8.1 Rule 19(2) provides as follows:
(2) The resolution authority may, on the resolution authority’s volition or on a resolution entity’s application, in accordance with rule 20, vary a resolution entity’s resolution component ratio if satisfied that it is prudent to do so.
8.2 Rule 19(5) provides as follows:
(5) In determining whether it is prudent to vary a resolution entity’s resolution component ratio (including whether to accept a resolution entity’s application for variation under subrule (3)), the resolution authority may take into account—
(a) any stabilization options expected to be applied under the preferred resolution strategy covering the resolution entity;
(b) any risks to resolvability related to the fact that there may be entities that are in the resolution entity’s resolution group but not in its LAC consolidation group, and whose assets are therefore not otherwise taken into account when determining the resolution entity’s LAC requirements; and
(c) any other matters the resolution authority considers relevant.
8.3 In deciding whether or not to vary a resolution entity’s resolution component ratio, the resolution authority will be seeking to ensure that the external loss-absorbing capacity that the resolution entity is required to maintain in excess of that needed to meet its regulatory capital requirements (if any) is sufficient to facilitate an orderly resolution through the implementation of the preferred resolution strategy.
8.4 One scenario which might give rise to a reduction in the resolution component ratio for a resolution entity that is a smaller AI, above but near the HKD 150 billion threshold, is where the preferred resolution strategy envisages a partial property transfer, for example because the business associated with the performance of critical financial functions is limited and more easily separable.
In such a scenario, only part of the balance sheet of the resolution entity would be expected to be recapitalised in resolution, which would be likely to require
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fewer recapitalisation resources (i.e. less loss-absorbing capacity).
8.5 Another scenario which might give rise to a reduction in the resolution component ratio for a resolution entity that is an AI is where the preferred resolution strategy envisages a whole bank transfer, for example because its business is relatively small and simple. In such a scenario, the business of a failed AI is expected to be taken over in resolution in a timely manner as a going concern by a transferee AI.
8.6 Orderly resolution of a failed (smaller) AI in this way may be possible with fewer LAC resources than would be required for a whole bank bail-in (with no transfer), because the transferee may already have sufficient capital, and/or may be willing and able to quickly raise additional capital, to support the transferred business in whole or in part. Where a transferee has made the commercial judgement that there is value to it in the failed AI (e.g. business synergies), the transferee may be willing to incur costs (e.g. by injecting capital to cover losses) to access that value.
8.7 It may also be the case that in such a scenario the whole bank transfer would involve the business of an AI that uses the standardised approach to risk-weighting its assets being transferred to an AI using the internal models-based approach. In these circumstances, it could be anticipated that over a transition period the transferee would seek to extend its internal models-based approach to the assets of the failed AI that have been transferred to it (subject to the prior approval of the MA). Once complete, this could be expected to lead to a more granular assessment of the risks associated with the transferred assets, with the potential to generate some capital efficiency over time. This may result in fewer recapitalisation resources being required to restore the business of the failed AI to viability, and consequently justify lower ex ante LAC requirements for the relevant resolution entity. It is of course not possible to be certain in advance that any transferee would be using the internal models-based approach. But if the resolution authority considers this to be sufficiently likely, some reduction in the resolution component ratio, and hence the LAC requirements, might be considered.
8.8 As described above, the resolution authority’s view is that using a transfer stabilization option is more likely to be feasible for smaller, simpler AIs. In particular, as discussed in section 2 above, the resolution authority would not
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expect that any such options would feature in the preferred resolution strategy of a D-SIB.
8.9 It follows from this that the scope of the appropriate reduction (if any) in the resolution component ratio for a resolution entity covered by a preferred resolution strategy that includes partial property transfer and/or whole bank transfer would depend on the size and nature of the resolution entity’s operations, and where the resolution entity is not an AI, then also the size and nature of the relevant AI. Generally speaking, it could be anticipated that where a resolution entity has a smaller, simpler business it could more readily be resolved through partial property transfer or whole bank transfer, and so a larger reduction in the resolution component ratio may be justified. For larger, more complex business it is likely that the appropriate reduction would be small, if not zero. In particular, no reduction would be anticipated in the case of any resolution entity that is a D-SIB.
8.10 Any such reduction can necessarily only reflect the resolution authority’s ex ante assessment of the quantity of loss-absorbing capacity that may be required to facilitate an orderly resolution in as yet uncertain future circumstances. In order to ensure that an appropriately prudent approach is adopted in taking such uncertainty into consideration, the resolution authority’s expectation is that, while acknowledging that the scope of any reduction in the resolution component ratio will ultimately depend on the particular circumstances of an individual resolution entity, even if all the above-mentioned factors were to apply, a total reduction in the size of the resolution component ratio of more than 50% would be unlikely to be considered prudent. This implies that in a situation where a reduction is justified but the supporting factors are fewer, or less clear, it is likely that any reduction would be less than 50%.
8.11 An example of a scenario which might lead to an increase in the resolution component ratio is where a resolution entity has one or more subsidiaries that are not in its LAC consolidation group, but whose operations are sufficiently connected to those of the resolution entity that failure of any such subsidiary may undermine the resolvability of the resolution entity. In such a scenario, one response would be for the resolution authority to include the relevant subsidiaries in the LAC consolidation group under rule 7. However, should that prove undesirable or impractical, an alternative would be to increase the resolution component ratio of the resolution entity. This would have the effect
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of requiring the resolution entity to maintain more external loss-absorbing capacity. These additional resources could then be used to address the failure of the subsidiary, thereby mitigating a risk to resolvability. In these circumstances any increase in the resolution component ratio would be calibrated to reflect the level of risk associated with the relevant subsidiary or subsidiaries not included within the LAC consolidation group.
8.12 The preceding paragraphs identify a number of factors that could be taken into account by the resolution authority in any consideration of whether to vary a resolution component ratio, and by how much. However, these should not be regarded as an exhaustive list, and the resolution authority may have regard to any other relevant factors.
8.13 The resolution authority will take into account all factors that the resolution authority considers relevant when making any determination on whether or not to vary a resolution entity’s resolution component ratio (and if so, by how much).
It follows from this that where circumstances change, it may be appropriate for the resolution authority to re-visit any determination to vary, or not to vary, a resolution component ratio. Accordingly, for each resolution entity the resolution authority will keep this issue under review. Should it be the case that following a change in circumstances the resolution authority determines that a variation (or a different variation) is prudent, this would be effected using the mechanism set out in rule 20, which provides the relevant resolution entity with the opportunity to make representations to the resolution authority and ultimately to appeal to the Resolvability Review Tribunal.
8.14 Rule 25 provides as follows:
(1) A material subsidiary’s modelled minimum external LAC risk-weighted ratio and modelled minimum external LAC leverage ratio are equal to the minimum external LAC risk-weighted ratio and minimum external LAC leverage ratio, respectively, that would apply to the material subsidiary if it were a resolution entity.
(2) For the purposes of determining its modelled minimum external LAC risk-weighted ratio and modelled minimum external LAC leverage ratio, these Rules apply to a material subsidiary in the same way, and to the same extent, as they apply to a resolution entity in the determination of
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its minimum external LAC risk-weighted ratio and minimum external LAC leverage ratio.
8.15 As is clear from rule 25, determining a material subsidiary’s resolution component ratio is a key step in the calibration of its modelled minimum external LAC risk-weighted ratio and modelled minimum external LAC leverage ratio, and from there its internal LAC requirements. Contractual loss transfer will be central to the preferred resolution strategy of any material subsidiary.
This 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. As such, in determining a material subsidiary’s minimum external LAC risk-weighted ratio and minimum external LAC leverage ratio as if that material subsidiary were a resolution entity, the resolution authority will in particular take into account the resolution component ratio that would apply to that material subsidiary were it a resolution entity with bail-in as its preferred resolution strategy.
8.16 Note further that as a consequence of rule 25, the paragraphs above in this section 8 that apply to the variation of a resolution entity’s resolution component ratio also apply in a corresponding manner to the calculation of a material subsidiary’s resolution component ratio (which will then impact on the calculation of its modelled minimum external LAC risk-weighted ratio and modelled minimum external LAC leverage ratio).
8.17 Paragraphs 8.4 and 8.5 above describe examples in which having partial property transfer or whole bank transfer as a preferred resolution strategy could justify a reduction in a resolution entity’s resolution component ratio. As discussed above, it is anticipated that the preferred resolution strategy of a material subsidiary would be contractual loss transfer, and if necessary bail-in – but not any of the transfer stabilization options. As such, it is not expected that the examples in paragraphs 8.4 or 8.5 could apply to any material subsidiary.
8.18 Indicative examples of the outcome of the combined guidance set out in section 2 above and this section 8 for resolution entities and material subsidiaries are set out in Table 3 below. Note, however, that these are examples only, and the nature of a preferred resolution strategy, and whether any adjustment to the resolution component ratio is prudent, will depend on the institution-specific
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circumstances of that entity, the outcome of the resolution authority’s resolution planning for that entity, and the resolution authority’s assessment of the likely consequences of the non-viability of the relevant AI.
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Table 3: Indicative preferred resolution strategy, resolution component ratio and (consolidated) LAC requirements for resolution entities and material subsidiaries (assuming internal LAC scalar of 75%)
Relevant AI RE or
75% 1.5 x capital component ratio
RE Bail-in, and/or (for smaller AIs) partial property transfer, whole bank transfer
75% 1.5 x capital component ratio
(internal LAC) Other
AI
- Development of a preferred resolution strategy is not currently
prioritised
- - -
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