SUPPLEMENTARY INFORMATION - [DRAFT FOR CONSULTATION]

[Note: This Part will be removed.]

Hong Kong Monetary Authority

Parts 1 and 3 : 30 April 2014 Parts 1 (revised) and 2 : 15 September 2014

Annex 1

Framework for adoption of ALA Option 2 in Hong Kong¹⁰² Background

1. Pursuant to Division 4 of Part 7 of the BLR, a category 1 institution that is running a HKD LCR mismatch may adopt Option 2 of the Alternative Liquidity Approaches (“ALA Option 2”) under the Basel III LCR framework by using HQLA (which must be level 1 assets) denominated in foreign currencies to cover its HKD LCR mismatch to the extent of meeting relevant requirements set out in section 38 of the BLR. Such requirements include –

(i) having a genuine need¹⁰³ to use such HQLA (which have not already been used by the institution to cover its foreign currency-denominated total net cash outflows¹⁰⁴) to comply with the minimum LCR requirement;

(ii) possessing necessary systems and capacity to manage foreign exchange risk associated with the use of such HQLA;¹⁰⁵

(iii) always holding an amount of HKD-denominated HQLA¹⁰⁶ (which must be level 1 assets) that is not less than 20% of the institution’s HKD-denominated total net cash outflows¹⁰⁷ (“20% minimum holding requirement”); and

(iv) subjecting such HQLA to foreign exchange haircuts (as required under section 39 of the BLR).

2. It is not the MA’s intention to require case-by-case approval of the use of ALA Option 2 by individual category 1 institutions. However, those institutions adopting ALA Option

102 LM-1 (under revision) will provide supplementary guidance on the ALA framework where appropriate.

103 For example, there may be a practical difficulty to significantly change the currency composition of the institution’s HQLA due to limited supply of HQLA denominated in HKD and other market circumstances.

104 Under the BLR, the term “foreign currency-denominated total net cash outflows” refers to a category 1 institution’s total net cash outflows (before applying the 75% ceiling on total expected cash inflows) that are denominated in foreign currencies.

105 Please refer to relevant guidance set out in LM-2 re foreign currency liquidity management for details.

106 Under the BLR, the term “HKD-denominated HQLA” refers to the total weighted amount of HQLA held by a category 1 institution (before making any adjustment in respect of the 15% ceiling on level 2B assets and 40% ceiling on total level 2A and level 2B assets) that are denominated in Hong Kong dollars.

107 Under the BLR, the term “HKD-denominated total net cash outflows” refers to a category 1 institution’s total net cash outflows (before applying the 75% ceiling on total expected cash inflows) that are denominated in Hong Kong dollars.

2 should be able to demonstrate their compliance with section 38 of the BLR for use of ALA Option 2 upon request by the MA.

Adoption of ALA Option 2 – Relevant parameters

3. The minimum LCR requirement (for the all-currencies LCR standard) will increase from 60% in 2015 to 100% in 2019 under the phase-in implementation timetable.

Assuming that the same level of HKD liquidity coverage applies in respect of HKD-denominated HQLA versus HKD-HKD-denominated total net cash outflows, the maximum level of HKD LCR mismatch that can be covered by foreign currency-denominated HQLA under ALA Option 2 can be determined by reference to the 20% minimum holding requirement referred to in paragraph 1 of this Annex. That is, if the minimum LCR requirement is 100% (and the same level of HKD liquidity coverage is expected), the maximum usage of ALA Option 2 (or foreign currency-denominated HQLA) will be 80% (= 100% – 20%) of HKD-denominated total net cash outflows.¹⁰⁸

4. The use of foreign currency-denominated HQLA to cover HKD LCR mismatch is subject to foreign exchange haircuts if the level of usage exceeds a certain threshold (as specified in section 39(2) of the BLR¹⁰⁹). Such haircuts are – ¹¹⁰

Haircuts

(a) Level 1 assets denominated in US dollars 2%

(b) Level 1 assets denominated in other major currencies with global transaction volume exceeding 10% of total global foreign currency market turnover (i.e.

EUR, JPY and GBP)

(c) Level 1 assets denominated in any other foreign currency that is freely convertible into Hong Kong dollars (including RMB assets that meet relevant qualifying criteria as HQLA)

10%

108 As noted from the BLR definitions of HKD-denominated HQLA, foreign currency-denominated total net cash outflows and HKD-denominated total net cash outflows, for the purposes of assessing the level of a category 1 institution’s HKD LCR mismatch, and hence determining the maximum level of usage of ALA Option 2 (i.e. the maximum amount of foreign currency-denominated HQLA that may need to be used by a category institution to cover its HKD LCR mismatch), it is considered unnecessary (and inappropriate) to apply the 15% ceiling on level 2B assets, the 40% ceiling on total level 2A and level 2B assets as well as the 75% ceiling on total expected cash inflows. The application of the 15% and 40% ceilings in respect of the aggregate amount of HQLA (calculated on an all-currency basis) is to avoid undue reliance on level 2A or level 2B assets, whereas the application of the 75% ceiling on total expected cash inflows is to ensure that a category 1 institution always maintains a minimum stock of HQLA sufficient to cover at least 25% of its total expected cash outflows (even if the institution maintains a net positive inflow position). Therefore, these ceilings are not intended to be applied for ALA purposes.

109 As reflected from section 39(2) of the BLR, foreign exchange haircuts do not apply to the relevant portion (or that part of the relevant portion) of foreign currency-denominated HQLA, held by a category 1 institution to cover its HKD LCR mismatch, that is not more than 25% of the institution’s HKD-denominated total net cash outflows.

110 Please refer to L3 (paragraph 59) for the underlying concepts and methodologies adopted by the HKMA to determine the respective haircuts for ALA purposes.

5. The threshold for application of foreign exchange haircuts will be 25% (in line with the Basel LCR standard) when the minimum LCR requirement reaches 100% on 1 January 2019. This means that the relevant portion of foreign currency-denominated HQLA subject to foreign exchange haircuts will not exceed an amount equivalent to 55% (=

100% – 20% – 25%) of HKD-denominated total net cash outflows. The threshold will be correspondingly adjusted based on the prevailing minimum LCR requirement during the phase-in period.

6. Based on the above reasoning, the relevant parameters in relation to the use of ALA Option 2 are summarised as follows:

A B C D E

7. The example below demonstrates the methodology underlying Table 2 of Section (II) of the Return for calculating the amount of haircuts on foreign currency-denominated level 1 assets if the reporting institution uses such assets to cover its HKD LCR mismatch.

(Unit: HKD’000 equivalent)

Total HKD USD Other

major $

RMB Other

$ 1 Total level 1 assets (before deductions)

(= Section (I), sub-item A1(f)

320 120 20 10 50 120

2 Total level 2A assets (before deductions) (= Section (I), sub-item A2(d))

240 30 50 80 20 60

3 Total level 2B assets (before deductions) (= Section (I), sub-item A3(c))

10 0 0 10 0 0

4 Total HQLA (before deductions) (= Section (I), item A4)

570 150 70 100 70 180

5 Total expected cash outflows (= Section (I), item B23)

1050 500 200 150 100 100

6 Total expected cash inflows (before application of 75% inflow ceiling)

8 The portion of HKD LCR mismatch which, if covered by foreign currency assets, needs to be subject to additional haircut on the foreign currency assets (=If (item 7 = 0, 0, item 7 – Max(item 5

– item 6,0)* Max(0,25% – (100% – item 13)))

9 Level of holding in HKD level 1 assets meets 20%

minimum holding requirement:

(“Yes” if HKD LCR mismatch ratio =/> 20%; “No”

if < 20%; N/A if HKD LCR mismatch does not exist)

Yes / No/

N/A

10 Surplus amount of level 1 assets in foreign currencies (if any)

(=Min ( Max ( item 4 – item 13* Max ( item 5 – item 6,0),0), item 1))

20 10 50 120

11 Relevant portion in item 10, used to cover HKD LCR mismatch calculated in item 8 does not align with Table 2]

20 10 50 10

12 Deduction from total HQLA - additional adjustment due to foreign exchange haircuts [to be mapped to Section (I), item A6]

2% 8% 10% 10%

7.2 0.4 0.8 5 1

13 Memorandum item: Minimum required level of LCR for the reporting period

[60%]

Explanatory Notes

 The figures in items 1 to 6 are copied from those reported by a category 1 institution in Section (I). In this example, the institution has a HKD LCR mismatch of HK$90 (item 7). If the institution uses foreign currency-denominated HQLA (which must be level 1 assets) to cover this amount of HKD LCR mismatch, a portion of these foreign currency-denominated HQLA (equivalent to HK$90 as indicated in item 8) will be subject to foreign exchange haircuts.

 Item 9 reflects whether the reporting institution is able to meet the 20% minimum holding requirement for HKD-denominated HQLA (which must be level 1 assets).

If the institution is unable to observe this requirement, it must notify the HKMA immediately, so that the HKMA may deliberate appropriate supervisory measures to cater for this situation.¹¹¹

 Item 10 calculates the surplus amount of foreign currency-denominated level 1 assets that can be used to cover HKD LCR mismatch. In this example, the reporting institution has surplus level 1 assets in USD (equivalent to HK$20), other major currencies (equivalent to HK$10), RMB (equivalent to HK$50) and other currencies (equivalent to HK$120).

 Item 11 determines the amount of foreign currency-denominated level 1 assets that are actually required to cover HKD LCR mismatch. In determining the order of usage of foreign currency-denominated HQLA to cover HKD LCR mismatch, it is assumed that foreign currency assets that are subject to the lowest foreign exchange haircut will be utilised first, followed by other foreign currency-denominated assets by an ascending order of the level of foreign exchange haircut applicable to those assets under the ALA framework. The order of usage is assumed to follow this order: (i) USD, (ii) other major currencies (EUR, JPY, GBP); (iii) RMB; and (iv) other currencies. In this example, the surplus level 1 assets denominated in USD (HK$20) will be utilised first, followed by the level 1 assets denominated in other major currencies (HK$10), then level 1 assets denominated in RMB (HK$50) and finally level 1 assets denominated in other currencies (up to an amount equivalent to HK$10, which is used to cover the remaining portion of HKD LCR mismatch that has yet been covered after using all surplus assets in USD, other major currencies and RMB).

111 The HKMA will elaborate on the possible supervisory measures in statutory guidelines (e.g. LM-1). Such measures may include, for example, temporarily allowing the institution concerned to use foreign currency-denominated assets to cover HKD LCR mismatch to the extent of exceeding the level indicated in column E of the Table under paragraph 6 of this Annex, but requiring the institution to observe an internal target level of LCR (which is reasonably above the statutory minimum level) and, where necessary, enhance its risk management systems to avoid falling below the 20% minimum holding requirement again.

 Item 12 calculates the total amount of foreign exchange haircuts resulting from the use of the relevant portion of foreign currency-denominated level 1 assets to cover HKD LCR mismatch. This total amount of foreign exchange haircut is mapped to item A6 of Section (I) for calculating the total amount of HQLA (after deductions).

Annex 2

Treatment of cash flows arising from forward contracts¹¹²

1. The term “forward contract” means a contract between two parties for entering into a transaction (e.g. to provide a loan of money, or to purchase, sell or exchange a specified quantity of a specified commodity, currency, financial instrument or thing) at a specified price on a specified future date (“Day F”). Some forward contracts may have a definite termination date (“Day T”). On Day F (and Day T where applicable), the counterparties to the contract will incur cash (or asset) inflows or outflows, which should be treated under the LCR according to the requirements set out below.

2. If the reporting institution has entered into a forward contract with a counterparty where Day F falls within the LCR period and Day T falls outside the LCR period (or Day T is not specified in the contract), the institution should report –

(i) in item B22, the contractual cash outflow to be paid by the institution on Day F¹¹³. If the institution will receive an HQLA qualifying asset on Day F under the forward contract (e.g. in the case of a forward asset purchase contract in which the institution is the asset buyer or a forward reverse repo contract in which the institution will receive collateral from the counterparty), the fair value of that asset (after application of haircuts in the case of a level 2A or level 2B asset) may be deducted from the contractual cash outflow arising from the contract; or

(ii) in item C10, the contractual cash inflow to be received by the institution on Day F. If the institution will deliver an HQLA qualifying asset on Day F under the forward contract, and the institution has counted that asset as HQLA (or has already re-hypothecated that asset to obtain funding), the fair value of that asset (after application of haircuts in the case of a level 2A or level 2B asset) should be deducted from the contractual cash inflow arising from the contract.

3. If Day F and Day T of a forward contract both fall within the LCR period, this contract is not considered under the LCR.¹¹⁴ If Day F of the contract had occurred before the

112 The guidance provided in this Annex is developed by reference to the BCBS FAQ (April 2014) (no. 15), with appropriate modifications, to enable general application to all forward contracts. It is noted that the BCBS FAQ is mainly addressing forward repo, forward reverse repo, forward collateral swap and forward asset purchase (or sale) contracts.

113 Or, in case of a forward securities swap transaction, report in item B22, the fair value of the asset to be delivered by the institution on Day F, net of the fair value of any HQLA qualifying asset to be received by the institution on Day F (after application of haircuts in the case of a level 2A or level 2B asset).

114 This treatment is provided in BCBS FAQ (April 2014) (no. 15) based on a simplified assumption that the cash flow to be generated on Day F (when the transaction is executed) and the opposite cash flow to be generated on Day T (when the transaction is terminated) will be offset exactly within the LCR period. The

start of the LCR period whereas Day T of the contract falls within the LCR period, the contract can be treated as a spot contract. The cash flows to be accounted for on Day T should be reported according to applicable requirements.¹¹⁵

reporting institution should however notice that this assumption may not always be valid in the light of the possibility that (1) there may be a difference between cash inflows and outflows generated at different points of time, or (2) there exists a time gap between Day F and Day T even though these two points of time both fall within the LCR period. The institution should manage the relevant liquidity risks that are not captured under the LCR.

115 For example, if a forward repo contract was executed on Day F which is prior to the LCR period and Day T falls within the LCR period, the contract should be captured in item B8 (instead of item B22) of Section (I) of Part 2 of this Return.

Annex 3

Completion instructions for Table 1 of Section (II) –

Determination of adjustments to HQLA for 15% ceiling on level 2B assets and 40%

ceiling on level 2A and level 2B assets

1. If the reporting institution has entered into any securities financing transaction¹¹⁶ which will necessitate the exchange of an asset for another asset, both of which are eligible for inclusion as HQLA¹¹⁷, within the LCR period, complete sub-items 2(d) to 2(f) of Table 1 (re adjusted level 1, level 2A and level 2B assets) by reversing the effect of the securities financing transaction from the institution’s HQLA positions, as if the exchange of the two HQLA qualifying assets were executed on the day when the LCR is calculated. Table 1 will generate the necessary figure for reporting of item A5 in Section (I) of Part 2 of this Return. If the institution has not entered into any such transaction, the institution should report sub-items 2(d) to 2(f) of Table 1 in the same amounts as those derived in sub-items 1(f), 2(d) and 3(c) in Section (I)A of Part 2 of this Return.

2. An illustrative example for the completion of sub-items 2(d) to 2(f) in Table 1, as well as the calculation of adjustments to HQLA for the 15% and 40% ceilings is provided below. To avoid doubt, the amounts shown in all diagrams in this Annex are

“weighted” (i.e. after applying the haircuts applicable to the assets).

2.1 Bank X has maintained the following positions in HQLA holdings:

(Unit: HKD’000 equivalent) 15% ceiling & 40 % ceiling)

5600 2700 2100 800 0

2.2 Some of the above assets are obtained through the two securities financing transactions specified below, which will be due for settlement within the LCR period.

(Unit: HKD’000 equivalent) Diagram 2 Receivable upon settlement Payable upon settlement

(1) securities reverse repurchase transaction

level 1 asset in USD (post-haircut fair value equivalent to HKD100)

Level 1 asset in HKD (post-haircut fair value is equal to HKD110)

(2) securities swap

116 “Securities financing transaction” is defined in the BLR as a repo-style transaction or a margin lending transaction.

117 This means that all relevant requirements set out in section 26 of the BLR are met by the asset concerned, or by the institution holding the asset in so far as those requirements relate to the asset.

57 Diagram 2 Receivable upon settlement Payable upon settlement

HKD200) HKD220)

2.3 If the two securities financing transactions are reversed, Diagram 1 will be adjusted as follows (whilst the figures in yellow cells should be reported in items 2(d) to 2(f) of Table 1):

(Unit: HKD’000 equivalent)

Diagram 3 Total HKD USD Other major $

(euro, JPY, GBP)

Other currencies (incl. RMB)

Level 1 assets (adjusted) 2090 890 700 500 0

Level 2A assets (adjusted) 1800 900 700 200 0

Level 2B assets (adjusted) 1680 800 580 300 0

Total adjusted HQLA (before applying 15% ceiling & 40 % ceiling)

5570 2590 1980 1000 0

3. Using the above example, Table 1 will calculate the adjustment figures for the 15%

ceiling and 40% ceiling by adopting the following steps:

3.1 Step 1: Before reversing any securities financing transaction, calculate the adjustments using the figures in Diagram 1 –

Adjustment for 15% ceiling

= Max (level 2B assets – 15/85*(level 1 assets + level 2A assets), level 2B assets – 15/60* level 1 assets, 0) = Max (1900 – 15/85*(2100 + 1600), 1900 – 15/60*2100, 0) = 1375

Adjustment for 40% ceiling

= Max ((level 2A assets + level 2B assets - adjustment for 15% ceiling) - 2/3* level 1 assets, 0)

=Max ((1600 + 1900 – 1375) – 2/3*2100, 0) = 725

Total adjustments for 15% ceiling and 40% ceiling = 1375+725 = 2100

Bank X’s HQLA position (before reversing securities financing transactions) is adjusted as follows after applying the 15% ceiling and 40% ceiling:

(Unit: HKD’000 equivalent)

Diagram 4 Total HKD USD Other major $

(euro, JPY, GBP)

Other currencies (incl. RMB)

Level 1 assets 2100

Level 2A assets 1600

1400

Level 2B assets 1900

0 Total HQLA (before applying 15% ceiling & 40% ceiling)

5600 3500

3.2 Step 2: After reversing securities financing transactions, calculate the adjustments for the 15% and 40% ceilings using the figures in Diagram 3 –

Adjustment for 15% ceiling

= Max (level 2B assets – 15/85*(level 1 assets + level 2A assets), level 2B assets – 15/60* level 1 assets, 0) = Max (1680 – 15/85*(2090 + 1800), 1680 – 15/60*2090, 0) = 1158

Adjustment for 40% ceiling

= Max ((level 2A assets + level 2B assets - adjustment for 15% ceiling) - 2/3* level 1 assets, 0);

= Max ((1800 + 1680 – 1157.5) – 2/3*2090, 0) = 929

Total adjustments for 15% ceiling and 40% ceiling = 1158+929 = 2087

Bank X’s HQLA position (after reversing securities financing transactions) is adjusted as follows after applying the 15% ceiling and 40% ceiling:

(Unit: HKD’000 equivalent)

Diagram 5 Total HKD USD Other major $

(euro, JPY, GBP)

Other currencies (incl. RMB) Level 1 assets (adjusted) 2090

Level 2A assets (adjusted) 1800 1393 Level 2B assets (adjusted) 1680 0 Total adjusted HQLA (after

applying 15% ceiling & 40%

ceiling)

5570 3483

3.3 Step 3: The more conservative outcome shown in Diagram 4 and Diagram 5 (i.e. HKD 3483 in this example) should be reported in item A5 of Section (I) of this Return.

3.4 If Bank X has not entered into any securities financing transaction, the figure to be reported in item A5 of Section (I) should be HKD2100 (as calculated under paragraph 3.1 of this Annex.

Annex 4

Treatment of deposits taken by deposit-taking companies under the LCR

1. The CIs set out in this Annex apply to category 1 institutions (or their specified associated entities in the case of AIs incorporated in Hong Kong) which are deposit-taking companies.

2. Pursuant to section 12(3) of the BO, “A deposit-taking company shall not, without the written permission of the Monetary Authority, repay any deposit within a period of less than three months (as specified in the First Schedule to the BO) from the date on which the deposit was taken by the company.” Nonetheless, this legal prohibition from early repayment of a deposit taken by a deposit-taking company (DTC) does not apply in the following situations:

(a) if the deposit has already been held by the DTC for three months or more from the date on which the deposit was taken by the DTC; and

(b) if the deposit has not been held by the DTC for three months or more from the date on which the deposit was taken by the DTC, but the MA has granted a written permission under section 12(3) for early repayment of the deposit.

Treatment for deposits subject to section 12(3) restriction

3. Deposits taken by a DTC with a remaining term to maturity that is beyond the LCR period (even though such deposits have been held by the DTC for less than three months) can be excluded from the calculation of the LCR, provided that no section 12(3) permission has been granted by the MA in respect of those deposits.¹¹⁸

Treatment for deposits not subject to section 12(3) restriction (due to holding of deposits for three months or more)

4. If deposits taken by a DTC have been held by a DTC for three months or more, the section 12(3) restriction does not apply to those deposits. The outflow treatment of those deposits should follow the CIs set out in item B1, B3, B5 or B6 of Section (I) of Part 2 of this Return as appropriate. That is,

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