Hong Kong has released its first consultation paper on the resolution of financial institutions;
The establishment of a bank resolution regime was seen as a necessary development for Hong Kong to remain an international financial centre;
As a first consultation paper, sources agreed that it was very general. However, it provides for the implementation of bail-in and grants powers to regulators similar to those given in the US, UK and Europe;
Restructuring lawyers expressed concerns with the ‘No Creditor Worse Off than in Liquidation’ concept introduced in the consultation paper, as well as the proposals for handling a failed bank;
The timeline is also an issue. The law implementing a bank resolution regime must be passed by December 31 2015 for Hong Kong to comply with the Financial Stability Board’s deadline.
Hong Kong released its consultation paper on the resolution of financial institutions in early January. While a bank resolution regime is necessary for Hong Kong to retain its status as an international financial centre, some are sceptical that it will be implemented by the end of 2015.
Jurisdictions around the world are establishing bank resolution regimes in accordance with the Financial Stability Board’s (FSB) Key Attributes of Effective Resolution Regimes for Financial Institutions. Hong Kong has started from scratch – it does not have even a corporate rescue regime – but seems to have included most key elements, including a bail-in mechanism.
Lawyers had previously noted that Hong Kong’s lack of a resolution regime was a concern when writing ‘living wills’ for global banks. This paper addresses many of their concerns and marks a significant step towards meeting international standards.
“The regulating authorities have looked around and realised that they don’t have the full set of tools in their armament for effective resolution of financial institutions,” said John Marsden of Mayer Brown JSM.
“They need the whole range to have an effective regime,” he added. “Unless they have all the options, they won’t be sure of what fits.”
What the consultation means for Hong Kong
Bank resolution has been a concern for global banks operating in Hong Kong since they began work on ‘living wills’ for their home regulators.
Sources have criticised the lack of options available to Hong Kong regulators to resolve financial institutions. Some also noted that regulators elsewhere were surprised that Hong Kong, considered a global financial centre, had limited powers in the event that a bank became non-viable.
Although some have expressed concerns that Hong Kong’s regulators will be given too much power, the rules are consistent with standards set by the US, UK and Europe, where most of the largest banks are headquartered.
Hong Kong’s attractiveness as a financial hub could be impacted if it lacks equivalent regulatory powers in the event of a bank resolution.
Royce Miller of Freshfields Bruckhaus Deringer explained that if the Hong Kong pieces of a banking group headquartered in the US, UK or Europe are unable to follow what might happen in a resolution scenario led by the headquarters regulator, the lead regulator will have its hands tied.
Miller said that the logical extension is that if Hong Kong doesn’t adopt these powers and its regulators don’t’ have the ability to resolve institutions quickly if there’s a crisis, it could cause systemic risk in the US, Europe and the UK.
“In that instance, there could be a view from some quarters that Hong Kong businesses of big financial groups would not be resolvable and that the groups would need to reconsider their structures in relation to Hong Kong,” he added.
Regulators are also ensuring that they follow international standards. The consultation paper established that bail-in will be available to Hong Kong regulators in a non-viability event. But more specific regulations related to bail-in will not be announced until Hong Kong regulators observe bail-in implementation in other jurisdictions.
Further reading
Bank resolution: why Asian regulators must act now
Asifma: Asia’s bank resolution regimes must look globally
NZ’s Open Bank Resolution: a new option for bank reform?
Concerns
‘No Creditor Worse Off than in Liquidation’
The paper is following the so-called No Creditor Worse Off than in Liquidation (NCWOL) principle outlined in the FSB’s Key Attributes to limit the adverse effect that the exercise of the resolution powers could have on any party.
But it’s unclear how this will be implemented in practice. Linklaters’ David Kidd said that the consultation paper is long on aspiration but short on detail.
“There are significant gaps to be filled in, in particular what happens to creditors that aren’t subject to deposit guarantees – are they left behind?” he commented. “The thought is that fair resolution will provide no worse outcomes than liquidation, but it remains to be seen how that is to be achieved.”
However the consultation paper doesn’t mention how the resolution authority will seek outcomes at least equal to those under liquidation for stakeholders. Sources thought that it might be via a new bank levy or a compensation fund, but specifics have not yet been announced.
Dealing with a failed bank
Another issue not addressed in the paper is what happens to the failed bank after its viable assets are transferred out.
Understandably, perhaps, it seems that the consultation paper is more concerned with the preservation of the viable business and its transfer out of the failing bank than dividing and dealing with the bank’s carcass, said Kidd.
But questions arise over regulatory oversight of what Kidd called the bank’s carcass, namely implementing the transfer of businesses and ensuring that the transition is going well.
The consultation paper noted that the whole or partial compulsory transfer of a financial institution is an option for regulators. However the consultation does not include an obligation that the rump of a transferred institution continue to provide support services to the transferred business operations, said Jennifer Colegate, senior associate at Mayer Brown JSM.
This is in contrast to bank administration in the UK, she added, which recognises the possibility that after a partial compulsory transfer, there will be a sensitive period of transition, and that the ongoing provision of services will be imperative to the business operations moved to the new institution or bridge bank.
Another issue relates to investigating liability for the failure of a financial institution.
In Hong Kong, Marsden said, liquidators have historically come into a company and wear a variety of hats: one is as an investigator of corporate failure. But the discussion paper is quiet on the investigatory aspects on the cause of failure, especially as the consultation paper envisages alternatives to liquidation. Further it is unclear whether the causes of failure will be investigated, and if so, who will do that.
Timeline
The FSB has given G-20 jurisdictions an end of 2015 deadline to meet the requirements described under the Key Attributes.
“This is the first consultation and is a good start, although it’s lacking meat,” said Marsden. “The sunset clause for this paper is at end-2015 and there’s a long way to go before this is done and dusted; the timing is ambitious.”
However some were not as confident that Hong Kong would meet the deadline. Sources pointed to the fact that the Law Reform Commission recommended that Hong Kong establish a corporate rescue regime in 1996, which, eighteen years later, still doesn’t exist. They feared that the bank resolution regime might encounter similar political difficulties because of the amount of stakeholders involved.
Miller was optimistic that Hong Kong will meet the deadline. There is a pretty clear international commitment that Hong Kong will pass legislation implementing a resolution regime by the end of 2015, he said.
“This is a place that doesn’t always move quickly, but can move faster than bigger jurisdictions – especially when there’s a will behind it,” he said.
Related links
Bank resolution: why Asian regulators must act now
Asifma: Asia’s bank resolution regimes must look globally
NZ’s Open Bank Resolution: a new option for bank reform?