Submission on Proposals for a Resolution Regime for Financial Institutions in Hong Kong

1. The Consumer Council (CC) is pleased to submit its views regarding a joint consultation paper issued by the Financial Services and the Treasury Bureau (FSTB), the Hong Kong Monetary Authority (HKMA), the Securities and Futures Commission (SFC) and the Insurance Authority (IA), on proposals for establishing a resolution regime for financial institutions (FIs) in Hong Kong.
2. CC believes that the outline of a resolution regime for FIs proposed in the consultation paper represents a good start on how such a regime might be constructed and how it might operate. The proposed resolution regime would give the Government an additional crisis management tool that may enhance its ability, when necessary, to secure continuity of critical financial services so as to minimize market lockups and adverse spillover effects, as well as minimizing damage to the wider economy, and to lower taxpayer costs in doing so. CC generally supports this proposal.
3. In the following paragraphs, CC provides views on the specific issues raised in the consultation paper which include objectives of the resolution regime, its framework and scope, the resolution powers, safeguards, funding, and cross-border coordination, for consideration by the Government.

Resolution objectives

4. It is proposed in the consultation paper that in deciding what form a resolution should take, the resolution authority will be guided by three objectives. The stated objectives are to: "(i) promote and seek to maintain the general stability and effective working of the financial system in Hong Kong, including by securing continued provision of critical financial services, including payment, clearing and settlement functions; (ii) seek an appropriate degree of protection for depositors, investors and policyholders; (iii) subject to pursuing resolution objectives (i) and (ii), seek to contain the costs of resolution and, in so doing, to protect public funds".
5. It is important that the resolution authority should have regard to these three objectives in carrying out resolutions, and the CC supports the setting of the condition in objective (iii) "subject to pursuing these first two objectives (i) and (ii)" as proposed in the consultation paper for securing least-cost resolution. Nevertheless, the cost to taxpayers of achieving a resolution should not be totally ignored given the large size of FIs to be covered by the regime, and the need to limit the moral hazard effects ("too-big-to-fail") of government intervention. There is in addition to the desire to avoid leaving taxpayers a large bill for problems that are not of their own making.
6. With regard to objective (ii), CC is of the view that the use of the wording: "seek an appropriate degree of protection for depositors, investors and policyholders" is not adequately affirmative in securing protection to depositors, investors and insurance policyholders due to the qualification "an appropriate degree of protection". CC suggests that the wording of the said objective could be changed to delete the qualification so as to read: "seek to secure protection for depositors, investors and policyholders".

Resolution framework

7. On the choice of appropriate framework for resolution, CC considers that a common framework for resolution through a single regime would provide clearer direction than separate regimes, particularly so for dealing with cross-sector financial services groups or financial conglomerates commonly existing in Hong Kong. While there is reference in the consultation paper to a "lead" resolution authority (pages 81 to 83) no specific detail is provided as yet, but it seems the individual existing regulators are still being considered to play a leading role in resolution with a "lead resolution authority" as a fallback position. CC considers that a much more clearer and proactive approach should be taken.
8. Suppose, for example, that a failed FI is a holding company with bank, securities, and insurance subsidiaries. Absent a common resolution framework and a body with overriding administrative power for all FIs (i.e. power over the different regimes for FIs operating in different sectors of the financial system), the resolution process could be highly fragmented and inconsistent. For example, the HKMA may be tasked to resolve the bank subsidiary, SFC to resolve certain of the securities subsidiaries, the IA to resolve the insurance subsidiaries, and the bankruptcy court to resolve the holding company and all its other subsidiaries. This could lead to different approaches taken to resolution with resulting inefficiency and inconsistency in securing the three stated objectives. A single resolution regime with FSTB to take the lead could potentially avoid much of the inefficiencies that could arise in the attempts to seek a resolution of cross-sectoral groups and competing claims by coordinating the resolution process under a common plan. The ultimate accountability and interface with affected consumers and investors could be much better defined to secure confidence and to manage the risks.

Scope of the regime

9. As to the scope of the resolution regime, CC is of the view that ANY financial institution - be it a bank or non-bank, a securities or investment firm, an insurance company, or a holding company - whether or not it is now subject to any regulatory oversight should be covered by the proposed regime if its failure poses systemic risk in Hong Kong.
10. CC supports the notion that all licensed banks, restricted licensed banks and deposit-taking companies should be included within the scope of the regime, given that they provide critical financial services and the failure of which could pose a significant threat to the stability and effective working of the financial system.
11. In considering the selection of relevant licensed corporations (carrying regulated activities in the securities and futures markets) and insurers to be included in the regime, CC is of the view that this should be based on size and inter-connectedness, as well the nature of financial services provided (i.e. whether they are critical or systematically important in Hong Kong should they fail). In the face of considerable diversity and uncertainty across types of financial institutions and economic circumstances over time, a review mechanism should be introduced to add/delete FIs from the scope of the regime. In fact, an ongoing review mechanism should be a major function of the proposed lead resolution authority, as ongoing monitoring of the day to day manifestation of the finance market, in addition to the viability of FIs is of equal importance.

Resolution powers

12. Regarding the issue of attaching any priorities to pursuing reforms designed to ensure that the claims of protected parties can be transferred out of liquidation proceedings, CC considers that a higher priority be given alongside the reforms being pursued to establish the resolution regime.
13. As noted in the consultation paper, this could enable the FIs' customers to have quicker access to their deposits and assets if the resolution authority is able to transfer deposits and client assets out of liquidation to an acquiring FI. CC sees it as essential and consistent with the resolution objectives to secure continued provision of critical financial services, as well as to secure protection for depositors, investors and policyholders.

Safeguards

14. Broadly, CC supports the proposition that the resolution regime should provide for a compensation mechanism safeguarding parties affected by resolution so that "no shareholders and creditors are worse off than in liquidation". CC welcomes the commitment that further consideration and detailed proposals for this mechanism will be set out in the second stage consultation. Particularly that more explanations should be given to the public concerning the interface arrangements between the resolution regime and the existing protection schemes established to protect depositors, investors and insurance policyholders.

Funding

15. With regard to the approaches to be adopted to fund resolution, CC is of the preliminary view that a combination of approaches be adopted. Any resolution should be funded from an assessment on the designated FIs and on a pre-arranged line of credit from the Government. CC supports the proposal that any call on public funds should be on a temporary basis. Consideration should also be given as to whether there should be any limits on the funding for a resolution.

Cross-border coordination

16. Because Hong Kong is a major international finance center virtually every FI here has substantial international operations and international connectivity. There is inevitably going to be an international dimension to any resolution for FIs. CC accepts that the priority should be to take a cooperative and coordinated approach to strengthen international resolution processes.

Conclusion

17. CC believes that this new resolution regime is needed to enable authorities to resolve failing FIs quickly without destabilizing the financial system or exposing taxpayers to the risk of loss from solvency support.
18. Nevertheless, CC considers it necessary to address potential concern arising from describing certain FIs as being "systemically important" or "too-big-to-fail" that will increase the moral hazard effects of government intervention. Any differential treatment in the resolution process may create unfair competition amongst the various FIs. Clarification should be made as to whether there would be any competition implications, and if yes, whether exemption from the scope of application of the Competition Ordinance would be granted to the resolution regime for reason of public policy.