1
Annex Banking (Exposure Limits) (Amendment) Rules
Part B Detailed Proposals
Item Heading Matters to be Provided for Remarks and Explanation of
Policy Intent 1 Commencement 1.1 The amendments will come into operation on 1 January 2019.
2 Amendment of Rule 6
“Notifiable event - prescribed notification requirement under section 81C of the Ordinance”
2.1 Amend Rule 6(2)(a) to the meaning along the following lines: “a failure to comply with a limit prescribed in a rule under Part 2, 4, 5, 6, 7, 8 or 9 applicable to an AI, or that limit as varied by the MA under a rule within the same part of that limit.”.
In relation to prescribed notification requirements under BO section 81C (as inserted by section 9 of the BAO), to incorporate additional notifiable events relating to failure to observe the exposure limits to be included into the Rules by the BELAR.
For Rule 6(2)(a), additional limits to be included are those referred to in paragraphs 4.1
2
(Part 4), 6.1, 6.2 (Part 5), 8.1, 8.2 (Part 6), 23.1 (Part 7), 31.1 (Part 8) and 35.1 and 35.2 (Part 9) below (on top of Rule 10 under Part 2).
Additional power to vary a limit is referred in paragraphs 9.1 (Part 6), 24.1 (Part 7), 32.1(Part 8) and 36.1 (Part 9) below (on top of Rule 11(1) under Part 2).
2.2 Amend Rule 6(2)(b) to the meaning along the following lines:
“a failure to comply with any conditions imposed by the MA in giving a consent, approval or specification under the circumstances referred to in paragraph 4.2, 16.1(u) and 25.1(b) below”.
To add new notifiable events in relation to “conditions” on top of those under current rule 13(3)(b).
Amendment of Rule 8
“Interpretation: equity exposure”
2.3 In rule 8(1)(b)
- Repeal - words after “consolidated”;
- Substitute by – “on the basis referred to in the notice issued by the Monetary Authority under rule 5(1).”
This amendment seeks to clarify the policy intent on the basis of consolidation.
3
Inclusion of new Parts 4, 5, 6, 7, 8, 9 and 10 into the Rules
2.4 To insert the parts below after Part 3 of the Rules. To replace sections 87A, 80, 81, 83, 85 and 88 of the BO and add necessary transitional provisions.
PART 4 – Acquisition of share capital in companies [Current BO s87A]
Division 1 General
3 Application of Part 4 3.1 This Part will be expressed to apply to AIs incorporated in Hong Kong 3.2 The Rules will express that in this part, “value” in the case of shares in a
company, means the total of
(a) the current book value of the shares and
(b) the amount for the time being remaining unpaid on the shares which is not counted under paragraph (a).
3.3 If an AI must value the share capital of a company in accordance with this Division at fair value, rule 4 applies in determining the fair value.
By and large, this Part is a direct replication of s87A of the BO except: (i) reference base for the limit has been changed from capital base to Tier 1 capital and (ii) s87A(3) is to be replaced by other transitional provisions in Part 10.
3.3: Cf rule14(3).
Division 2: Limit on acquisition of share capital in companies 4 Limit on acquisition
of share capital in companies
4.1 Subject to paragraph 4.5, the Rules will provide that an AI shall not: ─ (a) acquire (whether by one acquisition or a series of acquisitions, and by
whatever means) all or part of the share capital of a company (and
BO section 81A (as inserted by section 9 of the BAO) provides for the MA to make
4
whether or not the company was established by the institution) to a value of 5% or more of the Tier 1 capital of the institution at the time of the acquisition unless the approval of the MA has been granted to the proposed acquisition of such share capital;
(b) if any such approval referred to in (a) is revoked, hold share capital in the company to a value of 5% or more of the Tier 1 capital of the institution on or after the time such revocation comes into effect.
4.2 The Rules will provide that the MA may at any time, by notice in writing served upon an AI, attach condition to an approval granted as referred to in
Rules prescribing limits, inter alia, on AIs’ exposures to the equity of any other company (s81A(1)(b)).
Cf BO s87A(2)(a).
BO section 81A(3)(i) (as inserted by the BAO) empowers the MA to consent, subject to any conditions the MA thinks fit, to the incurring of specified exposures or the acquisition of specified interests generally, or in a particular case or class of cases such that the exposures or interests need not be taken into account in calculating whether an AI has reached a limit.
Cf BO s87A(2)(b).
Cf BO s87A(4).
5
paragraph 4.1(a) and may amend or cancel such conditions, in each case, with effect from the time specified in the notice (being a time reasonable in all the circumstances of the case).
4.3 The MA may revoke an approval as referred to in paragraph 4.1(a)- (a) in such case as he thinks fit; and
(b) with effect from such time as he may specify being a time reasonable in all the circumstances of the case.
4.4 Where the MA refuses to grant approval as referred to in paragraph 4.1(a) or revokes an approval, he should notify the AI concerned in writing of the refusal or revocation.
4.5 For the purpose of paragraph 4.1, share capital of a company acquired by an AI shall not include share capital so acquired-
(a) in the course of the satisfaction of debts due to the institution; or
(b) under an underwriting or a subunderwriting contract for a period not exceeding 7 working days, or such further period as the Monetary Authority approves in writing, and subject to such conditions as he may think proper to attach thereto in any particular case.
Cf BO s87A(5).
Cf BO s87A(6).
Cf BO s87A(8)
PART 5 – Advance against security of own shares, etc [Current BO s80]
6
Division 1 General
5 Application of Part 5 Interpretation
5.1 This Part will be expressed to apply to all AIs.
5.2 In relation to any AI incorporated outside Hong Kong, this Part will be expressed to apply only to its principal place of business in Hong Kong and its local branches, and should so apply as if that principal place of business and those branches were collectively a separate AI.
5.3 The Rules will provide for the following definition used in this Part:
“Basel Committee’s capital standards” mean the capital standards first published by the Basel Committee in International Convergence of Capital Measurement and Capital Standards in April 1988, including any subsequent amendments and supplements.
5.4 The Rules will provide for the following terms used in this Part should have the meaning given by section 2(1) of the Capital Rules:
Additional Tier 1 capital instrument;
CET1 capital instrument;
Tier 2 capital instrument.
Cf BO s79(4).
BO section 81A(3)(e) (as inserted by the BAO) provides that Rules made by the MA may specify in respect of an AI incorporated outside Hong Kong that any provision of the Rules is to apply only to the business of the AI in Hong Kong.
BO Section 81A(1)(a)(iv) (as inserted by the BAO) provides for Rules made by the MA to prescribe limits on exposures incurred by an AI against the security of its own shares or other instruments that are
7
5.5 The Rules will provide that a capital-in-nature instrument means an instrument other than shares that is--
(i) issued by an AI incorporated in Hong Kong and that qualifies as a CET1 capital instrument, additional Tier 1 capital instrument or Tier 2 capital instrument pursuant to the Capital Rules;
(ii) issued by an institution incorporated outside Hong Kong that is eligible for inclusion in its capital base under any regulatory regime in the jurisdiction of its incorporation which is applicable to the institution and which prescribes requirements relating to the capital resources of financial institutions for the purpose of implementing locally in that jurisdiction the Basel Committee’s Capital Standards with or without modification;
(iii) issued by a holding company incorporated in Hong Kong of an AI incorporated in Hong Kong that would qualify as a CET1 capital instrument, additional Tier 1 capital instrument or Tier 2 capital instrument pursuant to the Capital Rules if the instrument were issued by the AI.
capital in nature. Section 81A(1)(a)(v) extends this to security over shares and capital instruments issued by group companies of the AI.
The policy intent is to extend the type of restricted security from shares (as presently in BO s80) to cover all capital-in-nature instruments which are subordinated and designed to absorb loss outside of liquidation.
Capital-in-nature instruments are most likely issued by regulated banking institutions.
Paragraph 5.5(i) and (ii) captures such institutions incorporated in HK (i.e. AIs) and outside HK respectively. In addition, paragraph (iii) seeks
8
to capture the capital-in-nature instrument issued by a local holding company (which may not be an AI) of a local AI.
This is considered necessary for regulatory purposes as a local holding company may be required by the MA to issue capital-in-nature instruments pursuant to provisions in the BO (e.g. a condition under s70) and we wish to ensure such capital to be genuine and not falling under the mischief that s80 is intended to guard against.
Division 2 Limit on advances against security of own shares etc.
6 Limit on advances against security of own shares, etc.
6.1 The Rules will provide that an AI shall not grant any advances, loans or credit facilities (including letters of credit), or give any financial guarantee or incur any liability, against the security of its own shares or capital-in-nature instruments.
Replication of BO section 80(1) with the restricted security extended from shares to capital-in-nature instruments
9
to reflect latest policy intent.
Limit on advances against security of shares, etc of holding companies, subsidiaries or fellow subsidiaries
6.2 The Rules will provide that an AI shall not, except with the approval in writing of the MA, which approval shall be subject to such conditions as the MA may think fit, grant any advances, loans or credit facilities (including letters of credit), or give any financial guarantee or incur any liability, against the security of the shares or capital-in-nature instruments issued by (a) any holding company of the institution;
(b) any subsidiary of the institution; or
(c) any other subsidiary of any holding company of the institution.
Replication of BO section 80(2) with the restricted security extended from shares to capital-in-nature instruments to reflect latest policy intent.
BO section 81A(3)(i) (as inserted by the BAO) empowers the MA to consent, subject to any conditions the MA thinks fit, to the incurring of specified exposures or the acquisition of specific interests generally or in a particular case or class of cases.
PART 6 - Limit on exposures to single counterparty or group of linked counterparties [Current BO s81]
Division 1 General
7 Application of Part 6 7.1 This Part will be expressed to apply to AIs incorporated in Hong Kong. BO section 81A(1)(a)(i) (as inserted by the BAO) provides
10
Interpretation of Part 6
7.2 The Rules will provide that for the purposes of this Part─
(a) the expression of “person” includes any partnership, any public body and any body of persons, corporate or unincorporated;
that the MA may make Rules prescribing limits on AIs’
exposures to a counterparty or a group of counterparties.
Cf BO s81.
7.2(a) replicates BO s81(8)(a).
We have determined not to adopt in the BELAR an equivalent provision to that currently in BO s81(8)(b) (i.e.
“the expression debt securities shall mean any securities other than shares, stocks or import and export trade bills”) and to let the term “debt securities”
take its ordinary meaning. We now consider that the original definition in s81(8)(b) is too wide and may capture unintended instruments.
11
(b) any reference to a provision taking effect as if a particular method, approach, section(s) or division(s) of the Capital Rules were applicable to an institution should include the case where that method, approach, section(s) or division(s) is actually applicable to the institution;
(c) For avoidance of doubt, derivative contract includes credit derivative contract.
7.2(b) – examples of such references can be found in paragraphs 19.3, 19.4 and 19.5 etc.
7.3 The Rules will provide that for the purposes of this Part, the following terms have the meaning given to them in section 2(1) of the Capital Rules:
affiliate
asset sale with recourse
bank
basic approach
bond
CCF
CCP
central counterparty
client
comprehensive approach
counterparty credit risk
country
12
credit conversion factor
credit default swap
credit derivative contract
credit event
credit linked note
credit protection
credit protection provider
credit risk
currency mismatch
default fund contribution
default risk exposure
derivative contract
direct credit substitute
financial sector entity
foreign public sector entity
forward forward deposits placed
group of companies
guarantee
haircut
incorporated
IRB approach
mark-to-market
note issuance and revolving underwriting facilities
13
notional amount
obligor
partly paid-up shares and securities
public sector entity
qualifying CCP
recognized netting
reference entity
reference obligation
risk-weighted amount
securities financing transaction
securitization issues
securitization transaction
sovereign foreign public sector entity
specific provisions
standard supervisory haircut
standardized (credit risk) approach
trade-related contingency
transaction-related contingency
underlying exposures
7.4 The following definitions will also be included for terms used in Part 6:
A group of linked counterparties has the meaning given in paragraph 10;
14
Asset-backed commercial paper programme has the meaning given by section 227(1) of the Capital Rules;
Call option means an option contract which gives the holder of the contract the option or right to purchase;
Category 1 AI means an AI designated by the MA as a Category 1 AI as described in paragraph 13.2;
Category 2 AI means an AI which is not a Category 1 AI;
Covered bond has the meaning given by rule 17 of the Banking (Liquidity) Rules (Cap. 155 sub. Leg. Q);
Counterparty credit risk exposure means an exposure to counterparty credit risk;
Exposure means any counterparty credit risk exposure as referred to under paragraph 13 and any non-counterparty credit risk exposures as referred to under paragraph 17;
Exempted sovereign entity means an entity falling within the categories identified in paragraph 16.1(d), (e), (f) or (g);
Forward asset purchase, in relation to an AI, means an off-balance sheet exposure to the credit risk of a loan, security or other asset (other than currency) that the institution has a contractually binding commitment to purchase from another party under a contract (excluding a put option contract written by the institution) on a specified future date;
FSB means the Financial Stability Board as defined in section 2(1) of
Covered bond: see BCBS LE standards paragraph 68.
The definition of forward asset purchase is based on the same definition in Capital Rules section 2(1) with modification to exclude written put. The policy intent is that under the LE framework, treatment of
15
the Financial Institutions (Resolution) Ordinance (Cap 628);
Internationally designated global systemically important bank (international G-SIB) – means, the holding company of a group of companies represented by a name that is included in the current list of global systemically important banks published by the FSB;
G-SIB-linked group means a group of linked counterparties pursuant to paragraph 10.1 where any of the persons specified under paragraph 10.1(a)-(g) is an international G-SIB or local G-SIB;
Initial margin has the meaning given by section 226V of the Capital Rules;
Investment structure means a structure which gives the investor an exposure to the assets underlying the structure, including without limitation, collective investment schemes and securitization
options in the banking book should follow the same treatment in the trading book.
See paragraph 17.6 below for the details. The calculation method follows the principle adopted in the BCBS LE standards that an exposure is
measured assuming
“jump-to-default” of the counterparty.
Current list of G-SIB published
by the FSB:
http://www.fsb.org/wp-content/
uploads/P211117-1.pdf
16
transactions, etc;
Liquidity support provider means a party which provides liquidity facilities within the meaning of section 227(1) of the Capital Rules with modification that the meaning is applicable to any entity instead of only in relation to an AI;
Loan-to-value ratio has the meaning given to it by section 65(10) of the Capital Rules;
Locally designated global systemically important bank (local G-SIB) – means an AI designated by the MA under section 3S of the Capital Rules;
Non-counterparty credit risk exposure means an exposure which is not an exposure to counterparty credit risk, as referred to under paragraph 17;
Non-segregated initial margin means initial margin which is not segregated initial margin;
Original maturity, in relation to an off-balance sheet exposure of an AI set out in Table A, means the period between the date on which the exposure is entered into by the institution and the earliest date on which the institution can, at its option, unconditionally cancel the exposure [cf the provision under item 9 of Table 10 under the Capital Rules section 71]
Put option means an option contract which gives the holder of the contract the option or right to sell;
17
Recognized collateral has the meaning given by section 51(1) of the Capital Rules;
Recognized credit derivative contract has the meaning given by section 51(1) of the Capital Rules;
Recognized credit risk mitigation means on-balance sheet netting referred to in paragraph 19.3, recognized collateral referred to in paragraph 19.4, recognized guarantee referred to in paragraph 19.5(a), recognized credit derivative contract referred to in paragraph 19.5(b) and a credit linked note referred to in paragraph 19.5(c);
Recognized guarantee has the meaning given by section 51(1) of the Capital Rules;
Segregated initial margin means initial margin which is segregated from the collecting party’s proprietary assets by either placing the collateral constituting the margin with a third party custodian or through other legally effective arrangements to protect the collateral from the default or insolvency of the collecting party;
The meaning of segregated initial margin is based on paragraph 3.4.4 of the HKMA’s Supervisory Policy Manual
module CR-G-14 on
non-centrally cleared OTC derivatives transactions – margin and other risk mitigation standards.
http://www.hkma.gov.hk/media /eng/doc/key-functions/banking -stability/supervisory-policy-m
18
Tranche means a contractually established segment (“relevant segment”) of the credit risk associated with a pool of underlying exposures in a securitization transaction or in a transaction of similar structure where─
(a) a position in the relevant segment entails a risk of credit loss greater than, or less than, that of a position of the same amount in each other contractually established segment; and
(b) no account is taken of credit protection provided by third parties directly to the holders of positions in the relevant segment or in other contractually established segments.
anual/CR-G-14.pdf
The definition of “tranche” is taken from section 227 of the Capital Rules with modification to accommodate transactions of a similar structure to securitization transactions.
Different tranches represent different credit risk to the holder, which increases from the senior tranche, mezzanine tranche to equity tranche.
Division 2 Limit on exposures 8 Limit on AIs’
exposures to single
and linked
counterparties
General
8.1 The Rules will provide that, subject as set out in paragraph 8.2 and 8.5, an AI must not incur aggregate exposures calculated as set out in paragraphs 13 and 14, to
(a) a single counterparty or
(b) a group of linked counterparties
which exceed an amount equivalent to 25% of the Tier 1 capital of the
8.1: CP paragraph 17,CP paragraph 18.
In relation to paragraphs 8.1 and 8.2, the policy intent is that a local G-SIB has to comply with both 8.1 (for exposures
19
institution.
Additional limitation for local G-SIB
8.2 The Rules will provide that, subject as set out in paragraph 8.3 and 8.4, an AI which is a local G-SIB must not incur aggregate exposures calculated as set out in paragraphs 13 and 14 to
(a) a single counterparty within a G-SIB-linked group, or (b) a G-SIB-linked group
which exceed an amount equivalent to 15% of the Tier 1 capital of the institution.
8.3 For an AI which has recently been designated as a local G-SIB, the Rules will provide that the exposure limit under paragraph 8.2 will start to apply on the first anniversary of the designation unless the MA notifies the AI of an earlier effective date which shall be not less than 6 months after designation.
8.4 In relation to a local G-SIB (A), if a group of linked counterparties has recently become a G-SIB-linked group because an entity in that group has
other than to a G-SIB-linked group) and 8.2 (for exposures to an entity within a G-SIB-linked group and to such a group as a whole).
8.2 to 8.4: CP paragraphs 19-21.
For a clarifying example about exposures between a local G-SIB and a G-SIB-linked group see Annex 3.
For 8.2(a) and (b), the policy intent is that the 15% limit should apply to A’s exposure to the entities in the G-SIB-linked group individually (per 8.2(a)) and collectively (per 8.2(b)).
20
recently become an international G-SIB as a result of the name representing that entity and its group of companies has recently been included in the current list of global systemically important banks published by the FSB, the Rules will provide that the exposure limits under paragraph 8.2 will start to apply to A’s exposure with respect to that group of linked counterparties on the first anniversary of the designation unless the MA notifies the AI in writing of an earlier effective date which shall be not less than 6 months after designation.
8.5 The Rules will provide that in relation to the limit referred to in paragraphs 8.1(b) and 8.2(b), if a group of linked counterparties includes a CCP, an AI may exclude clearing related exposures (as referred to under paragraph 17.8(d)(a) to the CCP from its aggregate exposures to that group of linked counterparties. To avoid doubt, such clearing related exposures to the CCP are still subject to the single counterparty limit under paragraph 8.1(a) or 8.2(a) (with the CCP being the single counterparty) if applicable.
8.5: CP paragraph 106, BCB LE standards paragraph 86; LE FAQ Q3.
9 MA’s power to vary single and linked counterparty limit
9.1 The Rules will provide that subject to the procedure set out in paragraphs 9.2, 9.3, 9.4 and 9.5, the MA may, by notice in writing served on an AI vary the limit referred to in paragraphs 8.1 and 8.2 above applicable to the institution if the MA is satisfied, on reasonable grounds, that it is prudent to make the variation, taking into account (a) the risks associated with the
BO section 81A(3)(j) (as inserted by the BAO) provides that the Rules may empower the MA to vary, in accordance with any procedure set out in
21
level or concentration of the AI’s single counterparty and linked counterparty exposures; (b) any risk mitigation measures taken by the AI to manage these risks; (c) the risks associated with any such risk mitigation measures and (d) any other factors as the MA may consider relevant.
9.2 If the MA proposes to serve such a notice on an AI, the Rules will require the MA to serve a draft of the notice on the institution.
9.3 A draft notice will – (a) specify –
(i) the proposed variation of the limit; and
(ii) the circumstances pertaining to, and the grounds for, the proposed variation; and
(b) include a statement that the institution may, within 14 days (or a longer period as the MA allows in any particular case) from the date of service of the draft notice, make written representations to the MA on any or all of the matters specified in the draft notice.
9.4 If the AI makes representations on the draft notice served on the AI, the Rules will provide that the MA may, after considering the representations–
(a) serve a notice on the institution in substantially the same terms as the draft notice;
Rules and in circumstances set out in the Rules, a limit applicable to an AI.
22
(b) serve a notice on the institution in terms modified to take account of any one or more of those representations that satisfies the MA that the modification concerned ought to be made; or
(c) elect not to serve a notice on the institution if satisfied by the representations that a notice should not be served.
9.5 If no representations are made by the AI, the Rules will provide that the MA may serve a notice on the institution in substantially the same terms as the draft notice.
9.6 The Rules will provide that a decision of the MA to vary any single counterparty or linked counterparty limit imposed under these Rules is a decision to which section 101B(1) of the BO applies.
9.7 To avoid doubt –
(a) the MA will be allowed to serve a draft notice on an AI in substitution for an earlier draft notice served on the institution; and (b) the reference to “substantially the same terms as the draft notice”
used in sub-paragraphs 9.4(a) or 9.5 above should not be construed to include the statement mentioned in sub-paragraph 9.3(b) above.
BO section 81A(4) (as inserted by the BAO) provides that the Rules may provide that a decision made by the MA under the Rules is a decision to which BO s101(B)(1) applies.
23
Division 3 Grouping linked counterparties 10 Determination of a
group of linked counterparties
10.1 The Rules will provide that subject as set out in paragraphs 11 and 12, in relation to a given counterparty, the persons below, being counterparties of the AI, will be regarded as a group of linked counterparties:
(a) that counterparty;
(b) any person which controls the given counterparty;
(c) any other person which is also controlled by the person in (b);
(d) any person which is controlled by the given counterparty;
(e) any person (Person A), which is not related to the given counterparty by the control relationship in (b) to (d) above, but is so interconnected with any person mentioned in (a) to (d) (Person B) that if Person B was to experience financial problems, in particular funding or repayment difficulties, Person A would also be likely to encounter funding or repayment difficulties;
(f) any other person which is controlled by Person A in (e);
(g) any other person which controls Person A in (e) and is so interconnected with Person A that if the Person A was to experience financial problems, in particular funding or repayment difficulties, that person would also be likely to encounter funding or repayment difficulties.
10.1: CP paragraph 22
See Annex 1 for further elaboration and examples of grouping of linked counterparties (CP paragraph 24; BCBS LE standards paragraphs 19-28).
(b) intends to capture
“controllers” (see 10.2 below).
(c) intends to capture “fellow subsidiaries”.
(d) intends to capture
“subsidiaries”.
(e) intends to capture persons related by economic interdependence.
(f) intends to capture subsidiaries of the persons in (e).
(g) intends to capture a
24
10.2 For the purpose of paragraph 10.1, one counterparty is regarded as having control over another counterparty if it─
(a) owns more than 50% of the voting rights in the other counterparty;
(b) has control of a majority of the voting rights in the other counterparty pursuant to an agreement with other shareholders;
(c) has the right to appoint or remove a majority of the members of the other counterparty’s board of directors (or a similar structure), or a majority of the members in the other counterparty’s board of directors (or a similar structure) have been appointed solely as a result of the first counterparty exercising its voting rights; or
(d) has the power, pursuant to a contract or otherwise, to exercise a controlling influence over the management or policies of the other counterparty (i.e. through consent rights over key decisions).
controller of the person (Person A) in (e) that is economically dependent on Person A.
Consistent with the practice in the EU (and with our previous approach in relation to the Liquidity Rules), we intend to set out technical details for the operation of 10.1(e) in a Code of Practice issued under section 97M of the BO (following amendment of section 97L(1) of the BO by section 18 BAO) [or in guidance to be issued pursuant to s7(3) of the BO].
Outline of contents for proposed guidance is set out in Annex 1 for information.
10.2: CP paragraph 23; BCBS LE standards paragraph 23.
25
11 Determination of a group of linked counterparties - sovereigns
11.1 The Rules will provide that when determining a group of linked counterparties, if two or more counterparties that are not themselves exempted sovereign entities are controlled by or are economically dependent on a counterparty that is an exempted sovereign entity, and are otherwise not linked, those counterparties are deemed not to be a group of linked counterparties.
11.1:CP paragraph 86; BCBS LE standards paragraph 61.
See Annex 1 for further elaboration.
12 Determination of a group of linked counterparties - The Financial Secretary Incorporated
12.1 The rules will provide that when determining a group of linked counterparties, if two or more counterparties are either controlled by or economically dependent on The Financial Secretary Incorporated established under the Financial Secretary Incorporation Ordinance (Cap 1015) and are otherwise not linked, those counterparties are deemed not to be a group of linked counterparties.
12.1: Replication of contents of BO s81(4A) as regards FSI.
Division 4 Calculation of aggregate exposures 13 Calculation of
aggregate exposures
13.1 The Rules will provide that an AI should follow the steps below to calculate its aggregate exposures to a given counterparty:
(A) Non-counterparty credit risk exposures
(i) Measure all non-counterparty credit risk exposures in the manner specified in paragraph 17 to the given counterparty;
(ii) Offset long and short positions to the same counterparty in the trading book as set out in paragraph 18. A net short position after
13.1(ii):CP paragraph 70, CP paragraph 79, CP paragraph 80.
26
offsetting, should be deemed to be zero. To avoid doubt, offsetting short positions in the trading book against long positions in the banking book is not allowed;
(iii) Offset an exposure to a counterparty (“A”) in the banking book by a short position arising from an option contract in relation to A also in the banking book;
(iv) (a) If the institution is a category 1 AI, in relation to an exposure in the banking book (other than an exposure specified under paragraph 16.1) covered by recognized credit risk mitigation, adjust the exposure to the amount of the exposure not covered by recognized credit risk mitigation (the CRM uncovered portion) as calculated in the manner set out in paragraph 19.1, save for such exposure as the MA may specify;
(b) If the institution is a Category 2 AI, in relation to an exposure in the banking book (other than an exposure specified under paragraph 16.1) covered by recognized credit risk mitigation referred to in paragraph 19.2, adjust the exposure to the CRM uncovered portion as calculated in the manner set out in paragraph 19.2, save for such exposure as the MA may specify;
13.1(iv): CP paragraphs 44 and 45.
13.1(iv) is part of the provisions seeking to compel the shifting of an exposure protected by credit risk mitigation to become an exposure to the credit protection provider.
Paragraph 13.1(iv) provides for the reduction of the original exposure to the CRM uncovered portion. This is supplemented by paragraph 15.4 which requires a new exposure to be recognised against the credit protection
27
provider in respect of the portion of the exposure covered by the recognized credit risk mitigation.
To illustrate the effect of the
“save for” provisions under 13.1(iv), assuming that the exposure specified by the MA is exposure arising from share margin financing (i.e. a loan secured by shares), then an AI should value its exposure to the borrower without taking into account the share collateral.
Accordingly it is not required to recognise an exposure to the issuer of the shares. (i.e. see paragraph 15.4, it is only required to recognise an exposure to the credit protection provider if the value of the original exposure is reduced.)
28
(v) Except for the off-balance sheet exposures covered under paragraph 17.2(c), deduct any specific provision made in respect of an exposure from the exposure;
(B) Counterparty credit risk exposures
(vi) Subject to the exemptions set out under paragraph 16, calculate the counterparty credit risk exposure of all the derivative contracts which the institution has entered into with the given counterparty.
The counterparty credit risk exposure is to be calculated as the
“default risk exposure” determined by the same method as the AI currently adopts under the Capital Rules for the purposes of calculating its capital adequacy, provided that the method is not an internal modelling approach. (N.B. There is, however, no need under the Rules to convert the exposure into a risk-weighted amount as occurs under the Capital Rules for the purposes of determining regulatory capital). If the AI adopts an internal modelling approach to calculate the default risk exposure of derivative contracts under the Capital Rules, the AI should use
13.1(v): CP paragraph 34.
The calculation method of off-balance sheet exposures under paragraph 17.2(c) already incorporates deduction of specific provision. The exception in 13.1(v) seeks to avoid double-counting.
13.1(vi)-(vii):CP paragraphs 38 and 41.
Capital Rules section 10A(1)(a) and (2) provides for the methods available to calculate counterparty default risk (as defined in section 2(1) of the Capital Rules) of derivative contracts (i.e. the current exposure method CEM, which is outlined in section 2(1) of the Capital Rules, as well as the
29
another approach available under the Capital Rules, as notified by the MA in writing after consultation with the AI, to calculate counterparty credit risk exposure of derivative contracts for the purposes of this Part;
(vii) Calculate the counterparty credit risk exposure of all the securities financing transactions which the institution has entered into with the given counterparty as the “default risk exposure” calculated by the same method it currently adopts under the Capital Rules for the purposes of calculating its capital adequacy (without conversion into the risk-weighted amount), provided that the method is not an internal modelling approach. If the AI adopts an internal modelling approach to calculate the default risk exposure of securities financing transactions under the Capital Rules, the AI should use another approach available under the Capital Rules, as notified by the MA in writing after consultation with the AI, to calculate counterparty credit risk exposure of derivative contracts for the purposes of this Part;
IMM(CCR)). Both methods estimate the future replacement cost (i.e. exposure at default) of a derivative contract or a group of derivative contracts at a future date when a default occurs. In brief, the exposure at default is estimated as the sum of (i) the current market value of the contract(s) and (ii) a potential future exposure component which reflects the potential changes in the market value of the contract(s) between the computation date (or, if applicable, the date of the last remargining before default) and the date the contract(s) can be terminated and replaced.
CEM is a simple method under which the potential future exposure component is calculated by using credit
30
conversion factors specified by the Basel Committee, while the internal model method (IMM(CCR)) is a more risk sensitive approach under which banks can use internal models (if already approved by relevant competent supervisory authorities) to calculate the potential future exposure component.
Capital Rules section 10A(1)(b) and (2) provides for the methods available to calculate counterparty default risk of SFTs (i.e. a method that does not involve the use of internal models by an AI and IMM(CCR)). Both methods estimate the default risk exposure of SFTs by regarding the money or securities delivered by a bank under the
31
(viii) (a) if the institution is a category 1 AI, in relation to a counterparty credit risk exposure in (vi) and (vii) above that is covered by recognized credit risk mitigation not yet considered in the calculation in (vi) and (vii) above, adjust the exposure to the CRM
SFTs to the counterparty concerned as an exposure to the counterparty secured by the money or securities received by the bank from the counterparty.
Under the "non-modelling"
method, potential changes in the market value of the securities delivered under the SFTs between the date of default and the date the securities can be liquidated are estimated by haircuts specified by the Basel Committee, while under the internal model method (IMM(CCR)) the bank can use internal models to estimate the changes.
13.1(viii):CP paragraphs 44-45.
32
uncovered portion as calculated in the manner set out in paragraph 19.1, save for such exposure as the MA may specify;
(b) if the institution is a Category 2 AI, in relation to a counterparty credit risk exposure in (vi) and (vii) above that is covered by recognized credit risk mitigation referred to in paragraph 19.2 not yet considered in the calculation in (vi) and (vii) above, adjust the exposure to the CRM uncovered portion as calculated in the manner set out in paragraph 19.2, save for such exposure as the MA may specify;
(ix) Deduct any specific provision made in respect of the derivative contracts or securities financing transactions covered by the calculation from the counterparty credit risk exposure calculated under (vi), (vii) and (viii) above.
(C) Calculation of aggregate exposures against a given counterparty
(x) Sum all the non-counterparty credit risk exposures and counterparty credit risk exposures against the given counterparty.
13.2 The Rules will provide that for the purpose of the calculation described in paragraph 13.1, the MA may by notice in writing to an AI, designate an institution as a Category 1 AI if any of the following is satisfied:
(a) the AI is internationally active;
13.1(ix):CP paragraph 34.
13.1(x):CP paragraphs 28 and 59.
For 13.2(c), an example of a condition is adequate internal control systems to report
“credit risk transfer” required
33
(b) the AI is significant to the general stability and effective working of the banking system in Hong Kong;
(c) the AI has applied to become a Category 1 AI, and the MA has accepted to designate the AI as a Category 1 AI, subject to any conditions as the MA may think fit.
on a Category 1 AI.
14 Calculation of aggregate exposures to a group of linked counterparties
14.1 The Rules will provide that an AI should calculate its aggregate exposures to a group of linked counterparties by summing the aggregate exposure to each counterparty within the group of linked counterparties calculated according to the process set out in paragraph 13.
Division 5 Calculation of exposures under certain circumstances
15 General 15.1 The Rules will provide for the following specific circumstances in connection with the calculation of exposure to a given counterparty or a group of linked counterparties under Part 6.
Investments linked by a common risk factor
15.2 The Rules will provide that if a person is
the fund manager of more than one collective investment scheme to which the AI has an exposure arising from the holding of units or shares of the scheme (except where the custodian of the assets in the scheme or basket is a separate legal entity),
the liquidity support provider to more than one asset-backed
15.2: CP paragraphs 18, 25 26, 27 and 43 and BCBS LE standards paragraphs 80 and 81.
34
commercial paper programme, to which the AI has an exposure arising from its holding of commercial papers issued under such programme,
the sponsor of more than one asset-backed commercial paper programme to which the AI has an exposure arising from its holding of commercial papers issued under such programme,
the credit protection provider (through credit default swaps or guarantee) of more than one synthetic securitization transaction in which the AI has invested,
a person playing any other role which represents a common risk factor for more than one collective investment scheme, securitization issue or similar structure in which the AI has invested,
the AI is deemed to have an exposure to this person equivalent to the aggregate current book value of its holdings in the collective investment schemes, securitization transactions and similar structures linked by the person as stated above. This exposure should be included in the AI’s non-counterparty credit risk exposures to the person in the calculation of aggregate exposures as set out in paragraph 13.1.
Protection seller of 15.3 The Rules will provide that if an AI has entered into a credit derivative 15.3: BCBS LE standards
35
credit derivative contract
contract as a protection seller, where the fair value of the contract is positive from the perspective of the institution (i.e. the present value of contracted but not yet paid periodical payment from the protection buyer exceeds the present value of the expected obligation of the protection seller under the contract), this positive value should be included in the AI’s counterparty credit risk exposures to the protection buyer in the calculation of aggregate exposures as set out in paragraph 13.1
footnote 19 to paragraph 48.
Exposure to credit protection providers
15.4 The rules will provide that if an AI has reduced the value of an exposure to the CRM uncovered portion of the exposure as set out in paragraph 19 or has offset an exposure in the trading book hedged by a credit derivative contract as set out in paragraph 18.4, the institution should include a new exposure to the credit protection provider as follows:
(a) where the credit protection is a recognized guarantee referred to in paragraph 19.5, the amount of reduction in the exposure covered by the guarantee should be included in the calculation of the AI’s aggregate exposure to the guarantor.
(b) where the credit protection is a recognized collateral referred to in paragraph 19.4, the amount of reduction in the exposure covered by the collateral should be included in the calculation of the AI’s aggregate exposure to the issuer of the collateral.
BCBS LE standards paragraph 43.
15.4(b): Recognised collateral can only be financial collateral.
For example a bond issued by a bank.
36
(c) Where the credit protection is a recognized credit derivative contract referred to in paragraph 19.5 or a credit derivative contract referred to under paragraph 18.4─
(a)
(i) other than a credit default swaps (which is covered in (ii) below), the amount of reduction in the exposure covered by the credit derivative contract should be included in the calculation of the AI’s aggregate exposure to the counterparty of the credit derivative contract;
(ii) which is a credit default swap and (1) both the protected exposure and the credit default swap are in the trading book and (2) either the counterparty or the reference entity of the credit default swap is not a financial sector entity, an amount equivalent to the default risk exposure to the counterparty calculated as set out in paragraph 13.1(vi) should be included in the calculation of the AI’s aggregate exposure to the counterparty of the credit default swap.
15.4(c)(ii): CP paragraph 78;
BCBS LE standards
paragraphs . 56 and 57.
Division 6 Exempted exposures
16 16.1 The Rules will provide that for the purposes of this Part, exposures do not include:
16.1(a):CP paragraph 33, BCBS LE standards paragraph 31, LE FAQ Q5.
37
(a) exposure amount to a counterparty that is deducted in determining the capital base of the AI in accordance with the Capital Rules;
(b) exposure to an affiliate of the AI if the conditions below are satisfied:
the AI and the affiliate are accounted for on a full basis in the consolidated financial statements of the holding company of the group of companies to which they belong, for the purposes of and in compliance with the Hong Kong Financial Reporting Standards issued by the Hong Kong Institute of Certified Public Accountants, the International Financial Reporting Standards issued by the International Accounting Standards Board or the standards of accounting practices applicable to the holding company in the place in which it is incorporated;
(c) exposure in the trading book which is not associated with the default risk of a counterparty, for example, exposure to commodities and currencies;
(d) exposure to the Government, including for the account of the Exchange Fund, through the holding of the Exchange Fund Notes and Bills;
(e) exposure to the central government of a country;
(f) exposure to the central bank of a country;
16.1(b): CP paragraph 110, BCBS LE standards paragraph 9 with local adaptation.
16.1(c): CP paragraph 60.
16.1(d): cf BO s81(6)(e).
Exchange Fund is defined in BO s2(1).
For 16.1(e) and (f) – BCBS LE standards paragraph 61. It should be noted that the Capital Rules will be revised
38
(g) exposure to a sovereign foreign public sector entity;
(h) exposure amount covered by recognized collateral or recognized guarantee issued by an entity listed under paragraph 16.1(d), (e), (f) or (g) above;
so that an AI’s concentration risk of exposures to a group of connected sovereign entities will be subject to a risk-weighted amount.
For 16.1(g), BCBS 61. The BCBS LE standards exempt a PSE that is treated like the sovereign of its place of incorporation under the capital framework, from the LE limit.
Currently no HK PSEs are treated like the Government under the Capital Rules.
Therefore (g) only covers sovereign foreign PSEs.
For 16.1(h), BCBS LE standards para. 61, also cf BO s81(6)(b)(i)(D). Under the BCBS LE standards, the exemption no longer refers to
39
(i) exposure amount covered by a letter of comfort with the consent of the MA, and subject to such conditions as the MA may impose, either generally or in any particular case or class of cases;
(j) any share capital or debt securities held as security for facilities granted by the institution, except for the collateral referred to under paragraph 15.4(b);
Tier 1 country.
For 16.1(i), cf BO s81(6)(b)(ii) Section 81A(3)(i) of the BO (as inserted by the BAO) provides for the Rules to empower the MA to consent, subject to any conditions the MA thinks fit to impose, to the incurring of specified exposures in a particular case or class of cases such that the exposures need not be taken into account in calculating whether an AI has reached an applicable limit under the Rules.
For 16.1(j), cf BO s81(6)(h) with necessary modification.
40
(k) any share capital or debt securities acquired by the institution in the course of the satisfaction of debts due to it, provided that all share capital and debt securities so acquired shall be disposed of at the earliest suitable opportunity, and in any event not later than 18 months after acquisition, or within such further period as the MA may consent to and subject to such conditions the MA may think proper to attach to such consent, in any particular case;
(l) any share capital or debt securities acquired under an underwriting or subunderwriting contract provided that such share capital or debt securities are not held for a period exceeding 7 working days, or such further period as the MA may consent to and subject to such conditions as he may think proper to attach to such consent, in any particular case.
For 16.1(k), cf BO s81(6)(h) and BO s81(7).
“Consent” better aligned with the enabling power in BO s81A(3)(i) but may need to revert to “approve” if
“consent” cause issue in the transitional provisions under Part 10.
For 16.1(l), cf BO s81(6)(i)(ii).
The policy intent is not to include an equivalent provision to BO s81(6)(j) in the Rules.
Under the new framework commitments are subject to a credit conversion factor (see Table A in paragraph 17.1 below) which should make exemption of underwriting commitment unnecessary.
41
(m) Any indemnity given by the institution to a person to protect that person against any damages which may be incurred by the person as a result of the person registering a transfer of shares where – (i) the instrument by means of which the transfer has been
effected, or purports to have been effected, has been provided, or purports to have been provided , by a subsidiary of the institution;
(ii) the authenticating signature on the instrument has been imprinted on it by a machine used by the subsidiary to imprint that signature on such instruments; and
(iii) that signature was unlawfully so imprinted on that instrument, or any financial guarantee given by the institution to that person in respect of any like indemnity given by that subsidiary to that person;
(n) exposures to the Housing Authority, within the meaning of the Housing Ordinance (Cap 283), arising from guarantees the Housing Authority gives for the purposes of the Home Ownership Scheme or Private Sector Participation Scheme;
(o) exposures to any of the following companies arising from the obligations placed upon the company for the purposes of the Mortgage Insurance Programme set up by The Hong Kong Mortgage Corporation Limited –
For 16.1(m), cf BO s81(6)(k).
For 16.1(n), cf BO s81(6)(kb).
For 16.1(o), cf BO s81(6)(kc).
Subparagraph (ii) is added in response to the recent restructuring of HKMC to
42
(i) The Hong Kong Mortgage Corporation Limited, or
(ii) any subsidiary of The Hong Kong Mortgage Corporation Limited;
(p) exposures to any of the following companies arising from the obligations placed upon the company for the purposes of the Guaranteed Mortgage-Backed Pass-Through Securitisation Programme set up by The Hong Kong Mortgage Corporation Limited –
(i) The Hong Kong Mortgage Corporation Limited, or
(ii) any company that issues mortgage-backed securities in connection with the Programme;
(q) exposure amount which it has been written off in the books of the institution;
(r) exposure to an AI or a bank if it is settled within the same calendar day of the location where it has been incurred;
(s) exposure of an AI, where the AI acts as a receiving bank in the context of an initial public offer, and the exposure is incurred to another AI for the purposes of placing the subscription monies received by the receiving bank to the interbank market; [If a definition of initial public offering (IPO) is required, it is an act of
transfer its Mortgage Insurance Programme to a subsidiary subject to the guarantee of HKMC.
For 16.1(p), cf BO s81(6)(m).
For 16.1(q), cf BO s81(6)(l).
Specific provisions made in respect of exposures are now taken care of by paragraph 13.1(v) (exposure calculation).
16.1(r): CP89-90, BCBS LE standards paragraphs 65-67;
LE FAQ Q1.
16.1(s) is a local specific exemption. The local IPO process involves the transfer of subscription monies to receiving banks. The
43
offering the stock of a company on a public stock exchange for the first time. If a definition of receiving bank is required—in relation to an IPO, it is a bank appointed by the issuer to receive subscription monies and provide services such as returning monies to unsuccessful subscribers.]
(t) exposure to qualifying CCPs related to clearing activities as referred to under paragraph 17.8(d)(a);
(u) any exposure: (i) specified in a consent given by the MA (which consent may be given to the AI, or a class of AIs, or generally to all AIs) where the MA considers that it is reasonable to allow such exposure not to be taken into account in calculating whether the AI has reached the limit referred to in paragraph 8.1 and 8.2, having regard to (a) the nature and risks associated with the exposure; (b) any risk mitigation measures taken by the AI to manage these risks;
(c) the risks associated with any such risk mitigation measures; and (d) any other factors as the MA may consider relevant; and (ii)
exemption seeks to avoid the large exposure limit restricting the normal process for a receiving bank to recycle the subscription monies back to the interbank market and in light of the removal of the general interbank exemption under the current BO section 81(6)(a) and (g).
16.1(t): LE FAQ Q2.
16.1(u) is similar to rule 13(2) and (3) under Part 3 of the rules.
Section 81A(3)(j) of the BO (as inserted by the BAO) empowers the MA to consent to the incurring of specified exposures, generally or in a
44
subject to such conditions as the MA thinks fit to impose on any such consent.
particular case or class of cases, such that such exposures need not be taken into account in calculating if limits under the Rules exceeded.
Division 7 Scope and valuation of exposures
17 General 17.1 The rules will provide that if an AI’s exposure must be valued in accordance with this Division at fair value, rule 4 applies in determining the fair value.
Cf rule 14(3).
Non-counterparty
credit risk
exposures in the banking book
17.2 The Rules will provide that an AI’s non-counterparty credit risk exposures in the banking book include the following:
(a) any exposure arising from on-balance sheet items which are neither derivative contracts (except for credit-linked notes) nor specified in other parts of this paragraph 17, measured at the current book value;
(b) holdings of shares in a company, measured at the current book value and the amount for the time being remaining unpaid on the shares which is not counted under the current book value of the shares;
17.2(a): CP35.
17.2(a): Credit linked note is a credit derivative contract by definition. However, the policy intent is that an AI holding a credit linked note (an on-balance sheet item) should recognise an exposure to the issuer of the credit linked note like holding any bond.
45
(c) off-balance sheet exposures measured at the principal amount [defined in paragraph 17.3 below] of the exposures, net of specific provisions, multiplied by the credit conversion factors specified in the table below:
Table A
Off-balance sheet exposures Credit Conversion Factor
(i) Direct credit substitutes 100%
(ii) Transaction-related contingencies 50%
(iii) Trade-related contingencies 20%
(iv) Asset sales with recourse 100%
(v) Forward asset purchases 100%
(vi) Partly paid-up shares and securities 100%
(vii) Forward forward deposits placed 100%
(viii) Note issuance and revolving underwriting facilities
50%
17.2(c): CP paragraph 36.
CCFs are designed to convert an off-balance sheet
“contingency” into a credit equivalent amount by applying a factor representing an assessment of the likelihood of the off-balance sheet item coming onto the balance sheet.
Table A is generally copied from Table 10 under the Capital Rules section 71(1), but made subject to a floor CCF of 10%
as required under the LE
framework (BCBS LE
standards paragraph 35).
46
(ix) Off-balance sheet exposures that do not fall within any of items (i) to (viii) above and arise from commitments-
(a) Subject to paragraph (d), which have an original maturity of not more than one year;
(b) Subject to paragraph (d), which have an original maturity of more than one year;
(c) Which may be cancelled at any time unconditionally by the AI or which provide for automatic cancellation due to a deterioration in the credit worthiness of the person to whom the institution has made the commitments;
(d) The drawdown of which will give rise to an off-balance sheet exposure falling within any of item (i) to (viii); or
100% or the factors below
(a) 20%
(b) 50%
(c) 10%
(d) The lower of the CCF applicable to the exposure based on the original
(ix) The formulation “100% or the factors below” seeks to accommodate preference of some banks to measure undrawn credit facility at the nominal value (even though this may be “less favourable” to the banks as it results in a higher credit equivalent amount and hence higher exposure value than if a lower percentage is used).
47
maturity of the commitment or the CCF
applicable to the off-balance sheet exposure arising from the drawdown of the commitment concerned (x) Any off-balance sheet exposure
other than default risk exposures in respect of derivative contracts or securities financing transactions that do not fall within any of items (i) to (ix).
100% Paragraph 17.2(x) is meant to be a catch-all provision.
Capital Rules s73(a) provides that items not specified in Table 10 (of the Capital Rules) are subject to a 100% CCF.
17.3 For the purposes of paragraph 17.2(c), principal amount, in relation to an exposure listed in Table A, means –
(i) in the case of an exposure which is an undrawn facility or the undrawn portion of a partially drawn facility, the amount of the undrawn commitment;
Cf: reference to meaning of principal amount under
Capital Rules section 51(1).
48
(ii) in other cases, the contracted amount of the exposure.
Certain
non-counterparty
credit risk
exposures in either the banking book or trading Book
17.4 The Rules will provide that an AI’s non-counterparty credit risk exposures set out in sub-paragraph 17.5, 17.6, 17.7, 17.10 and 17.11 are to be measured by the methods as set out under those paragraphs, irrespective of whether the exposures are in the banking book or trading book.
Securities financing transactions – exposure to underlying assets
17.5 The Rules will provide that an exposure in respect of the securities underlying a securities financing transaction should be valued in accordance with the following provisions.
(a) If the securities financing transaction is a repo-style transaction that falls within paragraph (a) or (b) of the definition of repo-style transaction in section 2(1) of the Capital Rules, an AI shall treat the securities sold or lent under the transaction remaining as its holding and value the exposure pursuant to paragraph 17.2(a) and (b) if the securities are held in the banking book; or paragraph 17.15 if the securities are held in the trading book.
(b) If the securities financing transaction is a repo-style transaction that falls within paragraph (d) of the definition of repo-style transaction in section 2(1) of the Capital Rules the institution shall treat any securities which it provides as collateral under the transaction as remaining as its holding and value the exposure
17.5:CP paragraph 38.
Cf Capital Rules section 75(2).
Cf Capital Rules section 75(4).
