Financial assets commonly securitised in Hong Kong include trade receivables, consumer/credit card loan receivables, lease/sales receivables, residential and commercial mortgage loans and collateralised loan obligations (mainly corporate or project loans).

The transaction structure typically follows a similar pattern, regardless of asset type. This involves pooling the underlying assets into a portfolio, which is then sold to a special-purpose entity (SPE). The SPE will finance the purchase by issuing securities to investors in the forms of debt securities. The portfolio will serve as collateral to secure the securities. The cash flows generated from the underlying assets (eg, loan repayments or rentals) are used to service these debt securities, providing returns to the investors. Variations on the structure may be used to cater for special considerations, such as commercial, accounting, tax and rating.

Principal applicable laws and regulations that could have a material impact on the structures relating to financial assets include (but are not limited to):

• Banking Ordinance (Cap. 155) and the Code of Banking Practice;
• Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules”) (In particular, Chapter 37 of the Listing Rules on Listing of Debt Issues to Professional Investors);
• Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (governing conducts of financial intermediaries);
• Companies Ordinance (Cap. 622);
• Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)(CWUMPO);
• Conveyancing and Property Ordinance (Cap. 219) in connection with insolvency, claw-back and avoidance of certain transfers of property;
• Inland Revenue Ordinance (Cap. 112);
• Law Amendment and Reform (Consolidation) Ordinance (Cap. 23) in respect of effecting legal assignment for the transfer of loans and receivables; and
• Securities and Futures Ordinance (Cap. 571)(SFO).

SPEs can be incorporated in any jurisdictions. Transaction parties typically use offshore SPEs due to their favourable tax treatments, stable and predictable laws and regulations, and simple administration. Cayman Islands and British Virgin Islands limited liability companies are the most preferred SPE entities by transaction parties in Hong Kong, although Hong Kong SPEs are also commonly used. There were occasional examples of PRC and Taiwan SPEs, but they were mainly used by large PRC/Taiwan multinational companies due to regulatory/licensing reasons.

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. Typically, the issuer’s bank accounts and underlying assets (eg, loan/lease receivables) of the issuer will be charged in favour of the note trustee for the benefits of the noteholders, and to secure the principal and interest payments under the notes. The originator or its affiliate(s) may provide other forms or credit support – eg, standby letter of credit, corporate guarantee or subordination.

The issuer is often an SPE that is isolated from its originator and permitted to undertake a restricted business scope.  The issuer acquires and holds financial assets through true sale transactions, issues asset-backed securities and provides security for the benefits of the noteholders and the note trustee. The issuer is obligated to comply with both financial and non-financial obligations under the terms and conditions of the notes – eg, compliance with applicable laws and regulations and reporting/notification/disclosure requirements on matters related to its business and financials that may have a material adverse impact on its ability to pay interests and repay principals to the noteholders at maturity of the notes.

A sponsor initiates and organises the securitisation process. The sponsor’s main responsibilities include selecting and packaging the assets for securitisation, ensuring the legal validity of the transfer or sale of these assets to the SPE, and sometimes underwriting or purchasing a portion of the issued securities by the SPE.  A sponsor is often the original owner of the securitised assets, and is thus often referred to as an “originator”. In practice, various types of financial institutions can act as sponsors in a securitisation transaction, including banks and investment funds, as well as trading companies and exporters.

The originator is the initiator of the securitisation transaction, with the aim of achieving its commercial and financing objectives. For example, in the case of 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. Originators are often large commercial enterprises or financial institutions. Please also refer to 2.2 Sponsors.

An underwriter or a placement agent is often referred to generally as an “arranger” in a securitisation 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 that acts as an underwriter also enters into the subscription agreement with the issuer for underwriting all or a part of the securities to be issued. Sometimes, an arranger also invests in the notes, through an affiliate.

A “servicer” manages or administers the underlying assets on behalf of the SPE. Their duties include collecting payments from the obligors of the loans or receivables, ensuring timely transfer of collected funds to the secured accounts charged to the security trustee, and monitoring communications with the obligors and managing any issues like delinquencies or defaults. Where the assets are securities such as equities and debt securities, the servicer could be a professional portfolio manager.

Servicers in securitisation transactions are typically financial institutions or specialised firms with expertise in asset management and servicing. Originating banks and loan originators often also act as primary servicers due to their existing relationship with the obligors, and with the third-party servicing firms involved.

Depending on the nature of the assets being serviced or managed, servicers may need specific permissions, licences or authorisations under Hong Kong laws. These may include banking and SFC licences for debt collection or asset management.

An investor purchases the assets-backed securities from the SPE. Their key responsibility includes to perform independent due diligence so as to assess risks and potential returns, evaluate the quality and structure of the underlying assets, and to make investment decisions. Investors can be pension funds, insurance companies, investment fund managers, commercial banks, governmental entities, and other institutional or professional investors. Investors provide the capital needed, enabling the asset originators to convert illiquid assets into liquid capital, and in return, earn profits based on the income from the underlying assets.

The use of bond/note trustees is not legally required under the law but they are necessary from an operational standpoint. Bond/note trustees are typically financial institutions like banks or professional trust companies. They act as fiduciaries for bondholders, monitor the day-to day compliance by the issuer and other obligors with their obligations under the bond agreement but only to the extent required, and act on matters related to the bondholders’ protection, especially in situations like defaults. They manage payments to bondholders and facilitate communication between the issuer and investors. When bond/note trustees are not used, their roles might be performed by other transaction parties, such as servicers or the issuing entity itself, subject to any legal/regulatory/operational limits.

The security trustee/agent holds the collateral of the transaction – eg, security created over the issuer’s assets (eg, receivables, bank accounts and other corporate assets) for the benefits of the bond/note holders.

Their responsibilities include ensuring the security interests are properly validated and maintained, usually also acting as account banks managing or safeguarding the collateral (eg, shares or cash in a custodian bank account), taking enforcement actions in defaults, and acting on the collective instructions of the bond/note holders (subject to be first being secured/indemnified/pre-funded as to any costs or liability that arise).

The roles of security trustees or agents are typically assumed by commercial banks and professional trust companies. Note that the trustee and security trustee/agent are usually the same institution with the capability to provide one-stop services.

The typical primary documentation used to effect bankruptcy-remote transfers of financial assets to the SPE includes sale and purchase agreements, legal assignments and other applicable security agreements, trust deeds, and servicing agreements. These documents legally formalise the sale of assets from the originator to the SPE, ensuring they are legally separated from the originator’s other assets. This separation is vital for maintaining the SPE’s bankruptcy remoteness, protecting the assets from being claimed by creditors of the originator in the event of the originator’s bankruptcy. The trust deed may also include provisions to prevent actions that could lead to the SPE’s winding-up, further enhancing its bankruptcy remoteness.

For example, an assignment of receivables in a securitisation is usually effected in the form of a sale and purchase agreement entered between the originator and the issuer.

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 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 other analogous actions, and that there are no circumstances or legal grounds upon which the obligations of the seller can be set aside or avoided.

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 sale and purchase agreement of the receivables.

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 financial statements to the note trustee upon 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, 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 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 are required to be on an arm’s length basis.

Terms governing the services provided by the servicer include, without limitation:

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

The principal default events are typically contained in the trust deed or indenture entered between the bond/note trustee and the issuer, as applicable, and include default provisions, without limitation, the following:

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

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 (including its directors, officers and affiliates) in connection with:

• 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.

Terms and conditions of the bonds/notes/securities, outlining all the rights and obligations of the issuer and the investors (eg, rights to payment, security, notices, and exercise of bondholders’ voting rights in bondholders’ meetings) would be included within the offering memorandum, the trust deed or indenture, and eventually annexed to the certificate evidencing the bonds/notes.

Derivatives that are commonly used to hedge different types of risks in a securitisation transaction include, without limitation, the following.

• Interest Rate Derivatives – for hedging against the risk of fluctuating interest rates – eg, interest rate swaps, caps, and floors. They help mitigate the mismatch between the interest rates of the securitised assets and the rates payable to the investor under the terms of the notes.
• Foreign Exchange Derivatives – where assets or cash flows involved in the securitisation are denominated in different currencies, foreign exchange derivatives like currency swaps or forwards can be used to hedge against the risk of currency value fluctuations, which can significantly impact the returns from the securitised asset.
• Credit Derivatives/Credit Default Swaps (CDS) – these are used in securitisation to hedge against the risk of credit defaults within the underlying asset pool, or to protect against the risk of default by the asset issuer.
• Commodity Derivatives – where commodity-based assets are involved in securitisation, commodity derivatives like futures and options can be used to hedge against the volatility in commodity prices.

The requirement and form of offering documents in Hong Kong securitisation transactions are dictated by whether the offering is public or private, the investor base (public or professional investors), whether specific exemptions apply, and whether the securities will be listed on the Hong Kong Stock Exchange.

Where a prospectus is not explicitly required under the law (eg, in certain private issuances or issuances to “professional investors” only), an offering circular or offering memorandum is normally produced for disclosure to investors. Contents typically follow those in public transactions, and include, without limitation, the following:

• details about the type(s) of securities issued, whether bonds, notes, or other forms of asset-backed securities;
• if applicable, brief details about any related prior tranches issued and their priority or pari-passu status in relation to the new tranche to be issued;
• information on interest rates, payment schedules, maturity dates, any early or compulsory redemption conditions;
• identification and explanation of the risk factors associated with the securities and the underlying assets;
• if applicable, details about credit enhancement measures and the credit ratings of the securities, and listing information of the securities;
• information on compliance with relevant legal and regulatory requirements, including disclosures under securities law and compliance with listing rules of the relevant stock exchanges(s) if the securities will be listed upon issuance; and
• description of the underlying assets backing the securities, including their origin, type, valuation, and cash flow patterns and any material risk factors that investors should consider when deciding whether or not to invest in the securities.

Please refer to 4.2 General Disclosure Laws or Regulations for specific regulations that apply.

There are no disclosure requirements specifically relating to securitisation transactions under Hong Kong law. However, please refer to 4.2 General Disclosure Laws or Regulations for certain general disclosure rules that apply to securitisation.

Where a securitisation involves the issuance of debt securities, such issuance may be subject to the disclosure and registration regimes 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 retail 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 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.

Unlisted Structured Products

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.

Misinformation

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:

• 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.

Principal Regulators

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.

Public Market v Private Market

In summary, 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, an offering memorandum is often used for similar disclosures in a transaction involving a broad investor base. Most securitisation transactions in Hong Kong, however, involve an issuance in the private market to professional investors only.

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;
• 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 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 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 has power to vary the prescribed limit, and make other amendments to reflect updates in regulatory standards or adaptations to new financial environments and practices. HKMA is the principal regulator of authorised institutions – eg, banks.

The Code on Unlisted Structured Investment Products requires continuing reporting in respect of certain matters. For instance, the issuer is required to 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 any guarantor) to perform its obligations under the securities.

The SFC is the principal regulator. If the issuer fails to meet any of these requirements, it might be required to cease advertising to or inviting offers from the public in Hong Kong until the situation is rectified.

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 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.

An RA is also 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. On 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 Banking (Capital) Rules (Cap. 155L), which is the main legislation implementing Basel III requirements in Hong Kong, requires that banks in Hong Kong 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 banking transactions.

Under these requirements, an authorised institution incorporated in Hong Kong (eg, a bank and other regulated financial institution) is 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.

The HKMA is the principal regulator in respect of such requirements.

No specific laws or regulations apply to the use of derivatives in securitisations or with regard to SPEs, although there are regulations relating to derivatives generally, such as those 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, and marketed to institutional investors or professional investors by commercial banks or financial firms.

Whilst banks are generally regulated by the Code of Banking Practice, banks and financial intermediaries which are registered or licensed with the SFC are also subject to SFC’s Code of Conduct in their dealings with investors. The Code of Conduct is therefore of general importance in regulating the conducts of financial intermediaries and for investor protection in Hong Kong, although it does not specifically target securitisations.

Investor protection under the SFC regime

The Code of Conduct provides some major protections for investors of investment products (ie, applicable to 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, and to disclose information to the investor 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.

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).

SFC’s regulatory powers

The SFC is the principal regulator. Under the SFO, the SFC has broad investigation and enforcement powers in relation to violations of the SFO or non-compliance with SFC’s Code of Conduct. If the SFC finds that a regulated person’s conduct suggests misconduct or demonstrates that they are not fit and proper, it has the authority to impose sanctions, which can include public reprimands, fines, or even revocation of licences.

The SFC’s Disciplinary Fining Guidelines provide a framework for determining the level of fines, taking into account factors such as the seriousness of the misconduct, its impact, and the regulated person’s conduct after the violation. The specific penalty depends on the nature and severity of the violation, and the SFC assesses each case individually.

Investor protection under the HKEx regime

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

Disclosure obligations – Chapter 37 of HKEx’s Listing Rules

Under the Listing Rules, certain disclosure requirements and continuing obligations apply specifically to the issuer and guarantor (if any) of the listed debt securities. For example, under Chapter 37 of the Listing Rules, issuers and guarantors are required to, without limitation:

• respond promptly to the HKEx’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).

HKEx’s regulatory powers

The HKEx is the principal regulator. It is given substantial regulatory authority to enforce adherence to its Listing Rules. The HKEx can investigate possible breaches and take disciplinary actions against violators – eg, the issuer, their directors and other relevant individuals can all be held accountable). These actions include public reprimands, censures, banning of personnel of professional advisers from being involved in listing-related activities, and imposing administrative and financial penalties.

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

The Statutory Stay Rules

Notably, the Financial Institutions (Resolution) (Contractual Recognition of Suspension of Termination Rights – Banking Sector) Rules (Cap. 628) (generally referred to as the “Stay Rules”) 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”, 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).

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 jurisdiction of an SPE, please refer to 1.4 Special-Purpose Entity (SPE) Jurisdiction.

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.

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.

All principal laws and regulations are covered in 1.3 Applicable Laws and Regulations.

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.

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.

Insolvency laws are a major consideration in securitisation as these enable a securitisation structure to be commercially feasible and serve to protect all parties’ interests. 

Typically, the assets backing the securing will need to be insulated from the financial and credit risks of the originator so that they will not form part of the originator’s assets subject to third-party creditors’ claims if the originator becomes insolvent.

This is enabled by establishing a “true-sale” transaction.

True Sales

To achieve such insulation and bankruptcy remoteness, a “true sale” of the assets should be made by the originator (as the seller) to the issuer (as the buyer).

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 following distinguishing features:

• 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. If the court finds that the transaction resembles a secured loan rather than a true sale, it may re-characterise the transaction as 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 not form part of the originator’s estate nor be subject to any insolvency proceedings in respect of the originator.

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.

Claw-backs

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.

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.

SPE Requirements and Structure

Hong Kong does not impose any specific requirements for an SPE in a securitisation.

An SPE is typically structured as an orphan entity and 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.

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.
• Independent officers – 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 so 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 – 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 – transaction parties can 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.

No Substantive Consolidation

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.

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

To ensure a transfer of financial assets (such as trade or loan receivables) is valid and enforceable, the originator will seek to transfer the assets to the issuer by way of legal assignment. Conditions that will need to be satisfied to achieve an effective legal assignment, include 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). This is sometimes called the perfection step.

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.

Notice of assignment

Although a 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.

Insofar as the form of the notice of assignment is concerned, 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.

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 specifically set forth in Section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Cap. 23).

Trust

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, or 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.

True Sale Transfer and Opinion

Please refer to 6.1 Insolvency Laws.

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.

Insolvency Opinions

In Hong Kong securitisations, insolvency opinions may be obtained. This is to assess and confirm the bankruptcy-remote nature of the SPE involved in the securitisation, and is crucial for ensuring that the SPE remains distinct and separate from the financial risks of the originator or its affiliates.

Please refer to 6.2 SPEs.

Generally, a transfer of financial assets (eg, loans or receivables) is not subject to taxes. However, if the transfer involves interests in Hong Kong real estate or Hong Kong stocks, this 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, and the transfer of which is registered in Hong Kong.

Generally, most loans and receivables would not be regarded as “Hong Kong stock” for Hong Kong stamp duty purposes. 

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

Special Purpose Entities (SPEs) engaged in securitisation transactions must consider several potential tax implications for income earned from financial assets. Hong Kong generally follows a territorial basis of taxation, meaning that only income sourced in Hong Kong is subject to taxation.

Profits Tax

SPEs in Hong Kong are subject to profits tax on assessable income or profits arising in or derived from Hong Kong. This includes income from financial assets, provided the income is considered to be sourced in Hong Kong.

Foreign-Sourced Income Exemption (FSIE)

Hong Kong introduced the FSIE regime, effective from 1 January 2023, which might be relevant for SPEs with income from outside Hong Kong. This regime is set to be further refined in 2024. It exempts foreign-sourced income from taxation in Hong Kong, subject to specific conditions.

To mitigate potential tax liabilities, practitioners can typically employ the following strategies.

• Ensuring Territoriality of Income – given Hong Kong’s territorial basis of taxation, SPEs may structure their transactions to ensure that the income generated by the financial assets is not considered to be sourced in Hong Kong. This would exempt such income from Hong Kong profits tax.
• Utilising FSIE Regime – for income sourced outside Hong Kong, SPEs can leverage the FSIE regime to claim exemption from Hong Kong tax. This requires careful structuring and adherence to the regime’s provisions to qualify for the exemption.

Hong Kong does not typically impose withholding taxes on most types of payments, except in limited circumstances (eg, royalties) that would generally not be applicable in a securitisation. Therefore, SPEs receiving cross-border payments under the financial assets or making payments under the securitisation transactions are generally not subject to withholding taxes in Hong Kong.

Tax issues in Hong Kong are normally handled by accountants.

Lawyers in Hong Kong do not usually give tax opinions for securitisation transactions.

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 usually do not give legal opinions related to securitisations.