Hong Kong’s Banking Exposure Limit Rules: Implementation Challenges

Many banks have merely instituted stopgap measures and temporary manual solutions to comply with BELR so far, say Synpulse’s Gregory Achache and Tim Alvner.

Last year, the HKMA (Hong Kong Monetary Authority) became one of the first supervisory authorities to implement new rules on assigning and measuring exposures according to Basel III standards, which better reflect a bank’s exposure to counterparties and potential defaults.

The BELR (Banking Exposure Limit Rules) offered a grace period for compliance which ended in December 2019. Some of the main changes in the exposure rules included:

The four tiers of counterparty exposure weight ratios in exposure calculation, Source: Synpulse

  • Change of calculation base for exposure ratios from overall capital base to Tier 1 capital
  • More detailed rules for measuring and capturing equity exposures, which recognise widely used risk mitigation practices
  • Inclusion of ‘economic dependence’ as a factor in defining groups of connected counterparties
  • Interbank exposures are no longer exempted

Despite the six months grace for mandatory compliance, many banks have merely instituted stopgap measures to comply, effectively lowering the sales volume to offer operations and reporting teams more time to manually support needed management information and other reporting processes which support front office. Rather than building out core platform capacity which can be a process absorbing the majority of a year, many banks have resorted to other temporary solutions such as ad-hoc reporting on existing tools or manual handling via spreadsheets.

These stopgap measures were introduced because BELR impacted banks widely and implementation entailed far-reaching system, process, and organisational changes. Institutions require time to build the expertise to set up new identification and calculation processes, and to evaluate necessary system enhancements going forwards.

Beyond considering new equity exposure calculation methods, the new rules necessitated changes to governance processes, including to allow banks to lower risk exposures if regulatory risk mitigation processes were instated. Beyond the process changes, additional training is necessary for frontline staff who are obliged to stay within regulatory and internal limits for product exposure, especially in the context of portfolio- and product lending. These frontline workers need to be fully acquainted with the concept and systems capabilities used when including economically dependent counterparties in the exposure, (as well as other contractual counterparties) as outlined in BELR to ensure ongoing compliance.

With the change in Hong Kong already underway, and institutions work to make the necessary changes to achieve compliance more efficiently, there are other industry trends that need to be considered:

Operationalising system changes

Financial institutions place themselves at risk by adopting a gradual approach including stopgap measures to regulatory change, especially when undergoing a major transformation as required by BELR. While key risk systems and credit reporting tools may have been modified to comply with the new rules, other vulnerabilities remain.

Core systems, workflow tools and notification dashboards in many cases have not been thoroughly reviewed and adapted to match the changes in other systems. This also applies to credit sales and advisory staff, many of which have not yet been trained or involved in the new risk management process.

The challenges increase when accounting for non-credit functions, such as complex product structuring and fund sales, whose inputs are crucial for BELR calculations. For instance, where one institution structures a product around the offering of another institution, the potential counterparty exposure that arises at the latter can increase complexity and impact regulatory risk involved in the sales effort at the former.

Follow-up regulatory reviews by HKMA

BELR implementation reviews by the regulators will add specification to the existing HKMA guidance. The clarifications typically issued in such review processes have a history of being more stringent; for instance, the HKMA clarified in January that for the purposes of BELR, life insurance policies which secure employee financial facilities are only considered acceptable security if certain criteria are met. New clarifications are also likely to outline possible enforcement actions for noncompliance, which will drive constant revisions of internal audit and process management requirements.

To increase organisational preparedness, banks need to review the sales processes, including sales conducted through third party firms, credit and lending department processes, and entity-wide risk functions. After this review, balanced scorecards for employees aligned with BELR should be implemented, along with an ongoing management review process based on these scorecards, to promote organisation-wide compliance.

Implementation in other jurisdictions

Although the HKMA was one of the first to implement rule changes on banking exposure limits, other jurisdictions will follow in due course.

In this regard, financial institutions will need to consider the interim implementation risks of cross-border differentiation: i.e., if products being sold in Hong Kong are originated, bought or structured in another jurisdiction. Data in other jurisdictions will need to be assessed based on Hong Kong requirements, where any differences identified will necessitate change in the sales process for cross-border trades.

For institutions in other jurisdictions looking to prepare for similar rules, it is important to understand and benchmark Hong Kong’s BELR with their own home regulatory frameworks, and to closely monitor the actions taken by Hong Kong entities to achieve compliance.

The change from a direct exposure to a framework that includes multiple levels of exposure also necessitates significant updates to an authorised institution’s internal risk reporting processes. These changes need to be unified and communicated across the entire organisation, as they become standard components of staff workflows.

One of the key challenges for authorised institutions in the coming years will be to set up a cross-jurisdictional BELR governance structure while continuously updating the local framework without hampering operational efficiency.

Gregory Achache is Associate Partner, and Tim Alvner is Senior Consultant, at Synpulse Hong Kong.

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