Jurisdiction - Hong Kong
Hong Kong – Second Consultation On The Establishment Of An Effective Resolution Regime For Financial Institutions Launched.

5 February, 2015


Legal News & Analysis – Asia Pacific – Hong Kong – Regulatory & Compliance


On 21 January 2015, the Hong Kong Government, jointly with the Hong Kong Monetary Authority (HKMA), the Securities and Futures Commission (SFC) and the Insurance Authority (IA) (collectively authorities), launched the second stage of public consultation on establishing an effective resolution regime for financial institutions (FIs) in Hong Kong.


The second consultation paper (CP2) sets out the conclusions reached from the initial consultation and seeks further views on various aspects of the regime including its scope, the resolution powers (eg stay of early termination rights and remuneration claw-back), the governance arrangements (especially the designation of resolution authorities), as well as safeguards and funding (in particular the no creditor worse off than in liquidation compensation mechanism).




As a result of the global financial crisis, the Financial Stability Board (FSB), tasked by the G20 leaders, has concluded that each of its member jurisdictions (of which Hong Kong is one) should establish a resolution regime to provide local authorities with administrative powers to rapidly bring about orderly resolution of failing financial institutions. In November 2011, the FSB issued the “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes) which serves as a skeletal guidance.


The first consultation paper (CP1) was published in January 2014. CP2 contains further details on various aspects of the proposed regime.


Scope Of The Proposed Regime


The authorities have decided to put forward a common framework for resolution through a single regime (as opposed to multiple section‑specific regimes), which will apply to all of the following:


  1. licensed banks;
  2. restricted licensed banks;
  3. deposit-taking companies;
  4. financial market infrastructures (FMIs) designated to be overseen by the HKMA under the Clearing and Settlement Systems Ordinance (other than those which are wholly owned and operated by the HKMA); and
  5. FMIs that are recognized as clearing houses under the Securities and Futures Ordinance (SFO).


CP2 proposes that the following should also be captured:


  1. licensed corporations which are subsidiaries or branches of groups which are identified as being (or containing) global systemically important financial institutions (G-SIFIs);
  2. licensed corporations which are themselves designated as non-bank non‑insurer G-SIFIs;
  3. insurers which are subsidiaries or branches of global systemically important insurers operating in Hong Kong;
  4. any insurer which is assessed to be systemically significant or critical locally on failure;
  5. branches of overseas FIs operating in Hong Kong;
  6. systemically important recognized exchange companies which are to be designated by the SFC.


Governance Arrangements


Resolution Authority


In terms of designating a resolution authority responsible for exercising the resolution powers under the regime, it is generally accepted by the public that a sectoral model as described in CP1 be adopted. In other words, the HKMA, the SFC and the IA would be the resolution authorities for in-scope FIs under their respective purview. The authorities now propose that the Financial Secretary should designate a leading resolution authority for each cross-sector financial group containing in-scope FIs, to be responsible for coordination and ultimate decision-making in resolutions involving cross-sector financial groups.


Non-Viability Condition And Financial Stability Condition


Under the current proposed regime, a resolution authority may initiate resolution if an FI meets both the non-viability condition and the financial stability condition.


The non-viability condition is met where it is assessed that an FI is, or is expected to become, no longer viable. This implies that:


  1. the FI is, or is expected to become, unable to meet one or more of the conditions set for its continued authorisation, licence or recognition to carry out regulated business or activities; and
  2. it is assessed that there is no reasonable prospect that private sector or supervisory action, outside of resolution, will result in the FI once again satisfying the relevant conditions.


The financial stability condition is met where it is assessed that resolution will serve to contain risks posed by non-viability to:


  1. the continuity of critical financial services; and
  2. the general stability and effective working of the financial system.


The authorities now propose in CP2 that the initiation of resolution should be subject to prior consultation with the Financial Secretary.


Resolution Objectives


In exercising the power of resolution, the underlying resolution objectives are to:


  1. promote and seek to maintain the general stability and effective working of the financial system in Hong Kong;
  2. seek an appropriate degree of protection for depositors, investors and policyholders;
  3. subject to pursuing the above two objectives, seek to contain the costs of resolution and, in so doing, to protect public funds.


The authorities have proposed an additional objective in respect of protection of client assets and are seeking views from the public in CP2.


Resolution Powers


Resolution Options


CP1 outlined the following resolution options:


  1. transfer of a failing FI, or some or all of its business, to a commercial purchaser;
  2. transfer of some or all of a failing FI’s business to a bridge institution;
  3. transfer of a failing FI’s assets and liabilities to an asset management vehicle (AMV);
  4. statutory bail-in of liabilities to absorb losses and recapitalise a failing FI; and
  5. (as a last resort) taking a failing FI into temporary public ownership.


CP2 contains further details and proposals on the necessary powers to enable the resolution authority to effect an orderly resolution.


Power To Remove Directors And Claw-Back Remuneration


The authorities propose an approach whereby removal of all of a failed FI’s directors, its Chief Executive Officer (CEO) and Deputy CEO is automatic on initiation of resolution, with removal of other senior management considered on a case-by-case basis.


It is also proposed that the resolution authorities be empowered to apply to the court for remuneration claw-back against relevant current or former directors who materially contributed to the FI becoming non‑viable. Comments are being sought specifically on whether the claw‑back should apply to both fixed and variable remuneration (both vested and unvested) or only to variable remuneration (both vested and unvested).


Power To Require Improvements


It is also proposed in CP2 that the resolution authorities be given a clear power to explicitly require structural, business, financial and/or operational changes to be made by an FI to improve its resolvability.


Temporary Stay Of Early Termination Rights


The authorities propose that there should be a temporary stay of early termination rights of counterparties to financial contracts with an FI in resolution and a temporary restriction or suspension of the rights of policyholders to withdraw from their insurance contracts. It is proposed in CP2 that the stay shall be effective from the publication of the public notice issued on commencement of the resolution proceedings until, at the latest, midnight in Hong Kong on the business day following that publication. The authorities seek public comment on whether this power should apply to FMIs.


No Winding-Up Petition Without Notice


In view of the potential conflict with winding-up proceedings, it is now proposed that a winding-up petition against an in-scope FI would be prohibited unless the relevant resolution authority has been given a 14‑day notice period to determine whether or not to initiate resolution.


Other Powers


A significant portion of CP2 relates to the proposed powers to be given to the resolution authority. Apart from the above, other powers elaborated upon in CP2 include:


  1. provision of temporary deposit protection scheme cover to reduce the incentives for transferred depositors to withdraw excess balances immediately on completion of a business transfer in resolution;
  2. scope of the bail-in power;
  3. list of liabilities that should be excluded from bail-in;
  4. power to impose a temporary moratorium on payments to unsecured creditors and to restrict enforcement of security interests;
  5. appointment of resolution managers to assist the resolution authority; and
  6. power to temporarily operate an FI during resolution.




“No Creditor Worse Off Than In Liquidation” (NCWOL) compensation


The Key Attributes state that creditors should have a right to compensation where they do not receive at a minimum what they would have received in a liquidation of the firm under the applicable insolvency regime. After considering the responses received from the public and the industry on CP1, the authorities concluded that there is a recognition that the local resolution regime should provide for an NCWOL compensation mechanism.


In relation to issues surrounding NCWOL compensation, CP2 proposes the following:


  1. the right to receive NCWOL compensation should be restricted to creditors and shareholders who held liabilities of a failed FI as at the point resolution commenced and who suffered an economic loss as a direct result of the resolution authority’s actions;
  2. the resolution authority should appoint a NCWOL valuer based on certain indicative criteria as to independence and expertise;
  3. the resolution authority should be afforded the power to remove the NCWOL valuer on the grounds of death, incapacity, bias, serious misconduct and/or the valuer no longer meeting the appointment criteria, similar to the approach taken to the removal of a liquidator;
  4. include in the primary legislation overarching valuation principles underpinning an NCWOL valuation, namely to use an appropriate valuation reference date, to adhere to creditor hierarchy in a winding-up and to disregard the actual or potential provision of any financial assistance from the authorities, outside of the course of business as usual operations;
  5. a Resolution Compensation Tribunal is to be established to deal with appeals in respect of an NCWOL valuation, whose decisions can be taken to the Court of Appeal on a point of law.


Pausing here, the authorities are yet to design a mechanism to provide parties affected by resolution with a right to appeal against some, if not all, of the decisions of the resolution authorities.


Certain Arrangements Protected From Resolution


Secured (or collateralised) arrangements, set-off and netting arrangements, title-transfer arrangements, structured finance arrangements and rules and arrangements with trading, clearing and settlement systems are protected arrangements in resolution. In CP2, the authorities propose to require FIs, as part of the resolution planning they undertake, to establish management information systems to monitor such arrangements and have the capability to deliver the relevant information at short notice. It is intended that the technical details and remedies for breaches will be addressed in the secondary legislation.


Protection From Civil Liabilities


CP1 proposed to offer protection from civil liability to officers, employees and agents of the resolution authorities exercising resolution powers and to directors and officers of FIs acting in compliance with the resolution authorities’ instructions. This is welcomed by the public and the industry. It is now proposed to extend the protection to apply to all employees of FIs in resolution.


Deferral Or Exemption From Compliance Of Certain Regulatory Requirements


The authorities propose in CP2 that a resolution authority may, after consulting with SFC, grant a deferral from compliance with the applicable disclosure requirements under the SFO in certain circumstances, which in turn would automatically defer compliance of any similar obligations under the Listing Rules and the Codes on Takeovers and Mergers and Share Buy-backs (Takeovers Code). It is expected that the Listing Rules and the Takeovers Code will be amended in due course.


The Listing Rules will also be amended to provide for an exemption for a listed entity that is a failing FI (or an affiliate) from compliance with the shareholders’ approval requirements where the relevant resolution authority has imposed or ordered the underlying transaction. The Takeovers Code will be amended to provide a general power to the Takeovers Executive to waive or modify the requirements under the Takeovers Code in relation to resolution.




During the global financial crisis, governments of many jurisdictions had to use unprecedented amounts of public funds to “bail out” failing financial institutions. One of the objectives of the proposed resolution regime is to ensure that the costs of resolution can be imposed on the shareholders and creditors of a failing FI rather than on taxpayers.


The conclusion from CP1 is that a funding mechanism with ex postrecovery from the industry is preferred over imposing levies on the industry in advance of any resolution. The authorities now seek views as to whether it may be preferable to empower the resolution authorities to determine how to raise the necessary funds taking into account the particular circumstances of each resolution. They also seek views on the overarching principles that may be set to guide the resolution authorities in this regard.


An initial, and non-exhaustive, list of resolution costs to which resolution funding arrangements could contribute on a temporary basis, and as necessary, includes:


  1. administrative expenses of resolution;
  2. NCWOL compensation;
  3. providing a guarantee of the assets of, or the liabilities issued by, the FI under resolution, its subsidiaries, a bridge institution or AMV;
  4. making loans to the FI under resolution, its subsidiaries, a bridge institution or AMV;
  5. purchasing assets of the FI under resolution;
  6. (as a last resort) providing or underwriting the provision of capital to an FI under resolution, its subsidiaries, a bridge institution or AMV.


Cross-Border Resolution


CP1 identified the need to provide for recognition procedures and/or take supportive measures in Hong Kong in cross-border resolutions in order to comply with the high-level standards set by the Key Attributes.


In September 2014, the FSB initiated a 3-month consultation exercise on cross border recognition of resolution action and is reviewing responses with a view to finalising guidance on this during this year. Further, agreement was recently reached on a draft protocol to the ISDA master agreement designed to support the cross-border enforceability of stays on termination rights arising from resolution. As work is still continuing at the international level, the authorities will defer further details on cross-border resolutions to the next consultation.


Information Sharing


It is broadly agreed that the existing framework governing information sharing by the regulatory authorities in Hong Kong, and as provided for under their respective ordinances, is consistent with the approach outlined in the Key Attributes. Therefore, it is proposed that a similar set of information sharing powers would be afforded to the resolution authorities in Hong Kong.




The CP2 marked a significant progress from CP1. However, some of the most difficult issues, such as the bail-in operation and cross-border resolutions, are yet to be properly and sufficiently addressed. A third consultation appears to be inevitable. The Government has indicated that it will aim to introduce legislative proposals into the Legislative Council by the end of 2015, as required by the FSB. We will keep abreast of further developments.


herbert smith Freehills


For further information, please contact:


William Hallat, Herbert Smith Freehills

[email protected]


Rachel Yu, Herbert Smith Freehills

[email protected]


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