Six months to go…staying the distance

The Hong Kong Monetary Authority (HKMA) has issued rules¹ requiring in-scope banking sector entities to include a provision (“contractual stay language”) in certain of their non-Hong Kong law governed financial contracts for the contractual parties to agree that they will be bound by the power of the HKMA (as resolution authority for the banking sector) to temporarily suspend the termination right of a counterparty to the contract. The HKMA rules came into operation on 
27 August 2021 but in-scope entities were given some time to implement the new requirements – 24 months (i.e. by 26 August 2023) or 30 months (i.e. by 26 February 2024) depending on the counterparties to the covered contracts.

With just six months till the first compliance deadline on 27 August 2023, how ready are you in terms of:

1. Contract scoping?

The HKMA contractual stay requirements apply to covered contracts which a covered entity enters into, renews or materially amends after the rules came into effect on 27 August 2021. The HKMA has deliberately set a very wide definition for covered contracts. Securities contracts, commodities contracts, derivatives contracts, FX contracts and master or other agreements relating to them all fall under the definition of covered contracts if the contract contains termination rights exercisable by the counterparty.

Most derivative or securities financing agreements (such as ISDA Master Agreements, Global Master Repurchase Agreements (GMRA) and Global Master Securities Lending Agreements (GMSLA)) are in scope – even those existing ones entered into before 27 August 2021 if the counterparties continue to trade under them. Be mindful of other categories of financial contracts such as custodian agreements, distribution agreements and collateral agreements given the width of the definition for “covered contracts”.

2. Finalising the implementation method?

Adhering to the ISDA Resolution Stay Jurisdictional Modular Protocol (the “ISDA JMP”) and the related Jurisdictional Module for Hong Kong would be the easiest way to comply with the HKMA’s contractual stay requirements. However, note that there may be practical difficulties in relying on this method alone. For the ISDA JMP to apply, all counterparties to a contract will have to adhere (and there may be complications where there is third party credit support relating to a contract). Certain types of agreements (e.g. the PRC law governed NAFMII Derivatives Master Agreement published by the National Association of Financial Market Institutional Investors) may have their own formalities for amendment. If the protocol method is not feasible, counterparties will have to use a bilateral amendment agreement.

If counterparties are reluctant to sign amendment agreements (or even just for ease of compliance), have you considered if one-way amendment works for a particular type of contracts? Note that some agreements preclude one-way amendments (e.g. section 9(b) of the ISDA Master Agreement requires all amendments to be in writing and executed by each of the parties or confirmed by an exchange of telexes or electronic messages). Proper due diligence should be conducted and the contractual position analysed for this purpose.

Various industry bodies have published template contractual stay language for use by market participants. Consider if this is appropriate for use in particular cases or whether amendments to such template language are required.

3. Sorting out how you will meet the HKMA’s requirements for legal opinions?

The HKMA requires covered entities to provide legal opinions to the effect that the contractual stay language included in an in-scope financial contract is legally enforceable. Some of the matters required to be opined on are governing law matters; others are capacity-related issues which are matters under the law of incorporation of the counterparty. Have you reached out to the relevant counsel to obtain such opinions?

Linklaters has extensive experience in advising financial institutions and their counterparties on the compliance with the HKMA contractual stay requirements. We have written extensively on this topic to assist clients with complying with the new requirements. You can access these materials here. We would be delighted to assist you if you have any questions.

¹ _{Financial Institutions (Resolution) (Contractual Recognition of Suspension of Termination Rights—Banking Sector) Rules (Cap. 628C, Laws of Hong Kong)}