Announcement: Moody's: Hong Kong's passing of Financial Institutions (Resolution) Ordinance is a key milestone

Moody's Investors Service says that the Hong Kong legislature's passing of the Financial Institutions (Resolution) Ordinance on 22 June is an important milestone in the government's efforts to revise its financial institutions resolution regime in line with the Financial Stability Board's recommendations.

However, although the Hong Kong legislature has passed the Financial Institutions (Resolution) Ordinance, the government has not yet enacted the legislation and the government and the Hong Kong Monetary Authority still need to complete major tasks ahead in order to render the legislation fully operational and to remove barriers to the resolvability of banks.

Specifically, the government and the Hong Kong Monetary Authority will need to make certain rules and regulations to be enacted as subsidiary legislation, such as protected arrangement regulations and loss absorbing capacity rules for financial institutions. The Hong Kong Monetary Authority will also need to develop firm-specific resolution plans for regulated banks.

As such, Moody's does not expect to classify Hong Kong as an Operational Resolution Regime jurisdiction in the context of its Banks methodology until first half 2017 at the earliest. In making this determination, Moody's considers the following factors: (i) whether there is legislation in place that enable the orderly resolution of a failed bank; (ii) there is a reasonable degree of clarity of the impact of a bank failure on depositors and other creditors; and (iii) there is an expectation of reduced government support given the government's intention to utilize the enabled legislation to resolve non-viable banks.

Moody's conclusions were contained in its just-released report, "Banks -- Hong Kong: Passage of FI Resolution Ordinance Moves Hong Kong Closer Towards a Revised Resolution Regime".

Once subsidiary legislation is passed and loss-absorbing capital rules are clarified, such that our criteria for an Operating Resolution Regime are met, Moody's would look to publish a Request for Comment setting out our revised approach to Loss Given Failure and the potential impact on ratings.

Moody's notes that a key piece of subsidiary legislation relates to regulations on "protected arrangements". These will likely clarify how a resolution authority would treat creditors who have entered into "protected arrangements" with a financial institution in resolution.

Moody's also expects the Hong Kong Monetary Authority to draft loss absorbing capacity rules for financial institutions. For banks, the loss absorbing requirement could entail the issuance of securities that are capable of absorbing losses in the event of non-viability, and such securities may rank junior to deposits and other senior unsecured liabilities in bank resolutions.

We expect banks to fulfill the loss absorbing capacity requirement by either issuing debt securities to third-party external investors or by issuing such securities to group entities including their parents.