The Banking Regulation Review: Hong Kong
Hong Kong has a three-tier system of banking institutions covering licensed banks, restricted licence banks and deposit-taking companies. There are separate licensing regimes, laws and regulations governing money lenders and money brokers. As at 28 February 2021, there were 161 licensed banks (eight of which were virtual banks), 17 restricted licence banks, 12 deposit-taking companies and 43 local representative offices of overseas banks in Hong Kong. The five largest licensed banks in Hong Kong measured by total assets are HSBC, Bank of China (Hong Kong), Standard Chartered Bank (Hong Kong), Hang Seng Bank and the Industrial and Commercial Bank of China (Asia) Limited. The Hong Kong Monetary Authority (HKMA) is the government authority responsible for maintaining monetary and banking stability in Hong Kong.
The regulatory regime applicable to banks
Companies wishing to carry on banking business or the business of taking deposits in Hong Kong are required under the Banking Ordinance2 to be authorised by the HKMA. These institutions are referred to in the Banking Ordinance as authorised institutions (AIs).
i The HKMA
The HKMA's functions and policy objectives are:
- maintaining currency stability;
- promoting the stability and integrity of the financial system;
- helping to maintain Hong Kong's status as an international financial centre; and
- managing the Exchange Fund (Hong Kong's official reserves).
The HKMA fulfils some of the functions of a central bank, such as formulating and implementing monetary policy, supervising banks and managing the Exchange Fund. Other functions, notably the issuance of bank notes, are carried out by three banks within Hong Kong's commercial banking sector: Bank of China, HSBC and Standard Chartered.
ii Banking regulation
The Banking Ordinance provides the legal framework for banking regulation, which is supplemented by two publications by the HKMA: the Supervisory Policy Manual and the Guide to Authorization. The Supervisory Policy Manual contains the HKMA's latest supervisory policies and practices. The Guide to Authorization sets out the HKMA's interpretation of the authorisation criteria, the procedures for processing applications for authorisation and the grounds for revocation of licences.
iii Local representative offices
Instead of seeking authorisation to be AIs, overseas banks may, with the approval of the HKMA, establish local representative offices in Hong Kong. Local representative offices are not allowed to engage in any banking or deposit-taking business in Hong Kong. Their role is therefore largely confined to liaison work between the overseas bank and its customers in Hong Kong.
iv AI eligibility criteria
Certain basic criteria must be satisfied to be eligible to become an AI and obtain a banking licence. The HKMA has general discretion to grant or refuse an application for authorisation and, if one or more of the criteria is not fulfilled, the HKMA must refuse the relevant application for authorisation. An AI must be a body corporate. Where the applicant for AI branch authorisation is a bank incorporated outside Hong Kong, the HKMA will confirm with the relevant overseas banking supervisory authority that it has given consent for the applicant to establish a branch in Hong Kong. The authorisation criteria for AIs, which are set out in the Seventh Schedule to the Banking Ordinance, ensure that only fit-and-proper institutions are entrusted with public deposits.
v Securities activities
The banking industry is regulated jointly by the HKMA and the Securities and Futures Commission of Hong Kong (SFC) to the extent that AIs carry on business in one or more regulated activities as defined in the Securities and Futures Ordinance3 (SFO). Regulated activities include dealing in securities, advising on securities, advising on corporate finance and asset management.
The foundation of the regulatory framework for the securities and futures industry is that carrying on a business in a regulated activity without a licence, and without reasonable excuse, is a criminal offence. AIs that carry on business in one or more regulated activities are defined as 'registered institutions' in the SFO. To become a registered institution, the institution in question must satisfy the SFC that it is a 'fit-and-proper' person.
The SFO sets out a limited number of regulated activities (such as leveraged foreign exchange trading and certain types of securities margin financing) that AIs may carry out without a licence. The SFO includes provisions that have not yet commenced whose effect is to extend 'regulated activities' to advising or dealing in derivatives (or other structured products). AIs will largely be exempted from the derivatives regulated activities but are required under other provisions – and in line with international standards – to comply with mandatory reporting, clearing and margining rules in respect of their derivatives activities.
vi Cross-border marketing
The Banking Ordinance prohibits marketing that invites members of Hong Kong's public to make deposits. The prohibition catches persons outside Hong Kong who market to persons in Hong Kong. The prohibition is subject to a number of exceptions, including invitations to make deposits with AIs and invitations to make deposits outside Hong Kong, which contain prescribed disclosures.
Hong Kong's securities legislation, under the SFO, similarly prohibits the active marketing of regulated activities to Hong Kong's public if the relevant service provider of the regulated activities has not been granted a licence by the SFC.
vii HKMA's approach to banks regulated by overseas regulators
The HKMA recognises that the primary authority for supervising overseas banks lies with the supervisory authority of the jurisdiction where the relevant bank is incorporated. Accordingly, not all of the provisions in the Banking Ordinance and the Supervisory Policy Manual are applicable to AIs incorporated outside Hong Kong. Corporate governance and capital adequacy are two areas where the Banking Ordinance and the Supervisory Policy Manual are not applicable to banks incorporated outside Hong Kong, although the Banking Ordinance does set out certain capital thresholds to be met by an institution to become and remain authorised.
However, the HKMA does retain supervising power over most matters of day-to-day conduct of banking affairs for overseas banks authorised in Hong Kong. Rules and guidelines under the Banking Ordinance covering areas such as the appointment of directors responsible for the Hong Kong operations of overseas banks, the code of conduct of their Hong Kong operation, internal risk controls and risk management, liquidity management, trading activities and money laundering are applicable to overseas banks authorised in Hong Kong.
i Relationship with the prudential regulator
The primary responsibility for the prudent management of an AI rests with the board of directors and management itself. The HKMA issues guidance to AIs through its Supervisory Policy Manual. While the Supervisory Policy Manual does not itself have the force of law, any failure to adhere to any of the guidelines set out in it may call into question whether an AI continues to satisfy the minimum criteria for authorisation under the Banking Ordinance.
The HKMA adopts a continuous supervision policy so as to detect and address problems at an early stage. Various techniques are used by the HKMA to gather information and to monitor the business of each AI, including:
- on-site and off-site examinations;
- prudential meetings with the senior management;
- meetings with the board of directors;
- cooperation with external auditors; and
- sharing information with other supervisors.
Furthermore, regular statutory returns are required to be submitted to the HKMA.
The HKMA adopts a risk-based approach to evaluate the safety and soundness of an AI, its risk-management systems and its internal controls. This enables the HKMA to pre-empt any serious threat to the stability of the banking system.
The major types of inherent risks identified by the HKMA are credit, interest rate, market, liquidity, operational, legal, reputational and strategic risks. A risk-management rating is assigned and factored into the management and other relevant components of the CAMEL rating system, which is an internationally recognised framework for assessing capital adequacy, asset quality, management, earnings and liquidity. The output of the CAMEL system is a supervisory rating to reflect the HKMA's view of the overall safety and soundness of the relevant AI.
For a Hong Kong-incorporated AI, the HKMA normally conducts a regular supervisory review once a year. The supervisory review process is a comprehensive assessment of the level of capital that a Hong Kong-incorporated AI should set aside for the major types of inherent risks identified for the purpose of risk-based supervision.
The HKMA has issued rules under the Banking (Capital) Rules4 that prescribe in detail how the capital adequacy of locally incorporated AIs should be calculated. These rules incorporate Basel III technical guidance. In addition, the HKMA's Supervisory Policy Manual module CA-G-5 (supervisory review process) sets out details of the changes to the supervisory review process that were necessitated by the implementation of the Basel III capital standards. The Banking (Capital) Rules have been amended in previous years to introduce several capital buffers such as the capital conservation buffer, the countercyclical capital buffer and the higher loss absorbency (HLA) requirement. The capital conservation buffer is an additional layer of Common Equity Tier 1 (CET1) capital above the hard minimum capital requirements that is 2.5 per cent of banks' total risk-weighted assets. The countercyclical capital buffer is a further requirement for CET1 capital ranging from zero to 2.5 per cent of risk-weighted assets for banks' private sector credit exposures in Hong Kong when the HKMA determines there is excess aggregate credit growth associated with a build-up of system-wide risk in Hong Kong. The HLA ratio will apply to domestic banks considered by the HKMA to be systemically important (there are currently no global systemically important banks (G-SIBs) headquartered and incorporated in Hong Kong). They will be obliged to comply with this requirement by maintaining an additional layer of CET1 capital increasing to a range of from 1 per cent to 3.5 per cent of their total risk-weighted assets.
While there are separate regulators for the prudential supervision of securities, insurance, Mandatory Provident Fund schemes and money lending businesses in Hong Kong, the HKMA supervisory review process assesses all the major risks of a banking group, whether arising from banking or non-banking activities.
The capital adequacy, concentration of exposures and liquidity of a Hong Kong-incorporated AI are supervised on a consolidated basis to enable the HKMA to assess any weaknesses within a banking or financial group that may have an impact on the AI itself, and to take any necessary defensive or remedial actions. When supervising banking groups, the HKMA takes a flexible approach to determining the scope of consolidated supervision. As a general rule, the banking group's local and overseas offices and financial subsidiaries are covered. Non-bank companies are included in the consolidation if they undertake financial business such as hire purchase, credit cards or leasing. Where non-bank companies (e.g., securities firms or insurance companies) are adequately supervised by other supervisors, the HKMA will rely heavily on their cooperation to ensure effective overall supervision of the banking group. The HKMA will also consider contagion risk in relation to an AI's holding and sister companies.
ii Management of banks
One of the authorisation criteria under the Banking Ordinance is that the HKMA must be satisfied that the chief executive and directors of the applicant company are fit and proper persons to hold their respective positions. The HKMA will have regard to the person's experience, knowledge and skills, as well as his or her reputation and character, competence, soundness of judgement and diligence, whether he or she has a record of non-compliance with non-statutory codes or disciplinary records, his or her involvement as a director in any companies wound up by the court, and his or her business record and financial soundness and strength.
The legal and regulatory duties of the management of AIs are detailed in the HKMA's Supervisory Policy Manual modules on corporate governance (CG-1 to CG-7). In particular, Supervisory Policy Manual module CG-1 (Corporate Governance of Locally Incorporated Authorized Institutions) sets out principles adopted by the HKMA in line with the Basel Committee on Banking Supervision's Principles for Enhancing Corporate Governance and Supervisory Policy Manual module CG-6 (Competence and Ethical Behaviour) sets out the latest developments in enhancing training programmes for banking practitioners in Hong Kong.
The board is ultimately responsible for the conduct of an AI's affairs, but the HKMA recognises that it may be beneficial for supervision of major functional areas to be delegated to certain specialised committees such as an executive committee, credit committee, asset and liability committee, remuneration committee and audit committee. It is also recognised that key functions and policies of an AI that is a subsidiary of another banking institution may be determined and centralised at the holding company level.
The Supervisory Policy Manual module SA-2 (Outsourcing) sets out the HKMA's supervisory approach to outsourcing and the major points that the HKMA recommends AIs to address when outsourcing their activities. The HKMA's main concerns are with accountability, risk assessment, the ability of service providers, confidentiality of customer data, the degree of control the AI maintains over outsourced activities, contingency planning and access to outsourced data by the HKMA's examiners and the AI's internal and external auditors.
iii Regulatory capital, loss-absorbing capacity and liquidity
Capital adequacy ratio
The HKMA must be satisfied that an AI has financial resources that are adequate for the inherent risks in its business to reduce the risk of insolvency. All AIs are required under the Banking Ordinance to maintain minimum levels of share capital. As regards Hong Kong-incorporated AIs, the HKMA's framework for capital adequacy is based on Basel III (which was implemented in Hong Kong on 1 January 2013).
A Hong Kong-incorporated AI is required under the Banking (Capital) Rules to maintain a CET1 capital ratio of at least 4.5 per cent, a Tier 1 capital ratio of at least 6 per cent and a total capital ratio of 8 per cent. Branches of foreign banks are not subject to this requirement but, based on the HKMA's past practice of generally requiring any foreign bank that wishes to establish a branch in Hong Kong to maintain a capital adequacy ratio of at least 8 per cent, it is likely that the HKMA will continue to require foreign banks to meet the three minimum risk-weighted capital ratios.
Under the supervisory review process discussed above, the HKMA may require an AI to have a capital buffer to cater for risks and uncertainties that are not already captured by the three minimum risk-weighted capital ratios. The HKMA has the power under the Banking Ordinance to vary any capital requirement rule applicable to an AI.
Hong Kong-incorporated AIs must also comply with the minimum leverage ratio set out in the Banking (Capital) Rules. The leverage ratio is a non-risk-based measure of an AI's capital adequacy, introduced as a 'back-stop' to restrict the build-up of excessive leverage in the banking sector and to provide an additional safeguard against model risk and measurement error in the risk-based capital adequacy ratios. The minimum leverage ratio is 3 per cent.
As mentioned in Section III.i, the HKMA has implemented the following capital buffers: the capital conservation buffer, the countercyclical capital buffer and (for domestic systematically important banks (D-SIBs)) the HLA requirement.
The capital conservation buffer is an additional band of CET1 capital at 2.5 per cent.
The level of the countercyclical capital buffer is an additional band of CET1 capital base that ranges from zero per cent to 2.5 per cent. The level is determined by the HKMA's analysis on whether there is excess aggregate credit growth associated with a build-up of system-wide risk in Hong Kong. It is an extension of the capital conservation buffer. On 28 January 2021, the HKMA announced the countercyclical capital buffer would remain unchanged at 1 per cent and noted that the economic environment in Hong Kong is subject to a high level of uncertainty.
The HLA requirement applies only to D-SIBs. It is also an additional band of CET1 capital base that acts an extension of the capital conservation buffer. The HLA range (where applicable) is normally between 1 per cent and 2.5 per cent, although there is a top range of 3.5 per cent. On 30 December 2020, the HKMA announced that Hong Kong's list of D-SIBs remains unchanged, covering six AIs: HSBC, Bank of China (Hong Kong) Limited, Hang Seng Bank Limited, The Bank of East Asia, Limited, Industrial and Commercial Bank of China (Asia) Limited and Standard Chartered Bank (Hong Kong) Limited. Of the six banks, the HKMA has designated the highest HLA (2.5 per cent for 2021) to HSBC and the lowest HLA (1 per cent for 2021) to The Bank of East Asia, Limited, Hang Seng Bank Limited and Industrial and Commercial Bank of China (Asia) Limited.
If a Hong Kong-incorporated AI's capital level erodes to a level falling within the capital conservation buffer zone, the countercyclical capital buffer zone, or, for a D-SIB, the HLA buffer zone, restraints will be imposed on that AI's distributions. A Hong Kong-incorporated AI is expected to discuss with the HKMA if it anticipates that any of its capital levels will fall close to the buffer zones.
Loss-absorbing capacity rules
The Financial Institutions (Resolution) Ordinance5 covers resolution, including bank resolution. On 14 December 2018, the Financial Institutions (Resolution) (Loss-absorbing Capacity Requirements – Banking Sector) Rules were issued and came into operation. The rules enable the HKMA to prescribe loss-absorbing capacity (LAC) requirements for 'within scope' financial institutions that are Hong Kong-incorporated AIs, and for their Hong Kong-incorporated holding companies or Hong Kong-incorporated affiliated operational entities. Not all Hong Kong-incorporated AIs will be classified as 'within scope' – meaning that not all Hong Kong-incorporated AIs will be subject to the LAC requirements. It is worth noting that the LAC consolidation group may differ from the regulatory capital consolidation group. The rules set out how to calculate LAC leverage ratios (both external LAC and internal LAC, and under a solo, solo-consolidated and consolidated basis), capital component ratios and resolution component ratios (which will often be the same as the related capital component ratio). External LAC risk-weighted ratio will, at a minimum, be the sum of an AI's capital component ratio and its resolution component ratio. Internal LAC risk-weighted ratio will be set at a fraction of the external LAC risk-weighted ratio (likely 75 per cent in most cases). There is a requirement for at least a specified portion (likely one-third) of the LAC to be in the form of LAC debt since LAC debt (unlike LAC equity) is not at risk of depletion before bank failure and so provides a fixed quantity of financial resources that can support an orderly resolution. The rules also cover disclosure requirements in relation to LAC and deductions for holding non-capital LAC liabilities.
The Banking (Capital) Rules contain provisions relating to LAC, including a provision that an AI must take into account its minimum LAC requirements, in addition to its minimum regulatory capital requirements, in calculating the CET1 capital remaining available to meet the capital buffer requirement.
Note that capital that counts towards meeting the regulatory capital requirement (i.e., those hard requirements, ignoring the 'softer' capital buffers) will generally count towards meeting a LAC requirement. This means that the new additional burden for a 'within scope' Hong Kong-incorporated AI will likely be the resolution component ratio.
Solo and consolidated capital adequacy ratio
In broad terms, the Banking (Capital) Rules impose capital requirements on Hong Kong-incorporated AIs at two levels: on a solo basis and a consolidated basis.
All Hong Kong-incorporated AIs are required to maintain a capital adequacy ratio on a solo basis, which provides a measure of each institution's (including its local and overseas branches) capital strength. A Hong Kong-incorporated AI may apply to the HKMA to include in its capital base, for the purposes of calculation of its solo capital adequacy requirement, the capital invested in any subsidiary that meets the criteria set out in the Banking (Capital) Rules (effectively requiring the subsidiary to be managed by that parent AI) such that the capital adequacy ratio of that institution will be calculated on a 'solo-consolidated basis'.
Where a Hong Kong-incorporated AI undertakes other banking and financial business through subsidiary companies, the HKMA normally also requires the AI to maintain its capital adequacy ratio on a consolidated basis. This is to ensure that the Hong Kong institution's capital position is maintained at an adequate level taking into account its exposures to risks stemming from such subsidiaries. It is usually the practice of the HKMA to set the same minimum capital adequacy ratio requirement at both the solo and consolidated levels, unless the results of the supervisory review process justify otherwise.
Group supervision may also extend to controllers of the AI, including an assessment of controllers' financial resources to provide continuing support to the AI.
Composition of capital base
Under the Banking Ordinance, the capital base of an AI is the sum of its Tier 1 capital and Tier 2 capital. Tier 1 capital is the sum of an AI's CET1 capital and its additional Tier 1 capital. The key elements of the CET1 capital of an AI are the AI's CET1 capital instruments; the amount standing to the credit of the AI's share premium account (if any) resulting from the issue of the AI's CET1 capital instruments; the AI's retained earnings and other disclosed reserves; and the amount of minority interests arising from the CET1 capital instruments issued by the consolidated bank subsidiaries of the AI and held by third parties. The Banking (Capital) Rules also set out in detail how an AI's additional Tier 1 capital and Tier 2 capital are to be calculated. In respect of each category of capital, the Banking (Capital) Rules also specify which items are to be excluded from the calculation, as well as which deductions are to be made.
The Banking (Capital) Rules set out approaches that a Hong Kong-incorporated AI can use to calculate its risk-weighted amounts for credit risk, market risk, operational risk and sovereign concentration risk. Each Hong Kong-incorporated AI is expected to choose options for calculating credit risk, market risk and operational risk based on the results of its own detailed feasibility study. However, there is a default approach for each of those risks that every Hong Kong AI must adopt unless the prior approval of the HKMA has been obtained for using another approach.
Banks in Hong Kong generally have strong capital bases. The consolidated capital adequacy ratio of Hong Kong-incorporated AIs was well above the 8 per cent requirement under the Banking (Capital) Rules (20.7 per cent as at the end of 2020).
The risk-based supervisory approach includes the continuous supervision of each AI's liquidity risk. Central to this is an assessment of an AI's ability to maintain adequate liquidity in the event of a liquidity crisis. The HKMA considers the amount of high-quality liquid assets that an AI can readily dispose of or pledge for funding; the results of stress tests on its cash-flow and liquidity positions; and the stability of the AI's funding sources and its contingency measures for dealing with crisis situations.
The Banking (Liquidity) Rules6 implement the Basel III liquidity coverage ratio (LCR) and seek to promote banks' resilience to short-term liquidity risks by ensuring they have sufficient high-quality liquid assets to meet their obligations for at least 30 days under an acute stress scenario.
The LCR applies only to AIs designated by the HKMA as 'category 1 institutions' under the liquidity rules. Category 1 institutions are those internationally active AIs or larger or more sophisticated AIs that are significant to the general stability of the local Hong Kong banking system or those AIs that have material liquidity risk. Since 1 January 2019, all category 1 institutions must maintain at all times an LCR of at least 100 per cent. Other AIs not designated as category 1 institutions (category 2 institutions) will be subject to the liquidity maintenance ratio (LMR), which is a modified version of the pre-existing liquidity ratio. Since 1 January 2019, all category 2 institutions must maintain on average in each calendar month an LMR of at least 25 per cent.
On 1 January 2018, a new net stable funding ratio (NSFR) and a new local core funding ratio (CFR) were brought into force. These apply to different categories of AI to ensure their assets are financed with sufficiently stable sources of funding. Since 1 January 2019, all category 1 institutions must maintain at all times an NSFR of at least 100 per cent unless certain exemptions apply and certain category 2 institutions (which are designated by the HKMA as category 2A institutions) must maintain on average in each calendar month a CFR of at least 75 per cent.
Whether incorporated in or outside Hong Kong, the LCR, LMR, NSFR or CFR (as applicable) will apply only to an AI's business in Hong Kong and its local branches (i.e., excluding any subsidiaries or overseas branches of the AI). For a Hong Kong-incorporated AI, the HKMA may require the LCR, LMR, NSFR or CFR (as applicable) to be calculated on a consolidated basis instead of on an unconsolidated basis, or on both a consolidated and an unconsolidated basis.
Liquidity of Hong Kong banks
Hong Kong banks' balance sheets have remained liquid in the aftermath of the global financial crisis and, although the LCR decreased slightly in the second half of 2020, the ratio was still well above the statutory minimum of 100 per cent. The consolidated quarterly average LCR of category 1 institutions in Hong Kong stood at 157.3 per cent (September 2018), 153 per cent (September 2019) and 156.8 per cent (September 2020). The average LCR of category 1 institutions was 156.5 per cent in the second quarter of 2020. The consolidated quarterly average LMR of category 2 institutions in Hong Kong stood at 52 per cent (September 2018), 54.5 per cent (September 2019) and 55.9 per cent (September 2020). The average LMR of category 2 institutions was 57.2 per cent in the second quarter of 2020.
iv Recovery and resolution
The HKMA is a member of the Financial Stability Board (FSB) and has committed in principle to improving the effectiveness of its own resolution regime in light of the FSB policy paper, Key Attributes of Effective Resolution Regimes, published in October 2011 and updated in October 2014. The Financial Institutions (Resolution) Ordinance,7 which is the primary legislation setting out Hong Kong's resolution regime, came into operation on 7 July 2017. The Ordinance establishes a cross-sector resolution regime for relevant financial institutions (including all AIs) with a view to avoid or mitigate the risks otherwise posed by their non-viability to the stability of Hong Kong's financial system.
The HKMA is contributing to the process of drawing up international resolution and recovery plans as a member of the crisis management groups of several G-SIBs.
In addition to the powers given under that Ordinance, the HKMA may also exercise a number of powers under the Banking Ordinance if, inter alia, an AI informs the HKMA that it is likely to become unable to meet its obligations, or that it is insolvent or about to suspend payment. The HKMA may also take such action unilaterally. In these circumstances, the HKMA, after consultation with the Financial Secretary of Hong Kong, may give directions to the AI in relation to its affairs, business and property.
The Supervisory Policy Manual contains a guideline on recovery planning, RE-1, which informs AIs of the key elements of effective recovery planning and sets out the HKMA's approach and expectations in respect of its review of recovery plans. The Banking Ordinance was amended on 2 February 2018 to give explicit statutory backing to recovery planning. The legislation covers the powers of the HKMA to:
- require the preparation and maintenance of a recovery plan;
- impose requirements on an AI to ensure the recovery plan is fit for purpose;
- impose requirements on an AI to revise its recovery plan;
- give directions to implement recovery plan measures under specific conditions;
- require AIs to notify certain trigger events; and
- extend recovery powers to an AI's locally incorporated holding company.
On 7 July 2017, the HKMA issued three codes of practice: Resolution Planning – Core information Requirements (CI-1); Operational Independence of the Monetary Authority as Resolution Authority (RA-1) and The HKMA's Approach to Resolution Planning (RA-2). On 20 March 2019, the HKMA issued the Resolution Planning – LAC Requirements (LAC-1) code of practice.
Conduct of business
i Conduct of business rules
The HKMA requires AIs to establish a code of conduct setting out the standards of behaviour expected of their management and employees. The code of conduct should discourage conflicts of interest, the granting and receiving of credit by members of staff to themselves or their relatives, bribery, personal investments when in possession of price-sensitive information and outside employment. It should also encourage staff to handle personal data carefully, and to contribute to the good reputation of the AI by reporting any illegal activities. The HKMA requires the effectiveness of the code of conduct and related systems to be audited regularly.
Furthermore, IC-1 (risk management framework) of the HKMA's Supervisory Policy Manual provides guidance on establishing an effective risk management framework (such as delineating responsibilities of the board and different committees of AIs), monitoring risk-taking activities and the risk management process and maintaining procedures to facilitate firm-wide risk.
ii The Code of Banking Practice
The Code of Banking Practice (the Code), issued jointly by the Hong Kong Association of Banks and the Deposit-taking Companies Association and endorsed by the HKMA, gives wider protection to customers and promotes good banking practices by aligning with international standards on financial consumer protection. The Code is issued on a voluntary basis, although the HKMA expects all AIs to comply with it and the HKMA monitors compliance. It covers areas such as terms and conditions, fees and charges, use of customer information, residential mortgage financing, card services and electronic banking services.
iii Banking confidentiality
Under common law, a term imposing a duty of confidentiality may be implied in contracts between a bank and its customer. The duty of confidentiality applies to information arising directly from the customer's account, and other information obtained through the relationship between the bank and the customer or in coming to decisions about the bank's treatment of its customers. For the purpose of this duty, where a banking group is structured through subsidiary companies, each subsidiary is considered as a separate entity. Therefore, restrictions on disclosure apply equally to transfers of information within a banking group as to transfers to a third party. In contrast, branches of a single corporate entity are considered to form part of the same entity. Therefore, information may be transferred freely between them subject to any applicable data protection laws.
There are four heads of acceptable disclosure of a customer's confidential information by a bank:
- compulsion of law;
- duty to the public;
- interests of the bank; and
- express or implied consent of the customer.
Head (c) is only applicable where disclosure is needed to protect the bank and not simply where it would be commercially advantageous.
Personal data are regulated in Hong Kong by the Personal Data (Privacy) Ordinance8 (PDPO). The purpose of the PDPO is to protect the privacy interests of living individuals in relation to personal data. It applies to any person (a data user) who controls the collection, holding, processing or use of personal data in Hong Kong. A 'person' for the purposes of identifying a data user includes 'any public body, any body of persons, corporate or unincorporated'. Branches as well as subsidiary companies may constitute separate data users, and transfers between them should be in accordance with the PDPO. A third party to whom data are outsourced (e.g., for the completion of IT tasks) will not be a data user for the purposes of the PDPO in relation to data it 'holds, processes or uses solely on behalf of another person' if it does not hold, process or use that data for any of its own purposes. This exemption is not available where the third party is involved in the collection of data.
According to the Code, AIs should treat their customers' (and former customers') banking affairs as private and confidential, and should at all times comply with the PDPO and any relevant codes of practice issued or approved by the Privacy Commissioner in the collection, use and holding of customer information.
In October 2014, the Office of the Privacy Commissioner for Personal Data, Hong Kong (PCPD), published a guidance note entitled, Guidance on the Proper Handling of Customers' Personal Data for the Banking Industry, which explains for the benefit of banks the PDPO requirements in relation to the collection, holding, processing and use of customer data. The guidance note contains a number of useful case studies that are based on matters that have been considered by the Privacy Commissioner. In October 2015, the PCPD published a revised edition of its frequently asked questions on Understanding the Code of Practice on Consumer Credit Data in relation to the Sharing of Mortgage Data for Credit Assessment Purpose. The publication addresses common questions regarding the regulations on the sharing of mortgage data by credit providers through a credit reference agency under the Code of Practice on Consumer Credit Data.
iv Potential sources of liability
The Supervisory Policy Manual reminds directors of AIs to be aware of their legal obligations under all applicable laws and regulations, including but not limited to the Banking Ordinance, the Companies Ordinance,9 the SFO, the PDPO, the Financial Institutions (Resolution) Ordinance, the Drug Trafficking (Recovery or Proceeds) Ordinance,10 the Organised and Serious Crimes Ordinance,11 the Anti-Money Laundering and Counter-Terrorist Financing Ordinance12 and the Prevention of Bribery Ordinance.13
The SFO contains provisions on market misconduct (insider dealing, market manipulation, disclosure of false or misleading information, etc.). The SFO also contains several key provisions applicable to AIs that are registered with the SFC to carry on a business in one or more regulated activities. In general, AIs are subject to the provisions of the SFO in the same way as licensed corporations (i.e., institutions that are licensed by the SFC) in respect of their regulated activities. The major areas of difference, arising from the need to avoid regulatory overlap with the Banking Ordinance, are capital requirements and the handling of client money.
Directors may be held personally liable for non-compliance with many of the requirements under the Banking Ordinance and the SFO. In certain circumstances, such as under some offences in the Theft Ordinance,14 directors may be held criminally liable for offences committed by companies of which they are a director.
Customer deposits are the most important source of funding for retail banks in Hong Kong. As at the end of June 2020, they accounted for 56.2 per cent of total liabilities. The high level of customer deposits has kept customer deposit rates at a low level: the average monthly savings rates for annual deposits of less than HK$100,000, as quoted by leading licensed banks, has remained low at 0.02 per cent since November 2020, a decrease from 0.12 per cent in December 2019. The high level of customer deposits also contributes to the low rate of interest offered on Hong Kong dollar loans by licensed banks in the Hong Kong interbank market (HIBOR): the one-month HIBOR averaged approximately 0.25 per cent (August 2020). HIBOR declined in 2020, reflecting a similar decrease in its US dollar counterpart and the expansion of the aggregate balance.
i Stable funding requirement
The HKMA introduced a stable funding requirement in October 2013, which requires AIs with significant loan growth to ensure they have adequate stable funding to support their lending business.
ii Provision of liquidity assistance by the HKMA
On 26 August 2019, the HKMA announced an updated liquidity facilities framework for AIs, to include a new resolution facility. The full liquidity facilities framework comprises: (1) settlement facilities (intraday repo and discount window); (2) standby liquidity facilities (including term repos and FX swaps) to make term liquidity available; (3) a contingent term facility, as a last-resort support arrangement available at the discretion of the HKMA, which will take into account contagion and systemic risks; and (4) a resolution facility, to ensure that an AI that has gone into resolution has sufficient liquidity.
On 31 March 2020, the US Federal Reserve announced the establishment of a temporary repurchase agreement facility for foreign and international monetary authorities (the FIMA Repo Facility) to help support the smooth functioning of financial markets. The HKMA, as one of the FIMA account holders, may enter into repurchase agreements with the Federal Reserve and temporarily exchange the US Treasuries held by the HKMA for US dollars, which can then be made available to AIs in Hong Kong. On 16 December 2020, the US Federal Reserve announced that the FIMA Repo Facility will continue until at least 30 September 2021.
On 3 April 2020, the HKMA encouraged AIs to utilise their liquidity buffers under the LCR and LMR regimes and stated that it will accept an AI operating temporarily with a lower level of liquidity ratio as a result.
Deposit protection scheme
Depositors receive credit protection for certain deposits (and subject to specified limits) under the deposit protection scheme (DPS), which was launched in 2006 under the Deposit Protection Scheme Ordinance15 (DPSO) under which eligible deposits are protected. Eligible deposits exclude:
- structured deposits;
- bearer instruments;
- term deposits with a maturity exceeding five years;
- deposits where the repayments are secured on the assets of the member of the DPS;
- offshore deposits;
- deposits held for the account of the Exchange Fund;
- deposits held by an excluded person under the DPSO; and
- financial products other than deposits.
The HKMA acts as an executive arm of the Hong Kong Deposit Protection Board in administering the DPS.
Only licensed banks are required and eligible to participate in the DPS. This is consistent with the aim of the DPS, which is to protect small depositors. A small number of licensed banks, which are branches of overseas-incorporated banks that are already covered by appropriate overseas deposit protection schemes, are exempted from the DPS.
The DPS is pre-funded by contributions from each member of the scheme. Further, the Deposit Protection Board has secured a credit facility from the Exchange Fund. The size of the credit facility is sufficient to cope with the simultaneous failures of two medium-sized banks.
Compensation will be paid to depositors when the court issues a winding-up order; or the HKMA, after consultation with the Financial Secretary, instructs the Deposit Protection Board to pay compensation. Under the DPS, each depositor (whether an individual or a corporate) who is not an excluded person under the DPSO is entitled to a maximum of HK$500,000 of compensation for each failed scheme member with which it places deposits.
To allow affected depositors to gain quicker access to the payout, the DPSO was amended in 2016 to adopt a gross payout approach for the determination of compensation. This enhanced protection for depositors so that any compensation paid to depositors is determined on the basis of their aggregate protected deposits held with a failed bank (up to HK$500,000 per depositor) without deducting the amount of liabilities owed by those depositors to the same bank.
Control of banks and transfers of banking business
i Control regime
Control of Hong Kong-incorporated AIs
The Banking Ordinance provides that no person shall become a controller of a Hong Kong-incorporated AI without the prior approval of the HKMA. A controller includes the following:
- an indirect controller: a person in accordance with whose directions or instructions the directors of the institution are accustomed to act;
- a majority shareholder controller: a person who controls over 50 per cent of the voting rights of the institution; and
- a minority shareholder controller: a person who controls between 10 per cent and 50 per cent of the voting rights of the institution.
Pursuant to Section 3(5) of the Legal Tender Notes Issue Ordinance,16 the Financial Secretary may amend any terms and conditions on which the authorisation to issue bank notes was granted. Shortly after Temasek Holdings, a Singapore state investment company, acquired a stake in Standard Chartered in 2006, the Financial Secretary of Hong Kong approved an additional policy requirement relating to the continuing authorisation of banks to be note-issuing banks. This provided that a note-issuing bank shall not have any close association with any foreign government or foreign government-controlled entity that either alone or with associates is entitled to control 20 per cent or more of the voting power of the note-issuing bank or its holding company. In effect, the policy requirement is a barrier to controlling 20 per cent or more of the voting power of any of the three note-issuing banks in Hong Kong (although a determined bidder may not view the note-issuing status as a fundamental issue).
While the acquisition of shareholdings and control in AIs incorporated outside Hong Kong do not need to be approved by the HKMA, the HKMA still needs to be satisfied that a person who is to be a controller of an AI is a fit and proper person to hold such a position. In doing so, the HKMA will rely heavily on the views of the home supervisor of the overseas-incorporated AI.
ii Approval process for controllers of Hong Kong-incorporated AIs
A person seeking to become a controller of a Hong Kong-incorporated AI must first serve on the HKMA a written notice of intention. The written notice must be submitted together with any supporting documents requested by the HKMA.
Subject to the below, it is generally the policy of the HKMA that a person who intends to hold 50 per cent or more of the share capital of a Hong Kong-incorporated AI should be a well-established bank or other supervised financial institution in good standing in the financial community and have appropriate experience. If a prospective majority controller does not fulfil this requirement, the HKMA's primary concern will be to ensure that any risks posed to the AI by the controller and the group to which the controller belongs are understood and well contained. To achieve this, the HKMA may impose conditions on the controller. If the controller is incorporated outside of Hong Kong, or is not a financial holding company nor a subsidiary of a financial holding company, the controller will generally be asked to establish a Hong Kong-incorporated holding company whose sole purpose will be to hold the shares of the AI. This holding company will be subject to conditions such as capital adequacy, liquidity, large exposures, intra-group exposures and charges over assets, group structure, activities undertaken, risk management, fitness and proprietary of directors and senior management and submission of financial and other information. The HKMA has recently encouraged the establishment of new virtual banks and stated in its Guideline on Authorization of Virtual Banks (reissued on 8 June 2018) that these conditions (on the establishment and supervision of a Hong Kong holding company) mean that non-financial firms (including technology companies) may apply to own and operate a virtual bank in Hong Kong.
The Banking Ordinance does not specify when written notice needs to be submitted to the HKMA. However, the HKMA's preference is to be approached at the earliest appropriate opportunity, and experience has indicated that the HKMA expects to be approached for an approval in principle before the formal application process begins. This includes an expectation to pre-vet any proposed announcement of the sale of an AI (regardless of whether or not the AI is incorporated in Hong Kong).
The HKMA then has up to three months from the date of service of the notice to serve a notice of consent, and the HKMA may need the full three months, particularly if the proposed controller is not an established bank or financial institution. In other, more straightforward cases, this period is normally six weeks to two months. The HKMA will be taken to have consented to a person becoming a controller of a Hong Kong-incorporated AI if it does not serve on him or her a notice of objection within the three-month period.
In granting the notice of consent, the HKMA:
- must be satisfied that the person is a fit and proper person to become a controller of the Hong Kong-incorporated AI;
- must be satisfied that the interests of depositors and potential depositors of that Hong Kong-incorporated AI would not be threatened by that person becoming a controller;
- takes into account the person's likely influence on that Hong Kong-incorporated AI if he or she were to become a controller; and
- will take into account the financial position, reputation or conduct of the applicant to determine whether the controller could potentially damage the Hong Kong-incorporated AI through contagion.
In granting the notice of consent, the HKMA may specify such conditions as it thinks proper to safeguard the interests of depositors and potential depositors.
Although not explicitly set out in the legislation, the HKMA will take similar considerations into account when considering controllers of non-Hong Kong-incorporated AIs, which it will review in the context of whether an AI remains fit and proper.
If the HKMA has served a notice of consent to the applicant, that person must become a controller within 12 months of the date on which he or she was served the notice of consent.
Controller financial support
Where a minority or majority shareholding in a Hong Kong-incorporated AI is being acquired, the HKMA will generally require the acquiring shareholder controller to provide a letter of comfort committing to provide capital support, liquidity support or both to the AI, if necessary. The form of the letter of comfort is set out in the HKMA's Guide to Authorization.
Transfers of banking business
While other common law jurisdictions have a court-sanctioned scheme process to effect the transfer of banking business without the consent of the depositors or other counterparties, Hong Kong does not have an equivalent process.
Notification to the HKMA
A Hong Kong-incorporated AI cannot make any arrangement, or enter into any agreement for the sale or disposal of all or any part of its banking business or its business of taking deposits, without the prior written approval of the HKMA.
Private member's bill
In a business or asset transfer in Hong Kong, private legislation is the only alternative to obtaining individual customer consent.
A private member's bill is a special type of legislation intended to affect or benefit some particular person, association or corporate body. It may be used to transfer all or part of a company's business to another company or to extinguish the rights of any creditor of the company, or both. The private member's bill procedure has been used for a number of bank mergers with a Hong Kong element (e.g., Citibank, Dao Heng Bank, Standard Chartered and Bank of Communications), although this procedure is rare and is not currently favoured by the HKMA.
The customer consent route is the usual form of transfer.
The year in review
On 3 November 2020, the HKMA informed AIs of the introduction of the Cybersecurity Fortification Initiative 2.0. This follows on from a review of the previous cybersecurity fortification initiative that was launched in 2016.
The initiative is underpinned by three pillars: (1) the Cyber Resilience Assessment Framework; (2) the Professional Development Programme; and (3) the Cyber Intelligence Sharing Platform.
The initiative came into effect on 1 January 2021 and is subject to a phased implementation approach for completing the relevant assessments (ranging from September 2021 to December 2021).
On 10 July 2020, the HKMA stated that it expects AIs to endeavour (and put in place detailed work plans) to achieve the following London interbank offered rate (LIBOR) transition milestones: (1) AIs should be in a position to offer products referencing the alternative reference rates to LIBOR from 1 January 2021; (2) adequate fall-back provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021 from 1 January 2021; and (3) AIs should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021.
On 23 July 2020, the HKMA confirmed that amendments to the terms of capital instruments to implement interbank offered rates (IBOR) benchmark reforms will not result in instruments being assessed anew under the Banking (Capital) Rules.
On 16 October 2020, the HKMA requested AIs to take early action to adhere to the International Swaps and Derivatives Association 2020 IBOR Fallbacks Protocol and to take proactive steps to encourage counterparties to do the same. The HKMA referred to its previous request for AIs to endeavour to include, from 1 January 2021, adequate LIBOR fallback provisions in all newly issued LIBOR-linked contracts that will mature after 2021.
On 21 October 2020, the HKMA reminded AIs to ensure fair treatment of customers in the reform and transition of interest rate benchmarks. This includes identifying any potential impact of the transition of interest rate benchmarks and their products and explaining clearly such impact to customers, especially retail banking customers. AIs are expected to develop robust customer communication programmes for consumer education and outreach. The HKMA stressed it is essential for AIs to make the necessary planning and preparation in advance, including sufficient training and up-to-date information to all relevant frontline staff.
iii Updates to the Supervisory Policy Manual
The HKMA continues to update the Supervisory Policy Manual, including, in particular:
- Module RE-1 (Recovery Planning) on 19 June 2020, to update it to consolidate previous HKMA guidance that was previously contained in an HKMA circular;
- Module CA-G-1 (Overview of Capital Adequacy Regime for Locally Incorporated Authorized Institutions) on 19 June 2020, to update it to:
- revise the guidance on the self-assessment of proposed capital instruments to be included within an authorised institution's capital base so as to align with the equivalent guidance in the 'Resolution Planning – LAC Requirements' (LAC-1) code of practice;
- update the guidance in relation to capital buffers, revised securitisation framework, sovereign concentration risk, leverage ratio and interest rate risks in the banking book to reflect the current capital regime in Hong Kong (in terms of both legal framework and associated supervisory practices); and
- outline the HKMA's plan to implement the remaining Basel Committee on Banking Supervision (BCBS) capital standards, covering those in relation to the Basel III final reform package. Of particular note is the HKMA's expectation that AIs should ensure that the terms of their future financial contracts are drafted so that a bearing of loss or a writing-off or conversion under a capital instrument does not trigger cross-default or cross-acceleration rights in those other financial contracts;
- Module LM-1 (Regulatory Framework for Supervision of Liquidity Risk) on 28 August 2020, to update it in light of the commencement of the Banking (Liquidity) (Amendment) Rules 2019 and to reflect developments in the Basel III liquidity standards; and
- Module CR-G-14 (Non-centrally Cleared OTC Derivatives Transactions – Margin and Other Risk Mitigation Standards) on 11 September 2020, to update it to:
- revise the phase-in schedule of initial margin requirements according to the announcement made by the BCBS and the International Organization of Securities Commissions (IOSCO) in April 2020;
- update the list of jurisdictions deemed comparable under the HKMA's margin requirements and risk mitigation standards; and
- clarify that genuine amendments made to existing derivatives contracts to give effect to benchmark reforms will not be considered as new contracts subject to the margin requirements.
On 16 March 2020, the HKMA issued its second edition of Regtech Watch. The publication highlights technology applications in credit risk management, including the application of machine learning models and other technologies to overcome challenges in credit underwriting and risk management processes. Cases include the use of data-driven income estimation to approve personal loans, machine learning-based methods to streamline corporate loan underwriting, and linguistic and sentiment analysis to identify adverse news about a borrower.
In June 2020, the HKMA issued its third edition of Regtech Watch. The publication highlights technology in supporting the effective implementation of anti-money laundering (AML) and counter-financing of terrorism (CFT) measures.
On 27 July 2020, the HKMA announced the appointment of KPMG Advisory (Hong Kong) Limited to assist with organising and rolling out activities to facilitate the adoption of regtech. As part of this work, the HKMA launched a regtech survey to collect views and insights around regtech development. The HKMA will prepare a white paper on regtech to analyse the current regtech landscape, identify pain points for regtech adoption and set out a roadmap for encouraging regtech growth and talent development.
On 29 September 2020, the HKMA informed AIs of the implementation of the 'AML/CFT Surveillance Capability Enhancement Project' (the AMLS Project), through which the HKMA is strengthening the use of data and supervisory technology in its risk-based AML/CFT supervision. This responds to the international trend of leveraging technology and data to identify and assess money laundering and terrorist financing risks to the stability and integrity of the financial system. AIs are asked to assess the implications of the AMLS Project with respect to the adoption of regtech solutions in their AML/CFT programmes.
In September 2020, the HKMA issued its fourth edition of Regtech Watch. The publication highlights technology applications in conduct risk management. The HKMA noted that, in general, AIs manage conduct risk by implementing surveillance programmes to: (1) monitor employee activities and detect irregular behaviour; and (2) collect data that can help the AI identify drivers of misconduct.
In December 2020, the HKMA issued its fifth edition of Regtech Watch. The publication highlighted the following.
- Remote access and collaboration platforms to support remote learning: this includes video conference solutions with additional security and storage of data on centralised and cloud-based data management systems that can be securely and remotely accessed.
- Enabling compliant business communication: this includes all-in-one enterprise messaging platforms that can bring together various messaging platforms such as WhatsApp and WeChat, so that all relevant communications are logged and auditable.
- Use of robotic process automation to streamline the process of granting covid-19 relief (by principal payment deferral): the robotic process automation performs time-consuming and repetitive work on a 24/7 basis and streamlines the process.
- Social distancing and contact-tracing solutions: artificial intelligence and three-dimensional cameras can measure the distance between customers, to identify in real time cases that breach the social distancing requirements and thereby assist in prompt remediation. Mobile phones' electronic signals (e.g., Bluetooth and wi-fi) and proximity data may (with user consent) be used to reconstruct contact histories of employees, to identify higher-risk employees and advise them to undergo self-isolation.
v Over-the-counter derivatives
Mandatory reporting of over-the-counter (OTC) derivatives came into effect on 10 July 2015 (although licensed banks were previously reporting OTC derivatives under simplified interim reporting requirements introduced in 2013). The scope of mandatory reporting was expanded on 1 July 2017 and currently covers certain interest rate swaps, non-deliverable forwards, FX derivatives, equity derivatives, credit derivatives and commodity derivatives.
Mandatory clearing (and related record-keeping requirements) of OTC derivatives commenced on 1 September 2016. This first phase of mandatory clearing focuses on certain standardised interest rate swaps denominated in US dollars, euros, sterling, Japanese yen or Hong Kong dollars and entered into between 'major dealers' – namely AIs, approved money brokers and licensed corporations – or between a major dealer and a 'financial services provider' specified on a list prepared by the SFC and approved by the HKMA. AIs that exceed the relevant average three-month clearing threshold (currently US$20 billion, which is determined in respect of all outstanding OTC derivatives (other than certain deliverable FX forwards and deliverable FX swaps)) will – if its counterparty is a major dealer that also exceeds the clearing threshold, or if its counterparty is a designated financial services provider – be subject to mandatory clearing and related record-keeping obligations in respect of the relevant interest rate swaps (although in respect of an AI incorporated outside Hong Kong, the obligations apply only to the transactions that are recorded in the Hong Kong books of that AI).
On 11 September 2020, the HKMA revised the Supervisory Policy Manual module (CR-G-14) on margin and other risk mitigation standards for non-centrally cleared OTC derivatives. The margin provisions apply to an AI in respect of certain non-centrally cleared derivatives it enters into with a 'covered entity' (although in respect of an AI incorporated outside Hong Kong, the obligations only apply to the transactions that are recorded in the Hong Kong books of that AI). A covered entity means: (1) a financial counterparty, meaning (broadly) a licensed or regulated entity that has, or whose group has, an average aggregate notional amount of non-centrally cleared derivatives for the relevant annual testing period (AANA) exceeding HK$15 billion; or (2) a significant non-financial counterparty, meaning a non-financial counterparty that has, or whose group has, an AANA exceeding HK$60 billion. The requirement to exchange variation margin started from 1 March 2017. The requirement to exchange initial margin has been phased in from that date, with a current AANA threshold for both the AI and its covered entity counterparty of HK$6 trillion, reducing to HK$375 billion with effect from 1 September 2021 and then HK$60 billion with effect from 1 September 2022. This delay follows the deferrals announced by the Basel Committee and IOSCO.
vi Bank culture reform
On 2 March 2017, the HKMA issued a circular seeking to promote sound corporate culture for banks. The circular concentrates on governance (emphasising the importance of senior management setting an appropriate tone from the top and leading by example), incentive systems (to avoid incentivising short-term business performance at the expense of the interests of customers and the safety and soundness of a bank) and assessment and feedback mechanisms (to monitor adherence to banks' cultures and behavioural standards, and to set out escalation steps, including whistle-blowing mechanics). Necessary enhancement measures were required to be implemented by 2 March 2018.
On 19 December 2018, the HKMA announced further measures to gauge the progress of bank culture reform in Hong Kong, stating that it will implement a number of supervisory measures. These include: AI self-assessments being extended to cover the banking culture; the HKMA, via site visits and off-site reviews, assessing and benchmarking AIs' practices; and the HKMA meeting with senior management and board members of AIs to gather insights and any lessons they have learnt.
The HKMA launched the first phase of AI self-assessment on culture in early 2019, requiring 30 AIs (including major retail banks in Hong Kong and selected foreign bank branches with substantive operations in Hong Kong) to submit their self-assessment outcomes within six months. The HKMA published its initial observations from the AI self-assessment exercise on 14 January 2020. Going forward, the HKMA plans to further progress its culture supervisory measures, including: (1) sharing more observations from its review of AI self-assessments; (2) commencing focused deep-dive reviews into certain key areas of banking culture, such as incentive systems of front offices in specific business streams of retail banks; and (3) continuing its culture dialogues with AIs.
On 22 May 2020, the HKMA issued the Report on Review of Self-assessments on Bank Culture, which covered a range of practices, including governance, incentive systems and assessment and feedback mechanisms. Common themes identified in the Report include:
- further work is needed to ensure incentive systems are designed to promote sound culture and prevent incidents of misconduct;
- stronger links are required to connect Hong Kong operations with the culture efforts of their headquarters or upstream entities as well as their downstream operations, as appropriate;
- deeper analysis is expected to benchmark AIs against the findings from the reviews of the major overseas misconduct incidents;
- more focus is needed to facilitate the undertaking by relevant staff of the continuous professional development under the Enhanced Competency Framework issued by the HKMA or by other professional bodies to complement the effort of promoting sound culture;
- more effort is needed to tackle the key challenge of culture assessment to identify the gaps between current progress and desired culture;
- more work is needed in promoting an environment that provides 'psychological safety' to encourage staff to speak up without fear of adverse consequences; and
- sustained effort is required in driving cultural changes and AIs should be mindful of 'culture fatigue'.
vii Green finance and green banking
On 13 May 2020, the HKMA announced a self-assessment framework to assess the 'greenness baseline' of an AI. The framework collects information about the stage of an AI's development with respect to climate risks and environmental risks under six key elements: governance; corporate planning and tools; risk management process; business policies, products and services; performance and resources; and disclosure and communication.
On 30 June 2020, the HKMA published a white paper on green and sustainable banking, setting out initial thoughts on supervisory expectations around four areas.
- Governance: AIs should develop a governance framework for climate resilience. The board should oversee the development and implementation of the AI's climate strategy.
- Strategy: AIs should embed climate considerations throughout the strategy formulation process, while organisational structures, business policies, processes and resources availability should be reviewed and enhanced to ensure effective strategy implementation.
- Risk management: AIs are expected to incorporate climate risk considerations into their existing risk management framework. They should identify the transmission channels and assess the impacts of physical and transition risks arising from climate change on their business. To this end, AIs should build capability over time to measure climate risks using various methodologies and tools, particularly scenario analysis. They should also implement processes to monitor and report exposures to climate risks and carry out measures to control and mitigate the exposures.
- Disclosure: AIs should develop an approach to disclosing climate-related information to enhance transparency. When considering the information to be disclosed, AIs should take the Task Force on Climate-related Financial Disclosures recommendations as the core reference.
The HKMA recommends AIs to consider these practices when developing their risk management framework (although noting that the practices are not prescriptive). The HKMA emphasises the importance of AIs being agile and responsive to changes when managing climate risks, given the nature of the risks.
On 7 July 2020, the HKMA published the 'Range of practices for management of climate risks' circular, setting out practical practices adopted or to be adopted by AIs that are more advanced in progressing their management of climate risks.
On 4 December 2020, the HKMA invited AIs to participate in a pilot exercise on a climate risk stress test to be undertaken in 2021. The objective of the exercise is to assess the climate resilience of the banking sector as a whole and to facilitate the capability-building of participating banks for measuring climate risks.
viii US dollar liquidity facility
On 22 April 2020, the HKMA introduced a temporary US dollar liquidity facility to help licensed banks meet their US dollar funding needs. The liquidity facility is part of a concerted effort by central banks to help alleviate tightness in the global US dollar interbank money markets brought about by the covid-19 outbreak. In principle, the liquidity facility is underpinned by the US Federal Reserve's FIMA Repo Facility. Competitive tenders for licensed banks to submit bids for US dollar liquidity will be conducted weekly. US$10 billion is available. The liquidity facility provides US dollar liquidity in the form of repurchase transactions (with the borrower licensed corporation providing eligible assets to the HKMA as collateral) for a term of seven days.
ix Covid-19 outbreak
On 6 February 2020, the HKMA published the 'Measures to relieve impact of the novel coronavirus' circular, in which it welcomed initiatives taken by some AIs to roll out temporary relief measures for their customers during this difficult time. Measures considered included a principal repayment moratorium for residential and commercial mortgages, fee reduction for credit card borrowing and restructuring of repayment schedules for corporate loans. The HKMA encouraged other AIs to consider taking similar action and indicated that a proactive response by the banking industry will help mitigate the financial consequences of the outbreak. The HKMA has extended the pre-approved principal repayment holiday scheme for small and medium corporates, most recently on 4 March 2021, to include principal debt otherwise due to be repaid on or before 31 October 2021.
On 7 February 2020, the HKMA reminded AIs that if they had operational difficulties meeting certain lodgement timing deadlines for documents such as audited accounts, they may apply to the HKMA for an extension.
In April 2020, the government introduced a concessionary low-interest loan under the SME Financing Guarantee Scheme, in which a 100 per cent loan guarantee is provided by the government to the lending AIs for a total loan guarantee commitment of HK$20 billion.
On 24 September 2020, the HKMA set out key principles in relation to remote onboarding of corporate customers. The HKMA emphasised that 'it is not necessary to ask a corporate's representative to visit the AI's business premise or to be physically present in front of a staff of the AI concerned in every case'.
x Launch of iAM Smart
On 29 December 2020, the Office of the Government Chief Information Officer launched the initiative of iAM Smart. In a circular of the same date, the HKMA encouraged AIs and Stored Value Facility licensees to actively consider the adoption of iAM Smart.
iAM Smart provides all Hong Kong residents with a single digital identity and authentication to conduct government and commercial transactions online. Users can make use of the biometrics in their personal mobile devices to authenticate their identities, which will have been verified against their Hong Kong ID cards during the iAM Smart registration process. This means that users can enjoy convenient access to various online services without the need to manage different groups of usernames and passwords or carry multiple security tokens. It is also possible (by attending in person for registration) for iAM Smart to support digital signing with legal backing under the Electronic Transactions Ordinance17 (legal backing means that it can be used to sign statutory forms and contracts with government).
iAM Smart may be used to store personal data. This avoids users filling in the same date when making different online applications. Users may also consent to their personal data being provided to other entities for different online services. iAM Smart is expected to facilitate remote onboarding of customers.
The HKMA regards the introduction of iAM Smart as a key milestone in the development of Hong Kong's fintech ecosystem.
xi Enhanced Competency Framework on Operational Risk Management
On 18 December 2020, the HKMA announced the launch of the Enhanced Competency Framework on Operational Risk Management. The Framework establishes a set of common and transparent competency standards for raising the professional competence of practitioners working in the operational risk management function of AIs. The intention is for the Framework to facilitate talent development and help enhance the professional competencies of bank staff engaged in operational risk management.
AIs are encouraged to adopt the Framework as part of their overall efforts in supporting relevant employees' ongoing professional development. The Framework is not, however, a mandatory licensing regime.
Looking back, the HKMA has previously launched six enhanced competency framework modules, covering:
- private wealth management;
- AML and CFT;
- treasury management;
- retail wealth management; and
- credit risk management.
Outlook and conclusions
We anticipate the following areas of focus or development in the next 12 months:
- further focus on regtech solutions, including for know-your-customer operations and procedures; and
- continuing focus on progressing the issuance of green finance in the Hong Kong markets.
1 Peter Lake is a partner at Slaughter and May. The author would like to thank his colleagues Ada Zhang and Adrien Yeung for their assistance in preparing this chapter.
2 Chapter 155 of the Laws of Hong Kong.
3 Chapter 571 of the Laws of Hong Kong.
4 Chapter 155L of the Laws of Hong Kong.
5 Chapter 628 of the Laws of Hong Kong.
6 Chapter 155Q of the Laws of Hong Kong.
7 Chapter 628 of the Laws of Hong Kong.
8 Chapter 486 of the Laws of Hong Kong.
9 Chapter 622 of the Laws of Hong Kong.
10 Chapter 405 of the Laws of Hong Kong.
11 Chapter 455 of the Laws of Hong Kong.
12 Chapter 615 of the Laws of Hong Kong.
13 Chapter 201 of the Laws of Hong Kong.
14 Chapter 210 of the Laws of Hong Kong.
15 Chapter 581 of the Laws of Hong Kong.
16 Chapter 65 of the Laws of Hong Kong.
17 Chapter 553 of the Laws of Hong Kong.