Hong Kong may front-run China TLAC requirements

The largest Chinese banks may be forced to issue bail-in debt under Hong Kong’s new resolution framework imminently, even though the Financial Stability Board (FSB) has given China an additional six years to comply with the global total loss absorbing capacity (TLAC) framework.

“Loss absorbing capacity requirements can be applied to any authorised institution incorporated in Hong Kong, regardless of whether their foreign parent’s jurisdiction has a resolution regime or not,” says a spokesperson for the Hong Kong Monetary Authority (HKMA).

The majority of the world’s global systemically important banks (G-Sibs) must comply with TLAC requirements from 2019, and have already begun issuing bail-in debt. However, the FSB gave emerging market G-Sibs – currently only the four largest banks in China – up to an extra six years to comply.

These four banks are unable to issue TLAC-eligible debt until the China Banking Regulatory Commission (CBRC) puts forwards its framework for this, but Hong Kong issued a consultation paper on internal LAC requirements for the locally systemic subsidiaries of G-Sibs in January.

“There is a disconnect,” says Simon Topping, a partner at KPMG. “How can you introduce an internal LAC framework for Chinese banks when there is nothing that can effectively trickle down?”

Under recommendations in the January consultation paper issued by the HKMA, subsidiaries of banks that have a materially significant presence in Hong Kong will have to make a certain proportion of the TLAC debt they have issued at group level available domestically, so it can be converted to equity in cases where the subsidiary becomes non-viable.

But there is no equivalent TLAC regime as yet in China, making it difficult for the HKMA to defer to home rules for subsidiaries of the Chinese banks falling under its jurisdiction.

The HKMA recommends setting internal LAC at between 75% and 90% of the external TLAC requirement that would apply to the sub-group if it were a resolution group, depending on “institution-specific circumstances”. This is in line with the FSB standards finalised in November 2015.

However, the consultation paper provides few clues as to how it plans to deal with subsidiaries of banks that have not issued TLAC at group level, prompting one banking analyst to remark: “How can the HKMA produce a consultation paper of 92 pages, which doesn’t point out that the second-biggest bank in Hong Kong isn’t actually going to issue any TLAC?”

It is a very different matter in Hong Kong… those banks that have already issued TLAC at the group level are directly competing with Chinese banks in the domestic market, and if you treat them differently you will create an uneven playing field

Simon Topping, KPMG

Two of the six banks designated by the HKMA as domestic systemically important banks (D-Sibs) are Chinese G-Sibs: the Bank of China, and the Industrial and Commercial Bank of China. Although China Construction Bank (CCB) has not yet been classed as a D-Sib, it has the third-largest pool of assets of any bank in Hong Kong – after HSBC and Bank of China – and could still be subjected to the new local LAC framework.

Topping says there are two approaches the HKMA could decide to take. One would be to defer to the group regulation authority – in this case the CBRC – and allow Chinese banks to apply LAC on a consolidated basis, which would effectively give the domestic subsidiaries the same six-year transition period currently enjoyed by the group entity. However, this would almost certainly put the non-Chinese G-Sibs operating in Hong Kong at a significant disadvantage until 2025.

“Although the FSB have given this transition period at G-Sib level, this doesn’t really affect the [international] competitive environment, because in reality the Chinese G-Sibs are largely domestic anyway,” says Topping. “It is a very different matter in Hong Kong though, because those banks that have already issued TLAC at the group level are directly competing with Chinese banks in the domestic market, and if you treat them differently you will create an uneven playing field.”

Second option

The second possibility would be for the HKMA to force the large Chinese banks it supervises to issue TLAC, irrespective of the home-country regulation.

Royce Miller, a partner at Freshfields law firm, based in Hong Kong, thinks the second approach has clear advantages since it keeps the HKMA, which is a key financial hub for most G-Sibs, in line with international standards.

“The HKMA doesn’t want to detract from Hong Kong as a financial centre, and they have been good at applying international rules and standards in the past, except where there is a particular reason to do something different,” says Miller. “The regulator is not going to hardwire something into the new LAC framework that limits its power to act locally in the future if it needs to.”

However, Miller also recognises the challenges the HKMA will face in imposing requirements on Chinese banks that are materially different from the ones they face at home. “Will they really want to front-run regulations?” he asks.

Closed-door discussions

The HKMA spokesperson hints at another channel at its disposal for managing the recovery and resolution process of Chinese banks: closed-door discussions with home regulators.

“For [institutions] subject to the proposed LAC rules who have foreign parent entities, [the HKMA’s] preference in the first instance will always be to develop a co-ordinated cross-border resolution strategy in co-operation with the foreign home authority,” says the spokesperson.

This is how the HKMA works with other regulators, such as the Financial Conduct Authority in the UK. Sonny Hsu, an analyst at Moody’s, says this may be why the HKMA is comfortable with the Hong Kong resolution entities of HSBC and Standard Chartered holding relatively low levels of external TLAC.

“The HKMA could also work closely with the CBRC to work out the best way for Chinese banks to be regulated, and how much capital and LAC they should be required to hold,” says Hsu.

Although Chinese authorities have not yet given any indication as to when they might introduce a TLAC framework, market participants speculate new rules could be forthcoming later this year – if regulators are to give banks enough time to issue all of the TLAC-eligible debt they will need by the 2025 deadline.

HKMA’s consultation closes on March 16 and the regulator plans to reveal new TLAC rules by the end of the year.