Regulator of the year: HKMA

Asia Risk Awards 2018

Arthur Yuen, HKMA

With all but one of the world’s global systemically important banks (G-Sibs) having operations in Hong Kong, the jurisdiction’s regulator has to make sure that global best practices are being followed.

The fact the Hong Kong Monetary Authority (HKMA) pursued this goal so diligently, while maintaining a healthy dialogue with industry, makes it a deserving winner of Asia Risk’s inaugural regulator of the year award.

“We have been trying very hard – not just this year, but over the past few years – to make sure we are operating a genuine risk-based approach,” says Arthur Yuen, the HKMA’s deputy chief executive. “This means we want the risk resources to be put in the right place.”

Significant strides have been taken in two crucial areas this year: putting the finishing touches on Hong Kong’s recovery and resolution regime; and making it easier for banks to book their regional risk in the city state.

Recovery and resolution

The HKMA finalised its framework for orderly resolution in July 2017, and this year has moved to fill in the finer details, most notably on the amount of loss-absorbing capacity (Lac) that regulated entities need to have in case of banking failure. The results of an industry wide consultation on the subject, which was published in July, will form the basis of the new rules.

At the heart of this framework is the need for co-operation with home regulators. This is why the HKMA has recommended setting internal Lac – the amount of Lac that cross-border banking groups should make available to their operations in Hong Kong – at just 75% of the external requirement, which is at the lower end of the 75–90% range recommended by the Financial Stability Board (FSB).

We have been trying very hard – not just this year, but over the past few years – to make sure we are operating a genuine risk-based approach. This means we want the risk resources to be put in the right place

Arthur Yuen, HKMA

The HKMA states that opting for a lower amount of internal Lac maximises the opportunity for cross-border co-operation, by tying up fewer resources that in the event of a failure might be better deployed elsewhere.

“When it comes to resolution, there is a tremendous need for co-ordination between home and host regulators, and yet there are no established frameworks for such co-operation,” says Yuen. “If we don’t even have a resolution framework or resolution function ourselves, how can we start doing that and try to establish co-operation principles? That is part of the reason we are pushing so hard.”

Another reason a resolution framework is so important for the HKMA is the systemic nature of the market it regulates.

“We regard ourselves as a fairly systemic jurisdiction – not just because we are such a large host, but because we are also a big net provider of funds to other banking systems in the world,” says Yuen, indicating that internationally active banks lean on Hong Kong to fund their business elsewhere.

Hong Kong has run a current account surplus for years. The surplus stood at just over HK$16.3 billion (US$2 billion) or 2.4% of GDP.

“If anything were to happen to our banking system, we would not be able to continue to provide as much funds to overseas markets. This would generate a fairly difficult spillover to other parts of the world.”

And the efforts the HKMA has put into developing its recovery and resolution framework are being recognised.

In February, a peer review from the FSB said Hong Kong was one of the few FSB jurisdictions with a fully cross-sectoral resolution regime. Such praise from the FSB is not given lightly and is evidence of the hard work the HKMA’s resolution team has put into developing the framework.

“We have been saying all along that we have to push along with the resolution work despite the fact that we do not think resolution is an everyday event,” he says. “And for the FSB to put a stamp on our work, saying it’s fully functional, I think that’s a very encouraging development from our perspective.”

Regional booking

The push for establishing Hong Kong as a hub for booking regional trades actually goes back several years, when regulators in the US and Europe decided they no longer wanted to be a receptacle of the world’s risk. Risk that is accumulated overseas, their argument went, should be booked overseas. As a result, banks began asking the HKMA if they could book their risk here rather than in London or New York.

“Our basic approach is very simple,” Yuen says. “First, we don’t want Hong Kong just to be a booking hub – we want it to be a centre for good risk management practices as well. Secondly, we want any banks booking trades here to have a regional locus.”

If a bank started talking about booking some African derivatives positions here then the HKMA will have questions. The HKMA doesn’t want to become some kind of alternative global booking centre, he says.

“Why should our risk management experts be knowledgeable about positions that have nothing to do with Asia?” asks Yuen.

We regard ourselves as a fairly systemic jurisdiction – not just because we are such a large host, but because we are also a big net provider of funds to other banking systems in the world

Arthur Yuen, HKMA

Far from opening up the floodgates to financial institutions eager to book their risk in Asia – many of whom have been hoping to escape the tentacles of Europe’s overhaul of investment practices known as Mifid II regulation – the HKMA wants to retain a firm grip on the risk that Hong Kong is exposed to.

One of the things the regulator has been working on this year is ramping up its internal model-approval process, including fast-tracking the approach where it makes sense. This has been particularly challenging in an environment where quantitative analysts, those that have the wherewithal to understand banking models, are in high demand.

For the most part, the HKMA is able to rely on guidance from institutions’ home regulators, who will have already scrutinised the internal models. The challenge comes if breaking up netting sets between trades fundamentally changes the risk profile of the bank.

“Home supervisors will have already looked at the models that banks are using, so we can accept some degree of reliance on home approval,” says Yuen. “But if you start breaking up a single global book into different entities, offsetting netting arrangements might not work any more, so that is something we need to look at.”

This year, to make it more appealing for banks to book trades here, the HKMA introduced a new banking bill to Hong Kong’s parliament that makes it possible for banks to reduce their total equity derivatives exposure by netting off long and short positions. At present, exposures have to be calculated on a gross basis.

Pain points

Since the global financial crisis of 2008, banks around the world have faced a barrage of new risk management legislation – and the HKMA has demonstrated strong commitment to its G20 obligations. However, the regulator also acknowledges how much pressure these new rules have put banks under. This is why, earlier this year, it launched an initiative to look at where the pain points for banks lurk, and see if anything can be done to reduce them.

“I think it’s important once in a while to take a look at our existing processes and monitoring metrics and see whether there are some things, which are relatively low priority, that the banks can do less of or do less frequently,” says Yuen.

One example of this is the stringent supervisory framework that is now in place in Hong Kong for selling and distributing products to retail clients. This was introduced to the market 10 years ago following the collapse of Lehman Brothers, when thousands of retail investors in Hong Kong and Singapore lost money through structured notes linked to bonds issued by the bank. Since then, Yuen says, the control mechanism for selling to retail clients has become more complex than it needs to be, especially given the heightened awareness in the industry about the dangers of mis-selling.

“Some of the things are really more cosmetic than real and so we are considering what an effective system should look at in order to protect the public against mis-conduct risk,” says Yuen.

The other thing the HKMA is thinking of doing is to streamline regulatory compliance through better use of technology.

“Other jurisdictions have started migrating from a prudential return arrangement to a more data-centric approach,” Yuen says. “Instead of having to submit prudential returns with respect to a particular portfolio, regulators can store data from banks and use these attributes to the number crunching, so they don’t have to regularly submit returns every month or every quarter. With better data management technology, supervisory interfacing with banks becomes much easier.”

Yuen says the HKMA plans to consult with industry very soon on how life can be made a little bit easier for banks, without disrupting the robust risk management framework that the regulator has worked so hard to construct.