Hong Kong Monetary Authority (“HKMA”) is the front-line regulator for licensed banks and deposit-taking companies (“AIs” or “authorised institutions”) in Hong Kong. LIBOR is used extensively in the Hong Kong banking sector. According to survey results released by HKMA in July 2020, LIBOR-linked products represented 30% and 11% respectively of the banking system’s total assets and total liabilities denominated in foreign currencies as of March 2020. In addition, there were about HK$35 trillion worth of derivative contracts referencing LIBOR.
The reform of the benchmark interest rate has significant implications for AIs in Hong Kong. HKMA has issued a number of Circulars to AIs regarding benchmark rate reforms since March 2019, requiring AIs to get ready for the transition. Similar to the regulators in other jurisdictions, HKMA mainly focuses on bank conduct and treat-customer-fairly principles, and readiness of systems and operations ahead of the transition.
Key Guidance and Areas of Regulatory Attention
- Guidance on Conduct – Treat Customer Fairly and Effective Customer Communications
(a) AIs should observe the Treat Customers Fairly Charter and other applicable requirements (including the Code of Banking Practice) throughout the interest rate benchmarks reform and transition process.
(b) AIs should act with due skill, care and diligence in their approach to the transition of interest rate benchmarks and when making decisions affecting customers, so as to reduce conduct risks. AIs should assess the impact on contract continuity, the risk of declining liquidity in the affected products, and the need to engage with product issuers for the transition. On product design and product due diligence, AIs should:
(i) identify any potential impact of the interest rate benchmarks transition on their products before distributing the products to the customers; and
(ii) clearly explain such impact to customers (especially retail banking customers) in the selling process.
(c) AIs are expected to develop robust customer communication programmes for consumer education and outreach, using appropriate channels (e.g. newsletters, FAQs or animated videos). AIs should introduce such programmes early to increase customer awareness and understanding, and help them make informed decisions. AIs should make the necessary planning in advance, including resources and staff training.
(d) When communicating with affected customers, AIs should:
(i) help customers understand the implications and options available (e.g. possible fallbacks for IBOR);
(ii) communicate in clear, fair, not misleading, and easy to understand language and manner, taking into account the knowledge and experience of the audience; and
(iii) provide customers with appropriate and accessible channels to make inquiries and complaints, and put in place proper and fair handling mechanisms and procedures.
- Guidance on Readiness
(a) In Hong Kong, the alternative reference rate (“ARR”) to the Hong Kong Interbank Offered Rate (HIBOR) is HONIA (Hong Kong Dollar Overnight Index Average). HIBOR and HONIA will co-exist. The ARR should be nearly risk-free and should serve as a fall-back for HIBOR.
(b) The boards of directors of Hong Kong-incorporated AIs and the head/regional offices of AIs incorporated overseas should oversee the preparatory and transition process and be kept informed of the progress. HKMA will monitor AIs’ progress and readiness for the transition as the reform develops. The preparatory work should cover the following elements:
(i) regular quantification and monitoring of affected exposures;
(ii) identification and evaluation of key risks arising from the reform under different scenarios;
(iii) formulation of an action plan to prudently manage the risks identified; and
(iv) close monitoring of the developments of benchmark reform, both in Hong Kong and internationally, and updating the scenarios and action plan as appropriate.
HKMA recommends AIs to use the IBOR Transition Guide for Asia (published by the Asia Securities Industry and Financial Markets Association) as a transition guide.
(c) AIs are expected to keep abreast of developments by both international and local authorities, standard-setting bodies and industry organisations on the benchmark reform in their preparation for the transition. Through regular surveys to collect information on AIs’ exposures referencing IBORs and the progress of their preparatory work for the transition, HKMA will monitor the status and take suitable follow up actions with individual AIs.
(d) Having regard to the transition milestones set by the Working Group on Sterling Risk-Free Reference Rates in the UK and the Alternative Reference Rates Committee in the US, HKMA announced the following transition milestones in July 2020 for AIs in Hong Kong:
(i) AIs should be in a position to offer products referencing the ARRs to LIBOR from 1 January 2021;
(ii) Adequate fall-back provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021 from 1 January 2021; and
(iii) AIs should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021.
HKMA expects AIs to endeavour to achieve the above transition milestones and put in place a detailed work plan (by products and by business lines). AIs should discuss with HKMA as soon as they are aware of their inability to meet these milestones. While reiterating that there is no intention to discontinue HIBOR, HKMA continues to evaluate the need for suitable fall-back provisions for HIBOR contracts.
(e) HKMA requests AIs to take early action to adhere to the IBOR Fallbacks Protocol published by ISDA. HKMA expects AIs to adhere to the ISDA Protocol before it takes effect and take proactive steps to encourage their counterparties to do the same. For new derivatives contracts, all those referencing the 2006 ISDA Definitions and executed on or after 25 January 2021 will automatically incorporate fallbacks. For existing LIBOR-linked derivatives contracts to which the ISDA Protocol is not applicable, AIs should continue to work with their counterparties to transition to ARRs.
(f) HKMA confirms and adopts the clarifications provided by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) in their joint statement regarding the BCBS/IOSCO framework for margin requirements for non-centrally cleared derivatives. Genuine amendments to existing derivatives contracts which are made to give effect to interest rate benchmark reforms will not be considered as new contracts from the perspective of the HKMA’s margin requirements. In addition, there is no requirement for initial margin documentation, custodial or other related operational arrangements that must be in place before a covered entity crosses the HKD375 million (or EUR50 million) initial margin threshold. Covered entities should however take necessary steps to prepare the documentation and other related arrangements well enough in advance to be in position to exchange initial margin when the threshold is exceeded and to protect exchanged initial margin with proper custodial arrangements.
 See Treat Customers Fairly Charter Principles, Hong Kong Monetary Authority, 28 October 2013, and Treat Customers Fairly Charter Implementation Examples, Hong Kong Monetary Authority, 28 March 2014.
 See 2020 Top Level Priorities and Roadmap, Working Group on Sterling Risk-Free Reference Rates, 16 January 2020, and related Further statement from the RFRWG on the impact of Coronavirus on the timeline for firms’ LIBOR transition plans, Working Group on Sterling Risk-Free Reference Rates, 29 April 2020. See also 2020 Objectives, Alternative Reference Rates Committee, 17 April 2020.