Financial Institutions (Resolution) (Loss-absorbing Capacity Requirements—Banking Sector) Rules
MR CHAN CHUN-YING (in Cantonese):
Deputy President, in my capacity as Chairman of the Subcommittee on Financial Institutions (Resolution) (Loss-absorbing Capacity Requirements―Banking Sector) Rules, I now report on the deliberations of the Subcommittee.
The purpose of the Financial Institutions (Resolution) (Loss-absorbing Capacity Requirements―Banking Sector) Rules (“the Rules”) is to prescribe loss-absorbing capacity (“LAC”) requirements for banks in Hong Kong and their holding companies and affiliated operational entities in Hong Kong that are within the scope of the Financial Institutions (Resolution) Ordinance (Cap. 628) (“FIRO”), so as to ensure the availability of sufficient LAC to absorb losses of such institutions and contribute to the restoration of their capital position in the event that such institutions were in resolution.
The Subcommittee has held three meetings with the Administration and the Hong Kong Monetary Authority (“HKMA”), and has received views from deputations.
The Subcommittee noted the grave concern expressed by small and medium-sized banks that they might be required to comply with the LAC requirements under the Rules. They were particularly concerned that HKMA had proposed in the draft text of the LAC Code of Practice chapter a total consolidated asset threshold of HK$150 billion, as a result of which most domestic banks might be subject to the LAC requirements and many small and medium-sized banks would face a substantial increase in their operating costs. A number of Subcommittee members pointed out that the legislative intent of FIRO was to establish a resolution regime for global and domestic financial institutions with systemic importance. If small and medium-sized banks were brought within the scope of the Rules, it would be inconsistent with the objectives of FIRO. The Subcommittee urged the Administration to consider prescribing in the Rules that only global systemically important banks (“G-SIBs”) or domestic systemically important banks (“D-SIBs”) should be subject to LAC requirements.
Moreover, some members were also concerned that HKMA would factor in the number of depositors of a bank and the total volume of deposits while deciding the total consolidated asset threshold, so as to protect the interests of depositors. They were of the view that the objective of protecting depositors should be achieved through other means, for example, the Deposit Protection Scheme, rather than LAC requirements.
As pointed out by HKMA, the threshold of HK$150 billion only serves as a starting point for HKMA’s classification of banks into “resolution entities” and “material subsidiaries”. Banks meeting the threshold would not be automatically subject to the Rules or the LAC requirements under the LAC Code of Practice chapter. It was only where the failure of a bank was expected to pose a risk to financial stability that the bank concerned would be subject to the LAC requirements. Regarding the concern over whether protection of depositors is one of the objectives of FIRO, HKMA responded that while exercising the powers under FIRO, it must have regard to the objectives as set out in section 8(1) of FIRO, which includes maintaining the stability and effective working of the financial system of Hong Kong. Allowing small and medium-sized banks to go into insolvency on failure would likely undermine the general confidence of participants in the financial market in Hong Kong and give rise to contagion within the financial system of Hong Kong, thereby affecting the stability and effective working of the financial system of Hong Kong. HKMA stated that if small and medium-sized banks could demonstrate to it that their failures could be managed via insolvency without posing a risk to financial stability, they would not be subject to LAC requirements.
In response to the concerns raised by members and the industry, the Administration and HKMA made a number of undertakings. These include: first, the total consolidated asset threshold set out in the LAC Code of Practice chapter will be increased to HK$300 billion and the Code of Practice chapter will be reviewed every three years; second, the earliest date on which D-SIB and non-D-SIB will be required to meet the LAC requirements are 1 January 2022 and 1 January 2023 respectively, and where HKMA has determined that an entity will not be able to meet its LAC requirements according to the prescribed timetable, HKMA can consider allowing a longer implementation period on a case-by-case basis; and third, as regards the calculation of minimum LAC debt requirement, eligible Additional Tier 1 capital instruments would be covered, irrespective of whether such instruments were accounted for as debt or equity.
Members of the Subcommittee generally welcomed the above undertakings given by the Administration and HKMA. As they noted, if the threshold is raised to HK$300 billion, around 12 banks may potentially be subject to the Rules, and these banks have around 200 000 depositors or more, whereas around 17 banks may potentially be required to comply with the Rules if the threshold is set at HK$150 billion. In addition, members stated that when HKMA conducted its triennial review on the Code of Practice, it should consider factors such as the prevailing market conditions in Hong Kong, the business conditions of banks and the relevant international development.
Members stressed that when implementing the resolution regime and the corresponding LAC requirements, Hong Kong should draw reference from the implementation and progress in other major international financial markets. Hong Kong should avoid being the forerunner of implementing the relevant requirements, thereby affecting the competitiveness of the Hong Kong banking sector. Also, some members expressed concerns about the higher costs incurred by small and medium-sized banks for issuance of LAC debt instruments as compared with large banks. In particular, if a number of domestic banks concurrently issue LAC debt instruments, the market may not be able to absorb all the instruments, hence a surge in interest rates.
As advised by HKMA, the annual cost of non-capital LAC debt instruments issued by banks in Hong Kong is 4% at a conservative estimate, and most domestic banks that may be subject to LAC requirements will issue internal LAC instruments to foreign parent companies within international financial groups, instead of issuing LAC debt instruments to the external market directly. Should there be unforeseen market conditions, HKMA has been empowered by the Rules to make flexible arrangements, including deferring the classification of a resolution entity or material subsidiary in respect of a bank.
Given that the Administration and HKMA have responded to the concerns of the Subcommittee and made relevant undertakings, members generally support the Rules and will not propose any amendment to the Rules.
Deputy President, the following are my personal views on the Rules. Our deliberations about LAC requirements were based on FIRO, which was actually passed by the Legislative Council in June 2016 and came into force on 7 July 2017. FIRO establishes a resolution regime for systemically important financial institutions in Hong Kong, in order to forestall or mitigate, as the case may be, the risks otherwise posed by their non-viability to the stability and effective working of the financial system of Hong Kong, including the continued performance of critical financial functions.
FIRO also establishes a cross-sectoral resolution regime for financial institutions falling within its scope, including banking sector entities (i.e. all authorized institutions), insurance sector entities, and securities and futures sector entities. The purpose is to meet the international standards set by the Financial Stability Board (“FSB”) in its “Key Attributes of Effective Resolution Regimes for Financial Institutions”.
Given the size, systemic importance, level of concentration, and scale of critical financial functions of Hong Kong’s banking system, as well as the necessity of keeping pace with the development of the relevant international guidelines, Hong Kong must give priority to introducing the Rules which are applicable to all authorized institutions (i.e. banks). Under the Rules, authorized institutions are required to maintain their minimum levels of LAC, which can be used to absorb losses and provide recapitalization resources to facilitate orderly resolution should the relevant authorized institutions cease, or become likely to cease, to be viable.
In fact, FSB has drawn up guidelines on LAC for banks, that is TLAC Term Sheet as we call it. Where a resolution entity or a material subsidiary is part of a G-SIB group that is required to meet TLAC requirements set out in FSB’s TLAC Term Sheet from 1 January 2019, i.e. next year, it will be required to meet the minimum requirements of FSB within three months of being classified as a resolution entity or a material subsidiary. Being an international financial centre, Hong Kong has a number of authorized institutions which are parts of G-SIB groups. They are required to meet the deadline for implementing the arrangements relating to LAC under the local legislation, so as to fulfil the minimum requirements of FSB.
While the Rules prescribe LAC requirements for all authorized institutions and their group companies, the Rules only ensure that an authorized institution will be required to meet LAC requirements if its failure is expected to pose risks to financial stability or to depositors. The draft Code of Practice of the Rules sets out the resolution authorities’ regulatory intention that authorized institutions with total consolidated assets above a certain threshold may potentially be subject to LAC requirements under the Rules. At the Subcommittee meeting on 28 November this year, HKMA confirmed that the threshold would be raised from the original HK$150 billion to HK$300 billion in the finalized version of the LAC Code of Practice chapter. In other words, authorized institutions with total consolidated assets below HK$300 billion will not be required to comply with LAC requirements, whereas those with total consolidated assets above HK$300 billion will be subject to LAC requirements if their failures are expected to pose risks to Hong Kong’s financial stability and to depositors.
So far as the resolution regime is concerned, the authorities have confirmed that except non-Chinese G-SIBs, the earliest at which any D-SIB will be required to meet LAC requirements is 1 January 2022, and the earliest at which any non-D-SIB will be required to meet LAC requirements has been extended to 1 January 2023. If an entity is unable to meet the requirements as scheduled, the resolution authorities may allow it to postpone the implementation, depending on the actual circumstances. Following ongoing dialogue with the industry, the resolution authorities proposed permitting eligible Additional Tier 1 capital instruments to count towards the minimum LAC debt requirement, irrespective of whether they are accounted for as debt or equity. The resolution authorities also confirmed that a review would be conducted on the approach they adopted within three years after the introduction of the LAC Code of Practice chapter. The review will take into account factors such as the prevailing market conditions, operations of the banks and international development.
Deputy President, the series of activities in respect of the deliberations about the Rules has actually facilitated the communication and positive interactions among the banking industry, Legislative Council and the Government, and enabled Members to have a better understanding about the implementation of the resolution regime and LAC. The industry generally welcomes the undertakings made by the Administration in response to the concerns and worries expressed. If these undertakings are actually carried out, I believe there will be a proper balance between complying with the international standards and maintaining the competitiveness of the local financial institutions.
Therefore, Deputy President, I wish to take this opportunity to thank members for the views they have voiced in the Subcommittee. I concur with their views and support the passage of the Rules.
I so submit.