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SCMP Reporter

HEAVYWEIGHT offshore banks will have to pay more for Hong Kong dollars to reflect political risk under reforms being mooted by the working group of the Hong Kong Capital Markets Association (HKCMA).

  Rating agencies have warned that big offshore banks cannot expect their ratings to prevail in the Hong Kong dollar market unless they guarantee the issues, taking the risk away from investors.

  The HKCMA working group is proposing that banks standardise document wording to make it clear to holders of certificates of deposit (CDs) that they bear the political risk - not the head office of the branch issuing the CDs.

  Branches and head offices are normally regarded as the same legal entity in law, but head offices are not obliged to redeem branch debt if political upheaval or changes mean the branch cannot repay the debt.

  Clauses spelling this out in CD documentation are known as 'ring-fencing' clauses, and bankers have said that 'ring-fencing' borrowers should pay a premium for political risk just as local borrowers do.

  An AAA-rated issuer pays less than an issuer rated A1.

   The territory's Hong Kong dollar rating is A1 from Moody's Investors Service and A-plus from Standard & Poor's (S & P).

  Both Moody's and S & P said Hong Kong's local currency rating was the absolute ceiling for Hong Kong dollars, regardless of how high a local branch's head office rating was.

  Bankers have said that some local branches of foreign banks issuing Hong Kong dollar CDs have sought pricing in line with what their head office's credit rating would command in another market and to avoid the risk premium for Hong Kong.

  They said investors were seeking out issues that were not ring-fenced, or whose pricing reflected the political risk investors were being asked to bear.

 Once documentation was standardised to make it clear that investors might have to bear political risk, pricing would rise accordingly, they said.

  One banker cited the case of ABN-AMRO's $1 billion floating-rate certificate of deposit (FRCD) which paid a low 0.3 percentage points over the Hong Kong interbank offered rate. ABN-AMRO is rated AA1 by Moody's.

  He said this pricing was unrealistic because the higher-rated head office of ABN-AMRO would not be liable to repay its branch's debt if political upheaval prevented the branch from doing so.

He said the territory's Hong Kong dollar rating effectively acted as a rating ceiling for offshore borrowers regardless of their rating in other currencies.

  'Everybody - no matter whether they are AAA or AA - has to be priced at A1 to reflect the value of the Hong Kong branch issue,' the banker said.

  The local currency rating acts as a limit on anyone else seeking to issue Hong Kong dollars, according to Moody's Investors Service senior analyst Lynn Exton.

  Ms Exton said the only way a top foreign bank could have its local branch's Hong Kong dollar debt rated higher than the Government's would be if the head office guaranteed to bear risk - not the holder of the Hong Kong dollar debt.

  S & P's Paul Coughlin agreed that there were ways a heavyweight foreign bank could avoid the territory's ceiling to cut its local currency borrowing costs, but it was difficult.

  'You would actually have to have a redemption formula allowing you to redeem [the debt] outside Hong Kong in another currency with a predetermined formula,' Mr Coughlin said.

  Some observers might not realise that regardless of how high a head office was rated, Hong Kong's local currency was the benchmark because of the political factor, he said.

  'The difference [between an AAA rating and Hong Kong's A-plus] is rather minimal because the overwhelming factor is political risk,' he said.



Foreign banks could pay more for HK dollars