People’s Republic of China-Hong Kong Special Administrative Region
Financial Sector Assessment Program-Basel Core Principles for Effective Banking Supervision-Detailed Assessment of Observance

This Basel Core Principles (BCP) for Effective Banking Supervision Detailed Assessment Report has been prepared in the context of the Financial Sector Assessment Program for the People’s Republic of China–Hong Kong Special Administrative Region (HKSAR). The Hong Kong Monetary Authority (HKMA) supervises a major international financial center which was affected, though not significantly so, by the financial crisis. The HKMA is maintaining its commitment to the international regulatory reform agenda and is an early adopter of many standards. Supervisory practices, standards, and approaches are well integrated, risk based and of very high quality. There is one area in relation to the overarching legislative framework and powers which warrants further attention. The HKMA enjoys clear de facto but not de jure operational independence. There are two important cross border dimensions for Hong Kong as an international financial center. One is related to HKSAR’s significant position as a host supervisor. The second is the increasing importance of Mainland China in the current portfolios and prospects of the locally incorporated institutions, and indeed in the choice of HKSAR as a platform for overseas institutions to establish relationships with Mainland China.

Abstract

This Basel Core Principles (BCP) for Effective Banking Supervision Detailed Assessment Report has been prepared in the context of the Financial Sector Assessment Program for the People’s Republic of China–Hong Kong Special Administrative Region (HKSAR). The Hong Kong Monetary Authority (HKMA) supervises a major international financial center which was affected, though not significantly so, by the financial crisis. The HKMA is maintaining its commitment to the international regulatory reform agenda and is an early adopter of many standards. Supervisory practices, standards, and approaches are well integrated, risk based and of very high quality. There is one area in relation to the overarching legislative framework and powers which warrants further attention. The HKMA enjoys clear de facto but not de jure operational independence. There are two important cross border dimensions for Hong Kong as an international financial center. One is related to HKSAR’s significant position as a host supervisor. The second is the increasing importance of Mainland China in the current portfolios and prospects of the locally incorporated institutions, and indeed in the choice of HKSAR as a platform for overseas institutions to establish relationships with Mainland China.

Summary of Key Findings and Preconditions

A. Introduction

1. HKSAR has a very high level of compliance with the Basel Core Principles (BCPs) for Effective Banking Supervision. The HKMA supervises a major international financial center which was affected, though not significantly so, by the financial crisis. The banking system is characterized by the dominant presence of institutions with foreign ownership, including the systemic note-issuing banks, which puts a premium on the Hong Kong Monetary Authority’s (HKMA’s) role as a host supervisory authority.

2. The HKMA is maintaining its commitment to the international regulatory reform agenda and is an early adopter of many standards. Supervisory practices, standards and approaches are well integrated, risk based and of very high quality. A number of the HKMA practices around corporate governance issues, including close and continuing attention to fit and proper standards and to the role played by the Board of an authorized institution (AI) deserve particular commendation.

3. There is one area in relation to the overarching legislative framework and powers which warrants further attention. The HKMA enjoys clear de facto but not de jure operational independence. Taken as a whole, there is much very good practice and certain important safeguards are in place, such as the potential for judicial review of decisions taken by government authorities. Nonetheless, the independence of the HKMA is not as fully protected by law as it could be.

4. There are two important cross border dimensions for Hong Kong as an international financial center. One is related to HKSAR’s significant position as a host supervisor. The second is the increasing importance of Mainland China in the current portfolios and future prospects of the locally incorporated institutions, and indeed in the choice of HKSAR as a platform for overseas institutions to establish relationships with Mainland China. The HKMA is alert to the potential risks of these dimensions and reflects this awareness in its supervisory planning, activities and relationships with other authorities. Nonetheless, techniques of cross border oversight continue to evolve and the HKMA is urged to remain in the forefront of, and contribute to, developing international supervisory practice, as it already recognizes it needs to do.

5. There are minor regulatory gaps both in respect of the HKMA’s powers and regulatory definitions. At present the good practices surrounding lending to parties related to the AI do not apply to its management. Consequently, the definition of related party (or the equivalent term in the Banking Ordinance, BO) needs to be expanded. In relation to external auditors, the HKMA does not have the explicit power to remove the auditor of an AI or to have direct access to the external auditor’s working papers. While the HKMA has been able to work around these restrictions, amendments to the appropriate legislation should be made.

B. Information and Methodology Used for Assessment

6. This assessment of the BCP for Effective Supervision is part of the 2013 FSAP update for HKSAR. The assessment of the HKMA was conducted during an IMF mission that visited HKSAR from November 7–26, 2013.1 HKSAR is among the early jurisdictions to be assessed against the BCP methodology issued by the Basel Committee on Banking Supervision (BCBS) in September 2012. In their self-assessment the authorities addressed both essential and additional criteria and the assessors have based their conclusions on compliance with both criteria. The last BCP assessment was conducted in 2002.

7. It should be noted that the ratings assigned during this assessment are not directly comparable to previous assessments. Gradings cannot be compared between this assessment and the former assessment as each has taken place under a different iteration of the methodology. In fact the methodology had been revised twice, in 2006 and again in 2012, since the last assessment and HKSAR was not assessed against the 2006 methodology. In revising the Core Principles (CPs) to reflect the lessons from the recent financial sector crisis, the BCBS has sought to raise the bar for sound supervision and to update the principles on the basis of emerging supervisory best practices. New principles have been added to the methodology along with new essential criteria for each principle that provide more detail and additional criteria that raise the bar even higher. Altogether, the revised CPs now contain 247 separate essential and additional criteria against which a supervisory agency may now be assessed. In particular, the revised BCPs strengthen the requirements for supervisors, the approaches to supervision and supervisors’ expectations of banks. While the BCP set out the powers that supervisors should have to address safety and soundness concerns, there is a heightened focus on the actual use of the powers, in a forward-looking approach through early intervention.

8. The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with officials of the HKMA, and additional meetings with the Financial Services and the Treasury Bureau (FSTB), auditing firms, professional bodies, and banking sector participants. The authorities provided a comprehensive self-assessment of the CPs, as well as detailed responses to additional questionnaires, and facilitated access to supervisory documents and files on a confidential basis as well as staff and systems.

9. The team appreciated the very high quality of cooperation received from the authorities. The team extends its thanks to staff of the authorities, who provided excellent cooperation, including extensive provision of documentation and technical support, at a time when many other initiatives related to domestic and global regulatory initiatives were in progress.

10. The standards were evaluated in the context of the Hong Kong financial system’s sophistication and complexity. The CPs must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of application, a proportionate approach is adopted within the CP, both in terms of the expectations on supervisors for the discharge of their own functions and in terms of the standards that supervisors impose on banks. An assessment of a country against the CPs must, therefore, recognize that its supervisory practices should be commensurate with the complexity, interconnectedness, size, and risk profile and cross-border operation of the banks being supervised. In other words, the assessment must consider the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria. For these reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

11. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team. Banking systems differ from one country to another, as do their domestic circumstances. Furthermore, banking activities are undergoing rapid change after the crisis, prompting the evolution of thinking on, and practices for, supervision. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Hong Kong authorities with an internationally consistent measure of the quality of their banking supervision in relation to the revised CPs, which are internationally acknowledged as minimum standards.

C. Overview of Institutional Setting and Market Structure

12. HKSAR has a large and well developed financial system. The banking sector includes 201 institutions—156 licensed banks, 21 restricted license banks, and 24 deposit taking companies—with assets equivalent to over 735 percent of GDP. The assets of the four largest banks—The Hong Kong and Shanghai Banking Corporation Limited (HSBC), Hang Seng Bank Limited (a subsidiary of HSBC), Bank of China (Hong Kong) Limited, and Standard Chartered Bank (Hong Kong) Limited—account for almost half of the total consolidated assets of the banking system. Lending to the corporate sector represents around half of the banking system’s total lending, while property-related lending accounts for about 30 percent.

13. HKSAR is an open banking market with significant foreign participation. Of the 156 licensed banks, 135 are foreign branches and 14 are foreign subsidiaries. There is a strong presence from global systemically important banks (G-SIBs) as 27 out of the 29 G-SIBs identified by the Financial Stability Board (FSB) in November 2013 undertake banking activities in HKSAR. Accounting for about 35 percent of total assets of the banking system, foreign branches operate a diversity of business models in HKSAR: some act as group liquidity hubs, some conduct investment banking activities, others are active in corporate lending or the local interbank market, and a few of them also have a substantial retail engagement.

14. In HKSAR, there are three tiers of deposit-taking institution. These institutions, collectively referred to as AIs, are regulated and supervised by the Monetary Authority (MA), through his office of the HKMA. These are (i) licensed banks—which can carry on the full range of banking business; (ii) restricted license banks (RLBs) (mostly merchant or investment banks) which may take deposits of at least HK$500,000 (or an equivalent amount in any other currency) without limit on term; and (iii) deposit-taking companies (DTCs) (principally consumer and trade finance companies) which may take deposits of at least HK$100,000 (or an equivalent amount in any other currency) of a tenor of not less than three months.

15. Hong Kong banks are well capitalized, profitable and have extremely low levels of nonperforming loans. The banking sector also appears well placed to meet new Basel liquidity standards. Banks’ capital adequacy remains robust at around 16 percent, with banks’ Tier 1 capital ratio at over 13 percent. Solvency stress tests conducted by the HKMA suggest that banks’ capital adequacy is generally resilient to both domestic and external shocks, including sharp increases in interest rates. Profitability is supported by steady improvements in net interest income since the cyclical trough in the first half of 2010. Banks’ funding continues to be dominated by customer deposits, with their share of funding constituting around 55 percent of liabilities. Sector wide liquidity, measured at 39 percent according to the HKMA metric is well above the statutory minimum of 25 percent and major banks will be required to adjust to the Basel 3 liquidity coverage ratio that will be implemented in HKSAR from 2015, while other AIs will be required to observe a modified version of the existing liquidity ratio. The loan to deposit ratio has increased steadily since 2009, reaching 72 percent in June 2013.

16. The Hong Kong securities markets are among the largest in the world and the insurance sector is large and well capitalized. As of June 2013, the total market capitalization of the stock exchange was US$2.7 trillion (HK$20.6 trillion), the sixth largest market capitalization among stock markets worldwide, or 1,000 percent of GDP. Nearly half of the 1,567 listed companies are from Mainland China, representing 56 percent of the total capitalization. In the insurance sector insurance penetration was 12.5 percent of GDP in 2012, predominantly from long-term insurance business. The insurance sector included 155 licensed insurers as at end of 2012—and as in the banking sector, many are foreign owned.

17. The stability of the system is underpinned by the Exchange Fund. The Fund includes assets backing the monetary base (HK$1.3 trillion as of June 2013), the fiscal and other government reserves (HK$0.9 trillion), plus other assets. Whilst the primary objective of the Fund is to sustain the currency stability (through the Linked Exchange Rate System), it can also be used to maintain the stability and integrity of HKSAR’s monetary and financial systems. In particular, it can be used to provide both liquidity and capital to the banking system in circumstances where there are implications for systemic stability and provides the backstop for the Deposit Protection Scheme (DPS). A swap facility with the People’s Bank of China provides a renminbi liquidity backstop (of HK$0.5 trillion).

D. Preconditions for Effective Banking Supervision

Sound and sustainable macroeconomic and financial sector policies

18. HKSAR has a well-established framework of fiscal, monetary and other macroeconomic policies. HKSAR has a highly externally-oriented economy, resulting in a high correlation to changes in global economic conditions, particularly those affecting the regional markets and its major trading counterparts in the Asian region and the United States. The nature of its economy underlies the importance of the stability of the external value of its domestic currency. In this connection, the primary monetary policy objective of HKSAR is to maintain currency stability, in terms of a stable exchange rate of the Hong Kong dollar against the U.S. dollar at a linked exchange rate. The linked exchange rate system was established in 1983 and is backed by foreign exchange reserves (of US$303.5 billion as at end-September 2013).

The Framework for Financial Stability Policy Formulation

Institutional and Legal Setting

19. In HKSAR, responsibilities for supervision of financial institutions and markets are divided among four principal financial regulators. The banking, securities and insurance industries and the operation of the Mandatory Provident Fund (MPF) and occupational retirement schemes are primarily regulated by four financial regulators, namely, the MA, the Securities and Futures Commission (SFC), the Insurance Authority (IA) and the Mandatory Provident Fund Schemes Authority (MPFA). Each of the financial services sectors is subject to a licensing/registration regime and a regulatory framework for ensuring the on-going safety and soundness of regulated entities and the conduct of their business in a proper, prudent manner. The supervisory authorities and agencies seek to ensure effective supervisory cooperation to ensure cross-sector issues of mutual concern can be dealt with in an effective manner.

Monetary Authority

20. The principal function of the MA, under the BO, is to promote the general stability and effective working of the banking system. The objectives of the BO are to regulate banking business and the business of taking deposits; to make provision for the supervision of AIs so as to provide a measure of protection to depositors; to promote the general stability and effective working of the banking system; to make provision for the supervision of money brokers and to provide for matters incidental thereto or connected therewith. The MA has issued ancillary rules and guidelines under the BO in relation to a range of areas and activities. The MA is the Chief Executive of an organization, referred to as the HKMA, which works to enable the MA to fulfill his statutory responsibilities. The activity which attracts regulation and supervision by the MA as an AI is the carrying on in Hong Kong of a business of taking deposits. Some nonbanking activities (e.g., securities, insurance and MPF intermediary activities) are conducted by AIs. As their front-line supervisor, the MA is responsible for supervising these activities in collaboration with the SFC, the IA, and the MPFA. AIs are also required to comply with the relevant codes or standards issued from time to time by these authorities.

21. The MA is also responsible for supervising money brokers which provide interbank broking services for their customers in making deposits of any currency, foreign exchange and related derivative products in HKSAR. Generally, money brokers do not take, buy or sell positions on their own behalf and only act as intermediaries between principals. In HKSAR, the number of money brokers is small and they do not pose significant systemic risk to the interbank foreign exchange and deposit markets.

Securities and Futures Commission

22. The regulatory objectives of the SFC as set out in the Securities and Futures Ordinance (SFO) include to maintain and promote the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry; to provide protection for members of the public investing in or holding financial products; to minimize crime and misconduct in the securities and futures industry; and to reduce systemic risks in the securities and futures industry. There are 10 “regulated activities” (including dealing in securities, advising on securities, dealing in futures contracts, advising on futures contracts, and asset management) stipulated under the SFO. In addition, the SFC has issued ancillary rules, codes and guidelines to govern specific operations.

Insurance Authority

23. The IA is responsible for regulating and supervising the insurance industry of Hong Kong. The IA is supported by the Office of the Commissioner of Insurance, a government department in HKSAR. As mandated in the Insurance Companies Ordinance (ICO), the principal function of the IA is to regulate and supervise the insurance industry for the promotion of the general stability of the insurance industry and for the protection of existing and potential policy holders. The IA’s major duties and powers include authorization of insurers, regulation of insurers and insurance intermediaries and liaison with the insurance industry. Insurance intermediaries in HKSAR are subject to a self-regulatory regime, under which self-regulatory organizations (SROs) approved by the IA perform supervisory, investigative, disciplinary and other regulatory functions on insurance intermediaries. Insurance intermediaries are required to be registered with one of the three SROs.

Mandatory Provident Fund Schemes Authority

24. The MPFA’s primary objectives under the Mandatory Provident Fund Schemes Ordinance (MPFSO) are to ensure compliance with the Ordinance and protect the interests of MPF scheme members. MPF intermediaries (selling and advising on MPF products) are required to be registered by the MPFA under the MPFSO. The MPFA also acts as the Registrar of Occupational Retirement Schemes under the Occupational Retirement Schemes Ordinance (ORSO). ORSO schemes are retirement schemes set up voluntarily by employers.

Money Service Operators

25. The Commissioner of Customs and Excise (CCE) is the authority in charge of licensing and supervising the Money Service Operator sector. Authorization by the CCE is required under the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO), for any person who wishes to operate money changing and/or remittance services as a business in HKSAR.

Role of self-regulatory organizations

26. In HKSAR there is currently a self-regulatory regime for insurance intermediaries. Three SROs, namely the Insurance Agents Registration Board under the Hong Kong Federation of Insurers, the Hong Kong Confederation of Insurance Brokers (HKCIB) and the Professional Insurance Brokers Association (PIBA), are responsible for the registration and conduct regulation of insurance intermediaries. The IA maintains general oversight over the SROs to ensure that they discharge their duties effectively. The self-regulatory framework is set out in Part X of the ICO, which stipulates the registration or authorization requirements for insurance intermediaries and empowers the IA to oversee the SROs. An insurance agent must be appointed by an insurer and the relevant appointment must be duly registered with the Insurance Agents Registration Board in accordance with the Code of Practice for the Administration of Insurance Agents issued by the HKFI. The Code of Practice sets out, among other things, the registration and conduct requirements for insurance agents. Insurance brokers are required to be either authorized directly by the IA or registered as a member of a body of insurance brokers approved by the IA, i.e., the HKCIB and PIBA. Insurance brokers are required to fulfill the minimum requirements stipulated in the ICO, which are elaborated upon in the guideline “Minimum Requirements for Insurance Brokers” issued by the IA.

27. The Government is proposing to establish an independent IA (IIA). This move is intended to respond to the rapid development in the insurance market and align with international practices. The self-regulatory regime for insurance intermediaries will be replaced by a direct regulatory regime, under which the IIA will be responsible for the licensing and conduct regulation of insurance intermediaries.

Money Lenders

28. Money lenders do not accept public deposits, are mainly funded by equity and must obtain a license under the Money Lenders Ordinance (MLO). Apart from licensing, the MLO regulates various aspects of money-lending transactions, including the form of loan agreement, advertisements, maximum interest rate, etc. The Licensing Court is responsible for the determination of applications for and granting of money lender licenses; the Registrar of Money Lenders is responsible for processing applications for money lender licenses, renewal of licenses and endorsement on licenses, as well as maintaining a register of money lenders for public inspection; the Commissioner of Police is responsible for enforcing the MLO, including carrying out examinations on applications for money lender licenses, renewal of licenses and endorsement on licenses, and investigations of complaints against money lenders.

29. The scale of operations of Money Lenders is modest. Bank borrowings constitute a relatively minor funding source for money lenders, estimated to account for less than 1 percent of banks’ total domestic loans. Lending by money lenders is estimated to account for less than one percent of the total loans of the banking sector in HKSAR.

Financial stability coordination

30. The HKMA has established the Macro-Surveillance Committee to focus on financial stability and macro prudential analysis. The Committee is chaired by the MA and its members include Deputy Chief Executives and Executive Directors drawn from both the banking and monetary sides of the HKMA’s operations. The committee identifies potential risks and threats to the monetary and financial system in HKSAR and discusses possible measures to address such risks, and reviews existing measures for managing risks in the monetary and financial system to identify possible gaps and ensure the adequacy of these measures. As part of its macro-financial surveillance, the HKMA publishes a Half-Yearly Monetary and Financial Stability Report. The other major financial sector regulators also have statutory financial stability mandates.

31. Interagency coordination on financial stability is supported by the Financial Stability Committee (FSC). The MA, the IA, the SFC and the FSTB of the government meet frequently to discuss regulatory issues, monitor cross-market risks and review issues that may have implications for financial stability. For the financial sector as a whole, an FSC was set up in 2000 to monitor the functioning of the financial system in HKSAR, including the banking, debt, equity, derivatives, insurance and related markets; and deliberate on issues with possible cross market and systemic implications. It reports to the Financial Secretary (FS) regularly and at any time where necessary. The committee, which meets on a monthly basis, is chaired by the Secretary for Financial Services and the Treasury (SFST) of the HKSAR Government and comprises the MA, the Chief Executive Officer of the SFC, and the IA.

32. The Council of Financial Regulators (CFR) has been established to minimize gaps or duplication in the regulation and supervision of financial institutions. The CFR facilitates sharing of information and views as well as identification of important trends. It also serves as a platform to review regulatory and supervisory issues with cross-sectoral implications. The CFR is chaired by the FS and consists of the SFST, the MA, the Chief Executive Officer of the SFC, the IA and the Managing Director of the MPFA. The CFR meets on a quarterly basis.

33. The FSC monitors the functioning of the financial system and deliberates on issues with possible cross sectoral and systemic implications. The FSC is chaired by the SFST and comprises the MA, the Chief Executive Officer of the SFC, and the IA. The FSC meets on a monthly basis and provides regular reports to the FS. Where regulatory action is needed, the FSC refers matters to the CFR.

A Well-Developed Public Infrastructure

System of business laws

34. HKSAR is a common law jurisdiction. When Hong Kong became a Special Administrative Region of the People’s Republic of China (PRC) in 1997, the Basic Law, which sets out the constitutional framework of the Special Administrative Region, came into effect. The Basic Law, enshrines the principle of “one country, two systems” and provides that all the laws previously in force (that is, the common law, rules of equity, ordinances, subordinate legislation and customary law) in HKSAR shall be maintained, except for any that contravene the Basic Law and subject to any amendment by the legislature of the HKSAR. Presently, laws in HKSAR consist of the Basic Law, locally enacted Ordinances, subsidiary legislation, the common law, rules of equity and customary law.

35. Orderly dispute resolution is governed by relevant ordinances. The Companies Ordinance (CO), Bankruptcy Ordinance, and the High Court Ordinance address orderly resolution of contractual disputes and enforcement of legal remedies. An effective court system (see below) further safeguards the enforceability of the respective rights of contractual parties. Alternative mechanisms for resolving disputes outside of court include arbitration and mediation.

Efficient and independent judiciary

36. The legal profession in HKSAR is divided into two distinct branches—barristers and solicitors. Generally, solicitors have limited rights of audience before the courts whereas barristers have unlimited rights of audience in all courts. The professional ethics and conduct of barristers and solicitors are monitored by their respective self-governing bodies, namely the Hong Kong Bar Association and the Law Society which are responsible for professional conduct and ethical standards.

37. The courts of justice in HKSAR comprise the Court of Final Appeal (which is the highest appellate court in the region), the High Court (which comprises the Court of Appeal and the Court of First Instance), the District Court, the Magistrates’ Courts, the Coroner’s Court, and the Juvenile Court. Each court has its own jurisdiction. In addition, there are a number of tribunals which adjudicate on disputes relating to specific and defined areas. They include the Lands Tribunal, Labor Tribunal, Small Claims Tribunal, and Obscene Articles Tribunal.

38. The HKSAR courts are operated by a Judiciary independent of the executive organ of the government and the legislature. Judicial appointment under the Basic Law is by the Chief Executive of the HKSAR on the recommendation of the Judicial Officers Recommendation Commission, an independent statutory body composed of local judges, and professionals. Judges have security of tenure until they reach retirement age and may only be removed for inability to discharge duties or misbehavior, by the Chief Executive on the recommendation of a tribunal appointed by the Chief Justice of the Court of Final Appeal. Judgments and awards of the Hong Kong High Court and above may be enforced on a reciprocal basis in a number of foreign jurisdictions including Australia, Belgium, France, Germany, India, Israel, Italy, New Zealand, and Singapore.

Accounting principles and rules

39. The CO imposes the obligation to keep proper accounts on companies in HKSAR. The accounts are prepared based on the Hong Kong Financial Reporting Standards (HKFRS) issued by the Hong Kong Institute of Certified Public Accountants (HKICPA). The HKFRS are in line with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB).

System of independent external audits

40. The accounts are audited according to the Hong Kong Standards on Auditing (HKSAs), issued by the HKICPA. The HKSAs are based on the International Standards on Auditing (ISA) issued by the IASB. Under these standards, the auditors are required to comply with ethical requirements and plan and perform the audit to obtain reasonable assurance as to whether the financial statements as a whole are free from material misstatement. Audits must be carried out by a practicing Certified Public Accountant. Practicing company auditors are regulated by the HKICPA under the Professional Accountants Ordinance, which empowers the HKICPA to monitor compliance with professional standards by auditors and to conduct formal investigation or to take disciplinary action. Where the company is a listed entity, investigation into possible auditing and reporting irregularities is conducted by the Financial Reporting Council (FRC), which is a statutory independent body constituted under the FRC Ordinance.

Availability of competent, independent and experienced professionals

41. HKSAR is one of the major international financial center in the world and, as a consequence, has attracted a significant population of highly qualified professionals particularly in the field of banking and finance.

Regulation and supervision of other financial markets

42. There is a well developed framework for the regulation and supervision of nonbanking financial activities in HKSAR. The MA is the frontline supervisor for AIs conducting regulated nonbanking financial activities (i.e., securities, insurance and MPF intermediary activities).

Payment and clearing systems

43. There are four principal payment systems providing large value interbank payments under a real time gross settlement system. The Hong Kong dollar, U.S. dollar, and renminbi payment systems handle interbank as well as bulk clearing and settlement while the euro payment system processes only interbank payments. The four Clearing House Automated Transfer Systems (CHATS) in HKSAR link with the Central Moneymarkets Unit to provide both real-time and end-of-day delivery-versus-payment (DvP) settlement services, including the interest-free intraday repo transactions. The four CHATS are also inter-linked to establish six cross-currency payment-versus-payment (PvP) links. Apart from the domestic DvP and PvP links, the HKMA has established a number of cross-border links with other central banks in the Asian region.

44. Clearing systems are well developed and well connected. The Central Moneymarkets Unit has external links with international debt securities settlement systems such as Euroclear and Clearstream. Transactions on the Stock Exchange of Hong Kong Limited (SEHK) and the Hong Kong Futures Exchange (HKFE) are cleared and settled through their three associated clearing houses, namely, the Hong Kong Securities Clearing Company (HKSCC), SEHK Options Clearing House and HKFE Clearing Corporation. Clearing and settlement of securities transactions in the stock market are carried out by the HKSCC through the Central Clearing and Settlement System (CCASS). There are system links between the CCASS and the three CHATS to support real-time DvP services (i.e. simultaneous settlement of both the securities and the payment legs of a transaction).

Credit bureaus

45. There are two major private credit bureaus operating in HKSAR. One focuses on consumer credit data sharing. The other, namely the Commercial Credit Reference Agency (CCRA), focuses on commercial credit data sharing. Sharing consumer credit data through credit reference agencies is governed by the Code of Practice on Consumer Credit Data (Code) issued by the Privacy Commissioner for Personal Data. The CCRA covers small and medium-sized enterprise customers which are non-listed limited companies with an annual turnover not exceeding HK$50 million as well as sole proprietorships and partnerships. The HKMA expects all AIs involved in the provision of credit to participate as fully as possible in the sharing and use of such data and has issued guidelines setting out the minimum standards that AIs should observe.

Framework for Crisis Management, Recovery and Resolution

Powers

46. Each of the regulators referred to above have powers which can be deployed for the prevention and handling of crisis situations. The MA uses trigger ratios and stress testing to provide early warning of potential problems and enable timely remedial action to be taken as well as using supervisory intervention powers, such as those under section 52 of the BO where certain conditions are met, to seek to contain and remedy a situation with a view to protecting the interests of depositors. (Please see also CPs 1 and 11).

Emergency Liquidity Assistance

47. The Exchange Fund can be used in a crisis affecting the banking system. The Exchange Fund is a discrete government fund, separate from the general revenue, established, used and controlled in accordance with the Exchange Fund Ordinance (EFO), which may be deployed to provide capital or liquidity support where the failure of an AI is assessed to have systemic consequences. The HKMA has published a policy on its role as lender of last resort (LOLR) for the granting of emergency liquidity assistance (ELA) to banks.2 The basic precondition is the judgment of the MA that the failure of an AI incorporated in HKSAR, if it is deprived of liquidity assistance, would damage the stability of the exchange rate, monetary or financial systems of HKSAR (i.e., systemic risk). Under this policy framework, ELA can only be granted to a solvent bank and provided, among other preconditions, that there is no prima facie evidence that the management of the bank is not fit and proper or that the distress is a result of fraud.

48. ELA may be provided for a period of a maximum 30 days, with a possible 30 days extension. The LOLR policy states that ELA is not intended for purposes other than short-term liquidity support. The HKMA will charge an appropriate interest rate to be decided in each specific case and which is sufficient to maintain incentives for good management. However, the rate will not be set so high that recovery efforts are undermined. The scale of support is related to the capital adequacy of the bank, up to 200 percent of the bank’s capital base for banks with a capital adequacy ratio (CAR) in excess of the statutory minimum, subject to an absolute limit of HK$25bn to a single bank. ELA may be provided in foreign currencies if needed.

49. In addition to liquidity support, the Exchange Fund may also be used to provide capital support to a problem bank. The terms and conditions for such support are not formally established or publicly disclosed as is the case for LOLR, but the MA has the power under the EFO to use the Exchange Fund to provide such support as he thinks fit to maintain the stability and the integrity of the monetary and financial systems of HKSAR. The MA would in practice seek the FS’s approval of his decision to provide capital support although in law there is no requirement to do so as the power to use the Exchange Fund for this purpose has been unconditionally delegated to the MA and he has complete discretion as to its exercise.

Information exchange and cooperation

50. Memoranda of Understanding (MOUs) support bilateral information exchange and coordination between regulatory authorities. For example, the MA has entered into comprehensive MOUs with his three principal counterparts—the SFC, IA, and MPFA.3 Under the MOUs, the parties agree to identify dedicated points-of-contact for coordinating interactions; commit to hold regular meetings to discuss matters of mutual interest relating to the performance of their regulatory and supervisory functions; and commit to information-sharing on specified trigger events, such as violations of regulatory requirements. Information sharing between the principal sectoral regulators is based on their respective ordinances (e.g., section 120 and section 121 of the BO, section 378 of the SFO, section 53A of the ICO, and sections 42 and 42AA of the MPFSO).

51. The FSTB plays a coordinating role in a crisis situation and may activate a Financial Services Branch Coordination Centre (FSBCC). The FSBCC facilitates communication in circumstances of high market volatility, or if a contingency event occurs in any segment of the financial sector. FSBCC serves to ensure that front-line regulators’ actions and media responses are consistent with each other and that the flow of information between regulators is unobstructed. The FSBCC has broad reach since it can facilitate the sharing of pertinent information with segments of the government that under normal circumstances would not be involved in financial sector matters. Also, FSBCC serves as a focal point of communication, information or assistance seeking between regulators and relevant government bureaus and departments, as well as liaison with the press. The FSBCC has been activated on several occasions in recent years.

Recovery and resolution planning

52. The HKMA is developing formal requirements for AIs in relation to recovery and resolution plans (RRPs). In late 2012, the HKMA began a consultation process on the requirements for RRPs and expects to issue guidance on recovery planning in early 2014. A Supervisory Policy Manual (SPM) module on recovery planning was issued for industry consultation in November 2013. Implementation of the requirements is expected to occur in phases, prioritizing institutions whose failure could pose the greatest risk to financial stability. It is expected that the first group of AIs will be required to submit recovery plans in the third quarter of 2014 and resolution plans will follow.

53. The HKMA participates in Crisis Management Groups (CMGs) for the G-SIBs that have significant operations in HKSAR. At present, the CMGs are focused on group-level RRPs. The HKMA proposes to set local recovery and resolution requirements, under which the local operations of cross-border groups would need to set out further detail tailored to the local context. Ultimately, it is proposed that these RRP requirements would apply to all AIs, albeit RRPs would be proportionate and so less detailed for small and non-complex institutions.

Bank resolution and liquidation

54. The MA can draw on his existing intervention powers should there be significant deterioration in the condition of an AI. In cases where the viability of an AI is under threat, these powers are designed to support supervisory intervention, to secure remedial action by the AI or the taking of protective measures. Ultimately, where viability is fundamentally undermined, the MA is empowered to revoke authorization or to make a report to the Chief Executive in Council which can in turn direct the FS to seek the initiation of liquidation proceedings.

55. Where an AI is no longer viable, the MA can draw on the powers made available under section 52 of the BO. The powers provided for under section 52, which are most relevant to a resolution scenario, are those that allow the MA to (i) issue binding directions to an AI to take any action or do anything whatsoever in relation to “its affairs, business and property”” and (ii) appoint a Manager to an institution to manage such of the affairs, business and property of the institution as may be directed by the MA in accordance with an objective set by the MA not inconsistent with the provisions of the BO (the Manager could for example sell or dispose of the business or property of the AI).

56. Nevertheless the MA’s powers in a resolution scenario are subject to certain limitations and do not provide for all the resolution options which the FSB’s Key Attributes say must be available. The Hong Kong authorities have carried out several self assessments against the requirements of the FSB’s Key Attributes, most recently to support the FSB’s Peer Review the report of which was published in April 2013. These assessments have identified a series of gaps which need to be addressed and the FSTB, in conjunction with the HKMA, SFC, and IA, are drawing up proposals on a common framework for resolution of financial institutions by means of a single resolution regime for HKSAR. It is expected that two rounds of public consultations will take place in 2014 before introducing a Bill into the Legislative Council in 2015.

57. In general, the winding-up of an AI is governed by the CO under the same rules that apply to any other company albeit subject to certain modifications under the BO. Accordingly, any creditor may petition the court for a winding up of an AI and the Court may grant the petition under fairly standard grounds (i.e., inability to pay debts). In addition, the FS can petition for the winding-up of an AI under the BO, either at the direction of the Chief Executive in Council (following a report to the Chief Executive in Council from the MA in exercise of the MA’s powers under section 52) or on his own initiative, following an investigation by the FS (conducted at the behest of the MA) into the state and conduct of the affairs, business and property of the AI. Where a petition for winding up of an AI is presented to the Court by a person other than the FS, a copy of the winding-up petition must be served on the MA, and he shall be entitled to be heard on the petition if the FS is not the petitioner. In the few cases where an AI has been liquidated, the MA has refrained from revoking the authorization of the AI until late in the liquidation process to ensure that the MA retains his statutory powers in relation to the AI.

The Adequacy of Systemic Protection (or Public Safety Net)

The Deposit Protection Scheme

58. The DPS and the Deposit Protection Scheme Fund (DPSF) are governed by the Deposit Protection Scheme Ordinance (DPSO). The Hong Kong Deposit Protection Board (DPB) acts only as a pay-box agency and its statutory functions are confined to the assessment and collection of contributions, managing the DPSF, making compensation payments to depositors and recovering payments from the assets of the failed Scheme member. Currently, the DPSF can only be used for payout, but not for other resolution purposes.

59. Membership of the DPS is compulsory for all licensed banks unless the deposits are covered by the home country deposit guarantee scheme. However, the home country scheme must be adequately underpinned and provide protection at least commensurate with Hong Kong standards. At the time of the assessments two German branches were exempted from joining the DPS.

60. All depositors, including individuals and corporates other than AIs are covered. All deposits under five years of maturity are covered. Off shore deposits, structured deposits, bearer form deposits (e.g., bearer certificates) and deposits from an excluded person such as a related company of the Scheme member, an AI or a director or controller of the Scheme member or its related company, are not covered by the DPS.

61. When the scheme is activated, deposits may be compensated by up to HK$500,000 (US$64,000) per depositor and bank. Compensation is on a net basis, i.e., after deducting liabilities from the deposits of the customer with that bank. Depositors receive priority over other general unsecured creditors. At the time of the assessment, 91 percent of depositors were fully covered.

62. The DPS is funded by annual contributions collected from member banks on a differential premium basis, Details of contribution determination, levy scheme, surcharge and calculation of fund size are specified in Schedule 4 to the DPSO.

63. An ex-ante funding approach is adopted to provide for the operating costs and reserve for absorbing the payout costs. The target fund size is 0.25 percent of total covered deposits in the banking sector. The DPB is also empowered to impose a surcharge if the fund size falls below 70 percent of the target fund size. In addition, the DPB has secured a standby liquidity facility of HK$120 billion (US$15.4 billion) from the Exchange Fund to ensure the adequacy of funding in meeting payout needs.

64. The MA is empowered, after consultation with the FS, to trigger payment of compensation to the depositors of a failed Scheme member pursuant to the DPSO. The MA is charged with implementing the decisions of the DPB under the DPSO. If either a Manager has been appointed under section 52 of the BO, or a provisional liquidator has been appointed, in respect of a Scheme member and the MA is of the opinion that the Scheme member is likely to become unable to meet its obligations then payments may be triggered after consultation with the FS.

Effective Market Discipline

Corporate governance

65. The corporate governance regime in HKSAR is founded on a combination of common law, statute and codes of practice. Common law establishes directors’ fiduciary duties and their duty of skill and care, while the CO sets out the rights and obligations of shareholders and officers of the company respectively. In addition, the Companies Registry has issued non-statutory guidelines on Directors’ Duties. Companies that are listed on the SEHK are subject to additional requirements under the Listing Rules of the SEHK including, in Appendix 14, a Corporate Governance Code. Listed Issuers are required to include a “corporate governance report” in their annual report. Recent developments include (i) updating of the SEHK Corporate Governance Code in January 2012 (with, among other things, new recommended best practices on Board evaluation of its performance and upgrading of best practices to rules regarding the proportion of independent non-executive directors on the Board); and (ii) passage of a new CO in July 2012 which aims to, among others, enhance corporate governance by strengthening the accountability of directors (including, among others, clarifying in statute the standard of directors’ duty of care, skill and diligence); enhancing shareholder engagement in the decision-making process; improving the disclosure of company information; fostering shareholder protection; and strengthen the rights of auditors. The date of coming into force of the new CO was March 2014.

Transparency and financial disclosure

66. HKSAR has well-developed arrangements promoting market discipline. General requirements for disclosure of financial information (i.e., audited annual accounts including balance sheet and profit and loss account) by companies incorporated in HKSAR to their shareholders are set out in the CO. AIs are also subject to the disclosure requirements under the BO, the Banking (Disclosure) Rules made under the BO, and the relevant guidelines laid down by the HKMA. Listed companies are subject to disclosure requirements under the Listing Rules of the Stock Exchange of Hong Kong. The requirement to disclose price sensitive information in a timely manner has had statutory backing under the SFO since January 2013. The SFC has been working closely with Hong Kong Exchanges and Clearing Limited (HKEx) in monitoring the compliance of listed companies with the new statutory regime.

Open and competitive markets

67. The policy of the government is not to distort normal market discipline by interfering in commercial decisions. The government has limited its role to: creating infrastructure and providing an efficient regulatory and administrative environment. There are no “policy loans” required by the government to be made in order to achieve public policy objectives. In the 2013 Index of Economic Freedom compiled by the Heritage Foundation, HKSAR was ranked first in the world for the 19th consecutive year.

E. Supervisory Powers, Responsibilities and Functions

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