April 24, 2019

HKMA and the Securities and Futures Commission (SFC) recently conducted coordinated inspections of a bank within a Mainland-based banking group and a licensed corporation (LC) owned by a subsidiary (Group). The agencies found that the Group,which is one of the many Mainland-based groups operating banks, licensed corporations, and other affiliates in Hong Kong, had entered into a series of complex transactions, via a private fund and other entities, that give rise to a number of serious concerns. HKMA and SFC have, therefore, issued this circular to encourage all institutions that may have adopted similar financing arrangements involving subsidiaries or affiliates of licensed entities to review them urgently and take all necessary steps to address all untoward risks.

Both HKMA and SFC identified concerns about certain activities of the Group. Inspection by HKMA identified deficiencies in the bank’s lending practices. Therefore, HKMA states that banks should ensure that credit facilities granted to their subsidiaries and affiliated companies or those of their holding company are granted on an arm’s length basis and subject to a prudent credit assessment, which should be at least as stringent as that performed on unrelated companies. The assessment should include an evaluation of the borrowing company's ability to repay and how the facility is intended to be used.

HKMA states that banks should also ensure that there is an effective post-lending monitoring framework to identify and follow-up on any major adverse developments of a borrower. If the borrower is engaging in high-risk activities (in this case, a margin loan to finance high-risk investments) or activities that deviate from its normal scope of business, the bank should critically assess the risk implications, including whether and how such activities may affect the repayment ability of the borrower as well as the reputation of the bank. The bank should take appropriate risk mitigation measures to reduce the risks identified. HKMA will review the effectiveness of controls of banks as part of its ongoing supervisory work.

SFC also found that the Group’s subsidiary, via a separate subsidiary holding a money lender license, also had provided lending to other listed companies secured by collateral provided by major shareholders. Some borrowers had pledged a significant proportion of the listed companies’ total issued shares (up to 70%). These were illiquid stocks of doubtful quality. SFC wishes to remind all holding companies or controllers of LCs to prudently manage the overall group financial risks to ensure it has the ability to provide financial support to the LCs and to contain contagion risks to the LCs that may affect their financial integrity.

Earlier, in a circular in August 2018, SFC had also expressed concerns about arrangements that effectively provide margin financing in the guise of investments. In the August 2018 circular, SFC had warned against facilitating the setting up or operation of securities margin financing arrangements by unlicensed persons to circumvent regulatory requirements. HKMA and SFC will continue to enhance regulatory cooperation and are also closely coordinating with Mainland regulators to share information and observations derived from their supervisory work.

 

Keywords: Asia Pacific, Hong Kong, Banking, Securities, Credit Risk, Special Purpose Vehicle, Margin Financing Activities, SFC, HKMA

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