The Hong Kong Monetary Authority (the HKMA) has published a consultation paper (the Consultation) on rules relating to contractual stays on termination rights in certain financial contracts (Stay Rules) for authorized institutions (AIs) under the Financial Institutions (Resolution) Ordinance (FIRO).
The Stay Rules require in scope AIs to adopt appropriate provisions in certain non-Hong Kong law governed financial contracts to the effect that parties to the contract agree to be bound by a temporary stay that may be imposed by the Monetary Authority (the MA) as resolution authority under the FIRO. The purpose of the Stay Rules is to allow the MA to exercise its powers to effect the orderly resolution of a non-viable AI and limit any market contagion risks which may arise from the large scale early termination of financial contracts following an AI’s entry into resolution. The Stay Rules take into account the relevant principles set by the Financial Stability Board (FSB) and the approaches adopted by other FSB member jurisdictions with equivalent Stay Rules.
Subject to comments received from the public consultation, the intention is to introduce the rules as subsidiary legislation under FIRO into the Legislative Council for negative vetting in the 2020/2021 legislative session.
Stay provisions in the FIRO
The FIRO contains two statutory methods for staying early termination rights arising from an AI’s entry into resolution:
- Section 89 of the FIRO which prevents certain measures taken by the MA from triggering a default event provision in a contract entered into by a qualifying entity where the substantive obligations provided for (including payment and delivery obligations and provision of collateral) continue to be performed (the ongoing stay provision).
- Section 90 of the FIRO which allows the MA (subject to the safeguards in section 91 of the FIRO) to impose a temporary suspension of a termination right of a counterparty to a contract if such a right becomes exercisable, provided that the obligations provided for in the contract for payment and delivery and for provision of collateral continue to be performed. The suspension must have a specified duration, which can be up to two business days (the temporary stay provision).
The Stay Rules are intended to ensure that the relevant contracts governed by non-Hong Kong law can be effectively bound by the temporary stay provision.
Scope of the Stay Rules
The HKMA has proposed that a within scope contract under the Stay Rules will be any financial contract that (i) is entered into by any “covered entity”; (ii) is a “covered financial contract”; (iii) is governed by non-Hong Kong law; (iv) contains a “termination right”; and (v) where the counterparty is not a financial market infrastructure[1].
What constitutes a covered entity?
For the purpose of the Stay Rules, a covered entity includes:
- a Hong Kong incorporated AI;
- a Hong Kong incorporated holding company of a Hong Kong incorporated AI; and
- a group company of a Hong Kong incorporated AI, but only to the extent that the covered financial contracts entered into by the group company contain obligations that are guaranteed or otherwise supported by the AI or the Hong Kong incorporated holding company of the AI.
What constitutes a covered financial contract?
For the purposes of the Stay Rules, covered financial contracts include:
- securities contracts[2];
- commodities contracts[3];
- futures and forwards contracts[4];
- swap agreements[5]; and
- master agreements of any of the preceding contracts or agreements.
What constitutes a termination right?
It is proposed that the FIRO definition of “termination rights” will be used which includes a right to: (i) terminate the contract; (ii) accelerate, close out, set off or net obligations, or any similar right that suspends, modifies or extinguishes an obligation of a party to the contract; or (iii) prevent an obligation from arising under the contract.
Application of the FIRO definition of “termination rights” will ensure that the same rights are bound by the temporary stay provision for both Hong Kong law governed and non-Hong Kong law governed in scope financial contracts.
How will the Stay Rules operate?
Once the Stay Rules come into force, the HKMA proposes that in scope AIs will be prohibited from:
- entering into new obligations under a within scope contract; and
- making any material amendments to any obligations under an existing within scope contract,
unless the contract contains the appropriate contractual provisions in a legally enforceable manner, to the effect that the parties to the contract agree to be contractually bound by a temporary stay that may be imposed by the MA.
The Consultation Paper provides examples of “material amendments” which include amendments to a key commercial element e.g. a reference rate, underlying asset, payment date or mechanism, or a maturity date. On the other hand, changes of a minor or administrative nature (e.g. addresses for notices) would not be considered material.
The HKMA is not proposing that the Stay Rules take effect retrospectively however, upon the expiry of a pre-existing contract that is within the scope of the Stay Rules, the contract may only be extended if the appropriate provisions under the Stay Rules are incorporated into the contract.
Timeframe for implementation
The HKMA proposes to implement the Stay Rules in phases as follows:
- For counterparties that are AIs, other foreign banks and entities that are part of a G-SIB group: 18 months from the date the Stay Rules take effect.
- For all other counterparties: 30 months from the date the Stay Rules take effect.
Ongoing stay provisions
The HKMA has also requested comments on whether there is any merit in requiring the inclusion of contractual provisions to (similarly) give effect to the ongoing stay provision, although it has indicated that this proposal will not form part of the Stay Rules and will not be implemented within the stipulated timeframes as the FIRO will need to be amended to empower the HKMA to make rules relating to the ongoing stay provision.
For full details on the Consultation Paper, including the reporting and compliance requirements proposed under the Stay Rules, please click here.
[1] This includes central counterparties but it is proposed that financial contracts with central banks as counterparties will not be excluded from the scope of the Stay Rules.
[2] Including: (i) contracts for the purchase, sale or loan of a security, a group or index of securities; (ii) options on a security or group or index of securities; (iii) repurchase or reverse repurchase transactions on any such security, group or index
[3] Including: (i) contracts for the purchase, sale or loan of a commodity or group or index of commodities for future delivery; (ii) options on a commodity or group or index of commodities; (iii) repurchase or reverse repurchase transactions on any such commodity, group or index;
[4] Including contracts for the purchase, sale or transfer of a commodity or property of any other description, service, right or interest for a specified price at a future date.
[5] Including: (i) swaps and options relating to interest rates; spot or other foreign exchange agreements; currency; an equity index or equity; a debt index or debt; commodity indexes or commodities; weather; emissions or inflation; (ii) total return, credit spread or credit swaps; (iii) any agreements or transactions that are similar to an agreement referred to in point (i) or (ii) which are the subject of recurrent dealing in the swaps or derivatives markets.
