On 20 November 2015 the Hong Kong Government published the Financial Institutions (Resolution) Bill (the Bill). The Bill seeks to bring Hong Kong into line with the latest international standards – the Financial Stability Board (FSB) ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ (Key Attributes) and to establish an effective cross-sector resolution regime for systemically important financial institutions (FIs).
The publication of the Bill follows two stages of public consultations on establishing an effective resolution regime in 2014 and in 2015 – the most recent consultation conclusions were issued in October.
The objectives of the proposed resolution regime, which are largely based on the Key Attributes, include:
- promoting and maintaining the stability and effective working of the Hong Kong financial system (including the continued performance of critical financial functions)
- protecting depositors/ policyholders of a within-scope FI and client assets to no less an extent than they would be protected on its winding-up
- in that context, minimising the need for recourse to public funds and containing costs of resolution.
Key proposals in the Bill include:
In line with the Key Attributes, the Bill proposes that the resolution regime will apply to any FI that could be systemically significant if it fails, including:
- all banks (authorised institutions under the Banking Ordinance)
- certain financial market infrastructures (designated clearing and settlement systems) recognised clearing houses
- certain recognised exchanges designated by the Financial Secretary (FS) as systemically important
- certain securities firms (licensed corporations under the Securities and Futures Ordinance (SFO) which are non-bank non-insurer global systemically important FIs (G-SIFI) – the criteria which will be determined at a future date by the FSB/International organisation of Securities Commissions (IOSCO), or certain related licensed corporations of G-SIFIs
- certain insurers (authorised insurers under the Insurance Companies Ordinance that are branches or subsidiaries of a global systemically important insurer)
- branches of foreign FIs and holding companies and affiliated operational entities of within-scope FIs (subject to conditions).
The FS will have the power to subsequently bring within its scope (regulated and un-regulated) FIs that are not initially covered by the regime if it appears that systemic disruption could result from their becoming non-viable.
Resolution authorities (RAs)
The Securities and Futures Commission, Hong Kong Monetary Authority (HKMA) and the Insurance Authority are proposed to be the RAs for the securities, banking, and insurance sectors respectively. As noted in the recent consultation conclusions, where an FI is part of a cross-sector group, the FS may designate a lead RA to be the ultimate decision-maker and lead the resolution by taking action itself and directing other RAs.
Preparatory powers of the RAs
The Bill provides for preparatory powers to assist in effective planning for and, if necessary, entry into resolution. These preparatory powers empower the RAs to:
- gather or obtain information from a within-scope FI or group company on demand or by inspection or investigation
- conduct resolution planning, perform resolvability assessments and direct FIs or their holding companies to remove identified obstacles to resolvability
- make rules prescribing loss-absorbing capacity requirements applicable to classes of within-scope FIs and imposing requirements to ensure contracts creating liabilities acknowledge their eligibility to be subject to bail-in provisions
- in the run-up to resolution:
- give directions to a within-scope FI or a group company of the FI, directors, chief executive officer (or deputy) or
- remove director(s), the chief executive officer (or deputy) of the failing FI or its holding company.
Initiation of resolution
Resolution may only be initiated following consultation with the FS where the relevant RA is satisfied that the within-scope FI meets three cumulative conditions:
- the FI has ceased, or is likely to cease, to be viable
- there is no reasonable prospect that private sector action (outside of resolution) would result in the FI becoming viable again within a reasonable period
- the non-viability of the FI will pose risks to the stability and effective working of the financial system of Hong Kong, including the continued performance of critical financial functions, and that resolution will avoid or mitigate those risks.
Further conditions apply to initiating the resolution of a holding company or affiliated operational entity of a within-scope FI.
An RA is also required to send a “letter of mindedness” to the FI concerned prior to initiating resolution.
The five proposed stabilisation options in relation to a failing FI include:
- transfer of:
- some or all of its business to (a) a purchaser or (b) a “bridge institution” (a vehicle to ensure continuity for particular critical financial services)
- its assets, rights or liabilities to an asset management vehicle
- it to temporary public ownership
- statutory bail-in (i.e. write-off or conversion into shares) of its liabilities to absorb losses and recapitalise it.
General resolution powers
The Bill grants general resolution powers to the RAs to support the effective application of stabilisation options, including powers to:
- impose a stay of early termination rights (up to two days)
- suspend obligations on payments to certain creditors and impose a stay on creditor actions (up to two days)
- prohibit the filing of a winding-up petition to the court
- defer certain authorisation requirements in certain circumstancesdefer certain disclosure requirements under the SFO for a listed entity that is (or is a group company of) a within-scope FI (subject to subject conditions)
- make rules imposing requirements on qualifying entities that contracts contain terms binding parties to any such suspension of termination rights imposed under the resolution regime
- operate and manage an FI in resolution
- (through the courts) claw back remuneration from certain senior management of an FI in resolution
- issue directions to a residual FI or affiliated operational entity requiring it to provide services essential to support any business of the non-viable FI.
As proposed in the second round of public consultation, the Bill introduces the concept of a “no creditor worse-off than in liquidation” compensation mechanism (NCWOL). There will be a rebuttable presumption that counterparties whose contracts are transferred on resolution to a new entity are no worse-off and accordingly should not receive compensation. To ensure the independence of the NCWOL compensation, the FS (as opposed to the RAs) will appoint a valuer.
The Bill also establishes the Resolution Compensation Tribunal and the Resolvability Review Tribunal to handle appeals against NCWOL compensation and resolvability measures respectively.
The Bill contains protections from civil liability for persons in good faith performing, or purported to be performing, a function under the Bill or assisting a person in such a performance or purported performance – including FIs, group companies, director(s), chief executive (or deputy) acting in good faith in complying with a direction of an RA.
An RA may apply public funding to facilitate the orderly resolution of a failed FI. This funding must be subsequently recovered. As well as seeking to recoup this from the FI, there is a mechanism for the ex-post recovery of costs incurred in relation to a resolution through a levy from within-scope FIs in the same sector as the failed FI – other than in the case of financial market infrastructures and exchanges where a “user pays” levy is instead proposed. The FS will, following public consultation, specify by regulation how a levy would be imposed in a specific resolution instance.
Further guidance on general principles and elements of cross-border recognition frameworks is expected to be issued by the FSB later this month. Despite this, the Bill provides that RAs, after assessing that no grounds for refusal exist and having consulted with the FS, may recognise all or part of a foreign resolution action so that it would have legal effect in Hong Kong. Additionally, an RA may use its powers under the Hong Kong regime to support a foreign resolution action where the conditions for initiating resolution have been met by a within-scope FI and to do so would be consistent with the resolution objectives.
The Bill will be introduced into the Legislative Council (LegCo) on 2 December 2015 for the first of three readings. Thereafter the Bill will be considered by the House Committee or referred to a bills committee for review and to propose amendments. Its general merits and principles will be debated and a vote taken to proceed to the next stage. If it is passed, the Bill will be given a second reading, and proposed amendments will be made as LegCo goes through the clauses of the Bill. It will then be put forward for a final reading (the third reading) which generally takes place on the same day. After the third reading the Bill will become an Ordinance. The Bill may take effect after it has been signed by the Chief Executive of LegCo and published in the Gazette, unless a later date is specified.
A copy of the Bill as gazetted is available here.