rest of this section. Additional information on the HKMA’s approach to resolution planning for AIs more generally is set out in the chapter of the Code of Practice entitled ‘The HKMA’s approach to Resolution Planning (RA-2)’.15
Preferred resolution strategies – resolution entities
2.16 Among other things, it is anticipated that the preferred resolution strategy identified under rule 3 for a resolution entity will set out which of the stabilization options provided for in the FIRO are expected to be applied in relation to that entity should it (or, where that entity is not an AI, the relevant AI) reach the PONV. These stabilization options can be divided into two broad categories:
the bail-in stabilization option,16 whereby certain liabilities issued by the entity are cancelled or modified (for example, by reducing their outstanding amount or converting them into equity);
and
four transfer stabilization options, whereby some or all of the assets, rights or liabilities (for example, the whole or part of an entity’s business) of, or securities issued by, the entity are transferred to a purchaser, a bridge institution, an asset management vehicle and/or (as a last resort) a temporary public ownership company.
2.17 For those AIs with large, complex, interconnected businesses, it may be risky to rely on the use of one or more transfer stabilization options which may involve, for example, the break-up of the business, or its
15 https://www.hkma.gov.hk/eng/key-functions/banking-stability/resolution/resolution-publications/
16 In this chapter, “bail-in” is used to refer to the exercise of the statutory bail-in stabilization option. The write-down or conversion into equity of LAC debt instruments in accordance with their terms and conditions is referred to as “contractual loss transfer”.
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transfer to a purchaser, within a tight timeframe. Accordingly, for larger AIs, bail-in is likely to be the most suitable stabilization option for delivering an orderly resolution that minimises risks to the stability and effective working of the financial system of Hong Kong, including to the continued performance of critical financial functions.
2.18 Transfer stabilization options are more likely to be appropriate for smaller AIs, whose operations are simpler and less interconnected.
This is because using a transfer stabilization option to transfer part of an AI’s assets and liabilities (“partial property transfer”) is more likely to be feasible where the business of the AI is such that it lends itself more readily to having some assets and liabilities separated out on failure, and this is more likely to be the case for smaller, simpler entities. And using a transfer stabilization option to transfer all of an AI’s assets and liabilities, or the entire shareholding in an AI, to a third party (“whole bank transfer”), is more likely to be feasible where it is easier for the potential transferee to assess the entirety of the business of the failed AI, and the risks associated with it, in a timely manner.
2.19 It follows from the above that the resolution authority would not expect any transfer stabilization option to be the main stabilization option in the preferred resolution strategy of a D-SIB. In practice, transfer stabilization options are more likely to be feasible for AIs that are prioritised for resolution planning, but are not classified as resolution entities (or material subsidiaries) and so are not subject to LAC requirements, e.g. AIs with total consolidated assets above but near the HK$150 billion threshold discussed above.
2.20 The general presumption is that the preferred resolution strategy for any entity classified as a resolution entity will therefore be the application of the bail-in stabilization option to support the entire balance sheet
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any particular classifiable entity, and the nature of that strategy, will depend on the institution-specific circumstances of the relevant AI, the outcome of the resolution authority’s resolution planning for that AI, and the resolution authority’s assessment of the likely consequences of the non-viability of that AI.
Preferred resolution strategies – material subsidiaries17
2.21 Material subsidiaries will be required to issue internal loss-absorbing capacity (directly or indirectly) to a resolution entity or a non-HK resolution entity. Should a material subsidiary reach the PONV, its preferred resolution strategy can therefore be expected to involve the imposition of loss on the internal loss-absorbing capacity through activation of contractual triggers (“contractual loss transfer”) included in the terms and conditions of the internal LAC debt instruments.
Contractual loss transfer is analogous to bail-in in the sense that it involves LAC debt instruments being written down or converted into equity in order to absorb loss and/or contribute towards recapitalisation.
Should, for whatever reason, contractual loss transfer not prove effective in imposing losses on relevant internal LAC debt instruments, the resolution authority would anticipate using the statutory bail-in stabilization option to do so, and so would also expect to see this option included in the preferred resolution strategy.
2.22 Where internal non-capital LAC debt instruments are issued to a group company incorporated in a non-Hong Kong jurisdiction, then as set out in section 2(2)(b)(ii) of Schedule 2 to the LAC Rules, contractual loss transfer can only be triggered if the home authority has consented, or not objected, within 24 hours of notification. However, if for any reason
17 Note that where a resolution strategy covers a material subsidiary, it may also cover that material subsidiary’s resolution entity (or non-HK resolution entity) and other entities in the resolution group.
In these circumstances, references in this chapter to a resolution strategy for, that relates to, or that covers, a material subsidiary, should be taken to be references to the relevant elements of any such broader resolution strategy.
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contractual loss transfer is not effected, this does not imply that the resolution authority will then necessarily apply stabilization powers without engaging with relevant non-Hong Kong resolution authorities.
On the contrary, the resolution authority would expect to continue to liaise closely with such non-Hong Kong authorities, and where appropriate would anticipate co-ordinating with any such authorities when using any stabilization powers – such as the bail-in stabilization option – so as to continue to facilitate the imposition of losses on non-capital internal loss-absorbing capacity in a way that supports co-ordinated, orderly cross-border resolution, whilst acting in a way that the resolution authority considers to be most appropriate for meeting the resolution objectives.
2.23 The indicative preferred resolution strategy for any entity classified as a material subsidiary will therefore be contractual loss transfer, with the application of the bail-in stabilization option as an alternative should contractual loss transfer not prove effective. Note, however, that this is indicative only, and whether a preferred resolution strategy should be identified as covering any particular classifiable entity, and the nature of that strategy, will depend on the institution-specific circumstances of the relevant AI, the outcome of the resolution authority’s resolution planning for that AI, and the resolution authority’s assessment of the likely consequences of the non-viability of that AI.