Hong Kong Consults on New Resolution Regime

Introduction

On 7 January 2013, the Hong Kong Monetary Authority (HKMA) issued a press release announcing the publication of its first stage public consultation, drafted in conjunction with the Securities and Futures Commission (SFC) and the Insurance Authority (IA), on establishing an effective resolution regime for financial institutions, including financial market infrastructures, in Hong Kong. 

The authorities believe that the existing statutory framework in Hong Kong does not meet the standards set by the FSB in its “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes).  Accordingly, they intend to establish a common framework for the resolution of Financial Institutions (FIs) in Hong Kong (similar to the approach adopted in the UK and the US) by establishing a single resolution regime, albeit one that accommodates certain sector-specific requirements.  Under this regime, each sectoral regulator would act as the resolution authority for FIs under their respective purviews, with measures to ensure an appropriate degree of cooperation.

The consultation paper contains no real surprises.  Rather, it is a sensible and well-written document which leans heavily on best practice from other jurisdictions and the requirements of the Key Attributes.  The first stage of the consultation process closes on 6 April 2014.  Thereafter, a second stage will be conducted later this year which will provide more specific details regarding the resolution regime.  Subject to the outcome of that second consultation, the Hong Kong Government will seek to introduce legislative proposals in 2015.  A summary of the first stage is provided below.

Scope of the Regime

It is proposed that the resolution regime in Hong Kong should cover:

• All authorized institutions (AIs), including all Licenced Banks, restricted Licence Banks (RLBs) and deposit-taking companies (DTCs);
• Financial market infrastructures (FMIs) designated under the Clearing and Settlement Systems Ordinance or recognized as clearing houses (unless owned and operated by the HKMA);
• Licensed corporations (LCs) which meet a minimum size threshold and which provide certain critical financial services such as:
  • dealing in securities or futures contracts;
  • asset management;
  • dealing in OTC derivatives; or
  • acting as a clearing agent for OTC derivatives;
• Insurers, specifically:
  • local operations of any global systemically important insurer (G-SII) and internationally active insurance groups with a presence in Hong Kong; and
  • any insurer which it is assessed could be systemically significant or critical locally on failure;
• Locally-incorporated holding companies of FIs;
• Local branches of FIs incorporated outside of Hong Kong; and
• Affiliated operational entities (where certain conditions are met and subject to firmer proposals to be set out in the second stage consultation).

Resolution Objectives

The following resolution objectives are proposed:

• Promotion and maintenance of general stability and effective working of the financial system in Hong Kong;
• Ensuring an appropriate degree of protection for depositors, investors and policyholders; and
• Subject to the above resolution objectives, seeking to contain the costs of resolution and the protection of public funds.

Resolution Triggers

Two resolution conditions must be considered before resolution action can be triggered.

First non-viability condition

The first proposed condition for initiating resolution is an assessment that an FI is, or is expected to become, no longer viable.  This would occur where the FI becomes unable to satisfy one or more of the conditions set in relation to the regulated business and activities it carries out.  Furthermore, the FI’s failure must pose a threat to financial stability.  Any assessment of whether the first non-viability condition has been met must consider how likely it is that actions taken outside of resolution could restore the FI’s financial viability or enable it once again to satisfy the conditions set for the carrying on of regulated business or activities, as appropriate.

Second non-viability condition

The second financial stability condition requires that resolution of a non-viable FI will only be initiated where it will better serve to secure continuity of critical financial services[1] and promote and maintain the general stability and effective working of the financial system as compared with liquidation.

Resolution Powers

It is proposed that resolution authorities should have the following powers:

• Resolution or stabilization options:
  • Compulsory transfer of an entire FI or some or all of its business to:
    • Another FI; or
    • A bridge institution (as a temporary arrangement);
  • Bail-in;
  • Temporary Public Ownership (TPO);
• Dealing with residual parts of a failed FI;
  • Transfer to an asset management vehicle; or
  • Insolvency proceedings.

Safeguards

Traditional creditor hierarchies and the principle of “no creditor worse off than in liquidation” (NCWOL) are both maintained.  In addition, entry into resolution and the exercise of any resolution powers will not trigger statutory or contractual set-off rights, or constitute an event of default which allows any counterparty of the failed firm to exercise contractual early termination rights.  Rather, the exercise of early termination rights will be subject to a temporary stay.  In addition, consideration is being given to providing safeguards in respect of the following:

• Secured (or collateralised) arrangements;
• Set-off and netting arrangements;
• Title transfer arrangements;
• Structured finance arrangements; and
• Rules and arrangements within trading, clearing and settlement systems.

Consideration of a number of aspects of the proposed regime will be deferred until the second stage of the consultation, including:

• Extending the scope to non-regulated operational entities within a financial group that are significant to the business;
• A methodology for identification of a lead resolution authority in each case;
• Bail-in;
• The threshold before use of the TPO resolution power is authorised;
• A comprehensive list of general resolution powers designed to support deployment of the key resolution options;
• Details regarding the temporary stay on termination rights;
• The potential adoption of powers to require, where necessary, the implantation of measures to remove barriers to resolution, including changes to a firm’s business practices, structure or organisation;
• A compensation mechanism for those left worse off than in insolvency; and
• The establishment of a privately-financed deposit insurance or resolution fund, or a funding mechanism for ex post recovery from the industry of the costs of providing temporary financing to facilitate the resolution of a failing firm.

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