Amendment to the 1988 Capital Accord for Bilateral Netting

Guideline No. 4.4

Amendment to the 1988 Capital Accord for Bilateral Netting

The Basle Committee issued in July 1994 an amendment to the Capital Accord to broaden the recognition of bilateral netting to include, in addition to netting by novation, transactions subject to any legally valid form of bilateral netting.

The Company and Financial Law Committee of the Law Society of Hong Kong has confirmed that Hong Kong law is sympathetic to the concept of netting. This opinion was set out in detail in a Statement of Law recently issued by the Committee. After obtaining the industry Associations positive response to the proposed implementation framework, the HKMA has decided to revise its capital adequacy regime to bring it in line with the revised Capital Accord. For this purpose, the Policy Paper at Annex A sets out the conditions under which the HKMA will be prepared to recognise netting arrangements and the method of calculating the credit exposure on bilaterally netted transactions for capital adequacy purposes.

Implementation of the revised framework requires amendments to the Third Schedule of the Banking Ordinance. This is being actively pursued and is expected to be completed within the first quarter of 1995. Authorised institutions will be advised of the commencement date in due course. In the meantime authorised institutions intending to take advantage of bilateral netting arrangements are advised to familiarise themselves with requirements and the procedural steps set out in the Policy Paper. Related to this, you should note that the Hong Kong Association of Banks has obtained a legal opinion that the Hong Kong IFEMA is enforceable under Hong Kong law. The HKMA has confirmed that this master agreement is acceptable for bilateral netting under the revised capital adequacy framework subject to the qualifications raised in the legal opinion and to the conditions set out in the Policy Paper. Your attention is drawn particularly to the requirements in paragraphs 10, 14 and 15 of the Paper.

Authorised institutions should also note the modifications which will be made to the reporting requirements after the revised framework takes effect. Annex B sets out the changes (highlighted in bold) which will be made to the completion instructions of the Capital Adequacy Ratio return (MA(BS)3) to take account of the expanded scope of bilateral netting and related changes to the methods of calculating the credit exposure on exchange rate and interest rate contracts (rate contracts).

The following institutions will continue to use the existing return form for reporting their rate contracts:

Institutions which use the original exposure method with bilaterally netted rate contracts will be required to use the two replacement pages at Annex C to report their rate contracts.

Should you have any queries or comments on the Policy Paper or the reporting arrangements, please feel free to contact Mr. Danny Leung (2878 8202) or Mr. C K Sum (2878 1624) of this Office.