Respondents’ comments MA’s response 1. Generally speaking respondents were fine with
the proposal to restrict primary issuance to PIs only. However, the CP also raised the prospect of allowing primary issuance only to those PIs who are not ‘retail banking customers’. There was a consensus among respondents who addressed this issue that primary issuance should be allowed to individuals who meet the criteria to qualify as PIs. Respondents commented that prohibiting issuance to ‘retail banking customers’
that meet the PI criteria would go beyond restrictions in other key financial centres (and anything in the existing regime in Hong Kong), and it would have a negative impact on liquidity and marketability, leading to higher costs and putting Hong Kong AIs at competitive disadvantage.
One respondent pointed out that there is no statutory definition of ‘retail banking customers’, and suggested that no such reference be made.
The MA’s view is that appropriate investor protection measures need to be put in place to ensure that investment in external LAC debt instruments is restricted to those who understand the risks that such investments involve, and are able to bear those risks. But the MA also acknowledges that more onerous distribution restrictions could lead to a smaller investor base, and could have a negative impact on liquidity and pricing. On balance, the MA’s existing judgement is that the issuance of external LAC debt instruments to all PIs can be permitted, subject to AIs meeting relevant conduct requirements referred to in the following rows of this Part.
The MA therefore intends that the AI LAC Rules will set out that in order to be eligible as external LAC, a debt instrument issued in Hong Kong will need to be issued to a PI as defined in section 1 of Part 1 of Schedule 1 to the Securities and Futures Ordinance (Cap. 571).
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PART VII RESTRICTIONS ON THE SALE AND DISTRIBUTION OF LAC DEBT INSTRUMENTS
Respondents’ comments MA’s response 2. Broadly speaking, respondents commented that
in principle having a minimum denomination requirement for LAC debt instruments would be acceptable, but all respondents on this question said that HKD 8 million was too high, and would have a negative impact on liquidity and marketability, leading to higher costs and reducing the investor base. Respondents pointed out that it would only apply to Hong Kong issuers, disadvantaging them in both Hong Kong and global markets. Two respondents said that orders below USD 1 million are often placed for these types of instruments, and that internationally comparable minimum denominations are USD 200,000 / EUR 100,000, i.e. around HKD 1-1.5 million. Current market practice among Institutional PIs is to use small denominations to improve transferability, liquidity, and pricing. One respondent made the point that in Hong Kong, the closest comparator
As for the preceding row in this table, in setting a minimum denomination requirement for LAC debt instruments there is a balance that needs to be struck between ensuring that investment in LAC debt instruments is in practice limited to those who understand and are able to bear the risks, and imposing unduly onerous regulatory requirements. On further consideration of this issue, and in light of respondents’ feedback, the MA’s present intention is to revise the proposal set out in the CP so that external LAC debt instruments denominated in Hong Kong dollars, US dollars, Euros or another currency are required to meet minimum denomination requirements of HKD 2 million, USD 250,000, EUR 200,000 or the equivalent of HKD 2 million in another currency, respectively.
The MA therefore intends that the AI LAC Rules will set out that in order to be eligible as external LAC, a debt instrument will need to meet these minimum denomination requirements.
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PART VII RESTRICTIONS ON THE SALE AND DISTRIBUTION OF LAC DEBT INSTRUMENTS
Respondents’ comments MA’s response under the existing regime is the minimum
denomination of HKD 500,000 needed to gain an exemption from complying with the prospectus requirement specified in the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.
32). Two respondents said that if a minimum denomination was required, it should not be higher than the equivalent of USD 200,000.
3. Several respondents expressed the view that further restrictions of the type set out in paragraph 134 of the CP (such as requiring written acknowledgement of risk from every investor, and setting minimum risk ratings for LAC debt instruments) are too onerous, in particular for secondary distribution and for sophisticated customers such as PIs, and would be inconsistent with the approaches followed in other financial centres. (And several respondents said that if written communications on risk with investors
In light of respondents’ feedback, and on further consideration of this topic, the MA intends to revise the proposed measures set out in paragraph 134 of the CP so that:
(i) offering and product documents for external LAC debt instruments must contain disclosure in respect of (1) risks (including that the instruments are complex and high risk); and (2) selling restrictions, i.e. issuance is permitted to PIs only;
(ii) primary and secondary market sale or distribution in Hong Kong of restricted products must be to PIs only;
(iii) AIs are required to make adequate disclosure by directing potential investors in any restricted products to the selling restrictions in the offering and product documents, and explaining to them relevant information such as the structure, features and risks of any restricted products;
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PART VII RESTRICTIONS ON THE SALE AND DISTRIBUTION OF LAC DEBT INSTRUMENTS
Respondents’ comments MA’s response was to be mandated, it should be one-way only,
and on a one-off basis, i.e. not required for every transaction.) It was submitted that the regime for LAC debt instruments should not be any stricter than that currently in place for regulatory capital instruments. Stricter requirements may have a significant negative impact on liquidity and pricing, for very little benefit. Respondents commented that licensed corporations and relevant AIs need to abide by the SFC’s Code of Conduct, which provides a robust regime which works well. One respondent proposed that if it was felt that more action was required in respect of LAC debt instruments, the MA / SFC could require relevant AIs / licensed corporations to provide enhanced training to their staff and ensure appropriate risk suitability disclosures, while also conducting detailed monitoring to ensure that proper due diligence is being conducted and that governance frameworks are
(iv) AIs are required to assure themselves that customers who wish to invest in restricted products have adequate knowledge or experience in products with bail-in, contingent convertible or convertible features;
(v) AIs who offer non-leveraged investment opportunities in restricted products are required to treat them as of at least high risk, with any leveraged opportunities being treated as of the highest risk, and to assign appropriate product risk ratings accordingly; and
(vi) a strong justification would be needed for any risk mis-match transactions.
The MA intends that the AI LAC Rules will set out that in order to be eligible as external LAC, the offering and product documents for an instrument must contain the disclosure referred to in (i) above. More generally, it is intended that the investor protection measures set out above will be implemented through the issuance of circulars. It is intended that certain exemptions will be available for transactions involving Institutional or Corporate PIs (see below).
For the avoidance of doubt, the MA does not currently intend to restrict the sale or distribution of restricted products in either the primary or secondary markets to PIs who are not retail banking customers, nor to require a written statement from every investor acknowledging that the investor understands and accepts the risks associated with the investment.
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PART VII RESTRICTIONS ON THE SALE AND DISTRIBUTION OF LAC DEBT INSTRUMENTS
Respondents’ comments MA’s response being adhered to.
4. Several respondents said that the proposed description of ‘restricted products’ could prove problematic, as it would not always be clear what was and was not included. It was suggested that the MA should provide more clarity on which products would and would not count as
‘restricted products’, and/or that the MA maintain a list of all such products, to provide certainty.
The MA acknowledges that in imposing restrictions on the distribution of restricted products, it is important that market participants are able to clearly identify which products are in scope. The intention is that the AI LAC Rules, and relevant circulars, will clearly identify which products are affected, and the relevant investor protection measures that apply.
5. One respondent sought clarity on the extent to which the requirements proposed in paragraph 134 of the CP – in particular, the provision of offering and product documents, should they not be available – could be waived for transactions involving Institutional or Corporate PIs, and/or in execution only transactions.
The MA’s intention is that intermediaries should, where available, provide each client with recommended investment products’ up-to-date prospectuses or offering circulars and other up-to-date documents relevant to the investments. Following on from the proposal in paragraph 136 of the CP, it is the MA’s present intention that AIs dealing with Institutional PIs be automatically exempt from the requirements set out in (iii), (iv), (v) and (vi) above, while AIs dealing with Corporate PIs could be exempted from the same requirements if they have complied with the procedures required under the SFC's Code of Conduct. In other words, AIs may conduct execution-only transactions for Institutional PIs, and under the aforesaid conditions for Corporate PIs, but not for Individual PIs.
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PART VII RESTRICTIONS ON THE SALE AND DISTRIBUTION OF LAC DEBT INSTRUMENTS
Respondents’ comments MA’s response 6. Several respondents suggested that the proposals
to automatically classify restricted products as
‘high risk’ or ‘highest risk’ may not be appropriate, as it would remove the ability to take into account the features of a particular product in determining its risk rating.
The MA regards restricted products as complex and high risk. In addition, the MA’s understanding is that AIs already typically classify debts with loss-absorption features as ‘high risk’. As such, the MA’s view remains that AIs who offer non-leveraged investment opportunities in restricted products should treat them as of at least high risk, with any leveraged opportunities being treated as of the highest risk.
7. One respondent said that any additional restrictions should not apply to instruments that are already in issue, as the risks are already understood.
The MA does not accept the view that simply because instruments are in issue, it can be assumed that the risks are already fully understood. However, the MA does accept that the requirements above that it is intended will be included in the eligibility criteria for external LAC instruments (i.e.
issuance in Hong Kong must be to PIs, they must meet minimum denomination requirements, and their offering and product documents must contain certain disclosures) should not apply to instruments already in issue when the AI LAC Rules come into operation. Were these requirements not to be disapplied, there would be no way for AIs to make such instruments compliant (short of redeeming them and issuing new instruments). However, the investor protection measures described above (including sale and distribution to PIs only) should apply to any future secondary market sale or distribution of restricted products that are already in issue when the AI LAC Rules come into operation.
50 PART VIII TREATMENT OF LAC INVESTMENTS
Respondents’ comments MA’s response 1. One respondent said that notwithstanding the
BCBS TLAC holdings standard, external LAC and internal LAC should both be deducted from LAC (not capital). Another respondent made the general point that deducting LAC holdings from regulatory capital is unnecessary and difficult to calculate; the risk is already adequately addressed by risk-weighting.
Generally speaking, the MA does not agree that holdings of external LAC should be deducted from LAC, rather than from capital. This could lead to increased contagion risk, and would be inconsistent with the BCBS TLAC holdings standard. See consultation paper CP18.03
‘Implementation of TLAC Holdings Standard’ issued by the HKMA in April this year.
The MA agrees, however, that holdings of internal LAC should be deducted from LAC, but with no materiality thresholds.
2. One respondent said that at the very least deductions from LAC rather than capital should apply for intragroup external LAC (issued between resolution groups within one banking group) and internal LAC. One respondent also said there should be a material holdings threshold below which deductions would not be made, that long and short positions should be netted out, with only the net amount being subject to deduction, and that there should be an exception for
On further consideration, where an AI holds non-capital LAC liabilities issued by an entity in a different resolution group but in the same banking group as the holding AI, the MA’s view is that such instruments should be deducted in the same way as for internal LAC, i.e. first from the holder’s own non-capital LAC, and then from the holder’s regulatory capital, with no deduction thresholds.
51 PART VIII TREATMENT OF LAC INVESTMENTS
Respondents’ comments MA’s response market-making.