15.1 Rule 41 provides as follows:
(1) The resolution authority, by written notice served on a resolution entity, may require the resolution entity to provide to the resolution authority, within the time specified in the notice, evidence of a kind specified by the resolution authority that the resolution entity’s external loss-absorbing capacity, or items claimed by the resolution entity to form part of its external loss-absorbing capacity, meet the requirements of these Rules.
(2) The resolution authority, by written notice served on a material subsidiary, may require the material subsidiary to provide to the resolution authority, within the time specified in the notice, evidence of a kind specified by the resolution authority that the material subsidiary’s internal loss-absorbing capacity, or items claimed by the material subsidiary to form part of its internal loss-absorbing capacity, meet the requirements of these Rules.
(3) Without limiting the kinds of evidence the resolution authority may specify, the resolution authority may require a resolution entity or material subsidiary to obtain, and provide to the resolution authority, independent legal advice acceptable to the resolution authority.
15.2 The inclusion of an item in a resolution entity’s external loss-absorbing capacity or in a material subsidiary’s internal loss-absorbing capacity is subject to the provisions of rule 37 or rule 39 (as applicable) of the LAC Rules. In order to ensure that a proposed item (including any item issued before the classification date of the resolution entity or material
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subsidiary will have to undertake a detailed self-assessment and will be expected to review and document:
(a) whether the item falls within paragraph (a), (b) or (c) of rule 37 (if it is intended to constitute external loss-absorbing capacity) or rule 39 (if it is intended to constitute internal loss-absorbing capacity) of the LAC Rules; and
(b) if the item is proposed to qualify as a LAC debt instrument, whether the criteria in Schedule 1 (if it is intended to constitute external loss-absorbing capacity) or Schedule 2 (if it is intended to constitute internal loss-absorbing capacity) of the LAC Rules are met.
15.3 As part of the self-assessment for any proposed LAC debt instrument, the resolution entity or material subsidiary should obtain a sufficiently independent legal opinion (preferably from an external legal firm) to ensure compliance of the proposed instrument from a legal perspective.
The legal opinion should address:
(a) the due incorporation and capacity of the issuer to issue the instrument and perform its obligations under it;
(b) the due authorization of the instrument by the issuer, and the absence of conflict with (i) the issuer’s constitutional documents and (ii) applicable law;
(c) the instrument constituting legal, valid, binding and enforceable obligations of the issuer;
(d) the legal effectiveness of any write-off/conversion provisions and the absence of legal impediments to such provisions operating in accordance with their terms;
(e) the legal effectiveness of the acknowledgement or agreement of the instrument holder in relation to any exercise of powers under the FIRO;
(f) the recognition of the governing law of the instrument; and
(g) the compliance of the instrument with the qualifying criteria set out in Schedule 1 to the LAC Rules (for an external LAC debt
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instrument) or Schedule 2 to the LAC Rules (for an internal LAC debt instrument), including the degree of subordination.
15.4 In addition, where the proposed LAC debt instrument is subject to the law of a jurisdiction other than Hong Kong:
(a) a legal opinion issued under such law should also be obtained, addressing the matters in paragraph 15.3 above (where applicable), as well as addressing the issue of whether such law could prevent the instrument from satisfying the criteria referenced in paragraph 15.3(g) above; and
(b) section 1(1)(k) of Schedule 1 to the LAC Rules (for an external LAC debt instrument) or section 1(1)(j) of Schedule 2 to the LAC Rules (for an internal LAC debt instrument) must be complied with.
15.5 However, where a resolution entity or material subsidiary proposes to issue a new LAC debt instrument with identical features (save only for price, maturity, amount and dates) to instruments previously issued that meet all the criteria set out in Schedule 1 (for external LAC debt instruments) or Schedule 2 (for internal LAC debt instruments) to the LAC Rules, and for which an independent legal opinion was obtained, the resolution entity or material subsidiary may, instead of obtaining a fresh legal opinion, obtain a confirmation issued by its in-house legal counsel that there are no other terms or any intervening changes that will render the previous legal opinion “out-of-date”.
15.6 After completing the self-assessment, the resolution entity or material subsidiary should submit to the resolution authority:
(a) a letter confirming that based on its assessment, the proposed item falls within paragraph (a), (b) or (c) of rule 37 or rule 39 (as applicable), and (for any proposed LAC debt instrument) meets the criteria in Schedule 1 or Schedule 2 (as applicable), such
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and
(b) the resolution entity’s or material subsidiary’s self-assessment of whether the item falls within paragraph (a), (b) or (c) of rule 37 or rule 39 (as applicable), and (for any proposed LAC debt instrument) meets the criteria in Schedule 1 or Schedule 2 (as applicable), including any relevant legal opinions referenced in paragraphs 15.3 and 15.4 above.
15.7 As a standing practice, a resolution entity or material subsidiary proposing to issue an instrument for inclusion in its loss-absorbing capacity is expected, when in doubt, to discuss with the resolution authority beforehand whether the instrument complies with the necessary criteria. For this purpose, the resolution entity or material subsidiary is expected to submit to the resolution authority the relevant supporting documents (including a summary of the main features of, and a draft term sheet for, the instrument, together with drafts of the confirmation letter, self-assessment and legal opinions referred to in the preceding paragraph) demonstrating that the instrument falls within paragraph (a), (b) or (c) of rule 37 or rule 39 (as applicable), and (for any proposed LAC debt instrument) meets the criteria in Schedule 1 or Schedule 2 (as applicable), for the resolution authority’s review.
15.8 Note that should a LAC debt instrument either:
(a) bear loss in accordance with its terms; or
(b) be written off, cancelled, converted, modified, or have its form changed, in the exercise of powers under the FIRO,
this should not trigger any cross-default or acceleration rights in any other financial contracts to which the issuer is a party. Were it to do so, this could increase the financial pressure on the issuer, and could potentially undermine the issuer’s viability. The resolution authority therefore expects that the terms and conditions of any LAC debt instrument should specifically set out that the occurrence of any event included in (a) or (b) above does not constitute an event of default.
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However, whether such an event could trigger cross-default or acceleration rights in any other financial contracts of the issuer will ultimately depend on the wording of any such rights in those other contracts. The resolution authority therefore expects each resolution entity and material subsidiary to ensure that the wording of any cross-default or acceleration rights in any financial contracts it enters into in the future does not allow for any such rights to be triggered following the occurrence of any event included in (a) or (b) above.
15.9 The resolution authority will, once no further follow-up issues need to be raised with a resolution entity or material subsidiary in respect of its proposed item, communicate its acknowledgement to the resolution entity or material subsidiary based on the confirmations by the resolution entity or material subsidiary referred to in paragraph 15.6(a) above. Such an acknowledgement should not be taken as confirmation by the resolution authority that the relevant item complies with all the criteria necessary for it to constitute external loss-absorbing capacity or internal loss-absorbing capacity (as applicable). Such compliance remains at all times the responsibility of the resolution entity or material subsidiary.
15.10 Generally speaking, it is to be expected that the process described in paragraphs 15.2-15.9 above would provide sufficient evidence on the eligibility of an item to be included within a resolution entity’s external loss-absorbing capacity or material subsidiary’s internal loss-absorbing capacity. Where the resolution authority requires additional evidence, it would be open to the resolution authority to use the powers under rule 41(1) or rule 41(2) to require that such additional evidence be provided.