Insolvency laws are a major consideration in securitisation in Hong Kong, where the insolvency laws enable a securitisation structure to be commercially feasible and act to protect all parties concerned. Typically, the assets backing and securing the notes or other asset-backed securities to be issued to investors, such as loans 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.

True Sales

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 transfer of rights by way of security under a secured loan. In determining whether a transaction constitutes a true sale, a Hong Kong court would look at a number of factors, including the parties' intention and the substance of the transaction rather than the labels the parties put upon it. More specifically, the court would take the following distinguishing features into account in its determination, without limitation:

• under the transaction documents, whether the originator has the contractual right to repurchase the subject assets and, if so, under what circumstances;
• if the assets are realised by the issuer at a profit, whether the issuer is contractually required to account to the originator for any such profit and, if the assets are realised by the issuer at a loss, whether the issuer is entitled to recover from the originator for such loss; and
• the intention of the parties and whether the transaction effected under the sale agreement also properly reflects the intention of the parties.

A transaction will not be treated as a true sale just because it is labelled 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, it 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 or definitive guidelines 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, which will therefore not form part of the originator’s estate nor be subject to any insolvency proceedings in respect of the originator. If the court finds the sale transaction to be a sham or fraud, then the transfer would be a true sale and thus no ownership in the assets would be transferred.

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, whereas the originator is entitled to an equity of redemption.

True sale opinions

A true sale opinion may be requested by and delivered to the arrangers, investors and auditors, 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. Depending on the nature of the originator or seller and related assets, the opinion may be subject to additional qualifications and assumptions.

Where the originator is a Hong Kong incorporated company and becomes insolvent, there is the possibility that the court may unwind the sale transaction if it finds that the sale of the receivables was either:

• an unfair preference or a transaction at an undervalue; or
• a disposition to defraud creditors.

Due diligence

In practice, transaction parties would conduct due diligence to check that there are no legal grounds for the sale transaction to be unwound prior to entering the sale transaction. On closing, the issuer (and the guarantor, if any) may also be required to provide directors' certificates certifying, inter alia, that the originator is not subject to any insolvency proceedings or aware of any circumstances that could result in the contemplated sale transaction being unwound or set aside, and that it is entering into the transaction in good faith, for value and on an arm's-length basis.

An SPE is typically used in securitisation transactions in Hong Kong, and acts as the beneficial owner of the assets transferred from the originator and the issuer of the asset-backed notes. Therefore, the SPE is used to insulate the assets from the financial and credit risks of the originator.

Requirements and Structure

Hong Kong does not impose any specific requirements for an SPE in a securitisation transaction. An SPE is typically structured as an orphan entity and is usually a separate legal entity with limited liability, which is not part of the originator or any corporate group, and whose shares are 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.

• Restrictive covenants: the business that the SPE may undertake will normally be restricted to that connected to the purchase and holding of the subject assets, the issuance of the asset-backed securities and other ancillary matters. For instance, generally speaking, the SPE may not own assets other than the subject assets in the securitisation transaction and the related collection and deposit accounts, and may not incur indebtedness nor grant any security other than in connection with the asset-backed notes. The liabilities and assets of an SPE in a securitisation transaction should be ring-fenced from those in unrelated transactions.
• Independent officers: independent directors will be appointed for the SPE. As the SPE is an orphan entity, managers and investors would want to ensure that the originator does not have absolute control over the SPE (other than on an arm's-length basis as an administrator or servicer, as applicable) and thus the SPE directors will usually not be affiliated with or nominated by the originator. This could also be required by auditors where the transaction is seeking off-balance sheet treatment.
• Limited recourse: the transaction parties will agree in the documentation that any recourse a party may have against the SPE in the securitisation will be limited to those assets owned and held by the SPE.
• Non-petition: the transaction parties will agree in the documentation that they will not commence insolvency proceedings against the SPE, even if an event of default has occurred.

Under such structure, the originator will not normally be able to exercise influence or control over the SPE.

Offshore SPEs

Although the SPE can be incorporated in Hong Kong, the transaction parties will more commonly use an offshore SPE (such as a Cayman Islands limited liability company) for various benefits, including more favourable tax treatments, simpler administration, lower regulatory and compliance costs, and as a commonly preferred jurisdiction of the transaction parties and the investors.

Offshore SPEs are also subject to Hong Kong local regulatory requirements. In particular, business registration is required if the SPE's business amounts to any form of trade, commerce, craftsmanship, profession, calling or other activity carried on for the purposes of gain in Hong Kong.

Currently, “substantive consolidation” is not a concept recognised under Hong Kong law or by Hong Kong courts. Each company (including an SPE) incorporated under Hong Kong law will be treated as a separate legal entity. 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 public record searches in respect of any insolvency and analogous proceedings or corporate actions taken with respect to the issuer.

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.

Conditions for a Legal Assignment

In order for the transfer of the financial assets (such as trade or loan receivables) 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. Certain conditions will need to be satisfiedin order to achieve a legal assignment, including the following:

• the originator’s entire (and not partial) interests in the assets are transferred to the issuer by way of an absolute and irrevocable assignment, rather than by an assignment by way of security;
• the assignment must be in writing and signed by the originator (normally in the formality of a deed);
• the subject assets must not be subject to any form of encumbrance nor otherwise be restricted or prohibited from transfer, whether contractually or by law; and
• the obligor of the subject assets (eg, the borrower of the loans) must be notified of such assignment (the notice of assignment can be served on the borrower by either the originator (as assignor) or the issuer (as assignee).

If an assignment fails to meet any of the above conditions, it would still be enforceable but instead would be an equitable assignment until all these conditions are satisfied. In particular, although the transfer would not be ineffective solely because of a failure to notify the obligor, the issuer (being the buyer of the assets) will not be able to enforce its rights directly against the obligor in the event of default by 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 to the obligor, there are no other requirements as to the form of the notice of assignment, except that the obligor must be informed with reasonable certainty that there has been an absolute and irrevocable assignment of the assets so that the obligor knows who 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.

Perfection

A legal assignment is perfected once the obligor of the receivables is notified of the assignment in writing. The requirements of a legal assignment are more specifically set forth in Section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Cap. 23). Although there is no prescribed time limit for serving the notice of assignment on the obligor, in practice the notice is served immediately or as soon as practicable after an assignment is made so as to protect the assignee's (ie, the issuer's) priority over the assigned receivables.

It is also typical to put in place a trust provision in the assignment (and also in the written notice of assignment to the obligor), expressly providing that any payments received by the originator from the obligor shall be promptly deposited into a designated account held in the name of the issuer, and if not deposited are deemed to be held on trust for the issuer.

Restrictions

In practice, the transaction parties will review the underlying contracts in respect of the financial assets (eg, the relevant facility agreement) to determine whether there is any restriction on transfers (eg, a negative pledge restriction). These restrictions are generally enforceable under Hong Kong law. If such restrictions exist, unless otherwise consented to by the obligor, the originator may be in default of these contracts for making the transfer, and the transfer could be challenged as void by the obligor.

Under Hong Kong law, security can be granted through an assignment by way of security or by way of a charge.

Assignment by Way of Security

In such cases, 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

This 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 one month of the creation of the charge if the chargor is a Hong Kong company or a foreign company registered with the Companies Registry to do business in Hong Kong as a non-Hong Kong company under Part 16 of the Companies Ordinance (Cap. 622 of the Laws of Hong Kong) (Companies Ordinance) and creating security over a wide range of assets in Hong Kong including a charge over book debts (but excluding a charge over account in relation to a deposit of money with another person, because a charge on the chargor's right to repayment of the deposited money is not regarded as a charge on book debts of the chargor and is therefore not registrable as a charge under the Companies Ordinance).

In the case of a foreign obligor not registered under Part 16 of the Companies Ordinance or if the security is created over assets outside Hong Kong, the charge will be perfected by fulfilling the registration requirements in the relevant registries of the foreign obligor's place of incorporation.

There is no other requirement for an assignment to be registered at any registries in Hong Kong; the only perfection requirement is the obligor of the receivables being notified of the assignment in writing.

Equitable Assignments

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:

• the original obligor discharges its repayment obligations by making required payments to the originator, not the issuer, and the obligor need not be concerned with whether the issuer ultimately receives the payments from the originator;
• the obligor and the originator may amend the underlying contracts without involving the issuer;
• where the obligor defaults under the underlying contract, the issuer will not be able to take actions directly against the obligor – the originator will need to be involved; or
• the asset is subject to the risk of later created assignments notified by a third party on the obligor, which would take priority over the first in place equitable assignment.

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 desired in a securitisation, depending on how they are constructed.

Stamp Duty

In Hong Kong, there are no capital gains or other taxes in connection with the transfer of receivables. 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 Hong Kong stocks could be subject to the payment of stamp duty.

Hong Kong stock is defined to include not only equities but also debentures, loan stocks, funds, bonds or notes denominated or redeemable in Hong Kong currency, the transfer of which is registered in Hong Kong (Section 2 of the Stamp Duty Ordinance (Cap. 117)). Generally, most loans and receivables would not be regarded as “Hong Kong stock” for Hong Kong stamp duty purposes and, as such, no Hong Kong stamp duty would be chargeable in relation to their transfers in a securitisation.

However, where a Hong Kong dollar debt instrument is in registered form, the transfer may attract stamp duty, which is payable in respect of contract notes for the transfers or sales of shares or stock. The applicable rate of stamp duty with effect from 1 August 2021 is 0.26%, which is charged on the consideration or the fair market value of the shares or stock transferred, whichever is higher. In addition, there is a fixed duty of HKD5 per instrument, duplicate and counterpart.

The stamp duty requirements are more specifically set forth in the Stamp Duty Ordinance (Cap. 117).

In previous decades, profits tax was only chargeable on a person who was 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 any tax assessment year, while foreign-sourced income (even received in Hong Kong) was exempt. This longstanding rule of taxing income based on the locality of the profits derived is about to be changed.

The Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Bill 2022 (the Amendment Bill) was gazetted on 28 October 2022, and introduced into the Hong Kong Legislative Council on 2 November 2022 for review. The Amendment Bill came into operation on 1 January 2023 and brings in a new regime for taxing specified foreign-sourced income, meaning any interest, dividend, disposal gain from the sale of equity interests in an entity (Disposal Gain) and IP income arising in or derived from outside Hong Kong.

Under the new regime, specified foreign-sourced income will be deemed to be sourced from Hong Kong and chargeable to profits tax if:

• the income is received in Hong Kong by a multinational enterprise carrying on a trade, profession or business in Hong Kong, regardless of its revenue or asset size; and
• the recipient entity fails to:
1. meet the economic substance requirement if the income is foreign-sourced interest, dividend or Disposal Gain);
2. comply with the nexus requirement if the income is foreign-sourced IP income; or
3. comply with the participation requirement if the income is foreign-sourced dividend or Disposal Gain.

Nevertheless, as the SPE is normally a foreign company and will not normally undertake any business in Hong Kong 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 does not generally impose a withholding tax, except in limited circumstances (eg, royalties) that would not generally be applicable in a securitisation.

Tax issues in Hong Kong are normally handled by accountants.

Hong Kong legal opinions may 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 disclosure rules that are 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 Ordinance, the Companies (Winding Up and Miscellaneous Provisions) Ordinance (CWUMPO) and the Securities and Futures Ordinance (Cap. 571) (SFO), as applicable.

Companies Ordinance

Under the Companies Ordinance, if the issuer is a Hong Kong company or a registered non-Hong Kong company, it is required to file a Form on Return of Allotment of Debenture or Debenture Stock within one month of the issue of the debt securities.

CWUMPO

Under the CWUMPO, an offer of debt securities to the public in Hong Kong – unless exempt – must be authorised by the Securities and Futures Commission (SFC) and also 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.

Exemptions

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.

• Professional investors' exemption – an offer made to professional investors can be exempted from the registration requirement. “Professional investor” is defined in Schedule 1 to the SFO and the Securities and Futures (Professional Investor) Rules (Cap. 571D), and includes investors who are, among others, authorised institutions (eg, banks), authorised insurers, collective investment schemes and individuals with a portfolio of not less than HKD8 million.
• Private placement exemption – an offer made to not more than 50 persons and containing a warning statement as specified in the Eighteenth Schedule to the CWUMPO can be exempted from the registration requirement. The warning statement generally stipulates that the contents of the prospectus have not been reviewed by any authority in Hong Kong, and that the investors should exercise caution and obtain professional advice in relation to the offer of debt securities.

Listing Rules

Separately, with effect from 1 November 2020, the Listing Rules on the listing of debt securities offered to professional investors of the Hong Kong Stock Exchange set out new disclosure and publication requirements applicable to new issuances and new continuing obligations (applicable to both new and existing issuances). For example, issuers (and guarantors, where applicable) are required to:

• publish listing documents (eg, offering circular and pricing supplement) (in English or Chinese) on the website of the Stock Exchange (www.hkexnews.hk) on the date of listing;
• state explicitly on the front cover of a listing document the intended investor market in Hong Kong (ie, professional investors only and not appropriate as an investment for retail investors in Hong Kong);
• announce any information that may have a material effect on their ability to meet their obligations under the listed debt securities;
• disclose a default (including any cross-default of the listed debt securities triggered by a default on other obligations of the issuer or the guarantor), insolvency, winding-up and similar applications or proceedings, or the appointment of manager or receiver; and
• make quarterly announcements following any suspension of trading.

Disclosure Requirements

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 as securitisation is considered a structured investment. 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.

Prospectus

As noted above, a prospectus is used to satisfy the disclosure requirements. The prospectus typically summarises the transaction structure, describes the relevant parties, the characteristics of the securitised assets and the terms and conditions of the notes, and lays out the materially important risks that potential investors should consider when deciding whether or not to invest in the notes or securities.

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 (and also the Hong Kong Stock Exchange in the case of listed debt issuances). For authorised institutions, the Hong Kong Monetary Authority (HKMA) is the principal regulator.

Misinformation

Where the prospectus contains mis-statements 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:

• directors of the issuer at the time of the issuance;
• persons who are named in the prospectus as a director of the issuer;
• promoters of the issuer; and
• persons who have authorised the issuance of the prospectus.

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 they can prove that the statement in question is not material or that they had reason to believe and did believe that the 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.

Public Market v Private Market

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, the SFO and the Hong Kong Stock Exchange, as applicable, while a private offering may be exempted from such requirements. Most securitisation transactions, however, involve an issuance in the private market to professional investors.       

A Hong Kong law legal opinion does not normally specifically state whether the content of the prospectus satisfies the above disclosure and registration requirements.

HKMA Guidance

There is no specific credit risk retention requirement under Hong Kong law. The HKMA has published a supervisory policy manual module (CR-G-12) on “Credit Risk Transfer Activities”, 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:

• assess its risk exposures to the subject transaction on an arm’s-length basis according to its normal assessment and approval processes; and
• apply a due diligence process, credit underwriting criteria and standards of analysis to the assets of the securitisation transaction that are as rigorous as those for assets that are originated or acquired by the institution for its own retention, and ensure that investors in the securitisation transaction have access to all materially relevant data concerning the transaction.

In addition, 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.

Non-compliance

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.

If acting as underwriters or investors, authorised institutions incorporated in Hong Kong are required to comply with statutory limitations on exposures and risk concentrations. In summary, an authorised institution must not incur exposures to a single counterparty or a group of linked counterparties that exceed 25% of its Tier 1 capital as per the Banking (Exposure Limits) Rules (Cap. 155S). The HKMA may vary the prescribed limit on an authorised institution.

As noted above, the HKMA is the principal regulator for authorised institutions such as banking institutions. The HKMA reviews and enhances the regulatory regime constantly to ensure that it is in line with international standards and that it addresses the latest market developments.

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.

Code of Conduct for Persons Providing Credit Rating Services (the CRS Code)

The activities of rating agencies (RAs) are subject to the regulations under the CRS Code.

The CRS Code provides for certain requirements that must be met by an RA that is 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.

In addition, 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 RAs 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.

Basel III

Hong Kong is expected to implement the Basel III requirements fully by 2024. The HKMA has announced that, in order to give the industry additional time to prepare for the implementation of the new/revised capital standards in the Basel III final reform package, the target effective dates of the standards in Hong Kong are intended to be revised as follows.

• Revised frameworks on credit risk, operational risk, output floor and leverage ratio will take effect as minimum requirements from 1 July 2023 (instead of 1 January 2023).
• Revised market and Credit Value Adjustment (CVA) risk frameworks – locally incorporated Hong Kong-authorised institutions (AIs) will be required to implement the revised frameworks for reporting purposes by 1 July 2023, while the relevant rules will take full effect o earlier than 1 January 2024. During the reporting-only period, locally incorporated AIs will still be required to calculate their regulatory market and CVA risk capital charges based on the existing Banking (Capital) Rules (Cap 155L).
• Revised disclosure framework – the disclosure requirements associated with the above revised frameworks will take effect according to the effective dates of the corresponding frameworks described above.

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 qualitative information on its strategy and risk management;
• a breakdown of its securitisation exposures in the banking book; and
• a breakdown of its securitisation exposures in the trading book.

More specific disclosure requirements are set forth in the Banking (Disclosure) Rules (Cap. 155M), which will be further updated (the effective date is to be confirmed) to reflect the new/revised disclosure requirements associated with the Basel III final reform package. Consequential amendments to the Banking (Capital) Rules (Cap. 155L) will also be made accordingly.       

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 SFC's Code of Conduct for Persons Licensed by or Registered with the SFC (the Code of Conduct)

In Hong Kong, the debt securities market is almost entirely private. The Code of Conduct provides for general investor protection in Hong Kong, although it is not applicable specifically to securitisations.

The Code of Conduct provides some major protections for investors of investment products (including securitisations). For instance, a licensed person (eg, an arranger) is required to take all reasonable measures to establish the following characteristics of an investor:

• its true and full identity;
• its financial situation and investment experience; and
• its 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.

In addition, 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.

SFC Rules Governing Bookbuilding and Placing Activities in Hong Kong

In 2022, the SFC added a set of new rules to the Code of Conduct, setting out the standards of conduct expected of intermediaries engaged in bookbuilding or placing activities in debt capital market transactions. From 5 August 2022, intermediaries involved in securitisation transactions engaging in such activities in Hong Kong will need to comply with these new requirements in the Code of Conduct.

The key requirements apply to offerings of listed or unlisted debt securities offered in Hong Kong or otherwise. In-scope activities carried out by intermediaries in Hong Kong include:

• bookbuilding activities;
• placing activities; and
• advising, guiding and assisting the issuer client in bookbuilding and placing activities (the Covered Activities).

For all listed or non-listed debt offerings, intermediaries must comply with these new requirements when engaging in a securitisation transaction that involves the Covered Activities after 5 August 2022, either when the transaction is announced or when they are appointed as a capital market intermediary (CMI) to such transaction and, where applicable, when the listing application is made.

Capital market intermediaries

The new requirements apply to CMIs and the overall co-ordinator (OC). A CMI is a licensed or registered person (a licensed corporation or a registered institution – eg, a bank) engaged in the Covered Activities. A CMI can be either a syndicate CMI (which is appointed by the issuer in the debt offering) or a non-syndicate CMI (which is not appointed by the issuer but is involved in the Covered Activities to certain extent).

An OC is usually a syndicate CMI that conducts the overall management of the offering, co-ordinates the bookbuilding or placing activities conducted by other CMIs, has control over the bookbuilding activities, and makes allocation or pricing recommendations to the issuer client. Also, if a CMI conducts any activities of the OC, it will also be considered an OC itself and be subject to the same obligations as the OC with respect to the updated Code of Conduct.

In terms of compliance, the distinction between a syndicate or a non-syndicate CMI is essential as it dictates the different obligations or expected standards of conduct for compliance with the new requirements.

Debt Offerings

In respect of debt offerings, a non-syndicate CMI is only required to comply with the following requirements:

• to identify and assess whether the investors are targeted investors or restricted investors, or have any associations with the issuer, the CMI or the same group of companies as the CML;
• to conduct bona fide management of orders, order books and details of underlying investors of omnibus orders, preventing "X-orders", which are orders in which the identities of investors are concealed, and which the SFC sees as problematic due to a lack of transparency; and
• adhere to restrictions on passing on rebates from issuer to investors and disclose any rebates and preferential treatment offered by the issuer to different investors.

A syndicate CMI is required to comply with the following additional requirements:

• to conduct adequate assessment of the issuer before engaging in a debt offering;
• to be formally appointed by written agreement with the issuer prior to engaging in the Covered Activities;
• to ensure that debt securities are only marketed to the targeted investors;
• to establish and implement an allocation policy that is fair and transparent;
• to establish policies and procedures to identity, manage and disclose conflicts of interest, and which govern proprietary orders of a group company or orders placed on behalf of funds and portfolios in which the CMI or its group company has a substantial (ie, over 50%) interest and allocations; and
• to meet ongoing obligations, including but not limited to:
1. there being sufficient resources and effective systems and controls to discharge said obligations and responsibilities;
2. communicating with the relevant authorities (ie, the SFC and the Stock Exchange of Hong Kong) in an open and co-operative manner;
3. making timely disclosure of complete and accurate information to the OC, non-syndicate CMIs and targeted investors; and
4. to maintain proper and sufficient records to demonstrate compliance with all applicable requirements.

The obligations and standards of conduct expected of an OC in debt offerings are as follows:

• to be formally appointed by written agreement with the issuer prior to engaging in the Covered Activities;
• to establish marketing and investor-specific strategies for the generation of orders, and advise the issuer on all applicable disclosure requirements with respect of any rebates and preferential treatment offered to investors;
• to ensure that the pricing process is credible and transparent, that the order book is managed in a proper and bona fide manner and that allocations are on a proper basis;
• to advise issuer clients to provide sufficient and all relevant information to syndicate CMIs to assess whether the investors have any association with the issuer, CMIs or their group companies; and
• to meet ongoing obligations, including:
1. to provide advice, guidance and recommendations to issuer clients in respect of the level of due care, skill and diligence required of an issuer in debt offerings;
2. to maintain communications with the SFC on any material non-compliance with Stock Exchange of Hong Kong requirements (where applicable), material changes to information previously provided, and reasons for ceasing to act;
3. to disclose the issuer's marketing strategies and disseminate material information related to the debt offering to syndicate CMIs and targeted investors; and
4. to keep sufficient records such as timely documentation of key changes in order books, key advice or recommendations given to investors, final decisions made, etc.

Exclusions

Notably, certain types of activities are excluded from the new requirements, as they are not considered to fall within the scope of the Covered Activities, such as:

• bilateral arrangements between the issuer and investors;
• private placements where only one or several investors are involved and where the terms of the transaction are directly negotiated and agreed between the issuer and the investors; or
• in transactions where debt securities are allocated to investors on a pre-determined basis (including pre-determined pricing).

The new requirements also do not apply to financial advisers and other professionals appointed by the issuers – to the extent they do not participate in the Covered Activities.

In addition to the SFC's Code of Conduct, investors may also rely on the protections provided in relation to disclosure laws and regulations applicable to the issuance of debt securities (see 4.2 General Disclosure Laws or Regulations).

The SFC is the principal regulator.

If debt securities are issued publicly, they are usually listed on the Hong Kong Stock Exchange (although they could be listed on a foreign stock exchange) and subject to the Listing Rules of the Hong Kong Stock Exchange (HKEx) relating to the listing of debt securities, including:

• in an offering to retail investors, if the shares of the issuer or the guarantor (in the case of a guaranteed issue) are not listed, the issuer or the guarantor must have total shareholders' funds of at least HKD100 million, and the nominal amount of each class of debt securities for which listing is sought must be at least HKD50 million; and
• in an offering to professional investors, effective from 1 November 2020, the issuer (whether a corporation or an investment trust) must have minimum net assets of HKD1 billion (unless it is a state corporation or its shares are listed) and is subject to a minimum issue size requirement of HKD100 million.

More specific requirements for the listing of debt securities are contained in the Listing Rules of the HKEx.

Disclosure obligations

There are also disclosure and continuing obligations applicable to the issuer and guarantor (if there is any) of the listed debt securities. For example, under Chapter 37 of the Listing Rules, issuers and guarantors are required to:

• respond promptly to the Stock Exchange’s enquiries in relation to unusual movements in the price or trading volume or the possible development of a false trading market or any other matters in relation to the listed debt securities, and, if requested, to publish announcements to inform the market or to clarify such matters;
• announce any information that may have a material effect on their ability to meet their obligations under the listed debt securities; and
• publish announcements relating to:
1. a default on its listed debt securities, which would include but is not limited to any cross-default of the listed debt securities triggered by a default on other obligations of the issuer or the guarantor; and
2. the appointment of a receiver or manager, a winding-up, a liquidation and/or any equivalent action (including voluntary winding-up).

The HKEx is the principal regulator.

While banks in Hong Kong are generally required to comply with various HKMA rules and regulations, there are no laws in Hong Kong that apply specifically to securitisations involving banks.

Recently, Hong Kong has followed other major jurisdictions in putting in place the Financial Institutions (Resolution) (Contractual Recognition of Suspension of Termination Rights – Banking Sector) Rules (Cap. 628) (the Stay Rules), which came into operation on 27 August 2021.

The purpose is to prevent contractual counterparties of a bank from terminating or closing out their positions solely as a result of the bank’s entry into resolution (eg, when they fall into financial distress) so as to prevent disorderly early termination of contracts on a mass scale, which could frustrate resolution actions taken by the HKMA resolution authority and thus result in significant systemic risks.

The Stay Rules require the insertion of a “suspension of termination rights provision” into the Covered Contracts (as defined below), such that the contractual counterparties agree to be bound by any temporary stay that the resolution authority may impose pursuant to Section 90(2) of the Financial Institutions (Resolution) Ordinance (Cap. 628).

The affected entities are AIs, their holding companies and any other group companies that are not themselves a Hong Kong AI (the Covered Entities); the affected contracts are their non-Hong Kong law-governed financial contracts containing a termination right exercisable by a counterparty (other than an excluded counterparty) (the Covered Contracts).

Covered Entities are required to comply with the Stay Rules by the end of the relevant initial period (ie, the period of 24 or 30 months beginning on 27 August 2021), which differs depending on the type of Covered Contracts and the type of counterparties involved.

Such financial contracts include the following, among others:

• securities contracts – ie, contracts for the purchase, sale or loan of a “transferable security”, including shares or bonds in companies;
• commodities contracts;
• derivatives contracts;
• currency contracts; and
• other contracts of a similar nature (but excluding short-term interbank borrowings with maturity of three months or less).

Such termination right refers to:

• a right to terminate the contract;
• a right to accelerate, close-out, set-off or net obligations, or any similar right that suspends, modifies or extinguishes an obligation of a party to the contract; or
• a right to prevent an obligation from arising under the contract.

Implications for Securitisations

If AIs (either as issuer or investor, or in any other capacity) enter into non-Hong Kong law-governed bond documents after 27 August 2021, such as subscription agreements, underwriting agreements, placement agreements, dealer manager agreements and agency agreements, they will need to examine carefully whether such contracts contain a termination right exercisable by a counterparty; if so, they will need to include the required contractual provision for contract parties to be bound by any temporary stay that the resolution authority (HKMA) may impose.

For issuers that are AIs or group companies that are not themselves an AI, the range of bond documentation that may fall within the ambit of the Stay Rules may be much wider, and each securitisation transaction involving banks or their group companies as issuers will therefore need to be considered on a case-by-case basis.

Implications for the Use of Derivatives in Securitisations

Where derivatives are used in securitisations or by the issuer in its underlying loan contracts and receivables, and where a Covered Entity (Hong Kong AI) is a counterparty, the Stay Rules will also apply, which could have the effect of temporarily suspending the rights of acceleration, close-out, set-off or netting obligations of the counterparties in the underlying derivatives contracts. This could adversely impede bondholders' rights to close out the positions in a derivative contract under a default situation in a securitisation transaction.

There are no specific rules or restrictions that apply to the form of SPEs or other entities used in securitisations. For the typical features of an SPE, please see 1.2 Special-Purpose Entities (SPEs).

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.

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 or 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 a securitisation. Typically, the 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, other than the generally applicable banking regulations to which authorised institutions (eg, banks) are subject.

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. The assignment of receivables in a securitisation is usually effected in the form of a sale agreement signed by the originator and the issuer, setting out the terms of the assignment and the receivables (and the security rights attached or relating thereto, if any) that are the assigned assets.

The principal subject matters in a sale agreement include the following:

• the transfer of the originator’s rights and obligations in respect of the receivables to the issuer;
• the consideration payable by the issuer for the transfer;
• the conditions that must be satisfied before the transfer may be effectuated and before the consideration becomes payable;
• the consequences for non-compliance with conditions; and
• the representations and warranties made by the originator or the issuer.

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 its compliance with any eligibility criteria relating to the nature or quality of the receivables, including that the originator is not subject to any winding-up, dissolution or bankruptcy proceedings or equivalent actions, and that there are no circumstances or legal grounds upon which the obligations of the seller can be set aside.

Perfection requirements and provisions vary depending on the type of assets over which security is created and the place of incorporation of the security providers. 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:

• will not transfer or otherwise dispose of the receivables to any other third parties other than as contemplated by the receivables sale agreement and the securitisation transaction;
• will not perform or omit to perform any action that would prejudice the interests of the issuer in the receivables; and
• will reimburse the issuer for any reduction in the amount received by the issuer under the loan documents due to any set-off by the obligor therein.

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 that:

• the issuer will keep proper books of account;
• the issuer will hold any payments received from the obligor of the receivables on trust for the noteholders and the note trustee;
• the issuer will notify the trustee upon the occurrence of default; and
• the issuer will send any financial statements to the note trustee upon the latter's request.

The issuer would also provide negative covenants, such as:

• the issuer will not create security interests over its assets other than those in connection with the notes;
• the issuer will not engage in any activity that is not incidental to or necessary in connection with the notes; and
• the issuer will not incur any indebtedness nor give any guarantee or indemnity other than in connection with the notes.

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 the following, without limitation:

• collecting the payments from the obligors under the loans or directing the obligors to make payments to the issuer;
• enforcing the covenants, undertakings and obligations of the obligors in respect of the loans; and
• maintaining full and proper records in respect of the loans.

The principal default events are typically contained in the trust deed or indenture, as applicable, and include the following, without limitation:

• non-payment by the issuer of the principal or interest on the notes;
• default by the issuer in respect of other indebtedness incurred by the issuer; and
• winding-up or bankruptcy in respect of the issuer.

The principal default events in receivables sale documentation include the following, without limitation:

• breach of warranties made by the originator; and
• winding-up or bankruptcy in respect of the originator.

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:

• the note trustee's exercise of its powers in accordance with the terms of the transaction documents; and
• the costs and expenses incurred by the note trustee for defending itself against or investigating any claim with respect to the note trustee's exercise of its powers.

The issuer is often an SPE that is permitted to undertake a restricted scope of business. 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 to obligors 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, with the following functions:

• assisting the originator in devising the overall securitisation structure;
• advising the originator on the viability of the transaction; and
• identifying and liaising 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 benefit of the noteholders.

The security trustee, on the other hand, holds the security created over the issuer's assets (eg, receivables, bank accounts and other corporate assets, as applicable) on behalf of the noteholders.

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 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, the originator does not typically own or have any exposure to assets while credit risks are transferred on said 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 categories of financial assets listed in 8.1 Common 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.