Banking Regulation 2021

Last Updated December 10, 2020

Hong Kong

Law and Practice

Authors



Allen & Overy has an international financial services regulatory team that is a strategic partner to the world’s leading financial institutions, guiding them through an increasingly complex regulatory landscape where national and international regulations may interact or conflict. With more than 80 financial services regulatory experts across its international network of offices, the firm brings the breadth and scale a global business needs, as well as an understanding of the local environment. It helps clients plan for and navigate the complex developments and challenges they are facing, protecting them from regulatory risk and advising them on how to take advantage of emerging opportunities. The group brings together an impressive list of leaders in their field, and amalgamates specialist expertise from the firm's Banking, Payments, Capital Markets, Investigations and Regulatory Enforcement practices, along with A&O Consulting and Markets Innovation Group (MIG) colleagues, supported by the advanced delivery and project management teams. This cross-practice, multi-product, international offering provides clients with greater access to market-leading expertise and innovative products and solutions tailored to their very specific, highly complex needs.

Regulators

The Hong Kong Monetary Authority (HKMA) is the central banking institution of Hong Kong, as well as the principal regulator responsible for maintaining the stability of the currency and banking system in Hong Kong.

The HKMA’s functions include:

  • supervising compliance with the Banking Ordinance (Cap. 155, Laws of Hong Kong) (BO);
  • ensuring that banks are operated in a responsible, honest and business-like manner;
  • promoting and encouraging proper standards of conduct and sound and prudent business practices amongst banks; and
  • ensuring that banking business is carried on with integrity, prudence and the appropriate degree of professional competence, and in a manner that is not detrimental to the interests of depositors.

If a bank also carries on business in one or more regulated activities under the Securities and Futures Ordinance (Cap. 571, Laws of Hong Kong) (SFO), it must register with the Securities and Futures Commission (SFC) as a “registered institution”. Regulated activities include (but are not limited to) dealing in securities, advising on securities, advising on corporate finance, and asset management.

The HKMA and the SFC have entered into a Memorandum of Understanding which sets out (amongst other things) the roles and responsibilities of the HKMA and the SFC when supervising registered institutions, including how information will be exchanged between the regulators.

Banks may also engage in a number of ancillary businesses (including through their subsidiaries), such as providing mandatory provident fund services, trust business and/or insurance. Depending on the businesses conducted, other licences and registrations may be applicable, alongside supervision by other regulators. This guide will only discuss the principal laws and regulations governing the banking sector.

Principal Laws and Regulations Governing the Banking Sector

The BO (and its subsidiary legislation) is the principal legislation establishing the legal framework for banks in Hong Kong. The HKMA also publishes various supplementary guidance to banks, including through:

  • its Supervisory Policy Manual (SPM);
  • guidelines;
  • circulars;
  • codes of practice;
  • explanatory notes; and
  • practice notes.

Other legislation in Hong Kong will also be applicable to banks, including (but not limited to):

  • the Companies Ordinance (Cap. 622, Laws of Hong Kong);
  • the Deposit Protection Scheme Ordinance (Cap. 581, Laws of Hong Kong) (DPSO);
  • the Personal Data (Privacy) Ordinance (Cap. 486, Laws of Hong Kong) (PDPO);
  • the Financial Institutions (Resolution) Ordinance (Cap. 628, Laws of Hong Kong) (FIRO);
  • the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap.615, Laws of Hong Kong) (AMLO);
  • the Drug Trafficking (Recovery of Proceeds) Ordinance (Cap. 405, Laws of Hong Kong) (DTRPO);
  • the Organised and Serious Crimes Ordinance (Cap. 455, Laws of Hong Kong) (OSCO);
  • the United Nations Sanctions Ordinance (Cap. 537, Laws of Hong Kong);
  • the United Nations (Anti-Terrorism Measures) Ordinance (Cap. 575, Laws of Hong Kong) (UNATMO); and
  • the Prevention of Bribery Ordinance (Cap. 201, Laws of Hong Kong).

Fully licensed banks are required to be a member of The Hong Kong Association of Banks (HKAB), which is a statutory body consisting of all of the fully licensed banks in Hong Kong. Restricted licence banks and deposit-taking companies have also established their own equivalent body: the Hong Kong Association of Restricted Licence Banks and Deposit-taking Companies (DTC Association). The HKAB and the DTC Association publish codes, guidelines and rules, which member banks are expected to comply with.

Banks that are also “registered institutions” are required to comply with the requirements under the SFO (and its subsidiary legislation) when carrying on the regulated activities. The SFC also publishes various guidance in the form of codes, guidelines, circulars and frequently asked questions, which registered institutions will need to comply with.

Types of Licences, Activities and Services Covered, and Restrictions on Licensed Banks’ Activities

Under the BO, Hong Kong has a three-tier banking system, comprising licensed banks, restricted licence banks, and deposit-taking companies (collectively known as authorised institutions, or AIs).

They are classified according to the nature of their business, and the amount and term of the deposits accepted, as follows:

  • Licensed banks:
    1. may carry on banking business (such as receiving deposits from the general public, and paying or collecting cheques drawn by or paid in by customers); and
    2. may take deposits of any size and maturity from the public.
  • Restricted licence banks:
    1. are principally engaged in merchant banking and capital market activities; and
    2. may take deposits of HKD500,000 and above without restriction on maturity.
  • Deposit-taking companies:
    1. are mostly owned by or otherwise associated with banks;
    2. may engage in a range of specialised activities, including consumer finance, commercial lending and securities business; and
    3. may take deposits of HKD100,000 or above with an original term of maturity of at least three months.

To facilitate the establishment of “virtual banks” in Hong Kong, in 2018 the HKMA published a revised “Guideline on Authorisation of Virtual Banks”, setting out principles which the HKMA will take into account during the authorisation process for virtual banks. A virtual bank is a bank that primarily delivers retail banking services through the internet or other forms of electronic channels instead of via physical branches.

Alternatively, an overseas bank may establish a local representative office in Hong Kong, whose role is confined mainly to liaison work with customers in Hong Kong; it is not allowed to engage in any banking business.

Statutory and Other Conditions for Authorisation

Under the BO, the HKMA has general discretion to grant or refuse an application for authorisation to operate a banking business or a business of taking deposits in Hong Kong. The HKMA is, however, obliged to refuse to authorise an applicant if the minimum criteria for authorisation are not fulfilled. These minimum criteria are set out in the Seventh Schedule to the BO and apply at the time of authorisation, and on a continuing basis thereafter. The manner in which the HKMA interprets them is set out in the “Guide to Authorisation” issued by the HKMA.

The minimum criteria for authorisation include, but are not limited to, the following:

  • the applicant bank fulfilling the minimum capital requirement;
  • the applicant bank being adequately supervised in its home country if it is an overseas bank;
  • the chief executive, directors, controllers and executive officers of the applicant bank being fit and proper persons;
  • the applicant bank’s financial positions in terms of capital, liquidity and asset quality being sound;
  • the applicant bank’s internal controls and accounting systems being adequate; and
  • the business of the applicant bank being carried out with integrity, prudence and competence.

When granting authorisation, the HKMA may impose conditions on the applicant bank or its controllers/holding companies.

Process for Applying for Authorisation

Prior to submitting a formal application, the HKMA encourages the applicant bank to discuss its plans with the HKMA. During the preliminary consultation, the HKMA and the applicant bank will discuss the proposed business plan and intended activities of the bank.

For the formal application, the applicant bank is required to submit an application letter to the HKMA stating the reasons for the application for authorisation, the background of the applicant, and how the relevant authorisation criteria are, or will be, met by the applicant. The applicant will also be required to submit a number of documents set out in Annex 2 of the HKMA’s “Guide to Authorisation”.

After receiving the application, the HKMA will review the documents to ensure that the minimum criteria for authorisation are satisfied and raise any queries they have with the applicant bank.

The time required to process an application will depend on a number of factors (such as the speed at which the application documents are prepared and the ability of the applicant to respond to the HKMA’s queries) but can take approximately nine to 12 months from preparation for the preliminary consultation with the HKMA to the receipt of approval-in-principle from the HKMA.

Upon authorisation, a bank is currently required to pay a fee of HKD474,340 (for fully licensed banks), HKD384,270 (for restricted licence banks) or HKD113,020 (for deposit-taking companies).

Requirements Governing Changes in Control

The BO provides that no person shall become a “controller” of a Hong Kong-incorporated bank without the prior approval of the HKMA. A “controller” is defined as:

  • any person in accordance with whose directions or instructions the directors of the company or of another company of which it is a subsidiary are accustomed to act (an “indirect controller”);
  • any person who, either alone or with any associate or associates, is entitled to exercise, or control the exercise of, more than 50% of the voting power at any general meeting of the company or of another company of which it is a subsidiary (a “majority shareholder controller”); and
  • any person who, either alone or with any associate or associates, is entitled to exercise, or control the exercise of, 10% or more, but not more than 50%, of the voting power at any general meeting of the company or of another company of which it is a subsidiary (a “minority shareholder controller”).

The HKMA must be satisfied that the “controller” is a fit and proper person to become a controller of the bank.

Generally, there are no statutory restrictions on foreign entities acquiring or increasing control over a Hong Kong-incorporated bank. However, conditions have been placed on the note-issuing banks in Hong Kong (ie, commercial banks in Hong Kong that are authorised to issue currency notes) such that they shall have no close association with any foreign government or foreign government-controlled entity that – either alone or with associates – is entitled to exercise or control the exercise of 20% or more of the voting power at any general meeting of the bank or its holding company, or either directly or indirectly influences or seeks to influence any aspect of the management or business of the bank.

If a majority shareholder controller is incorporated outside Hong Kong, the HKMA may also require the controller to establish a holding company incorporated in Hong Kong, whose sole purpose will be to hold the shares of the bank; this “intermediate” holding company may itself be subject to certain conditions, in addition to those imposed on the bank and its ultimate holding company (if applicable).

For banks incorporated outside Hong Kong, no statutory approval will be needed from the HKMA upon a change in control, although the HKMA still must be satisfied that the controller is fit and proper; the HKMA will rely heavily on the views of the home supervisor in making this assessment.

Nature of the Regulatory Filings and Related Obligations

To become a controller of a Hong Kong-incorporated bank, a person must apply to the HKMA prior to the change in control by serving a notice in writing to the HKMA and submitting supporting documents required by the HKMA. The relevant documents will depend on the percentage shareholding acquired and the nature of the proposed controller.

A person may then become a controller if the HKMA serves a “notice of consent” before the expiration of three months from the date of service of the notice, or if that period expires without the HKMA having served a “notice of objection”; if the HKMA requests information from the person, the time period before expiry will be extended.

The HKMA may choose to place conditions on the controller when granting its approval.

Corporate Governance Framework

As one of the minimum criteria for authorisation, the HKMA must be satisfied that the bank has adequate systems of control. Banks are required to maintain high standards of corporate governance to ensure that there is adequate board and senior management oversight of the risk management and control systems. The HKMA places great importance on effective corporate governance within banks to ensure that the banking business is managed in a controlled and prudent manner.

The main corporate governance and systems and controls requirements applicable to banks are set out in SPM CG-1 “Corporate Governance of Locally Incorporated Authorised Institutions” issued by the HKMA. SPM CG-1 is applicable to all Hong Kong-incorporated banks, although banks incorporated outside Hong Kong should have reference to the applicable principles. Some key components of the corporate governance frameworks are also contained in other relevant SPM modules, and the HKMA also sets out its expectations in various additional guidance and circulars from time to time.

Board and Senior Management

SPM CG-1 provides that the bank’s board of directors is ultimately responsible for ensuring that the bank complies with all laws and regulations in Hong Kong.

It is generally expected that a Hong Kong-incorporated bank will establish various board committees (such as a nomination committee, audit committee, risk committee, remuneration committee and culture committee) composed of directors (including independent non-executive directors (INEDs)) as part of the bank’s corporate governance framework.

The HKMA also expects that either one-third or three of the board members (whichever is higher) of a fully licensed bank will be INEDs, and at least two of these INEDs should have a background in accounting, banking or another relevant financial industry.

Senior management who are responsible and accountable for running a bank on a day-to-day basis should ensure that the bank’s activities are consistent with the business strategy, risk appetite and policies approved by the board.

Bank Culture Reform

In recent years, the HKMA has stressed the need for banks to develop and promote a sound corporate culture that supports prudent risk management and high ethical standards. In particular, the HKMA has stressed that the board and senior management of banks must (i) establish the banks’ culture and behavioural standards that promote prudent risk-taking and fair treatment of customers, (ii) design appropriate incentive systems to promote cultural and behavioural standards, and (iii) develop appropriate tools to monitor the adherence of individual business units and relevant staff to the banks’ culture and behavioural standards.

As one of the minimum criteria for authorisation, the HKMA must be satisfied that every director, manager, chief executive and executive officer of the bank is a fit and proper person.

Under the BO, consent from the HKMA is required for the appointment of directors (for Hong Kong-incorporated banks) and chief executives. In considering whether the directors or chief executives are fit and proper persons, the HKMA will have regard to the following factors:

  • their reputation and character;
  • their knowledge and experience, competence, soundness of judgement and diligence;
  • whether they have a record of non-compliance with non-statutory codes or disciplinary records; and
  • their business records and other business interests.

Banks that are also “registered institutions” are required to appoint at least two individuals as “executive officers” to be responsible for directly supervising the conduct of each regulated activity. Under the BO, consent from the HKMA is required for the appointment of executive officers. In assessing the fitness and proprietary of executive officers, the HKMA will have regard towards the fit and proper guidelines set out in the SFO and various guidance published by the SFC.

The HKMA may conduct face-to-face meetings to assess a candidate’s personal qualities, skills, knowledge and understanding of the bank’s business, key regulatory and supervisory requirements, and whether the candidate will be able to adequately fulfil the proposed role.

Banks are also required to notify the HKMA when they appoint “managers” (persons who are responsible for the conduct of certain prescribed functions in the bank, such as information technology, internal audit and compliance). The HKMA must continue to be satisfied that managers appointed by the banks are fit and proper persons.

Roles and Responsibilities

The board has the ultimate responsibility for the operations and financial soundness of the bank. Key roles and responsibilities of the board include:

  • setting and overseeing the objectives of the bank and the strategies for achieving the objectives;
  • establishing and overseeing risk governance;
  • appointing and overseeing senior management; and
  • setting corporate values and standards.

Senior management appointed by the board to operate the bank on a day-to-day basis have key roles and responsibilities, including:

  • implementing business and risk strategies approved by the board;
  • providing the board with regular, adequate and comprehensible information in relation to material matters of the bank;
  • ensuring the risk limits are consistent with the bank’s overall risk appetite;
  • establishing an effective information management system to report to the board and senior management;
  • establishing a management structure that promotes accountability and transparency throughout the organisation, and facilitates the delegation of duties to staff, and oversight of those they manage; and
  • ensuring the competence of the managers and staff responsible for the business and internal control functions of the bank.

Remuneration Framework

The remuneration requirements are set out in SPM CG-5 “Guideline on a Sound Remuneration System”, as supplemented by the HKMA in various guidance and circulars from time to time. As noted above, in recent years the HKMA has actively encouraged sound remuneration and incentive policies as part of the Bank Culture Reform.

A bank is required to establish a sound remuneration policy that is appropriate and consistent with the bank’s culture, long-term business and risk appetite. In particular, the remuneration systems established by the bank should discourage inappropriate and excessive risk-taking that could threaten the safety and soundness of the bank.

The board is ultimately responsible for overseeing the establishment and implementation of the remuneration policy. The board should establish a “remuneration committee”, which is responsible for designing and operating the bank’s remuneration system and making recommendations in respect of remuneration policy and practices to the board.

Applicability

The remuneration policy should cover all employees, particularly those who could have a material impact on the bank’s risk profile and financial soundness. Specific regard should be had to the following types of employees:

  • senior management personnel who are responsible for oversight of the bank’s firm-wide strategy or activities or those of the bank’s material business lines;
  • individual employees whose duties or activities in the course of their employment involve the assumption of material risk or the taking on of material exposures on behalf of the bank;
  • employees whose activities may expose the bank to material amounts of risk and who are subject to incentive arrangements; and
  • employees within risk control functions.

Remuneration Principles

The incentive systems of the bank should reward good business performance and adherence to the bank’s culture and behavioural standards commensurate with an employee’s respective seniority and responsibilities. The bank’s remuneration policy should avoid incentivising short-term business performance at the expense of the interests of customers and the safety and soundness of the bank.

Key remuneration principles that underpin sound remuneration polices include:

  • a proportionate balance of fixed and variable remuneration;
  • the use of instruments for variable remuneration;
  • exceptional use of guaranteed minimum bonuses;
  • pre-determined criteria for performance measurement;
  • the exercise of judgement;
  • the deferment of variable remuneration; and
  • restrictions on hedging exposures.

Remuneration Disclosures

Banks are required to annually disclose matters relating to their remuneration structure and framework, such as:

  • information relating to the governance structure of the remuneration system;
  • information relating to the design and structure of the remuneration processes; and
  • quantitative information on the amount and type of remuneration paid to senior management and key personnel.

Consequences of Breach

A breach of SPM CG-5 and the related guidance on remuneration may call into question whether the bank concerned continues to satisfy the minimum criteria for authorisation.

The AMLO sets out the statutory requirements for anti-money laundering and counter-terrorist financing (AML/CTF). The HKMA also publishes various guidelines and circulars setting out its supervisory approach, in particular the “Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (for Authorised Institutions) (the AML Guideline), which sets out the statutory and regulatory AML/CFT standards which banks should meet. Compliance with the AML Guideline is enforced through the AMLO and the BO.

Central to the effective implementation of an AML/CTF regime is the risk-based approach that banks are required to adopt when conducting business with customers.

Key AML/CTF Requirements

Institutional ML/TF risk assessment

Under the AMLO, banks are required to conduct institutional money laundering and terrorist financing (ML/TF) risk assessments to identify, assess and understand its ML/TF risks in relation to:

  • its customers;
  • the countries or jurisdictions its customers are from or in;
  • the countries or jurisdictions the bank has operations in; and
  • the products, services, transactions and delivery channels of the bank.

AML/CTF systems

Banks must have AML/CTF systems that are appropriate to the nature, size and complexity of the business, and that are approved and overseen by senior management.

In addition, compliance management arrangements are required to implement the AML/CTF systems, which includes the appointment of a compliance officer and a money laundering reporting officer.

Customer due diligence

Customer due diligence must be carried out by banks before establishing a business relationships with customers.

While simplified due diligence is permitted in low risk situations (eg, transactions with public bodies or listed companies in Hong Kong), enhanced due diligence must be carried out in high risk situations (eg, transactions with politically exposed persons and their close associates or in jurisdictions that are subjected to United Nations sanctions).

Monitor business relationships

Banks are required to continuously monitor business relationships with customers through:

  • conducting regular reviews of customers’ information to ensure that they are up-to-date and relevant; and
  • conducting appropriate monitoring of transactions carried out for the customers and identifying transactions that are unusually large in amount or have no apparent economic/lawful purpose.

Record-keeping

Records must be maintained by banks relating to customer due diligence and transactions throughout the duration of the business relationships with their customers and for at least five years after the end of the business relationships.

Staff training

Banks are required to implement policies to ensure that their staff are adequately trained to implement the AML/CTF systems. The scope and frequency of AML/CTF training should be tailored to the specific risks faced by the bank.

Suspicious transaction reporting

Under the DTRPO, OSCO and UNATMO, banks are under a statutory obligation to report suspicious transactions to the Joint Financial Intelligence Unit (which is jointly run by the Hong Kong Police Force and the Hong Kong Customs and Excise Department); failure to report knowledge or suspicion is a criminal offence.

Deposit Protection Scheme

The DPSO establishes the deposit protection scheme (the Scheme), which is operated by the Hong Kong Deposit Protection Board (DPB).

All licensed banks are required to be members of the Scheme, which protects depositors (both individuals and corporations) in Hong Kong by paying compensation in the event of the failure of a bank. A depositor is entitled to be compensated up to a maximum of HKD500,000 per bank.

Depositors are not required to apply to the banks nor pay any fee for protection under the Scheme. The Scheme is funded by annual contributions paid by Scheme members, with the amount being determined by the size of protected deposits held with the Scheme members and the supervisory ratings assigned to them by the HKMA.

Deposits held with restricted licence banks and deposit-taking companies are not protected by the Scheme.

Types of Deposits Protected under the Scheme

Most of the commonly placed bank deposits (in any currency) qualify for protection under the Scheme, including current accounts, savings accounts, secured deposits and time deposits with a maturity not exceeding five years.

Type of Deposits That Are Not Protected under the Scheme

Deposits that are not protected under the Scheme are set out in the First Schedule to the DPSO and include the following, amongst others:

  • structured deposits;
  • time deposits longer than five years in maturity;
  • bearer instruments (eg, bearer certificates of deposit);
  • offshore deposits;
  • deposits held for the account of the Exchange Fund of Hong Kong; and
  • deposits held by an excluded person (eg, a related company of a Scheme member, multilateral development banks, licensed banks, restricted licence banks, deposit-taking companies, foreign banks, senior management, and controllers and directors of a Scheme member and its related companies).

Duty of Secrecy

Under Hong Kong law, banks are under a common law duty to maintain secrecy in relation to the customer’s account, their transactions and any other information concerning the customer’s affairs. This duty is an implied term of the contract between a banker and its customer.

A “customer” is someone (individual or corporate) who has an account with a bank (where the relationship is that of debtor-creditor), or who interacts with the bank such that the relationship of banker and customer exists, even though at that stage there is no account being opened.

The duty of secrecy arises when the relationship of banker and customer is established, and continues even after the account is closed or the relationship ends.

Principal Exceptions Permitting Disclosure

The duty of secrecy is not absolute and is subject to four major exceptions:

  • where disclosure is under compulsion of law (eg, disclosure in relation to suspicion of money laundering or terrorist financing);
  • where there is a duty to the public to disclose;
  • where the interests of the bank require disclosure (eg, defending itself against potential liability to third parties); and
  • where the disclosure is made with the consent of the customer – consent can be express or implied, and may be given generally or limited to specific information.

Consequences of Breach of the Duty

A customer may have a claim for damages and/or seek injunctive relief if the bank breaches its duty of secrecy.

Other Confidentiality Obligations

Apart from the common law duty of secrecy, confidentiality obligations may also arise in the following scenarios:

  • as a result of express contractual obligations;
  • where a bank is placed in a fiduciary position;
  • from the equitable law of confidence, which may confer an obligation to maintain the confidentiality of disclosures made to a person in a professional capacity (such as a banker);
  • from the HKMA’s guidance; and
  • by virtue of legislation, such as the PDPO and related guidance from the Office of the Privacy Commissioner for Personal Data (the Commissioner), the dedicated data privacy regulator.

HKMA guidance

The HKMA’s guidance includes circulars on customer data protection and the HKMA’s SPM SA-2 “Outsourcing”, which requires banks to ensure that any outsourcing arrangement complies with relevant statutory and common law customer confidentiality requirements, and regulatory expectations.

The HKMA has also endorsed – and expects banks to comply with – the HKAB’s “Code of Banking Practice” (the Code), which is a non-statutory, voluntary code that applies to personal customers (ie, private individuals). The Code requires banks to treat existing and former customers’ banking affairs as private and confidential, and to comply with the PDPO and related guidance from the Commissioner.

Breach of the HKMA’s regulatory guidance or the Code may lead to the HKMA disciplining the bank.

PDPO

The PDPO regulates personal data protection in Hong Kong and, among other things, outlines how data users (such as banks) should collect, handle and use personal data. Personal data means any data relating directly or indirectly to a living individual and from which it is practicable for the identity of the individual to be directly or indirectly ascertained, if such data is in a form in which access to or processing of it is practicable.

Exemptions from compliance are available – eg, where personal data is required under any law or court order, for legal proceedings, or for the exercising or defending of legal rights.

The Commissioner has issued codes of practice and published guidance on handling personal data, including the “Guidance on the Proper Handling of Customers’ Personal Data for the Banking Industry”, the “Code of Practice on Consumer Credit Data”, and the “New Guidance on Direct Marketing”.

Breaches of the PDPO may lead to civil actions and/or constitute criminal offences, which may result in fines and imprisonment.

Framework

Under the BO and its subsidiary legislation, banks are required to maintain adequate capital adequacy and liquidity ratios. The HKMA has implemented the Basel III requirements in accordance with the timeline set out by Basel Committee on Banking Supervision (the Basel Committee).

Following the announcement of the deferral of implementation of the Basel III final reform package by the Basel Committee, the HKMA announced the deferral of the Basel III final reform package in Hong Kong by one year – to 1 January 2023.

Capital Requirements

Banks incorporated in Hong Kong are required to follow the capital requirements set out in the Banking (Capital) Rules (Cap. 155, Laws of Hong Kong), which implement the Basel III standards on minimum capital requirements.

The HKMA’s SPM CA-G-1 “Overview of Capital Adequacy Regime for Locally Incorporated Authorised Institutions” provides guidance on the calculation of the capital adequacy ratio (CAR), which is the collective term that refers to the three risk-weighted capital ratios:

  • Common Equity Tier 1 (CET1) capital ratio;
  • Tier 1 capital ratio; and
  • total capital ratio.

Banks incorporated in Hong Kong are required to maintain a CET1 capital ratio of at least 4.5%, a Tier 1 capital ratio of at least 6% and a total capital ratio of at least 8%.

The CAR requirements for Hong Kong-incorporated banks are calculated on a solo basis or on a consolidated basis, both of which measure the capital adequacy of a bank based on the capital strength, risk profile, or the on- and off-balance sheet exposures of the bank. The solo basis takes into account the combined position of the bank’s head office and branches (both in Hong Kong and overseas), whereas the consolidated basis includes assets and liabilities of the bank’s subsidiaries as specified by the HKMA. However, generally, only subsidiaries undertaking relevant financial activities (eg, lending, financial leasing, custodial/safekeeping, etc) would be specified by the HKMA for the consolidated basis. A bank may also apply to include a subsidiary in the calculation of its solo CAR (a “solo-consolidated” basis) if the subsidiary satisfies certain criteria set out by the HKMA.

Foreign banks operating via a branch in Hong Kong are not subject to these requirements. However, the HKMA would generally require a foreign bank that wishes to set up a branch or subsidiary in Hong Kong to maintain capital levels consistent with the latest applicable capital standards issued by the Basel Committee.

Capital Buffers

To bolster the resilience of the banking sector against adverse economic developments, Hong Kong-incorporated banks are also required to maintain capital buffers, including the following:

  • a capital conservation buffer, which is a band of CET1 capital equal to CET1 capital equal to 2.5% of risk-weighted assets;
  • a countercyclical capital buffer (CCyB), which operates as an extension of the capital conservation buffer and is meant to build up additional capital during periods where excessive credit growth leads to a build-up of system-wide risks in the Hong Kong financial system. The CCyB is expected to be “released” when the credit cycle turns to absorb losses and enable the banking system to continue lending in the subsequent downturn; and
  • a higher loss absorbency (HLA) buffer for global systemically important banks (G-SIBs) (there are currently none headquartered and incorporated in Hong Kong) or domestic systemically important banks (D-SIBs). The HLA requirement applicable to a D-SIB (expressed as a ratio of a bank’s CET1 capital to its risk-weighted assets as calculated under the Banking (Capital) Rules) ranges between 1% and 3.5% (depending on the level of the D-SIB’s systemic importance). The HLA requirement (together with the countercyclical capital buffer) is an extension of the Basel III capital conservation buffer.

Where a bank’s net CET1 capital ratio equals or falls below the required buffer level (being its capital conservation buffer as extended by any CCyB and HLA requirement (if applicable)), restrictions will be imposed on the bank’s discretionary distributions (eg, dividends, share buybacks, discretionary bonus payments to staff, etc).

The HKMA will generally require banks to comply with the minimum CAR requirements on a consolidated basis, in addition to a solo/solo-consolidated basis.

Liquidity Requirements

The liquidity requirements are set out in the Banking (Liquidity) Rules (Cap. 155Q, Laws of Hong Kong), which implement Basel III liquidity standards. The HKMA’s SPM LM-1 “Regulatory Framework for Supervisory of Liquidity Risk” provides guidance on the statutory liquidity requirements.

Liquidity coverage ratio

The liquidity coverage ratio (LCR) is only applicable to category 1 institutions, which include internationally active or sophisticated banks that are significant to the general stability of the banking system in Hong Kong.

Expressed as a percentage, the LCR is the total weighted amount of a category 1 institution’s “high-quality liquid assets” over the total weighted amount of its “total net cash outflows” over 30 calendar days.

All category 1 institutions must maintain an LCR of at least 100% at all times.

Liquidity maintenance ratio

Banks that are not designated as category 1 institutions (ie, category 2 institutions) are subject to a liquidity maintenance ratio (LMR), which is a local liquidity standard developed by the HKMA. Expressed as a percentage, the LMR is the amount of a category 2 institution’s “liquefiable assets” over the amount of the institution’s “qualifying liabilities” (after deductions) over a calendar month.

All category 2 institutions must maintain an LMR of at least 25% on average in each calendar month.

Net stable funding ratio

To reduce funding risk over a longer time horizon, banks are required to fund their activities with sufficient stable sources of funding.

All category 1 institutions must maintain, at all times, a net stable funding ratio (NSFR) of 100%, unless self-rectification provisions apply. Expressed as a percentage, the NSFR is the amount of a category 1 institution’s “available stable funding” over the amount of the institution’s “required stable funding”.

Category 2 institutions designated by the HKMA as category 2A institutions must maintain, on average, a core funding ratio (CFR) of at least 75% in each calendar month. Expressed as a percentage, the CFR is the amount of a category 2A institution’s “available core funding” over the amount of the institution’s “required core funding”.

The LCR, LMR, NSFR and CFR (as applicable) apply to banks, irrespective of their place of incorporation, and must be calculated on the basis of the bank’s business in Hong Kong (“Hong Kong office basis”).

A bank incorporated in Hong Kong with overseas branches must calculate the LCR, LMR, NSFR and CFR (as applicable) on an unconsolidated basis, covering all of its business in Hong Kong and overseas branches.

The HKMA may also require a Hong Kong-incorporated bank with any “associated entity” (eg, the bank’s subsidiary, an entity of which the bank is able to control 20% or more of the voting power, or an entity where the bank has significant influence over its conduct) to make calculations on a consolidated basis, being the bank’s Hong Kong office basis or an unconsolidated basis (where applicable) plus one or more of its associated entities specified by the HKMA.

Recovery Framework

The HKMA may require banks (either those incorporated in Hong Kong or the Hong Kong branch of overseas-incorporated banks) to prepare and maintain a plan setting out the measures that the banks can take to stabilise and restore their financial resources and viability when they come under severe stress.

The HKMA’s SPM RE-1 “Recovery Planning” provides guidance for banks in establishing their recovery plans. SPM RE-1 is applicable to Hong Kong-incorporated banks and Hong Kong branches of banks incorporated outside Hong Kong. However, the HKMA recognises that a proportionate approach is required to recovery planning; SPM RE-1 applies in a proportionate manner, having regard to the bank’s size, structure and business mix, and to the systemic risks associated with the bank’s activities. SPM RE-1 largely complies with the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions (the Key Attributes).

Recovery plan

A bank’s recovery plan should:

  • form an integral part of the bank’s risk management framework;
  • identify and explain how the bank will monitor the need to trigger recovery actions;
  • set out a full menu of credible recovery options to cope with a range of stress scenarios;
  • assess the impact, timeframe for implementation and probable success of the recovery options and the associated risks;
  • define the criteria for triggering the implementation of the recovery plan or individual recovery options in it;
  • identify the key steps, milestones and processes for implementing the recovery options and the key management personnel involved in activation and decision-making;
  • ensure that the bank has appropriate contingency arrangements in place that would enable it to continue to operate as it implements recovery measures;
  • assess the additional requirements that may be needed during crisis situations in order to maintain the bank’s membership of, or continued access to, financial market infrastructure; and
  • map out a communication strategy with the authorities, public, financial markets, staff and other stakeholders to support the deployment of the recovery options.

The HKMA notes that simpler recovery plans may suffice for smaller Hong Kong-incorporated banks and Hong Kong branches of banks incorporated outside Hong Kong with relatively simple business models and a limited scale of business activities in Hong Kong; however, the bank’s recovery plan must still cover the elements set out above.

Resolution Framework

The FIRO establishes the legal basis for a cross-sectoral resolution regime in Hong Kong. Under the FIRO, the HKMA is the designated resolution authority for the banking sector.

The FIRO is designed to be compliant with the international resolution standards set out in the Key Attributes, and has the following resolution objectives:

  • to promote and maintain the stability and effective working of the financial system in Hong Kong, including the continued provision of critical financial functions;
  • to protect deposits or insurance policies;
  • to protect client assets; and
  • to contain the costs of resolution and protect public money.

The HKMA has published a FIRO Code of Practice, which provides guidance on its approach to the resolution regime.

Resolution planning

The HKMA has the power to conduct resolution planning well in advance of any actual failure. Resolution planning involves:

  • gathering information from the bank;
  • setting and operationalising a preferred resolution strategy for the bank;
  • assessing the bank’s resolvability; and
  • addressing impediments to resolution.

Through the resolution planning process, the HKMA will work with the relevant bank to implement any necessary changes to its legal structure, business operations and/or structure of financial resources necessary for enhancing resolvability so that its preferred resolution strategy can be implemented effectively if needed.

Stabilisation options

The HKMA may apply one or more of the following stabilisation options in resolving a bank:

  • transfer some or all of the business of a failing bank to a purchaser;
  • transfer some or all of the business of a failing bank to a bridge institution;
  • transfer some or all of the assets, rights and liabilities of a failing bank to an asset management vehicle;
  • bail-in; and
  • as a last resort, transfer a failing bank to a temporary public ownership company.

Depositor Preference under Insolvency

The Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32, Laws of Hong Kong) provides the general framework for the insolvency of corporations in Hong Kong (including banks). In the event of a bank’s winding-up, depositors are regarded as preferential creditors and have priority over other unsecured creditors, up to HKD500,000 per depositor.

Under the DPSO, where a depositor has been paid compensation under the Scheme, the DPB will take on the claims of depositors up to the compensation amount paid to them under the Scheme and be subrogated to the rights and remedies of the depositors.

The HKMA continues to play an active role in promoting and enhancing the efficiency, safety and development of the banking system. Key upcoming regulatory developments include the following.

Regulatory Response to COVID-19

In March 2020, the Basel Committee announced that the implementation of the final Basel III reform package will be deferred by one year to 1 January 2023 as a result of the impact of COVID-19 on the global banking system. Following the Basel Committee's announcement, the HKMA also announced that the implementation of the Basel III final package in Hong Kong will be deferred accordingly.

The HKMA also stated that their 2020 Supervisor-Driven Stress Test will be postponed by one year to 2021, to provide additional operational capacity for banks to respond to the challenges brought by COVID-19.

The HKMA has closely worked with the banking sector to put repayment deferments and other measures in place to support industries and individuals that have been affected by COVID-19.

Rolling Bad Apples

In May 2020, the HKMA issued a consultation paper entitled “Implementation of Mandatory Reference Checking Scheme to Address the ‘Rolling Bad Apples’ Phenomenon” (the RBA Consultation Paper). The RBA Consultation Paper outlines the HKMA’s proposed framework for a “Mandatory Reference Checking Scheme” to be adopted in the local banking sector (at least initially). The purpose of the Mandatory Reference Checking Scheme is to ensure that banks are aware of, and properly assess, any previous misconduct committed by individuals who they are looking to employ.

The consultation closed in August 2020; the HKMA will be reviewing the responses and looking to establish the Mandatory Reference Checking Scheme in due course.

Private Banking; Wealth Management; Greater Bay Area

In recent years, the HKMA has been exploring various initiatives to promote the growth of the private banking and wealth management industry. One particular area which the HKMA has looked into closely is the opportunities presented by the Greater Bay Area (GBA), which is the integrated economic and business region in South China, consisting of Hong Kong, Macao and nine other cities in Mainland China.

To further facilitate cross-border capital flows, in June 2020, the HKMA, the People’s Bank of China and the Monetary Authority of Macao jointly launched the cross-boundary Wealth Management Connect pilot scheme (Wealth Management Connect) in the GBA.

Under the Wealth Management Connect, it is proposed that residents in the GBA can invest in eligible investment products distributed by banks in Hong Kong, and vice versa.

It is expected that the HKMA will continue to engage with its regulatory counterparts in the region to establish cross-boundary arrangements to promote Hong Kong as a leading centre for wealth management and private banking whilst maintaining Hong Kong’s robust regulatory protections for investors.

Green and Sustainable Banking

The HKMA has committed to promote green and sustainable banking, and has been working with banks to manage environmental, social and governance (ESG) risk. The HKMA adopts a three-phased approach to promoting green and sustainable banking:

  • Phase I – the HKMA will develop a common framework to assess the “greenness baseline” of individual banks and collaborate with international bodies to provide technical support to banks;
  • Phase II – the HKMA will engage the banking sector and other relevant stakeholders in a consultation on the supervisory expectation or requirement on green and sustainable banking; and
  • Phase III – after setting the targets, the HKMA will implement, monitor and evaluate banks’ progress.

In 2020, the HKMA took significant steps to complete Phase I and begin Phase II of the three-phased approach.

In May 2020, the HKMA, the SFC and other regulators established the Green and Sustainable Finance Cross-Agency Steering Group (the Steering Group). The main aims of the Steering Group are to co-ordinate management of climate and environmental risks to the financial sector, and to help accelerate the growth of green and sustainable finance in Hong Kong. One of the first tasks of the Steering Group is to develop a local green taxonomy for use by all financial regulators in Hong Kong (taking international standards and local circumstances into account).

The HKMA also launched a self-assessment exercise for banks on green and sustainable banking in May 2020 to assess the financial risks associated with climate and environmental issues.

In June 2020, the HKMA published the “White Paper on Green and Sustainable Banking”, outlining its initial thoughts on its supervisory approach to climate and sustainability issues. The thoughts are summarised in nine guiding principles – covering the issues of governance, strategy, risk management and disclosure – and are designed to help banks develop frameworks and strategies to manage ESG risk.

The HKMA is currently reviewing the results of the banks’ self-assessment exercise and collecting feedback on the White Paper in order to build on the guiding principles and formulate ESG supervisory requirements.

The HKMA plans to launch a formal consultation on ESG supervisory requirements in 2021, and to conduct a pilot climate stress testing exercise to assess the climate resilience of the banking sector.

Technology

Promoting greater adoption of technology in the banking sector has been one of the HKMA’s key work priorities in recent years. In 2020, the HKMA worked with the banking sector to explore greater use of technology in banking operations in a number of different areas, including as set out below. It is anticipated that the HKMA will continue to focus on the use of technology to improve the productivity and internal controls within the banking sector.

The HKMA has recognised that COVID-19 has brought increased demand for remote on-boarding and the digital delivery of financial services, and the use of financial technology (fintech) can provide significant support to banks in managing the challenges posed by the pandemic. The HKMA intends to continue to promote the adoption of fintech across all types of financial services.

Artificial intelligence (AI) has also been adopted in key functional areas of banks, as a way of improving efficiency and strengthening risk management. The HKMA is currently exploring the use of AI alongside the banking sector to streamline compliance processes through the use of regulatory technology (regtech) and to integrate technology into the supervisory process through the use of supervisory technology (suptech).

Since the inaugural AML/CFT Regtech Forum in 2019, there has been a significant increase in regtech adoption. With a view to fostering a larger and more diverse regtech ecosystem, the HKMA has developed a two-year roadmap to promote regtech adoption in the banking sector in its White Paper entitled “Transforming Risk Management and Compliance: Harnessing the Power of Regtech”. The HKMA intends to introduce a series of events and initiatives in the next two years, with the aim of transforming Hong Kong into a regtech hub.

In September 2020, the HKMA implemented the AML/CFT Surveillance Capability Enhancement Project (the AMLS Project), which aims to strengthen the use of data and suptech in HKMA’s risk-based AML/CFT supervision, and to prioritise the resources of the banking sector as a key stakeholder within the broader AML/CFT ecosystem in Hong Kong.

In November 2020, the HKMA announced the launch of the upgraded Cybersecurity Fortification Initiative (CFI) 2.0. The current CFI, which aims to raise the cyber-resilience of Hong Kong’s banking system, has been enhanced to streamline the cyber-resilience assessment process while maintaining effective control standards commensurate with the latest technology trends. The CFI 2.0 will come into effect on 1 January 2021 and will be implemented in a phased approach.

During the Hong Kong Fintech Week 2020, a range of initiatives were announced by various stakeholders to further foster the banking ecosystem in Hong Kong. The HKMA announced that it will explore a new data strategy and build a “Commercial Data Interchange” to facilitate more secure and efficient data flow between banks and sources of commercial data. The HKMA also noted that Project Inthanon-LionRock (the joint study conducted by the HKMA and the Bank of Thailand on the application of central bank digital currency (CBDC) to cross-border payment) has entered the second phase; the two authorities will explore business use cases in cross-border trade settlement and capital market transactions, and enhance the cross-border corridor network prototype to support CBDCs of other central banks in the Asia Pacific region.

Reform of Interest Rate Benchmarks

Subject to any further extension to the discontinuation deadline agreed by regulators, the London Inter-bank Offered Rate (LIBOR) will be discontinued at the end of 2021. As LIBOR is used extensively in the Hong Kong banking sector, the discontinuation of LIBOR will have significant implications on the operations of banks. To enable a smooth and timely transition before the discontinuation of LIBOR at the end of 2021, the HKMA expects banks in Hong Kong to adhere to the following transition milestones:

  • banks should be in a position to offer products referencing the alternative reference rates (ARRs) to LIBOR from 1 January 2021;
  • from 1 January 2021, adequate fall-back provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021; and
  • banks should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021.

The HKMA and the Hong Kong Treasury Markets Association are also jointly evaluating the need for a suitable fall-back for Hong Kong Interbank Offered Rate (HIBOR) contracts, but the HKMA has stated that there is no current intention to discontinue HIBOR.

Bank Culture Reform

The HKMA has announced various steps in the past few years as part of its Bank Culture Reform initiative to foster a sound corporate culture within banks. Self-assessments were conducted by banks in Hong Kong, and the HKMA published the Report on Review of Self-assessments on Bank Culture (the BC Report) in May 2020. The BC Report identified common themes and a range of practices amongst banks on how they approach their culture reform. The HKMA expects banks to adopt good practices identified in the BC Report with reference to their own circumstances.

As the next step, the HKMA will conduct focused reviews to closely look at the incentive systems of front offices of retail banks in the business of distributing banking, investment and/or insurance products. The HKMA intends to work closely with the banks during the upcoming period to promote sound bank culture and share industry-wide insights and practices on culture.

Proposed Code of Practice for Trust Business

In July 2020, the HKMA published a consultation paper on enhancing the regulation and supervision of trust business in Hong Kong. The HKMA proposes to introduce a Code of Practice for Trust Business (the Code for Trust Business) applicable to all banks and their subsidiaries conducting trust business. The Code for Trust Business aims to enhance the protection of client assets held on trust and to promote the fair treatment of customers and a customer-centric culture in trust business. The consultation closed in October 2020. It is anticipated that the HKMA will review the comments submitted with a view to finalising and issuing the Code for Trust Business in due course.

Allen & Overy

9th Floor
Three Exchange Square
Central
Hong Kong

+852 2974 6986

charlotte.robins@allenovery.com www.allenovery.com
Author Business Card

Law and Practice

Authors



Allen & Overy has an international financial services regulatory team that is a strategic partner to the world’s leading financial institutions, guiding them through an increasingly complex regulatory landscape where national and international regulations may interact or conflict. With more than 80 financial services regulatory experts across its international network of offices, the firm brings the breadth and scale a global business needs, as well as an understanding of the local environment. It helps clients plan for and navigate the complex developments and challenges they are facing, protecting them from regulatory risk and advising them on how to take advantage of emerging opportunities. The group brings together an impressive list of leaders in their field, and amalgamates specialist expertise from the firm's Banking, Payments, Capital Markets, Investigations and Regulatory Enforcement practices, along with A&O Consulting and Markets Innovation Group (MIG) colleagues, supported by the advanced delivery and project management teams. This cross-practice, multi-product, international offering provides clients with greater access to market-leading expertise and innovative products and solutions tailored to their very specific, highly complex needs.

Compare law and practice by selecting locations and topic(s)

{{searchBoxHeader}}

Select Topic(s)

loading ...
{{topic.title}}

Please select at least one chapter and one topic to use the compare functionality.