Insolvency laws are a major consideration in securitisation in Hong Kong. Typically, the subject assets backing the notes or other asset-backed securities to be issued to investors, such as loan receivables and trade receivables, will need to be insulated from the financial and credit risks of the originator (ie, the seller of the assets) so that they will not form part of the originator's estate if the originator becomes insolvent, and thus will not be subject to insolvency proceedings in respect of the originator. In this chapter, the terms "originator" and "seller" refer to the seller of the assets in securitisation, while the terms "issuer" and "buyer" refer to the buyer of these assets.
To achieve such insulation and hence bankruptcy remoteness, a "true sale" of the assets should be made by the originator (as the seller) to the issuer (as the buyer). After the true sale, the relevant assets would no longer be the assets of the originator, so will not form part of the originator’s estate.
There are a number of fundamental differences between a true sale and a secured loan. In determining whether a transaction constitutes a true sale, a Hong Kong court would look at several factors, including the parties' intention and the substance of the transaction. More specifically, the court would take the following distinguishing features into account in its determination, without limitation:
A transaction will not be treated as a true sale just because it is characterised as such by the relevant parties. Judging by the above factors, if the court finds that the transaction resembles a secured loan rather than a true sale, the court may recharacterise the transaction as a secured loan. The court may also consider other relevant factors in the overall circumstances of a securitisation transaction, but no absolute criteria have been established in the determination of whether a transaction constitutes a true sale or a secured loan.
Upon the transfer of the assets to the issuer in a true sale, the originator will cease to be the beneficial owner of the assets and therefore these assets will not form part of the originator’s estate nor be subject to any insolvency proceedings in respect of the originator.
In the case of a secured loan, the assets being charged in favour of the issuer will remain the assets of the originator, subject to the security interest created over the assets.
A true sale opinion may be requested by and delivered to the arrangers, investors and auditors, as applicable, to provide comfort to these parties, for investing purposes and/or for accounting treatment. A true sale opinion normally relates to the effectiveness of the sale of the assets to the issuer and states that the assets will not form part of the originator's assets after the sale. A true sale opinion would be subject to usual and fair assumptions, such as the capacity and corporate authority of the originator to enter into the transaction and the legal title of the originator to the assets being sold.
An SPE is typically used in securitisation transactions in Hong Kong, and typically acts as the beneficial owner of the assets transferred from the originator and the issuer of the asset-backed notes. The SPE, therefore, is being used to insulate the assets from the financial and credit risks of the originator.
There are no required aspects of an SPE in a securitisation in Hong Kong. An SPE is typically structured as an orphan entity and usually a limited liability company, with its share capital being held by a charitable trust so that the SPE becomes bankruptcy remote.
Depending on the transaction structure, the transaction parties often seek to incorporate the following aspects when establishing the SPE.
Under such structure, the originator normally will not be able to exercise influence or control over the SPE.
Although the SPE can be incorporated in Hong Kong, more commonly the transaction parties will use an offshore SPE (such as a Cayman Islands limited liability company) to achieve, inter alia, more favourable tax treatments.
Currently, "substantive consolidation" is not a concept recognised under Hong Kong law or by Hong Kong courts. A company (including an SPE) incorporated under Hong Kong law will have its own legal personality. Where the originator becomes bankrupt, an insolvency official would not have the power to consolidate the issuer's assets with those of the originator, unless there are exceptional circumstances, such as fraud.
A transaction opinion will be provided in respect of the SPE's capacity and corporate authority to enter into the transaction documents and the securitisation transaction generally. The transaction opinion also reports the results of the relevant searches (including bankruptcy searches) in respect of the issuer. The transaction opinion is typically subject to usual and fair assumptions, such as the authenticity of the signatures and documents reviewed by the legal counsels.
The insolvency law of the jurisdiction of the SPE (if not Hong Kong) would apply in the event of the insolvency of the SPE. However, insolvency courts in Hong Kong are not bound to recognise or enforce the laws of the SPE's jurisdiction, especially if they are considered contrary to public policies, for instance.
In order for the transfer of the subject assets to be valid and enforceable, the originator will transfer the assets to the issuer by way of an assignment, which can be legal or equitable. In order to achieve a legal assignment, certain conditions will need to be satisfied, including the following:
If an assignment fails to meet any of the above conditions, it would still be enforceable but instead would be an equitable assignment until such time as it does satisfy all these conditions. In particular, although the transfer would not be ineffective solely because of a failure to notify the original obligor, in the event of default by the obligor the issuer (being the buyer of the assets) will not be able to enforce its rights directly against the obligor. Rather, the issuer would be required to join the originator in the proceedings against the obligor by adding the name of the originator as a claimant to any claim against the obligor.
Other than being an express written notice, there are no other requirements as to the form of the notice, except that the original obligor must be informed with reasonable certainty that there has been an assignment of the assets so that the original obligor knows to whom it has to pay in the future, and the notice must be unconditional. It would be prudent to ensure the notice was in English or Chinese, where necessary or applicable. A notice cannot be served on the obligor prior to the transfer of the assets as the transfer has not yet occurred.
An assignment is perfected once the above conditions have been satisfied. The requirements are more specifically set forth in Section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Cap. 23).
In practice, the transaction parties will review the underlying contracts in respect of the subject assets (eg, the relevant facility agreement) to determine whether there is any restriction on transfers of these assets. These restrictions are generally enforceable under Hong Kong law. If such restrictions exist, unless otherwise consented to by the original obligor, the originator may be in default of these contracts for making the transfer and the transfer could be challenged by the obligor under the contracts.
Under Hong Kong law, security can be granted either through an assignment by way of security or by way of a charge.
In the case of an assignment by way of security, the assets (eg, loan receivables) will be assigned to the secured party with a condition for reassignment of the assets when the underlying obligations being secured are fully fulfilled. Assignment by way of security can be legal or equitable, depending on whether the assignment has been perfected by notifying the obligor of the receivables. The perfection requirements are the same as those set out above.
Security by way of a charge essentially creates an encumbrance over the receivables and therefore no ownership right over the receivables is transferred to the secured party at the time the charge is created. Note that a charge is perfected when it is properly registered with Hong Kong's Companies Registry within the prescribed period if the chargor is a Hong Kong company or a foreign company registered with the Companies Registry to do business in Hong Kong under Part 16 of the Companies Ordinance.
As noted above, an assignment that fails to comply with any requirements in respect of a legal assignment will be an equitable assignment, with the following characteristics:
Although there are certain alternatives to effect the transfer of the subject assets, such as through a declaration of trust or through synthetic swaps, these alternatives may not necessarily achieve the bankruptcy remoteness as desired in a securitisation, depending on how they are constructed.
The potential tax involved in transfers from the originator and any intermediary operating companies or SPEs before the financial assets are finally lodged in the ultimate transferee would be stamp duty. Whether stamp duty is payable for the transfer of the subject assets depends on the nature of those assets. Generally, a transfer of receivables (whether trade or lease receivables) is not subject to stamp duty, while a transfer of interests in land and stocks could be subject to the payment of stamp duty. Receivables would not be regarded as "stock" for Hong Kong stamp duty purposes and, as such, no Hong Kong stamp duty charge would arise in relation to receivables in a securitisation. The requirements are more specifically set forth in the Stamp Duty Ordinance (Cap. 117).
Profits tax is chargeable on a person who is carrying on a trade, profession or business in Hong Kong in respect of such person's assessable profits arising in or derived from Hong Kong for a particular year from such trade, profession or business. Nevertheless, as the SPE normally will not undertake any business other than purchasing the assets and issuing the notes, it might not be deemed to be carrying on a trade, profession or business in Hong Kong.
Hong Kong generally does not impose a withholding tax except in limited circumstances (eg, royalties) that would not be applicable in a securitisation.
Tax issues in Hong Kong are normally handled by accountants.
In relation to tax, legal opinions usually cover issues regarding withholding tax on payments under the notes or other asset-backed securities and stamp duty on the issuance of such notes or securities and the execution of the relevant documentation.
Whether a securitisation transaction can receive off-balance sheet treatment from the originator’s group is subject to the auditor’s accounting analysis.
Lawyers in Hong Kong do not usually give legal opinions in this respect.
There are no disclosure requirements specifically relating to securitisation under Hong Kong law. However, please see 4.2 General Disclosure Laws or Regulations for certain general rules for disclosure applicable to securitisations.
Where a securitisation involves the issuance of debt securities, such issuance may be subject to the disclosure/registration regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO) and the Securities and Futures Ordinance (Cap. 571) (SFO), as applicable.
Under the CWUMPO, an offer of debt securities to the public in Hong Kong – unless otherwise exempted – must be issued with a prospectus that complies with the mandatory requirements set forth in the CWUMPO. For instance, the prospectus must specify the general nature of the business of the issuer, the investors' rights in respect of interest, security and redemption, and other information that is sufficient to enable a reasonable person to form a valid and justifiable opinion on investing in such debt securities. Unless otherwise exempted, the issuance must also be authorised by the Securities and Futures Commission (SFC).
Nevertheless, the CWUMPO and the SFO provide a number of exemptions in respect of the above requirements. The following two exemptions are often sought by the parties in a securitisation:
The Code on Unlisted Structured Investment Products promulgated by the SFC also sets forth certain disclosure requirements that might be applicable in a securitisation transaction in Hong Kong. For instance, the prospectus for the debt securities should contain a description of the key components of the transaction structure, a description of the events of default in which the debt securities may be terminated before the scheduled maturity and the rights of the investors in the event of such termination.
As noted above, a prospectus is used to satisfy the disclosure requirements. The prospectus typically summarises the transaction structure, describes the relevant parties and the terms and conditions of the notes, and lays out the risks that might be involved in investing in the notes for the investors’ attention.
Where a prospectus is not explicitly required under the law (eg, in certain private issuances), an offering circular or offering memorandum is normally produced for disclosure to investors. Contents typically follow those in public transactions.
The principal regulator is the SFC. For authorised institutions, the Hong Kong Monetary Authority (HKMA) is the principal regulator.
Where the prospectus contains misstatements that cause an investor to incur loss or damage, civil liability may arise under Section 40 of the CWUMPO, and the following persons could be liable to pay compensation to the investor for such loss or damage:
In addition to this civil liability, Section 40A of the CWUMPO states that any person who authorised the issuance of the prospectus that contains untrue statements can also be liable for criminal liability, including imprisonment and a fine. Nevertheless, such person would not be liable for criminal liability if he or she can prove that the statement in question is not material or that he or she had reason to believe and did believe that statement was true.
On the other hand, under Section 103(4) of the SFO, a person who makes a public offering of securities without the SFC's authorisation or exemption can be subject to a fine of HKD500,000 and imprisonment for three years. Where there is a continuing offence, such person can be subject to a further daily fine of HKD20,000 for each day that such offence continues.
There are no significant differences between the public market and the private market in terms of the size of securitisation or the types of investors. As noted above, a public offering of asset-backed notes will be subject to the disclosure and registration requirements under the CWUMPO and the SFO, as applicable, while a private offering may be exempted from such requirements. Most securitisation transactions, however, involve an issuance in the private market to sophisticated investors.
A Hong Kong law legal opinion normally does not specifically state whether the content of the prospectus satisfies the above disclosure and registration requirements.
There is no specific credit risk retention requirement under Hong Kong law. The HKMA has published a supervisory policy manual module (CR-G-12) with the aim of providing guidance to authorised institutions (eg, banks) on the vital elements of an effective risk management system for credit risk transfer activities.
In particular, where an authorised institution acts as the originator in a securitisation, it is required to carry out the following actions, among others:
Additionally, unless otherwise agreed with the HKMA, an authorised institution such as a bank should refrain from making investments in, or incurring exposure to, a securitisation transaction where the originator has not disclosed its compliance with applicable risk retention requirements – ie, requirements designed to ensure originators in securitisations retain certain economic exposure to the transactions for the purposes of aligning the parties' interests.
Module CR-G-12 is a non-statutory guideline issued as a guidance note, and the above actions are recommendations by the HKMA. No penalties are stipulated for non-compliance with Module CR-G-12.
As noted above, the HKMA is the principal regulator for authorised institutions such as banking institutions.
The Code on Unlisted Structured Investment Products requires continuing reporting in respect of certain matters.
Under the Code on Unlisted Structured Investment Products, the issuer must comply with certain requirements throughout the period during which any of its obligations remain outstanding. For instance, the issuer shall inform the SFC and all investors if it ceases to meet any of the core requirements specified in this code (including that the issuer should have a net asset value of not less than HKD2 billion and that it should not be the subject of any winding-up, dissolution or bankruptcy proceedings). The issuer should also notify the SFC and all investors, to the extent permitted by applicable law, of changes in circumstances (including financial conditions) that could reasonably have a material adverse effect on the ability of the issuer (or the guarantor, if any) to perform its obligations in connection with the securitisation.
The SFC is the principal regulator. If the issuer fails to meet any of the above requirements, it might be required to cease advertising to and inviting offers from the public in Hong Kong, and to rectify the situation as soon as possible.
The activities of rating agencies (RAs) are subject to the regulations under the Code of Conduct for Persons Providing Credit Rating Services (the CRS Code).
The CRS Code provides for certain requirements that must be met by an RA licensed in Hong Kong, including that an RA may not undertake any business that could potentially cause any conflict of interest in relation to its credit rating business. In connection with this, representatives of an RA are prohibited from making recommendations regarding the structural design of structured finance products, including securitisations.
Additionally, an RA is obliged to encourage the issuer of a securitisation to disclose all relevant information regarding securitisations for the purposes of enabling the investors and other rating agencies to conduct independent analysis. In respect of rating announcements, the RA is required to disclose whether the issuer has informed the RA that it is disclosing all relevant information or whether any information remains non-public.
The SFC is the principal regulator. The CRS Code is a guiding document for the SFC in considering whether an RA satisfies the requirement of being fit and proper to be or to remain licensed or registered. The CRS Code does not have the force of law.
Hong Kong is expected to implement the Basel III requirements fully by 2023. The Banking (Capital) Rules (Cap. 155L) require banks to hold adequate capital, and set out the various capital adequacy ratios and the framework for the calculation of such ratios. The rules are applicable to securitisation transactions, among other things. Furthermore, an authorised institution incorporated in Hong Kong (eg, a bank) is currently required to disclose certain information relating to its securitisation transactions, including:
The specific requirements are set forth in the Banking (Disclosure) Rules (Cap. 155M).
The HKMA is the principal regulator in respect of such requirements.
There are no specific laws or regulations that apply to the use of derivatives in securitisations or with regard to SPEs, although there are regulations relating to derivatives generally (such as regulations relating to disclosure and margins).
The Code of Conduct for Persons Licensed by or Registered with the SFC (the Code of Conduct), promulgated by the SFC, provides for general investor protection in Hong Kong, although it is not applicable specifically to securitisations.
The Code of Conduct provides for some major protection to investors of investment products (including securitisations). For instance, a licensed person (eg, an arranger) is required to take all reasonable measures to establish the true and full identity of an investor, the investor's financial situation and investment experience, and the investor's investment objectives. When making any investment recommendation or solicitation, the arranger is also required to ensure that the suitability of such recommendation or solicitation is reasonable in all the circumstances for the investor.
Additionally, the arranger is required to disclose to the investor information that is relevant to the transaction before or at the point of sale, including the arranger's capacity, affiliation with the issuer (if any), benefits received by the arranger and terms under which the investor may receive a discount on fees. Where a cooling-off period has been incorporated into a securitisation product, the arranger is also required to execute the investor instruction promptly where the investor decides to exercise its right to back out of the transaction, and the arranger should pass on to the investor the refund received from the relevant issuer, although the arranger may charge a reasonable administrative fee for such services.
Investors may also rely on the protections provided in relation to the issuance of debt securities (see 4.2 General Disclosure Laws or Regulations).
The SFC is the principal regulator.
While banks in Hong Kong are generally required to comply with various rules and regulations of the HKMA, there are no laws in Hong Kong that apply specifically to securitisations involving banks.
There are no specific rules that apply to the form of SPEs or restriction as to the entity of SPEs used in securitisations. For the typical features of an SPE, please see 1.2 Special-Purpose Entities.
SPEs are typically incorporated in offshore jurisdictions (such as the Cayman Islands).
Typically, the material factors include tax treatment, bankruptcy remoteness and that there are no particular current problems regarding enforcement in Hong Kong.
As discussed in 4.10 SPEs or Other Entities, the business undertaken by SPEs is usually restricted.
Typically, unless the transaction specifically requires it, SPEs will avoid activities that require appropriate licensing, such as advising on securities and dealing in securities.
A typical securitisation structure would not require the SPE to obtain any licences.
Depending on the applicable laws and regulations, the regulators involved may vary; these may include the HKMA and/or the SFC.
Depending on the transaction structure and the goal that the originator is trying to achieve (eg, off-balance sheet treatment), various forms of credit enhancement may be used in securitisation. Typically, bank accounts and assets of the issuer are charged in favour of the noteholders and the note trustee to secure the payments under the notes. The originator can also provide liquidity support to the issuer (eg, letter of credit) if the issuer becomes unable to fulfil its repayment obligations under the notes, and the originator (or an affiliate of the originator) may also provide a guarantee or other collateral to the noteholders and the note trustee.
Government-sponsored entities do participate in the securitisation market. For example, the Hong Kong Mortgage Corporation Limited (an entity wholly owned by the Hong Kong government through Hong Kong's exchange fund) has participated in a securitisation to provide a platform for banks to convert illiquid assets (eg, mortgage portfolios) into more liquid assets, among other purposes.
Investors in securitisations include various financial institutions and private funds. There is no law specifically prohibiting or limiting investment in securitisation products by any type of entity.
As loan receivables are a major type of asset being securitised in Hong Kong, they will be used as an example for the purpose of this section. As discussed above, the sale of the receivables in a securitisation will be effected by way of an assignment and through a sale agreement.
The principal subject matters in a sale agreement include the following:
Typical warranties made by the originator include its capacity and corporate authority to enter into the sale transaction. The originator will also provide warranties as to its legal title to the subject receivables and the compliance with any eligibility criteria relating to the nature or quality of the receivables. In some transactions, the issuer may also provide warranties in respect of its capacity and corporate authorities.
Perfection requirements and provisions vary depending on the type of the assets over which security is created. In the case of a legal assignment of loan receivables, for example, notice must be given to the original obligor under the loans in respect of such assignment so that the issuer may take actions directly against the obligor in the event of a default by the obligor under the loan document.
The principal covenants provided by the originator to the issuer are usually set forth in the receivables sale agreement. Typical covenants include that the originator:
The principal covenants provided by the issuer to the noteholders and the note trustee are set forth in the trust deed and include positive covenants such as:
The issuer would also provide negative covenants, such as:
Typically, in a securitisation, the originator will also take up the role of a servicer (or an "administrator" as it is sometimes called) to provide services with respect to the receivables being transferred to the issuer. The originator will enter into a service agreement with the issuer, which sets forth the detailed services to be provided and the payment arrangements in respect of the servicing fee. The terms and conditions of the service agreement would be on an arm’s-length basis.
Major services provided by the servicer include, without limitation:
The principal default events are typically contained in the trust deed or indenture, as applicable, and include, without limitation:
The principal default events in receivables sale documentation include, without limitation:
The originator (as the seller and servicer of the loans) typically agrees to indemnify the issuer for damages and losses sustained by the issuer in connection with the originator's failure to fulfil its obligations or breach of the contracts.
On the note level documents, the issuer would agree to indemnify the note trustee against damages and losses caused by the issuer. The issuer would also agree to indemnify the note trustee for other damages and liabilities sustained by the note trustee (and its directors and officers, etc) in connection with the following:
As discussed above, the issuer is often an SPE with a restricted scope of business permitted to be undertaken. The issuer’s obligations include acquiring and holding the financial assets, issuing the asset-backed securities and providing security for the benefits of the noteholders and the note trustee. The issuer also pays for the interests under the notes and, at maturity, repays the principal of the notes to the noteholders.
A sponsor is often referred to as an "originator" in securitisations in Hong Kong. The originator is normally the initiator of the securitisation transaction, with the aim of achieving its commercial and financing objectives. In relation to the loan receivables, the originator (or its subsidiaries) would be the lender of the loans and would sell the loan receivables to the issuer. In Hong Kong, originators are often large commercial enterprises or financial institutions.
An underwriter is often referred to as an "arranger" in securitisations in Hong Kong. Typically, the arranger is an investment bank and assists the originator in devising the overall securitisation structure, advises the originator on the viability of the transaction, and identifies and liaises with potential investors. The arranger will also enter into the subscription agreement with the issuer for underwriting. Sometimes, an arranger also invests in the notes, through an affiliate.
See 5.5 Principal Servicing Provisions.
An investor purchases the debt securities (ie, asset-backed notes) from the issuer or underwriter, as applicable. Investors can be financial institutions, private funds or governmental entities.
The note trustee acts under the instructions of the noteholders in respect of the actions being taken by the noteholders. The note trustee also holds the rights in the financial assets for the benefits of the noteholders.
The security trustee, on the other hand, holds on behalf of the noteholders the security created over the issuer's assets (eg, receivables, bank accounts and other corporate assets, as applicable).
The note trustee and the security trustee can be the same institution with the capability to provide all the above services.
Synthetic securitisation is not expressly prohibited under Hong Kong law and can be achieved under the current legal framework. However, there have been only a few synthetic securitisation transactions in the past two decades.
The laws and regulations that apply to a non-synthetic securitisation would also apply to synthetic securitisations; please see 4 Laws and Regulations Specifically Relating to Securitisation.
Balance sheet synthetic securitisations involve the transfer of credit risks of the assets owned by the originators to investors. The risk transfer can be achieved either through an SPE to the investors or directly to the investors, commonly through the use of credit default swaps or total return swaps. Another type of synthetic structure is commonly referred to as an "arbitrage structure". In an arbitrage synthetic securitisation, while credit risks on the referenced assets are transferred, the originator typically does not own or have any exposure to such assets. The originator and investors usually engage in an arbitrage synthetic securitisation for speculative purposes. The arbitrage structure is not commonly used in Hong Kong.
Various types of financial assets have been seen in securitisations in Hong Kong, including trade receivables, corporate loan receivables, project loan receivables, consumer loan receivables and property mortgages.
Securitisations in respect of the above categories of financial assets usually adopt a similar structure, unless there are unique features or commercial, accounting or rating factors that require variations on the structure to satisfy the relevant requirements.