Financial Institutions (Resolution) Ordinance Gazetted

The Financial Institutions (Resolution) Ordinance (FI Resolution Ordinance), gazetted on 30 June 2016 to be effective on a date appointed by the Secretary for Financial Services and the Treasury, will establish a resolution regime in Hong Kong to mitigate the risks posed by the non-viability of systemically important financial institutions to the stability and effective working of Hong Kong’s financial system. Following the financial crisis which began in 2007/8, the Financial Stability Board put forward a series of international regulatory reform initiatives. One such initiative established new international standards for effective resolution regimes in order to reduce the impact of the failure of systemically important financial institutions. The FI Resolution Ordinance was enacted in line with such international standards.

The main features of the FI Resolution Ordinance are summarized below:

Scope of the FI Resolution Ordinance

The resolution regime under the FI Resolution Ordinance is a single cross-sector resolution regime covering “within scope financial institutions” (see table below).

The Hong Kong Monetary Authority (HKMA), the Insurance Authority and the Securities and Futures Commission (SFC) are designated as the resolution authorities for a banking sector entity, an insurance sector entity and a securities and futures sector entity, respectively. If a failing within scope financial institution operates across multiple sectors, a lead resolution authority (depending on the centre of gravity of the group with respect to the sectors in which it operates) will coordinate the resolution.

Within Scope Financial Institutions

Banking sector entity
  • an authorized institution (AI) incorporated in HK
  • an AI incorporated outside HK
  • a settlement institution or a system operator (as defined in the Payment Systems and Stored Value Facilities Ordinance) that is not a settlement institution / system operator wholly owned and operated by the HK Government 
Insurance sector entity
  • an authorized insurer that is a globally systemically important insurer 
Securities and futures sector entity
  • a licensed corporation that is a non-bank non-insurer global systemically important financial institution
  • a licensed corporation that is a branch or subsidiary of, or a subsidiary of a holding company of, a global systemically important bank or a global systemically important insurer
  • a recognized clearing house 

The Financial Secretary may designate a financial institution as a within scope financial institution, and also may designate a current list published by the Financial Stability Board as a list of global systemically important banks, global systemically important insurers and global systemically important (non-bank non-insurer) financial institutions.

Initiation of Resolution

A resolution authority may only initiate the resolution of a within scope financial institution if it is satisfied that all of the following conditions are met:

  • the financial institution has ceased, or is likely to cease, to be viable;
  • there is no reasonable prospect that private sector action (outside of resolution) would result in the financial institution again becoming viable within a reasonable period; and
  • (a) the non-viability of the financial institution poses risks to the stability and effective working of the financial system of Hong Kong, including to the continued performance of critical financial functions; and

(b) resolution will avoid or mitigate those risks.

Stabilization Options

There are five stabilization options that a resolution authority may use:

  • transfer of the financial institution (or some or all of its business) to a purchaser;
  • transfer of the financial institution (or some or all of its business) to a bridge institution;
  • transfer to an asset management vehicle for receiving and managing some or all of the assets, rights and liabilities of a within scope financial institution or a bridge institution;
  • a bail-in (e.g. cancelling or changing the form of liabilities owned by a within scope financial institution); and
  • temporary public ownership of the within scope financial institution (note that this is an option of last resort and requires the approval of the Financial Secretary).

These stabilization options may be applied singly, concurrently or sequentially and may be limited to only part of the business of a within scope financial institution.

Other Powers

The FI Resolution Ordinance confers on resolution authorities a wide range of statutory powers to implement the resolution regime including, inter alia:

  • (i) making a resolvability assessment to determine whether there are any impediments to the orderly resolution of a within scope financial institution (or its holding company) and giving directions to remove or mitigate the effect of significant impediments, and (ii) devising strategies for securing an orderly resolution of a within scope financial institution (including the making of loss-absorbing capacity requirement rules for the financial institution);
  • making capital reduction instruments for authorized institution where relevant, and suspending obligations to make a payment or delivery under a contract to which the financial institution, or a subsidiary of the financial institution, is a party;
  • (i) directing a within scope financial institution to continue to provide essential services for the performance of critical financial functions in Hong Kong, (ii) prohibiting the filing of a winding-up petition of the financial institution to the court unless the relevant resolution authority has been notified and afforded time to assess whether resolution should be initiated, and (iii) operating and managing the financial institution in resolution;
  • removing the CEO, deputy CEO or directors of a within scope financial institution if the resolution authority considers that doing so will assist in meeting resolution objectives;
  • applying to court for a clawback order against an officer or former officer of a within scope financial institution to recover remuneration already received by the officer and/or to cease the officer’s entitlement to receive unpaid remuneration awarded during a period of three years (subject to an extension of a further period of three year by court in specified circumstances (i.e. maximum six years)) immediately preceding the date on which the resolution of the financial institution was initiated; and
  • information-gathering and investigatory powers on the financial institutions if the resolution authorities have reasonable cause to believe that an offence under the FI (Resolution) Ordinance may have been committed.

Compensation and Review Mechanism

Pre-resolution creditors or pre-resolution shareholders would be eligible for compensation if they are treated less favourably on the resolution than they would have been on a winding up. The amount of compensation would be decided by an independent valuer. Any aggrieved pre-resolution creditor or shareholder of the financial institution may apply to the Resolution Compensation Tribunal (to be established) for a review of the independent valuer’s decision. The determinations made by the Tribunal, except those on questions of law, would not be subject to appeal.

Resolvability Review Tribunal

A Resolvability Review Tribunal (RRT) will also be established reviewing (a) any decision made by a resolution authority to serve notice on a within scope financial institution requiring it to take measures to remove or mitigate the effect of impediments to an orderly resolution of that financial institution, and (b) any decision of a resolution authority made pursuant to the loss-absorbing capacity requirements rules for within scope financial institutions. The determinations made by RRT, except those on questions of law, would not be subject to appeal.

Recognition of Non-Hong Kong Resolution Actions

After consulting the Financial Secretary, a resolution authority may make a recognition instrument to recognize a resolution action taken in a non-Hong Kong jurisdiction. The resolution authority must not make a recognition instrument if it is of the opinion that (a) the recognition would have an adverse effect on the financial stability in Hong Kong, (b) the recognition would not deliver outcomes that are consistent with the resolution objectives, or (c) the recognition would disadvantage Hong Kong creditors or Hong Kong shareholders relative to their counterparts elsewhere.

The following diagram gives an overview of the resolution life cycle under the resolution regime:

(Click here to view chart)

The commencement of the FI Resolution Ordinance will depend on the passing of subsidiary legislation under the Ordinance by the Legislative Council.

A copy of the FI Resolution Ordinance can be downloaded via the link below:

Further Consultation Conclusions on Introducing Mandatory Clearing and Expanding Mandatory Reporting for OTC Derivatives Market Published

The HKMA and the SFC have jointly published “Further Consultation Conclusions on Introducing Mandatory Clearing and Expanding Mandatory Reporting” for the second stage of the over-the-counter (OTC) derivatives regulatory regime. These Consultation Conclusions mainly relate to the technical aspects of the regime such as:

  • removal of the requirement to submit PDF files when reporting transactions;
  • further clarification and guidance on completing specific data fields; and
  • acceptance of internal code references (in place of other counterparty identifying particulars) when reporting transactions involving individuals.

The Consultation Conclusions further include:

  • a revised list of entities that will be regarded as financial services providers for the purpose of phase 1 clearing; and
  • a revised version of the specific data fields to be completed under the expanded phase 2 reporting regime.

The subsidiary legislation for implementing phase 1 clearing and phase 2 reporting has already been enacted and will come into effect on 1 September 2016 and 1 July 2017 respectively. As a consequence:

  • the above revised list of financial services providers and the list of comparable jurisdictions (to remain unchanged) for phase 1 clearing must be gazetted before 1 September 2016; and
  • the above revised data fields for phase 2 reporting must be gazetted before 1 July 2017.

Meanwhile, the HKMA is working on the next phase of system enhancements for the trade repository that it operates. Separately, the SFC is also in the process of reviewing applications for designated central counterparties (with four such applications currently in the pipeline).

A copy of the Consultation Conclusions can be downloaded via the link below:

SFC Publishes New Issue of Takeovers Bulletin

The SFC has published a new issue of the Takeovers Bulletin covering, amongst others, the following areas:

  • In view of the growing trend of “talks” announcements being issued under Rule 3.7 of the Takeovers Code, the Takeovers Executive (Executive) reminded parties and their advisers that Rule 3.7 announcements should not be issued as a matter of convenience as they would have an impact on the market price of the subject offeree companies. The Executive also emphasized the importance of parties maintaining confidentiality during negotiations so that the need to issue a “talks” announcement should not arise. Lastly, the Executive repeated that using trading suspensions to facilitate negotiations between parties would not be acceptable.
  • The Executive believed that it was important that both offeree and offeror companies retain a financial adviser to assist them in transactions which involve the issue of an offer document, offeree board circular, whitewash document, share buy-back offer document or off-market share buy-back circular. The Executive further took the view that for Code’ purposes, a financial advisory relationship arises as soon as an adviser starts working with its client. The signing of an engagement letter, of itself, should not be determinative of when an advisory relationship arises. Accordingly, a financial adviser should ensure proper policies and procedures are in place to allow prompt communication among all its relevant departments, including the compliance department, to ensure that the provisions of the Takeovers Code are observed, in particular Rules 21 and 22.
  • The Executive may not grant a whitewash waiver in respect of a transaction involving the issue of new securities under Note 1 on dispensations from Rule 26 of the Takeovers Code if the subject transaction does not comply with other applicable rules and regulations (including the Listing Rules) notwithstanding that all relevant requirements under the Takeovers Code may have been complied with. Therefore, a Rule 3.5 announcement relating to a whitewash waiver is required to include the following statement or a statement to similar effect:

“As at the date of this announcement, the [Company] does not believe that the [proposed transaction(s)] gives rise to any concerns in relation to compliance with other applicable rules or regulations (including the Listing Rules). If a concern should arise after the release of this announcement, the Company will endeavor to resolve the matter to the satisfaction of the relevant authority as soon as possible but in any event before the dispatch of the whitewash circular. The Company notes that the Executive may not grant the whitewash waiver if the [proposed transaction(s)] does not comply with other applicable rules and regulations.”

A copy of the Takeovers Bulletin can be downloaded via the link below:

Listing Rules–Related Development

Stock Exchange Updates a Guidance Letter

The Stock Exchange of Hong Kong Limited (Stock Exchange) has updated the Guidance Letter (GL25-11) on the granting of waivers from strict compliance with Main Board Listing Rule 4.04(1) (or GEM Listing Rules 7.03(1) and 11.10) relating to inclusion in the accountants’ report of the listing applicant’s consolidated results for each of the three financial years immediately preceding the issue of the listing document.

The Stock Exchange now includes in the Guidance Letter a new paragraph stating that it will not grant the relevant rule waiver if there is material adverse change in the listing applicant’s performance in the period from the date to which the latest audited accounts of the applicant have been made up to the latest practicable date (or up to the end of the forecast period where a profit/loss forecast has been prepared under the Listing Rules) and/or a downward trend in an applicant’s recent business performance to the extent that it may not meet the minimum profit requirement if such waiver is not granted. In other cases where a waiver has been recommended, the Stock Exchange may impose conditions on the disclosure in the listing document to ensure that there is reasonably sufficient information to enable investors to have an informed assessment of the issuer absent an accountants’ report. Such enhanced disclosure can include:

  • a profit/loss forecast under Main Board Listing Rules 11.16 to 11.19 (or GEM Listing Rules 14.28 to 14.31);
  • a qualitative analysis of the change in the applicant’s performance since the date to which the latest audited accounts of the applicant have been made up to the latest practicable date (or up to the end of the forecast period) and how it compares with the previous period; and
  • the detailed reasons for the change.

A copy of the Guidance Letter can be downloaded via the link below:

SFC Enforcement Action

SFC Commences Market Misconduct Tribunal Proceedings against Former Director for Insider Dealing

The SFC has commenced proceedings in the Market Misconduct Tribunal against Mr. Cheng Chak Ngok, former executive director, chief financial officer and company secretary of ENN Energy Holdings Limited (ENN Energy), over alleged insider dealing in the shares of China Gas Holdings Limited (China Gas).

The background of the case was that on 12 December 2011, ENN Energy and China Petroleum & Chemical Corporation issued a joint announcement regarding a joint pre-conditional voluntary general offer (Pre-conditional Offer) for the shares of China Gas. The SFC alleged that Mr. Cheng, who was aware of the Pre-conditional Offer since mid-November 2011, purchased China Gas’ shares via a nominee account between mid-November 2011 and early December 2011. The shares were sold shortly after the issue of the joint announcement at a profit of HK$3 million.

A copy of the SFC Notice can be downloaded via the link below: