AN EFFECTIVE RESOLUTION REGIME FOR FINANCIAL INSTITUTIONS IN HONG KONG
Consultation Response and
Certain Further Issues
Financial Services and the Treasury Bureau Hong Kong Monetary Authority Securities and Futures Commission
Insurance Authority
9 October 2015
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Introduction
1. The Financial Services and the Treasury Bureau (“FSTB”) of the Government of the Hong Kong Special Administrative Region (“HKSARG”), in conjunction with the Hong Kong Monetary Authority (“HKMA”), the Securities and Futures Commission (“SFC”) and the Insurance Authority (“IA”) (together “the authorities”), issued a second consultation paper (“CP2”) on their proposals for establishing an effective cross sectoral resolution regime for financial institutions in Hong Kong on 21 January 2015.1 This followed the publication of an earlier stage consultation paper (“CP1”) on the same subject in January 2014.2
2. This paper concludes the consultations mentioned above and summarises the key comments received following the issuance of CP2, the authorities’
responses to those comments and the authorities’ proposals for taking forward this initiative. It also discusses certain further issues, which were referenced in CP2 as remaining under development internationally.
Consultation Feedback
3. The three-month consultation period for CP2 ended on 20 April 2015. A total of 28 submissions were received from a variety of sources including industry associations, professional bodies and financial institutions. The names of the respondents to CP2 (“respondents”) (other than those who requested anonymity) are listed in Annex 1.
4. The vast majority of respondents continued to indicate broad support for the resolution regime proposals, noting in particular the importance of timely implementation for Hong Kong as a major international financial hub, with some respondents strongly encouraging the authorities to prioritise implementation of the reforms. A number of respondents provided constructive comments for further developing the proposals and others sought clarification on certain operational details. The major comments received and the authorities’ responses are discussed below
1 http://www.fstb.gov.hk/fsb/ppr/consult/doc/resolutionregime_e.pdf
2 http://www.fstb.gov.hk/fsb/ppr/consult/resolution_e.pdf
together with the authorities’ latest policy stance on a number of items.
Annex 2 sets out the major comments received and the authorities’
responses in more detailed tabular form for ease of reference.
5. No specific questions are asked in this paper. However, if any interested party wishes to raise further substantive points regarding the contents of this paper, they may do so via the relevant regulatory authorities. Any further comments should however be provided swiftly as the intention remains to submit a Bill to the Legislative Council (“LegCo”) by the end of year.
CP2 - Major Comments and Authorities’ Responses
Scope of the Resolution Regime
6. As articulated in CP2, the scope of the resolution regime will be tailored to reflect the risks which the authorities currently perceive could be posed to the continuity of critical financial services and wider financial stability locally by the failure of certain types of financial institution (“FI”). The scope in respect of authorized institutions (“AIs”), licensed corporations (“LCs”), insurers and financial market infrastructures (“FMIs”) remains as proposed in CP2. Respondents indicated broad support for the proposal to bring systemically important recognized exchange companies (“RECs”) (i.e. companies that operate systemically important stock markets or future markets) within the scope of the regime. In CP2 it was proposed that the SFC should be responsible for this process. However, on further reflection, the authorities consider it preferable for the Financial Secretary (“FS”) to be empowered to designate systemically important RECs as being within the scope of the regime, on the recommendation of the SFC.
7. In addition, with a view to accommodating any future changes in the potential risks posed by different types of FI, CP2 also consulted on whether the FS should have a designation power with which to subsequently bring FIs (not initially covered by the regime), within its scope if, in future, it should become apparent that systemic disruption could result were they ever to become non-viable. 3 Respondents
3 See paragraph 34 of CP2.
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generally agreed with this proposal, with some indicating that the power should be based on clear, transparent and consistent principles or guidelines and a few suggesting that the power should be subject to public consultation before being exercised.
8. The proposal in CP2 did not explicitly discuss whether the proposed designation power should be limited to regulated FIs or whether it could (or should) be extended to unregulated FIs. Having carefully considered respondents’ comments, and with a view to ensuring that the regime remains fit for purpose in addressing the risks posed by any FIs that could be systemically significant or critical on failure, the authorities intend to provide for the designation power to extend to both regulated and unregulated FIs.
9. It is of course clearly desirable that an unregulated FI should first be brought within the regulatory perimeter before being made subject to the resolution regime. However, it is not inconceivable that future financial innovation could swiftly result in the creation of new entities or structures that rapidly interpose themselves into the financial system, gaining a significant foothold, before the case for regulation becomes apparent or before the necessary regulatory regime and apparatus can be established and made operational. In the aftermath of the recent global financial crisis, there has been an increased focus on “shadow banking” and the identification of significant shadow banking activities and entities. The financial services sector is also evolving rapidly in terms of infrastructure, systems and products, and so going forward, it will likely continue to be the case that more resources will be devoted to monitoring the boundaries of regulation. This should work to reduce the prospect of having to designate an unregulated class of FIs as falling within the scope of the resolution regime. However, to avoid the possibility of being caught without any of the tools necessary to address a systemic institution, regulated or unregulated, particularly at a time when its condition is deteriorating rapidly, the authorities consider it prudent to provide for the FS’s power of designation to extend to bringing unregulated FIs within the scope of the resolution regime.
Lead resolution authority (“LRA”)
10. Respondents all agreed that an LRA should be designated for each
cross-sector financial group (i.e. a group containing within-scope FIs under the purview of different resolution authorities) in circumstances where the interconnection between the within-scope FIs within the group structure renders a “group” resolution more appropriate. Respondents also agreed with the proposal that the FS should designate the LRA by reference to the relative systemic importance of the within-scope FIs within the group once the legislation establishing the regime comes into effect (i.e. that designation should be made “in advance” and not at the time of any actual resolution). A few respondents sought further clarity on how the authorities would undertake an assessment of relative systemic significance in a manner that would ensure objectivity and consistency when applied to FIs operating in different sectors of the financial system.
The authorities note these comments and intend to develop an assessment methodology drawing upon elements of the processes established internationally to assess the systemic importance of banks, insurers and other entities.
11. The vast majority of respondents agreed that the role of the LRA should be one of coordination and, if and when required, ultimate decision maker.
Some respondents noted that the regime would need to contain sufficient detail on how the LRA and the other resolution authorities would interact with each other, including during resolution planning for a cross-sector financial group.
12. Having further considered the need to ensure that the LRA can act swiftly and flexibly under all circumstances in order to effect timely resolution, the authorities have concluded that the LRA’s “ultimate decision making”
power should include both an ability to direct another resolution authority to take (or not to take) a specified action, and where necessary, to take an action itself (in both cases in accordance with the powers provided in the legislation establishing the resolution regime) in respect of a within-scope FI which would not usually be under its purview. The authorities expect, however, that it would be relatively rare for an LRA to act “unilaterally”
in taking action in place of another resolution authority. Effective resolution planning should inform in advance the likely courses of action to be taken by each resolution authority, with the aim of facilitating swift coordinated action to resolve a cross-sector financial group. It is envisaged that the practical aspects of coordination, including how resolution authorities: conduct group resolvability assessments; develop
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group-specific resolution strategies and plans; and communicate with FIs as regards such plans; will be set out in a Memorandum of Understanding (“MoU”) between the resolution authorities specifically focussed on their resolution functions.
Bail-in
13. Overall there remained general support from respondents for the five proposed stabilization options,4 discussed in both CP1 and CP2. A number of respondents considered that the approach to bail-in to be adopted in Hong Kong should be consistent with current international developments relating to cross-border resolution and might emulate the
“Bank of England’s Approach to Resolution”5 including the use of certificates of entitlement. Respondents also made a number of constructive comments on various issues (including valuation) with respect to the bail-in mechanism. The authorities will take note of these in developing processes and procedures for the practical execution of bail-in. The authorities expect to issue guidance or a Code of Practice setting out their approach to carrying out bail-in once the legislation establishing the resolution regime comes into effect.
Liabilities excluded from bail-in
14. The authorities intend that the legislation establishing the local resolution regime will identify those liabilities permanently excluded from the application of bail-in, based on the grounds set out in paragraph 107 of CP2. Since CP2, the authorities have considered and identified some additional liabilities which they now intend to exclude from any bail-in, including:
15. Deposits: Having reflected further on the potential systemic consequences of bailing-in depositors, the authorities are now minded to exclude all deposits from the scope of bail-in. Hence it is intended that the exclusion extend to all deposits falling within the definition of “protected deposit” under the Deposit Protection Scheme Ordinance (Cap. 581)
4 Namely: (i) transfer to a commercial purchaser; (ii) transfer to a bridge institution; (iii) transfer to an asset management vehicle; (iv) bail-in and; (v) temporary public ownership.
5 http://www.bankofengland.co.uk/financialstability/Documents/resolution/apr231014.pdf
(irrespective of amount) and to deposits held by restricted licence banks or deposit-taking companies which, had they been taken by a Scheme member, would have fallen within the definition of “protected deposit”.
16. Liabilities to former or current employees of FI in respect of wages:
Rather than excluding liabilities to former or current employees of an FI in respect of “fixed salary and pension benefits” as proposed in CP2, the authorities are now minded to exclude liabilities to former or current employees of the FI that fall within the definition of “wages” under the Employment Ordinance (Cap. 57) as well certain “benefit” provided for in that Ordinance. This reflects the intention that the regime should protect the basic constituents of pay which employees rely on for their livelihood.
The “benefits” proposed to be excluded from bail-in are holiday pay, annual leave pay, sickness allowance, maternity leave pay, paternity leave pay, severance payment, long service payment, payment in lieu of notice, end of year payment and terminal payment.
17. A full list of liabilities which the authorities propose to exclude from bail-in is at Annex 3.
Bridge institution
18. Respondents were generally receptive to the bridge institution stabilization option outlined in CP1 and CP2. CP1 and CP2 proposed powers for the resolution authority to transfer all or selected assets, rights and liabilities from a non-viable FI to a bridge institution. However, observing developing practices in other jurisdictions6 and assessing the desirability of taking such an approach locally, the authorities now also intend to provide for the possibility of transferring shares of a non-viable FI to a bridge institution. It remains the case that the authorities continue to think that the most likely use of a bridge institution would be as a vehicle to ensure continuity for particular critical financial services (e.g.
deposit-taking), necessitating a partial transfer of assets, rights and liabilities whilst leaving non-critical parts of the business in the residual FI. However, extending the scope of the bridge institution stabilization
6 Article 40(1)(a) of the EU’s Bank Recovery and Resolution Directive (“BRRD”) requires that member states provide resolution authorities with the power to transfer to a bridge institution shares or other instruments of ownership issued by one or more institutions under resolution.
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option in the manner described above, offers a resolution authority the additional flexibility to secure the onward sale of the entire FI in the short- to medium-term, perhaps once a third party purchaser(s) has been afforded sufficient opportunity to conduct due diligence, whilst maintaining the provision of critical financial services in the interim.
19. As explained in CP2, a key purpose of using a bridge institution is to allow a resolution authority to swiftly stabilise and, importantly, continue part or all of an FI’s business to ensure uninterrupted provision of critical financial services in circumstances where the resolution authority assesses that there is a realistic prospect of concluding a purchase on suitable terms relatively soon but which cannot be arranged immediately. The resolution authority would accordingly be seeking to dispose of the business of the bridge institution and wind it up without delay once it had served its purpose. To this end, and to impose discipline on the resolution authority in this regard, it is intended that the legislation establishing the resolution regime will require a resolution authority to wind up a bridge institution within two years following the last transfer made to the bridge institution. Where a sale is pending or extension is otherwise necessary to meet the resolution objectives, the legislation will provide for the possibility to extend this two year period, after consultation with the FS.
20. It was envisaged in CP2 that a bridge institution would be a company limited by shares and incorporated under the Companies Ordinance (Cap.
622) with the Government as the initial shareholder. The authorities intend to proceed on this basis.
21. The manner in which a bridge institution is capitalised will depend to some extent upon the resolution strategy deployed in any given case. If a bridge institution is used in conjunction with a bail-in, then all or part of the capitalisation might be achieved through debt write-off or the conversion of the FI’s debt instruments into equity in the bridge institution.
Given that the philosophy underlying resolution is to minimise the use of public funds, approaches involving capitalisation by write-off or conversion of the FI’s debt would obviously be preferred. However, where necessary to achieve a swift and orderly resolution, some public funds might be deployed temporarily to capitalise a bridge institution.
This would be on the basis that such funds would be recouped from sales of shares in, or assets from, the bridge institution or, failing which, from
the resolution funding arrangements (see section under Resolution funding arrangements).
Temporary stays on early termination rights
22. Respondents generally agreed with the resolution authority having the power to temporarily stay counterparties’ early termination rights in respect of financial contracts. Respondents were also generally satisfied with the proposed conditions for, timing and duration of temporary stays described in CP2, emphasising the need to broadly follow the approach being adopted in key overseas jurisdictions. Furthermore, a considerable number of respondents were of the view that broader provision should be made such that the resolution authority may also apply a temporary stay to non-financial contracts where such contracts contain early termination rights and are critical to the operational continuity of the FI in resolution.
23. The authorities concur that, although financial contracts will likely be the most sensitive to the exercise of early termination rights, there are other contracts of particular importance to the ongoing business of an FI (for instance in some cases leases of branch premises) which may well contain default provisions that could be triggered by matters related to resolution. The authorities have consequently determined that, in order to avoid precipitating any disorderly termination of contracts that could undermine resolution action, the scope of the temporary stay should be extended to all contracts whose early termination could hinder the ability of the resolution authority to achieve the resolution objectives.
Accordingly, both financial and non-financial contracts will be within the scope of the temporary stay (and will be equally subject to the relevant safeguards).
24. It is expected that FIs, in the course of resolution planning, will identify the contracts that are critical to their business and that therefore must be continued in resolution and will further identify the extent to which they contain early termination rights that could pose a threat to continuity on resolution.
Power of the resolution authority in relation to the filing of a winding-up petition 25. If resolution can be pre-empted and avoided by a single creditor
petitioning for the winding-up of a within-scope FI, this could frustrate
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the underlying objective of maintaining financial stability. Therefore, CP2 proposed that a resolution authority be afforded a period of 14 days to consider whether to initiate resolution before any winding-up petition could be filed with the Court. While respondents in general did not raise any major objection to this concept, some expressed concern that 14 days might be unduly long. Having considered respondents’ comments, the authorities propose to shorten the period from 14 to 7 days.
26. In the context of bail-in, whilst an FI remains “in resolution” in the sense that the resolution authority is continuing to take steps to achieve the effective application of the bail-in stabilization option (including primarily valuation for the purpose of determining final bail-in terms), there remains a need to prevent any competing winding-up action being taken and the authorities intend to provide for this in the legislation establishing the local resolution regime. However, where the application of a stabilization option results in the critical financial services being transferred out of a residual FI, it is envisaged that any such residual FI may enter winding-up proceedings.
Supporting the transferred business
27. There may still however be links between a residual FI and any business transferred by application of a stabilization option. In such cases, the authorities intend to empower the resolution authority to direct the residual FI to continue to provide any support services (such as information technology, human resources and compliance functions): (i) which are essential to the continuity of any critical financial services that have been transferred out of the residual FI, but (ii) which, for some reason, have not been transferred alongside them. Where such a direction is issued by the resolution authority, it must provide for the residual FI to receive consideration on reasonable commercial terms for the provision of such support services.
28. In the circumstances described in paragraph 27, there would be no intention to prevent the residual FI from entering into winding up proceedings (should the shareholders and/or creditors move to do so).
However, if the winding up of the residual FI does commence, it is intended that this should not immediately affect the resolution authority’s ability to direct the residual FI to continue the provision of services essential to the continuity of critical financial services which have been
transferred. Winding-up proceedings could commence and continue in respect of any other parts of the residual FI’s assets. When, however, the liquidator eventually needs to deal with the assets deployed in providing the support services, in order to complete the liquidation of the residual FI, the intention is that the liquidator should give the resolution authority six months’ notice to make other arrangements for the provision of such services. It is also intended that a liquidator of a residual FI should be obliged to support the resolution authority if it should be necessary, following the application of a stabilization option, to undertake any supplemental or reverse transfer of assets, rights or liabilities out of, or into, the residual entity in order to ensure the effectiveness of resolution.
29. This approach reflects respondents’ preference in their submissions to CP2 that continuity of support services from the residual FI should be provided for by means of direction to a person controlling the FI (in this case the board of the FI or any liquidator of the FI) rather than by the establishment of a new service company for the purpose.
Remuneration claw-back
30. As described in CP2, the authorities intend to provide in the legislation establishing the local resolution regime, for applications by a resolution authority for claw-back of remuneration to be determined by the court.
It is intended that such applications may be made at any time by the resolution authority once the resolution of an FI has been initiated.
Respondents’ views on whether claw-back should apply to both fixed and variable, or only to variable, remuneration, as well as on how far back in time the claw-back power should reach, were mixed. In order to avoid creating incentives to skew compensation packages towards fixed remuneration (and thereby reduce FIs’ flexibility in reducing remuneration levels in periods of poor performance), the authorities intend to apply claw-back to both fixed and variable remuneration. CP2 discussed approaches observed overseas to setting time limits on the period preceding initiation of resolution in relation to which remuneration may be subject to claw-back. On balance the authorities are inclined to limit claw-back to the period of three years preceding the initiation of resolution but extendable by the court for up to three further years back in cases of dishonesty.
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Safeguards
31. Respondents to CP1 agreed that the regime should provide for a “no creditor worse off than in liquidation” (“NCWOL”) safeguard and sought further detail on aspects of the mechanism, which were subsequently included in CP2 for further consultation. A core element underpinning NCWOL is valuation. CP2 proposed that a NCWOL valuer would undertake a hypothetical valuation of how pre-resolution shareholders and pre-resolution creditors of an FI would have fared in a winding-up and contrast this with an assessment of the actual treatment those pre-resolution shareholders and creditors have received as a result of resolution. This determines whether they may be worse off on resolution than in liquidation and, in turn, whether any NCWOL compensation may consequently be due.
32. Counterparties whose contracts are transferred on resolution to a new entity to be continued to be performed on the same terms and conditions arguably benefit from the resolution action, as their contracts continue with a new financially sound entity without any disruption. Similarly, counterparties of a within-scope FI which is subject to bail-in, but whose liabilities are not included within the scope of the bail-in provision, would also benefit from maintaining their relationship with a financially stronger entity. In these circumstances, the authorities intend to create a rebuttable presumption that counterparties in this position are no worse off in resolution and hence should not be entitled to receive NCWOL compensation.
33. The majority of respondents supported the proposal in CP2 that the resolution authority should be the entity tasked with appointing a NCWOL valuer. On further reflection, however, bearing in mind the importance of ensuring that the valuation process is (and is manifestly seen to be) independent and taking note that the resolution authority may be a party to any appeals against the NCWOL valuer’s assessments, the authorities have come to the view that the resolution authority is not best placed to appoint the NCWOL valuer. The authorities now intend, instead, to provide for the FS to appoint a person (“appointing person”) who, in turn, would appoint a NCWOL valuer based on the independence and expertise criteria set out in Box F in CP2. Any terms and conditions for the appointment of the NCWOL valuer by the appointing person would be approved by the FS. The authorities believe that this
arrangement will reinforce the independence of the appointment process which should, in turn, strengthen the overall credibility of the NCWOL mechanism.
34. As noted in CP2, the authorities will set out in the legislation establishing the resolution regime some high level valuation principles, to which the NCWOL valuer must adhere in discharging his functions. These relate to: (i) adherence to the creditor hierarchy in the hypothetical liquation valuation; (ii) disregard of any public financial support; and (iii) disregard of the effect of any stabilization option. The authorities intend to include a provision in the legislation to enable the Secretary for Financial Services and the Treasury (“SFST”) to make rules prescribing the process for the conduct of, and specifying any further assumptions (such as the valuation reference date for the hypothetical liquidation valuation) to be made by the NCWOL valuer in undertaking, the NCWOL valuation.
Appeal against NCWOL valuation
35. Respondents expressed support for the establishment of a Resolution Compensation Tribunal (“RCT”) specifically to hear appeals on NCWOL valuation, as well as for the proposed approach for establishing the RCT as set out in CP2. Accordingly, the legislation establishing the resolution regime will provide for the setting up of the RCT and for the Chief Justice to set rules in relation to the RCT’s operation. It is also intended that the RCT would, on application by any pre-resolution shareholder or pre-resolution creditor or the resolution authority, have the power to revoke the appointment of the NCWOL valuer on the grounds set out in CP2 (paragraph 174).
Resolution authority’s decisions in requiring FIs to adopt appropriate measures to remove barriers to orderly resolution and appeal mechanism
36. As explained in CP2, the resolution authority’s power to issue a direction requiring a within-scope FI to make changes (for example, in relation to structure and operations) for the purpose of improving its resolvability (“ex ante resolvability measures”) will assist in promoting financial stability. Respondents indicated broad support for this, noting however that such power should be subject to checks and balances. To this end, the authorities intend to set out in the legislation establishing the resolution regime certain considerations to which a resolution authority
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must have regard before issuing a direction relating to an ex ante resolvability measure, including those as set out in paragraph 132 of CP2 (e.g. how difficult it would be to carry out an orderly resolution of the FI if the contemplated measures were not taken, the likely impact of complying with direction, including on future viability and capacity of the FI to continue to provide critical financial services).
37. The authorities have also considered further the necessary reach of the ex ante resolvability measures in order to ensure orderly resolution is achievable for FIs. Observing practices overseas,7 and noting that in some cases orderly resolution of a within-scope FI may only be feasibly achieved by initiating resolution at the holding company level due to the way in which a group is structured or operates, the authorities intend to extend the scope of powers to require ex ante resolvability measures to be taken by holding companies of within-scope FIs. This should also allow more flexibility in the way in which identified impediments may be removed.
38. Given the potentially intrusive nature of such powers, the authorities recognise the need to provide an avenue of appeal in relation to the exercise of ex ante resolvability measures (to supplement the iterative process between the resolution authority and the FI/holding company during the course of which formal representations against proposed ex ante resolvability measures may be made to the resolution authority).
After further deliberation, the authorities are inclined to the view that appeals relating to ex ante resolvability measures should be heard by a separate Resolvability Review Tribunal (“RRT”) to be established specifically for the purpose. Accordingly, provision will be made for this in the legislation establishing the regime. The skill-sets and experience expected to be required of members of the RRT may differ in substance from those required in assessing valuation and compensation.
Hence it is considered preferable not to seek to use the RCT for this
7 Under Article 17 of the EU’s BRRD, certain measures to address or remove impediments to resolvability are applicable to the holding company and parent holding company of an FI, including requiring changes to legal or operational structures of any group entity, and requiring the issue of eligible liabilities (or otherwise take other steps) to meet the minimum requirement for own funds and eligible liabilities under the BRRD.
purpose. The authorities have also considered making use of the existing
“sectoral” tribunals established (or to be established) under the relevant regulatory Ordinance for each sector (e.g. the Banking Review Tribunal for AIs, the Securities and Futures Appeal Tribunal for LCs; and the Insurance Appeals Tribunal (after the Independent Insurance Authority has been established) for authorized insurers). However, this would require extending the jurisdiction of these tribunals; there may also be some mismatch in terms of the experience and skill-sets required and difficulties may be encountered in connection with resolvability assessments by an LRA of a cross-sector group and identifying the correspondingly appropriate tribunal of appeal in such circumstances.
Protecting certain types of financial arrangements in resolution
39. CP2 continued the discussion from CP1 on measures to protect the economic effect of certain financial arrangements on the application of stabilization options. These “protected arrangements”, as identified in Annex IV of CP2, are: secured arrangements; set-off and netting arrangements; title-transfer arrangements; structured finance arrangements;
and clearing and settlement systems arrangements. Under these arrangements, significant numbers of market participants rely on the interaction of the arrangements’ constituent parts to limit their exposures to loss and so there is merit, from the perspective of preserving broader financial stability, in endeavouring to limit the effects of resolution powers which could separate, modify or terminate the constituent parts of such arrangements or avoid and override the effect of set-off or netting.
40. Separation of the constituent parts of one of these types of arrangement is most likely to occur with a partial property transfer (where only part but not all of a failed FI’s assets, rights and liabilities are transferred). CP2 however also noted that certain arrangements may need specific protection in bail-in as any bail-in of a gross liability under one leg, or one part, of an arrangement might likewise have the effect of undermining the economic purpose of the arrangement. Respondents to CP2 did not make any specific suggestions on safeguards in respect of bail-in, but a number suggested that a similar approach to that proposed for protecting financial arrangements on a partial property transfer might suffice.
41. In the case of bail-in, the authorities consider that it may be appropriate to impose restrictions on the resolution authority such that it should seek
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only to bail-in the “net” amount under any secured, set-off, netting or title-transfer arrangement. Furthermore, in the case of any inadvertent bail-in of a gross amount in breach of this safeguard, there is merit in the resolution authority having the ability to take remedial action to reinstate, restore or otherwise address the position of a person adversely affected, by using the resolution authority’s power under the regime to effect an issuance or transfer of securities or a transfer of assets (i.e. cash), for example.
42. As indicated in CP2, and having considered the matter further, the authorities intend to provide in the legislation establishing the local resolution regime for a rule-making power enabling the SFST to prescribe requirements in relation to a resolution authority’s treatment of protected arrangements when applying stabilization options. The technical details of how arrangements are to be protected, exclusions from the scope of protection and remedies for inadvertent breaches under bail-in and partial transfer will be set out in these rules.
Resolution funding arrangements
43. While the proposed resolution regime provides a means by which to ensure that the cost of failure (and of resolution) are borne by the shareholders and creditors of a failed FI, there may be some cases where the costs of resolution exceed the costs which can actually be imposed on shareholders and creditors through the resolution process. CP2 consulted on providing resolution funding arrangements for the regime such that recovery of the “excess” costs of resolution may be made on an ex post basis, once it is clear how much needs to be recouped, from the wider financial system.
44. Respondents generally agreed that it would be appropriate to set overarching principles for an ex post funding mechanism to guide the setting of the levies to recover the costs incurred. With regard to the costs which can be met through the resolution funding arrangements, there was support from some respondents for a non-exhaustive list of such costs, but more support for an exhaustive list. The authorities are however inclined to the view that any list would of necessity have to be non-exhaustive as the types of cost involved would likely vary in practice, depending upon the way in which a given FI is ultimately resolved. However, the
authorities would emphasise the intention that resolution funding may only be used for, or in connection with, the application of a stabilization option(s) for carrying into effect the provisions under the regime. This would include preparatory work leading directly to the application of a stabilization option(s) (but not, for example, resolution planning and resolvability assessment conducted in “business as usual” circumstances), as well as the costs that follow as a result of the application of the stabilization option(s) (e.g. payment of any NCWOL compensation assessed to be payable and the costs relating to the appointment of a NCWOL valuer and the conduct of the NCWOL valuation). However, before deploying any such funds, the resolution authority would be obliged to have regard to the available resources at the failed FI before doing so.
45. A variety of suggestions were received regarding the scope of the ex post levy (i.e. which FIs should be required to contribute) and, in particular, some respondents felt that it was not appropriate for all sectors to contribute to resolution funding arrangements. Respondents generally expressed support for a proportionate, risk-based assessment of contributions, with assessed contributions taking into account the size of, and risks posed by, an FI’s local operations. One respondent noted that the EU has still not decided on how to allocate FMI losses and thought any decisions on FMI loss allocation at this stage would be premature.
Other respondents thought resolution costs may be more properly allocated on a case-by-case basis, having assessed the range of market participants that would have been affected by the failure of the particular FI in resolution.
46. Having considered respondents’ views, the authorities confirm their intention to provide in the legislation establishing the local resolution regime for a mechanism for an ex post recovery of the relevant costs incurred in the resolution of an FI (as described in paragraph 44), after having taken into account any “proceeds of resolution” that may contribute to the resolution funding arrangement.8 It is considered highly unlikely that any “proceeds of resolution” would be sufficient to cover all
8 Such proceeds of resolution may include, for example, any proceeds from the sale or disposal of securities in, or assets, rights and liabilities of, a bridge institution, temporary public ownership company or asset management vehicle.
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costs of resolution in excess of those which can be imposed on shareholders and creditors of the failed FI, and hence an ex post levy would still be necessary in most cases. However, to cover the very unlikely event if there should be a “surplus” of funds in the resolution funding arrangement once a resolution has been completed, the authorities are minded to provide in the legislation for the FS to make rules with respect to entitlements to, and distribution of, any surplus.
47. In terms of the apportionment of a levy to the financial sector, the authorities intend it be imposed on those FIs which are both within the scope of the resolution regime and within the same sector as the failed FI.
For cross-sector groups, a mechanism will be established on a case-by-case basis to apportion contributions across the relevant sectors by reference to the composition of the failed cross-sector group. In the case of FMIs (and by extrapolation any recognized exchange companies designated as within-scope) it would not seem logical to confine a levy only to other within-scope FMIs or within-scope exchanges (i.e.
within-scope entities operating in the same sector) as a wide variety of FIs, across all sectors, arguably benefit from the orderly resolution of an FMI (or an exchange) and the resulting continuity of its critical financial services. Accordingly, for FMIs (and exchanges), the authorities are inclined to favour a “user pays” levy model.9
48. In view of the possible variations in the apportionment of costs among different types of FIs, the authorities are of the view that the mechanism for raising the levy should be able to take into account the particular circumstances of each resolution and apportion cost in a proportionate manner in each case, whilst respecting the overarching approach outlined in paragraph 46 above. The authorities intend to achieve this by providing legislating for the rate of levy to be prescribed by resolution of LegCo for a given resolution case. The detailed mechanism for the calculation and apportionment of the levy underpinning the LegCo resolution for prescribing the rate of levy will be set out in rules made, after public consultation, by the FS and subject to vetting by LegCo.
Cross-border resolution and information sharing
9 A “user” of an FMI or exchange refers to a participant of the FMI or the exchange or a client of such a participant.
49. Most respondents agreed with the setting of specific “cross-border conditions” as outlined in CP2 before the local regime may be used to recognise or support foreign resolution measures. Respondents generally emphasised the importance of collaboration and information sharing between home and host resolution authorities. Whilst most respondents agreed that support and recognition of foreign-led resolution action should not be automatic, some stated that any discretionary powers which the resolution authority in Hong Kong may have not to recognise or support a cross-border resolution should be limited only to those circumstances identified in the Financial Stability Board (“FSB”)’s consultation paper on cross-border recognition of resolution actions (“FSB cross-border CP”).10 50. The authorities remain of the view that, in principle, a coordinated and
cooperative approach to the resolution of a cross-border FI has the potential to better protect financial stability across both home and host jurisdictions. A resolution authority could therefore be expected to recognise and act in support of a cross-border resolution action if it will deliver a satisfactory outcome for stability in Hong Kong and will not disadvantage local creditors relative to foreign creditors. As Hong Kong plays host to a significant number of FIs operating as subsidiaries or branches of foreign firms, it is important that the local resolution regime balances the need to promote financial stability and fair treatment locally with measures to recognise resolution actions being taken by a foreign resolution authority to resolve an overseas incorporated FI. Accordingly, the authorities propose to make provision for a statutory recognition framework enabling a resolution authority, after consultation with the FS, to recognise all or part of a foreign resolution action, to the extent that it would produce substantially the same legal effect in Hong Kong. A resolution authority may recognise a foreign resolution action irrespective of whether the “trigger conditions” for initiation of resolution locally are met11, and such recognition may have effect with respect not only to within-scope FIs but all FIs.12
10 See FSB (2014), http://www.financialstabilityboard.org/wp-content/uploads/c_140929.pdf
11 These “trigger conditions” are that, the FI is non-viable and poses systemic risk locally and no private sector solution is at hand. See paragraph 59 of CP2.
12 It is envisaged that recognition may also be given in respect of assets, liabilities or contracts of a foreign FI in resolution which are located or booked in, or subject to the law of, Hong Kong even if
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51. However, other conditions must be met before a resolution authority can recognise a foreign resolution action; specifically recognition must not be granted if the resolution authority is of the opinion that recognition would:
(i) have an adverse effect on financial stability in Hong Kong; (ii) not deliver outcomes that are consistent with the resolution objectives; or (iii) disadvantage Hong Kong creditors or shareholders (or both) relative to their counterparts overseas. Moreover, a resolution authority could only recognise a foreign resolution action if it is of the opinion that an arrangement is in place such that any Hong Kong shareholders or creditors would be eligible to claim compensation broadly consistent with what they would be eligible to claim if the resolution action had been originated locally. A resolution authority may also take into account any fiscal implications for Hong Kong in deciding whether to recognise a foreign resolution action.
52. The FSB cross-border CP also explains that “recognition and support measures complement each other and in some cases both may be required to achieve the desired outcome”, and provides examples in its Annex on how different resolution scenarios may call for the use of either (or both) recognition and support measures. In addition to a framework for recognising foreign resolution actions described in paragraph 50 above, a resolution authority may also be able to use the stabilization options in the local regime in respect of within-scope FIs to support foreign resolution actions, provided that the “trigger conditions” for resolution are also met in such cases.
53. The merits of establishing contractual approaches to the cross-border recognition of resolution actions, particularly in respect of the recognition of stays on early termination rights and the exercise of bail-in powers, are also discussed in the FSB cross-border CP. Such approaches could be used as an interim recognition measure while statutory frameworks are being developed, but they might also support the efficacy of the statutory frameworks once the latter are in place. The authorities accept that the use of contractual provisions can support the application of stabilization options by underpinning powers to impose stays and to effect bail-in, particularly in a cross-border context. Accordingly, the authorities
the FI has no physical presence in Hong Kong. See Scenario 2 of the Annex to the FSB cross-border CP.
intend to provide, in the legislation establishing the local resolution regime, for: (i) amendments to the Banking (Capital) Rules (Cap. 155L) so that the terms and conditions of Additional Tier 1 and Tier 2 capital instruments issued by AIs must contain provisions by which the holder of any such instrument explicitly recognises the potential for such instruments to be written off or converted by the resolution authority; (ii) the resolution authority to be able to make rules requiring the terms and conditions of other liabilities, which are not specifically excluded from bail-in, to contain provisions by which the holder explicitly recognises that the liability may be subject to “bail-in” and; (iii) the resolution authority to be able to make rules requiring the terms and conditions of certain financial and other contracts (considered of importance in maintaining continuity of critical services) to contain provisions by which each counterparty agrees to be bound by a temporary stay on early termination imposed by the resolution authority to the contract.
54. Information sharing was discussed in CP2 (building upon the earlier discussion in CP1) although no specific questions were raised. The authorities intend the legislation establishing the local resolution regime to provide for a broad confidentiality requirement to attach to the undertaking of resolution-related functions but with specified gateways to allow the resolution authority to disclose information. Gateways would allow provision of information, amongst others, to: (i) other resolution authorities (and authorities that carry out functions in relation to resolution), including those overseas, where disclosure will assist the recipient to perform its functions and the recipient is itself subject to adequate confidentiality restrictions; (ii) NCWOL valuers for the purpose of enabling them to undertake the necessary valuation exercises required under the regime; and (iii) the RCT and the RRT. The information sharing powers as regards other resolution authorities will apply continuously (i.e. not just when an FI becomes non-viable or when it is apparent that the FI is in difficulty and approaching the point of non-viability) and will hence support advance resolution planning.
55. In line with the information gathering provisions which are generally common in regulatory ordinances, it is intended that the legislation establishing the local resolution regime will provide powers for a resolution authority to require the provision of information, records and documents which the resolution authority needs in order to perform its
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functions. These powers will be supported by powers of inspection and investigation, including the application for a magistrate’s warrant to enter premises specified in the warrant to search for, seize and remove such records or documents.
56. As discussed in CP2, the proposed resolution regime will empower the resolution authority to devise resolution strategies, develop resolution plans and perform resolvability assessments. In parallel with the legislative process, further consideration will be given to approaches to resolution planning. A proportionate approach will be adopted and requirements may vary across sectors. 13 As previously noted, the authorities’ intention is to issue a Code of Practice to provide guidance on the manner in which resolution functions will be performed. The authorities’ approach to resolution planning may be included within the Code or separate standalone guidance may be issued on various aspects of the resolution planning process as appropriate.
Discussion of Further Issues
Deferral of authorization criteria
57. Where a transfer of a regulated business from a non-viable FI to a bridge institution takes place, the bridge institution will in the normal course need to be authorized or licensed to conduct that business. In these circumstances, the authorities are inclined to provide flexibility for the bridge institution by deferring the application of certain authorization criteria required for the conduct of regulated businesses under the Banking Ordinance (Cap. 155), Securities and Futures Ordinance (Cap.
13 For example, the HKMA has already begun to roll out its recovery planning requirements for local AIs and has clearly set out in its guidance the expectation that an AI’s recovery plan should be proportionate to the nature, scale and complexity of its operations. The HKMA has also indicated its intention to issue a corresponding Supervisory Policy Manual (“SPM”) module on Resolution Planning in due course. For the full SPM module on Recovery Planning (RE-1) see:
http://www.hkma.gov.hk/media/eng/doc/key-functions/banking-stability/supervisory-policy-manual/
RE-1.pdf
571) or the Insurance Companies Ordinance (Cap. 41) for a relatively short period of time (not more than 12 months). The intention would be:
(i) to facilitate speed of transfer to a bridge institution whilst ensuring continuity in the provision of critical financial services; and (ii) to reduce the extent to which public funds might need to be immediately deployed upon the initiation of resolution in order to meet capital, liquidity or other financial resources ratios in circumstances where the Government stands behind the bridge institution, pending an anticipated swift, onward sale of the shares in, or assets from, the bridge institution to a purchaser. The authorities are cognisant of the need to avoid competitive distortion in the market and, weighing this against the public interest in securing swift and orderly resolution, on balance consider a temporary deferral from compliance with all of the relevant authorization criteria to be justifiable in the case of a bridge institution. On a case-by-case basis the decision of whether to provide such a temporary deferral will be made by the relevant licensing authority upon an application by a relevant bridge institution.
58. In the case of a transfer of the shares in a within-scope FI to a bridge institution, the authorities consider that it is relatively less likely for the need for such a deferral. The FI would continue to conduct the regulated business and the FI should retain its existing authorization. Similar considerations apply in the case of a temporary public ownership (“TPO”) company where the shares in the within-scope FI would be transferred to a TPO company owned by the Government.
59. In the case of a transfer to a commercial purchaser of all or part of the failing FI’s regulated business, the authorities consider it important that any acquirer must be capable (financially and operationally) of absorbing and running the business transferred. Hence the authorities are not minded to provide for a deferral of authorization criteria in such cases.
60. The authorities have also considered whether an asset management vehicle (“AMV”) might need to be authorized to conduct a regulated business and, if so, whether there is justification for allowing it to operate for any period before complying with authorization criteria. Generally, it seems unlikely, at least in the case of AIs, insurers and FMIs, that any business requiring ongoing compliance with authorization criteria would in fact be transferred to an AMV. However, an AMV set up to hold the assets and/or outstanding positions of a failed FI might conceivably be
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conducting SFC regulated activities and would in these circumstances be required to be licensed by the SFC. In such a case, the authorities consider that the licensing authority should also be able to defer the application of authorization criteria to an AMV on a temporary basis in the same way as proposed for a bridge institution.
Total loss-absorbing capacity (“TLAC”)
61. As noted in CP2, work continues at the international level on the development of requirements for global systemically important banks (“G-SIBs”) to maintain in issue a sufficient minimum level of loss-absorbing instruments in order to facilitate resolution and, in particular, render bail-in a feasible and credible resolution option.
62. Nearly sixty public submissions were made to the FSB by a variety of stakeholders in response to its consultation on a draft TLAC Term Sheet for G-SIBs at the turn of the year.
63. Most respondents expressed overall support for the objective of TLAC, with some viewing a TLAC requirement as an important step in promoting confidence in orderly resolution and ending the too-big-to-fail phenomenon observed during the global financial crisis.
64. A variety of views were expressed by respondents on: (i) the calibration of TLAC requirements in the light of both historical loss experience and post-crisis reforms; (ii) the need for additional institution-specific requirements above a common minimum TLAC requirement; (iii) the
“neutrality” of TLAC between single-point-of-entry (“SPE”) and multiple-point-of-entry (“MPE”) resolution strategies; 14 (iv) the prepositioning of internal TLAC at material subsidiaries within a group in terms of its location, calibration, and composition; (v) the criteria for instruments to qualify as TLAC; (vi) the duration of any exemption from TLAC requirements for G-SIBs headquartered in Emerging Market Economies; (vii) the public disclosure of TLAC to advance investor confidence and market discipline; and (viii) any restrictions to be imposed on the holdings of TLAC by other banks.
65. The FSB is now revising the TLAC Term Sheet in light of the comments
14 SPE and MPE strategies were discussed in Box I of CP1.
received and the results of a range of impact studies. The final version of the TLAC Term Sheet is expected to be finalised ahead of the G20 Summit in November 2015. Thereafter a “conformance” period (informed by the results of the impact studies) will be allowed for G-SIBs to comply with the TLAC standard.
66. Reflecting the FSB’s international mandate, the TLAC standard is applicable to banks which are systemic cross-border (i.e. G-SIBs).
Although there are currently no G-SIBs headquartered in Hong Kong, many G-SIBs have a significant presence here15 and the authorities consider it important that the local resolution regime should provide a means for the imposition of loss-absorbing capacity requirements on locally incorporated entities of G-SIB groups in line with the groups’
resolution strategies and the TLAC Term Sheet. Furthermore, the concept underlying TLAC (namely that feasible resolution, particularly bail-in, of a systemically important financial institution depends upon the institution having sufficient loss-absorbing capacity) could apply to entities other than G-SIBs, for which the preferred resolution strategy emanating from the resolution planning process involves bail-in. Generally speaking, this might be expected to be the case for the larger, more complex, FIs where it becomes increasingly unlikely that a resolution authority could either separate or dispose of individual business lines swiftly or find a purchaser capable of acquiring the entire institution. It is also the case that in future the FSB may seek to tailor other loss-absorbing capacity requirements for globally systemic entities from other sectors and the authorities see merit in providing in advance for this by inclusion of a rule-making power into the framework of the local resolution legislation.
Implementation might then subsequently be effected through the issuance of rules, which would be subsidiary legislation, once international standards are issued.
67. Accordingly, to: (i) provide a means to operationalise the TLAC Term Sheet once finalised; (ii) accommodate resolution strategies involving bail-in for other (non-G-SIB) banks; and (iii) facilitate the imposition of loss-absorbing capacity requirements for FIs in other sectors; the authorities propose to include in the legislation establishing the local
15 29 of the 30 G-SIBs (from the list designated by the FSB in November 2014) have a presence in Hong Kong.
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resolution regime provisions allowing a resolution authority to make rules prescribing loss-absorbing capacity requirements applicable to classes of within-scope FIs (or their holding companies or subsidiaries). Such rules, which as noted above would be subsidiary legislation, could give effect to global standards on loss-absorbing capacity promulgated by the FSB subject to such modifications as the local resolution authority thinks fit, having regard to local circumstances. This approach could be used to extend the provisions of the TLAC Term Sheet to other classes of AI (in addition to G-SIBs) if the resolution authority considers it appropriate to make a modification to this effect in Hong Kong.
68. To the extent any instruments included within the required loss absorption pool (or indeed any debt instruments within the scope of the bail-in power) are governed by a law other than that of Hong Kong, there is a risk that the exercise of the bail-in power under Hong Kong’s resolution regime may not be recognised in foreign jurisdictions. To address this, as noted in paragraph 53 above, it is intended that a resolution authority should be able to require any such instruments to include within their terms and conditions “contractual recognition clauses” by which the holder of the instrument explicitly recognises and agrees to be bound by the terms of a bail-in under the Hong Kong resolution regime.
Write-off and conversion of capital instruments issued by AIs
69. Currently, the regulatory capital framework in Hong Kong (which reflects the international Basel III standard) requires banks to maintain regulatory capital in a form that is considered loss-absorbing. To achieve this, provision is made in the Banking (Capital) Rules (Cap. 155L) for Additional Tier 1 capital instruments and Tier 2 capital instruments to be issued on terms that they can be converted into common equity or written off should the issuing AI reach the point of non-viability (“PONV”).
70. There could be instances where these contractual provisions for write-off or conversion of Additional Tier 1 capital instruments or Tier 2 capital instruments have not been triggered under the provisions of the Banking (Capital) Rules (Cap. 155L) before the resolution authority decides that an AI fulfils the conditions for resolution under the resolution regime. In these circumstances, the FSB’s Key Attributes of Effective Resolution
Regimes for Financial Institutions (“Key Attributes”)16 (3.5(iii)) provide that the resolution authority should have power to:
“upon entry into resolution, convert or write-down any contingent convertible or contractual bail-in instruments whose terms had not been triggered prior to entry into resolution”….. and treat any instruments resulting from the conversion alongside other existing equity or debt instruments in the bail-in of the firm.
71. The sequence of events envisaged by the Key Attributes means that the write-off or conversion of Additional Tier 1 capital instruments or Tier 2 capital instruments should occur before the application of any stabilization option. Accordingly, the authorities intend to provide in the legislation establishing the local resolution regime for the HKMA, as the resolution authority for AIs, to either convert into equity or write-off Additional Tier 1 capital instruments or Tier 2 capital instruments in accordance with their terms once the HKMA has decided that the conditions for resolving an AI are met and before a stabilization option is applied to the AI.
72. As non-viability is the principal element of the first condition proposed for initiating resolution and PONV is the contractual trigger for the capital instruments as prescribed by the Banking (Capital) Rules (Cap. 155L) and, as in each case, the HKMA is the authority charged with assessing whether the condition or trigger is met, the position of the holders of the relevant capital instruments should not be materially affected by the proposed power referred to in paragraph 71.
Preparatory powers
73. The authorities consider that the orderly resolution of a within-scope FI will require substantial advance planning both in a “business as usual”
environment and, with increasing intensity, in any period leading up to resolution. To permit a resolution authority to undertake necessary planning activities pre-resolution, the authorities propose to include a range of “preparatory” powers in the legislation establishing the resolution regime which will be exercisable before (and, in certain circumstances, continue to be exercisable after) the commencement of resolution.
16 See FSB (2014), Key Attributes of Effective Resolution Regimes for Financial Institutions (re-issued), http://www.financialstabilityboard.org/wp-content/uploads/r_141015.pdf
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74. The first such power relates to the gathering of information needed (i) for
“business as usual” resolution planning and assessment of resolvability as well as (ii) for the evaluation of the financial condition of the FI and the determination of the potential systemic impact of its failure in contemplation of any resolution (see paragraph 55 above).
75. In any lead-up to a potential resolution, the resolution authority may need to take steps to ascertain whether putative resolution strategies or plans can be put into operation. This might, for instance, extend to ascertaining any expression of interest from a prospective commercial purchaser. In this connection, the authorities note that during the preparatory phase for a potential resolution, certain parties both within and outside the FI may become privy to sensitive information relating to the impending resolution which, if disclosed, could jeopardise its success. To protect confidentiality, in these circumstances the authorities propose that the resolution authority should have the power to require specified persons (including FIs, their affiliates and relevant classes of professionals providing advice or other services to an FI or the resolution authority) not to disclose certain information (whether to the public or third parties) without the prior consent in writing of the resolution authority.
76. It is also not inconceivable that in the run-up to a potential resolution, officers of a failing FI might seek (not necessarily with any malign intention) to take actions that may impede the ability of the resolution authority to effectively exercise a stabilization option. To address this, the authorities intend to provide the resolution authority with a power of direction. Where the resolution authority is satisfied that the FI has ceased, or is likely to cease, to be viable, and that resolution will avoid or mitigate the systemic risks otherwise posed by the non-viability of the FI (regardless of whether there is reasonable prospect of private sector action that might avert the need for resolution) the resolution authority should have the power to issue such directions to the FI or its directors, or senior management in relation to its affairs, business and property as the resolution authority deems fit. Both positive (to do something) and negative (to refrain from doing something) directions could be issued for the purpose of securing orderly resolution and thereby furthering the resolution objectives. The power to issue directions would supplement the powers of the resolution authority to seek to improve resolvability by requiring barriers to resolution to be removed (see paragraph 36).
77. Respondents to CP2 were generally not in favour of an automatic removal of all directors or senior management of a failing FI entering into a resolution and many expressed the view that case-by-case consideration was more appropriate. On further reflection, the authorities are inclined to agree with the respondents and now propose to empower the resolution authority to remove directors and senior management of an FI, as well as those of a holding company of an FI, on a case-by-case basis both: (i) in the period immediately preceding potential resolution (i.e., where the resolution authority is satisfied that the FI has ceased, or is likely to cease, to be viable, and that resolution will avoid or mitigate the risks otherwise posed by the non-viability of the FI to the stability of the financial system of Hong Kong); and (ii) at the time of application of any of the stabilization options. Such a power might be exercised for instance in situations where a director or a member of senior management is no longer needed in order to conduct the ongoing business of the FI because of the effect of the stabilization option on that business.
Initiation of Resolution
78. Prior to initiating resolution, it is intended that the resolution authority should issue a “letter of mindedness” to the FI concerned, informing it that the authority is minded to initiate resolution, and should thereafter allow the FI to make representations to the resolution authority. The resolution authority will seek to allow the FI a reasonable period of time to make such representations but this must of course be interpreted in the context of the particular circumstances of the FI and the urgency with which the resolution authority may need to take resolution action. In practice it is expected that the senior management or directors will be closely engaged in the course of resolution planning (or seeking private sector options) well before the formal issuance of a letter of mindedness.
Client assets in resolution
79. CP2 consulted on whether it is necessary to introduce an additional resolution objective in respect of the protection of client assets. Whilst respondents’ views were mixed, more respondents expressed support for an additional objective than those who did not. The authorities, on further reflection and for the sake of clarity, propose to include such a specific objective in the legislation establishing the local resolution
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regime. This is in line with the approach adopted in the EU BRRD (Article 31) and the UK Banking Act (section 4(8)) as well as the Key Attributes (Preamble and Section 2 in Appendix II Annex 3).
80. CP2 proposed that client assets held by or on behalf of a within-scope FI that are protected under applicable domestic laws and regulation should be excluded from bail-in. The authorities propose to adopt the definition of “client assets” under the Securities and Futures Ordinance (Cap. 571) (“SFO”) and expand the definition to cover assets held by a within-scope FI or its affiliated operational entity and holding company in the course of conducting the business of acting as a trustee or custodian.17 The intention of this extended definition is to protect the existing common law position that trust/custody assets are protected from the insolvency of trustees/custodians and so should continue to be protected despite the introduction of the resolution regime.
Tax treatment on exercise of certain resolution powers
81. Some respondents to CP1 raised the need to consider the treatment of stamp duty and profits tax in connection with the exercise of stabilization options. The authorities have considered this matter and intend to consider requests for such tax exemptions on a case-by-case basis, where justified.
Next Steps
82. The authorities are proceeding to prepare a Bill for introduction into LegCo by the end of the year. The authorities intend to continue their dialogue with various stakeholders throughout the legislative process and thereafter as rules, Codes of Practice and guidance are developed and issued.
17 It should however be noted that, for the sake of clarity, where liabilities of, or securities issued by, a within-scope FI form part of client assets, then these liabilities or securities may nevertheless be bailed-in.
Financial Services and the Treasury Bureau Hong Kong Monetary Authority
Securities and Futures Commission Insurance Authority
9 October 2015
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