The “rules of stay” – what this means for authorized institutions and their affiliates in Hong Kong

What are the rules of stay?

On August 27, 2021, the Financial Institutions (Resolution) (Contractual Recognition of Suspension of Termination Rights – Banking Sector) Rules (Cap. 628C, Laws of Hong Kong, the “Rules of stay“) entered into force, requiring”covered entities“to include provisions in certain non-HK governed laws”financial contracts“to the effect that the contracting parties agree to be bound by any suspension of termination rights which may be imposed by the Hong Kong Monetary Authority (the”HKMA“).

The rules of stay were established in accordance with Article 92 of the Financial Institutions (Resolution) Ordinance (Cap. 628, Laws of Hong Kong, the “Arrangement“), which enables the HKMA to implement rules to ensure the effective implementation of the suspension of termination rights scheme which already exists under Article 90 of the Ordinance.

The purpose of the Residence Rules is to ensure an effective cross-border suspension of termination rights imposed under the laws of HK in respect of contracts governed by non-HK laws. The view of the HKMA is that counterparties to a covered contract should not terminate or close their positions only following the entry into resolution of the covered entity. The introduction of residence rules therefore reduces the risk of disorderly termination of contracts unrelated to Hong Kong law on a large scale.

Seen from another perspective, the suspension rules can be seen as HK’s version of Article 55 of the European Union Bank Recovery and Resolution Directive.

Key definitions under residence rules

A brief summary of the key definitions of residence rules is presented below.

(a) A “covered entity” means (i) an authorized institution incorporated in Hong Kong (a “AI“), (ii) a Hong Kong holding company of an IA, or (iii) a related company of an IA.

(b) A “covered contract” means a financial contract which is governed by a law other than Hong Kong and contains a right of termination which may be exercised by a counterparty (other than an excluded counterparty).

(c) An “excluded counterparty” means the HKMA and any financial market infrastructure, government or central bank.

(d) A “financial contract” means:

(i) a securities contract which is:

(1) a contract to buy, sell or lend a security (or a group or an index thereof);

(2) a repurchase or reverse purchase transaction on a transferable security (or a group or an index thereof); Where

(3) a margin financing transaction on securities

(ii) a goods contract that is:

(1) a contract for the purchase, sale or loan of a product (or a group or an index thereof); Where

(2) a repurchase or reverse purchase transaction on a commodity (or a group or index thereof);

(iii) a derivative contract;

(iv) a contract for the purchase, sale or delivery of Hong Kong currency or any other currency;

(v) a contract of a similar nature to article (i), (ii), (iii) or (iv) above; Where

(vi) a framework or other agreement insofar as it relates to a contract listed in any of points (i) to (v) above,

but excludes short-term interbank loan contracts with an original maturity of 3 months or less.

What Should Covered Entities Do?

Covered entities must ensure that covered contracts contain a clause or condition (established or evidenced in writing) to the effect that the parties agree in a legally enforceable manner that, despite any other clause or condition of the contract or of any other agreement, arrangement or understanding, the parties (other than an Excluded Counterparty) will be bound by any suspension of termination rights in connection with such contract which may be imposed by HKMA (a “suspension of termination rights“).

The rules of stay also require that the covered entities have adequate control and record keeping systems to ensure and demonstrate compliance with the rules of stay. Covered entities must notify HKMA of any breach of compliance.

Where a Covered Entity fails to include a suspension of termination rights provision in any of its Covered Contracts, HKMA may require that Covered Entity to implement a remediation plan for such breach. HKMA will also be empowered to require a covered entity to provide legal advice on the applicability of a suspension of termination rights provision.

Does this have an impact on conventional loan agreements?

Our informal discussions with HKMA and other market players, as well as the conclusion of the HKMA residence rules consultation published on December 31, 2020, strongly suggest that APLMA type loan agreements in the form of denominated loans in HKD and / or other currencies governed by English (or other non-HK law (“HK outlaw conventional loan agreements“) are not” contract[s] for the purchase, sale or delivery of Hong Kong currency or any other currency “, and more importantly, not a” financial contract “. the lender to the borrower of the currency of the loan when drawing, and (ii) the remittance by the borrower to the lender of the same currency upon payment of principal, interest etc. Instead, point (iv) of the definition of “financial contract” is only intended to cover foreign exchange contracts such as foreign exchange contracts.

Therefore, unlike the UK’s ‘bail-in rules’, which cover conventional loan agreements, covered entities will not need to include a Hong Kong law version of the bail-in clause of the UK. the AML in their non-HK conventional law. loan agreements.

Likewise, typical hedging agreements used in conventional non-Hong Kong law loan agreements that are secured would not be “a contract for the purchase, sale or delivery of currency from Hong Kong or any other. other currency “, but may or may not (depending on the facts) fall under the other headings of what constitutes a” financial contract “.

Conclusion

Although the residence rules do not apply to conventional loan agreements outside Hong Kong law, the residence rules have a significant impact on the other activities of the covered entities (for example, structured products). In this regard, covered entities should review their operational systems to ensure that they are able to comply with suspension rules, and also to ensure that its documentation for covered contracts includes an appropriate suspension of rights provision. of termination.

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