19 December, 2018
Hong Kong’s new loss absorbing capacity (“LAC”) rules (the “LAC Rules”) which are due to come into effect on 14 December 2018, the Hong Kong Monetary Authority (“HKMA”) and the Hong Kong Government have published a set of responses (the “Responses”) clarifying certain details around the application and scope of the LAC Rules.
In this note we examine the key points set out in the Responses, as well as some practical considerations for issuers contemplating the issue of LAC eligible instruments going forward.
Overview
Following our recent alert1 on Hong Kong’s new loss absorbing capacity (“LAC”) rules (the “LAC Rules”) which are due to come into effect on 14 December 2018, the Hong Kong Monetary Authority (“HKMA”) and the Hong Kong Government have published a set of responses (the “Responses”) clarifying certain details around the application and scope of the LAC Rules2.
In this note we examine the key points set out in the Responses, as well as some practical considerations for issuers contemplating the issue of LAC eligible instruments going forward.
Further updates on the application and scope of the LAC Rules
The key takeaways from the Responses can be summarised as follows:
In-scope authorised institutions: as envisaged by the HKMA, an authorised institution will only be subject to the requirements under the LAC Rules and the FIRO Code of Practice Chapter on Resolution Planning3 (the “LAC Code of Practice”) where the failure of such authorised institution is expected to pose a risk to financial stability, including to depositors. Following consultation, the HKMA has increased the threshold for determining the application of the LAC Rules and the LAC Code of Practice to an authorised institution from HK$150 billion4 to HK$300 billion in total consolidated assets. The HKMA has, however, stressed that such a threshold should be seen as indicative, rather than absolute. It is therefore important that there remains sufficient flexibility to allow for institution-specific characteristics to be taken into account (for example, the number of depositors for a particular authorised institution).
Timing for compliance with LAC requirements: the HKMA has sought to give greater clarity on the transition periods for the implementation of LAC requirements by relevant authorised institutions:
- for Hong Kong domestic systemically important banks (“D-SIBs”) that are part of non-emerging market economy headquartered global systemically important banks (“G-SIBs”): classification of such authorised institutions as classifiable entities is expected to be made in 2019, with compliance with the LAC Rules required within three months of their classification;
- for all other Hong Kong D-SIBs: classification of such authorised institutions as classifiable entities is expected to be made by 1 January 2020, with compliance with the LAC Rules required by no later than 24 months of their classification (1 January 2022); and
- for all other in-scope Hong Kong authorised institutions: classification of such authorised institutions as classifiable entities is expected to be made by 1 January 2020, with compliance with the LAC Rules required by no later than 36 months of their classification (1 January 2023). This revised 1 January 2023 start date therefore provides such authorised institutions with a one-year extension for compliance.
In addition, the HKMA has made clear that where it determines that an authorised institution will not be able to meet its LAC requirements under the LAC Rules and the LAC Code of Practice to the published timetable, there may be flexibility to consider allowing a longer implementation period on a case-by-case basis.
Minimum one-third debt requirement: following ongoing dialogue with the industry, the HKMA now proposes to allow eligible Additional Tier 1 (“AT1”) capital instruments, whether accounted for as debt or equity, to count towards the minimum one-third debt requirement for LAC instruments. This resolves some previous uncertainty as to the LAC eligibility of equity-accounted AT1 capital instruments, and represents a positive development which will provide issuers with greater flexibility when assessing their capital requirements.
Ongoing review of the LAC Code of Practice: in the spirit of ensuring the LAC requirements remain effective, robust and appropriate in light of the banking landscape in Hong Kong, the HKMA intends to undertake a review of the forthcoming LAC Code of Practice no later than three years after its introduction.
Practical Considerations
For smaller authorised institutions, the increased entry-level total consolidated assets threshold (although indicative only) and the extended deadline for compliance with the LAC requirements should provide some relief.
For those authorised institutions that are required to comply with the LAC requirements, the proposal to allow eligible AT1 capital instruments, whether accounted for as debt or equity, to count towards the minimum one-third debt requirement for LAC instruments will be a welcome development. For these in-scope authorised institutions, the LAC Rules will take effect from 14 December 2018. However, many authorised institutions will not be classified for some time, and so it will be important for such authorised institutions proposing to issue AT1 and Tier 2 capital instruments or other eligible LAC instruments during this interim period to consult the HKMA early on for guidance and to discuss the impact of the LAC Rules and the LAC Code of Practice on any such issuances.
In addition, issuers of such instruments may wish to consider including specific provisions in the terms of such instruments which permit amendments to be made to the terms in order to ensure LAC eligibility without requiring securityholder consent.
For further information, please contact:
William Liu , Partner, Linklaters
william.liu@linklaters.com
1 Hong Kong strengthens banks’ resilience to shocks by implementing loss-absorbing capacity rules.
2 Responses to list of follow-up actions arising from the discussion at the LegCo LAC Rules Subcommittee meeting on 23 November 2018 and published on 27 November 2018 (LC Paper No. CB(1)218/18-19(02)).
3 The draft FIRO Code of Practice Chapter on Resolution Planning – LAC Requirements issued for industry consultation was published on 19 October 2018.
4 See paragraph 2.6 of the LAC Code of Practice.
