HKMA clarifies ring-fencing

MARKET practitioners doubt the release of a standardised ring-fencing statement by the Hong Kong Monetary Authority (HKMA) can revive the moribund fixed-rate certificate of deposit (CD) market.

To clarify confusion in the market caused by different statements inserted in recent CD documents, the HKMA, the territory's central bank, issued a recommended version to the Capital Markets Association.

Ring-fencing statements are restrictive clauses which say that repayment of the deposit will take place only at the Hong Kong branch, and that the bank's head office will not be obliged to repay under force majeure situations, such as civil war.

HKMA empasised that such clauses were consistent with Hong Kong law and therefore were unnecessary.

Because the clauses were redundant and easily could cause confusion to investors, HKMA preferred they were omitted, or reduced to a simple statement that CDs were governed by Hong Kong law.

However, in cases where banks had global policy to put in such a clause, HKMA argued that the clause should be standardised.

The recommended version reiterates that the issuing bank and its Hong Kong branch are one single entity, implying that the issuer has full responsibility for such deposits.

But this obligation will be annulled if the local branch is prevented from repaying the deposits due to 'an act of war, insurrection or civil strife; or an action by the government or any instrumentality of it in Hong Kong'.

HKMA strongly advised banks against voluntarily scrapping the protection given to the head office, granted under Hong Kong law.

Such a move 'is not the practice in other major international financial centres and could lead to the development of a two-tier structure in the debt market'.

Any banks who want to depart from HKMA's recommendations are requested to consult the central bank.

Market practitioners welcomed the HKMA's move which they said would help clarify the extent of responsibility accorded by such restrictive clauses.

Yet, they said investors had opted for papers under banks' global medium term note (MTN) programmes.

'These papers are issued out of the bank's headquarters. There will be no question about the repayment,' a dealer said.

Besides, credit ratings of the CDs issued by a local branch of a foreign bank might end up being capped by Hong Kong's sovereign rating.

'If so, investors might as well buy MTR (Mass Transit Railway) papers which have the sovereign rating and higher liquidity,' he said.

The fixed-rate CD market is predominantly a fund managers' market. Their ability to buy CDs of a lower credit rating might be hindered by the investment strategy laid down in the fund's prospectus.

'So even if issuers give a higher pricing for the CDs, investors may not be able to buy,' he said. The times of fixed-rate CD markets being a source of cheap funds for foreign banks might be gone, he said.