Structured Finance and Securitisation 2010: Country Q&A - Hong Kong

Keywords: securitisation market, Hong Kong, mortgage-backed securities, RMBSs, HKMC

MARKET AND LEGAL REGIME

1. Please give a brief overview of the securitisation market in your jurisdiction. In particular:

   How active and/or developed is the market and what notable transactions and new structures have taken place recently? To what extent have central bank liquidity schemes assisted the securitisation market in your jurisdiction? Were retained securitisations common in the last 12 months? Is securitisation particularly concentrated in certain industry sectors? Despite having a developed legal framework to support securitisation, Hong Kong has a low level of securitisation activity. This is generally due to the ready availability of other more conventional types of funding at inexpensive rates. The most significant securitisation activity over the past decade has been the domestic issuance of residential mortgage-backed securities (RMBSs) by the Hong Kong Mortgage Corporation (HKMC), creating a robust secondary mortgage market.

   Over the past 12 months, market activity has remained relatively inactive due to both:

   The global financial crisis. Recent bad publicity in the Hong Kong media relating to retail structured products following the global insolvency of Lehman Brothers. The Hong Kong Monetary Authority (HKMA), the principal financial regulator, has not formally introduced any liquidity schemes to assist the securitisation market. However, the HKMA actively supports financial markets in other ways, such as the guaranteeing of bank deposits.

2. Is there a specific legislative regime within which securitisations in your jurisdiction are carried out? In particular:

   What are the main laws governing securitisations? Is there a regulatory authority? There are no securitisation-specific laws or regulatory authorities in Hong Kong.

   On 1 July 1997, Hong Kong became the Hong Kong Special Administrative Region (HKSAR) of the People's Republic of China (PRC). In HKSAR v Ma Wai-kwan and others (29 July 1997), the Hong Kong Court of Appeal decided that the common law and rules of equity of England which applied in Hong Kong on 30 June 1997 continue to apply in the HKSAR, subject to their independent development, both (Article 8, Basic Law of the Hong Kong Special Administrative Region (HKSAR)):

   Unless they contravene the Basic Law of the HKSAR. Subject to any amendment by the HKSAR's legislature. Some of these laws and rules affect securitisations.

   REASONS FOR DOING A SECURITISATION

3. Which of the reasons for doing a securitisation, as set out in the Model Guide, usually apply in your jurisdiction? In particular, how are the reasons for doing a securitisation in your jurisdiction affected by:

   Accounting practices in your jurisdiction, such as application of the International Financial Reporting Standards (IFRS)? National or supra-national rules concerning capital adequacy (such as the Basel International Convergence of Capital Measurement and Capital Standards: a Revised Framework (Basel II Accord) or the Capital Requirements Directive)? What authority in your jurisdiction regulates capital adequacy requirements? Usual reasons for securitisation

   The usual reasons for securitisation are the same as those set out in the Model Guide (see Model Guide, Reasons for doing a securitisation).

   Accounting practices

   The mandatory sources of generally accepted accounting principles (GAAP) are:

   Companies Ordinance (Cap. 32) for companies incorporated in Hong Kong. The Hong Kong Financial Reporting Standards (HKFRS), which are fully harmonised with the IFRS. The accounting and disclosure requirements of the Hong Kong Stock Exchange for companies listed on its main board and on its growth enterprise market. Balance sheet benefits are now less of an incentive for originators and sponsors subject to IFRS. This is because it is increasingly difficult to justify not consolidating or recognising the accounting effects on a securitisation SPV in the originator's or sponsor's balance sheet.

   Capital adequacy

   Hong Kong has implemented Basel II under the:

   Banking Ordinance (as amended by the Banking (Amendment) Ordinance 2005). Banking (Capital) Rules. Bank (Disclosure) Rules. The HKMA regulates capital adequacy requirements.

   THE SPECIAL PURPOSE VEHICLE (SPV)

   Establishing the SPV

4. How is an SPV established in your jurisdiction? Please explain:

   What form does the SPV usually take and how is it set up? What is the legal status of the SPV? How is the SPV usually owned? Are there any particular regulatory requirements that apply to the SPVs? SPVs typically take the form of a limited liability company. One or more persons can form a company by subscribing to a memorandum of association and complying with the relevant registration requirements (section 4, Companies Ordinance (Cap. 32)).

   A duly incorporated company under the Companies Ordinance is treated as a separate legal entity. It has the capacity, rights, powers and privileges of a natural person (section 5A, Companies Ordinance (Cap. 32)).

   A company is legally owned by its members (that is, shareholders in the case of companies limited by shares). In relation to SPVs, ultimate beneficial ownership is usually with a charitable trust. There is no prescribed minimum share capital. However, for practical purposes, this is not usually less than HK$1,000 (about US$130) or a foreign currency equivalent. There is a capital duty of 0.1% payable on the authorised share capital (subject to a cap of HK$30,000 (about US$3,870)).

   There are no laws or regulatory requirements specifically applying to SPVs (see Question 2).

5. Is the SPV usually established in your jurisdiction or offshore? If established offshore, in what jurisdiction are SPVs usually established and why? Are there any particular circumstances when it is advantageous to establish the SPV in your jurisdiction?

   SPVs can be established in Hong Kong or offshore. If established offshore, it is usually for tax reasons. Typical offshore jurisdictions include the Cayman Islands, British Virgin Islands and other low tax jurisdictions.

   A foreign company intending to conduct business in Hong Kong must register as a non-Hong Kong company with the Hong Kong Companies Registry within one month of establishing a place of business in Hong Kong. The tax rate on profit derived in Hong Kong is the same for Hong Kong and foreign companies.

   Ensuring the SPV is insolvency remote

6. Is it possible to make the SPV insolvency remote in your jurisdiction? If so, how is this usually achieved?

   It is possible to make the SPV insolvency remote through a combination of methods, including:

   Placing restrictions to prevent the SPV incurring liabilities outside the scope of the relevant transaction. Properly pre-defining cash flows and subordination. Ensuring that all the SPV's potential creditors covenant to both: limited recourse (that is, limiting creditors' recourse to available funds); non-petition (that is, prohibiting any creditor from taking legal action or commencing insolvency proceedings against the SPV). Putting in place adequate liquidity, reserve and hedging facilities. Incorporating the SPV in a tax neutral jurisdiction. Ensuring the SPV is treated separately from the originator

7. Is there a risk that the courts can treat the assets of the SPV as those of the originator if the originator becomes subject to insolvency proceedings? If so, can this be avoided/ minimised?

   There is no general doctrine of substantive consolidation (that is, where assets of a separate legal entity such as an SPV can be treated as those of the originator and used to satisfy the originator's liabilities). Only in very limited circumstances is the separate legal personality of a company ignored (for example, in the case of fraud).

   THE SECURITIES

   Issuing the securities

8. Are the securities issued by the SPV usually publicly or privately issued?

   The securities can be privately or publicly issued, depending on the transaction's individual circumstances.

9. If the securities are publicly issued:

   Are the securities usually listed on a regulated exchange in your jurisdiction or in another jurisdiction? If in your jurisdiction, please briefly summarise the main documents required to make an application to list debt securities on the main regulated exchange in your jurisdiction. Are there any share capital requirements? If a particular exchange (domestic or foreign) is usually chosen for listing the securities, please briefly summarise the main reasons for this. Securities can be issued on the Hong Kong Stock Exchange or a regulated foreign exchange, depending on investor requirements and preferences...