In Hong Kong, Hong Kong Monetary Authority (HKMA) and Securities and Futures
Commission (SFC) are the financial regulators in banks and securities industry
respectively.
HKMA
Background
Hong Kong Monetary Authority, the government authority in Hong Kong, is responsible
for maintaining monetary and banking stability. It was set up on 1 April 1993 by merging
the Office of the Exchange Fund and the Office of the Commissioner of Banking. Its
main functions and responsibilities are governed by the Exchange Fund Ordinance and
the Banking Ordinance.
Functions of HKMA
The key functions of HKMA are:
 to keep the Hong Kong dollar stable;
 to manage the Exchange Fund;
 to promote the safety of Hong Kong's banking system; and
 to develop Hong Kong's financial infrastructure so as to enable money to flow
smoothly, freely and without obstruction.
Departments involved in HKMA
Responsibility is shared among three departments within the HKMA:
 The Banking Supervision Department handles the day-to-day supervision of
authorized institutions,
 The Banking Policy Department formulates supervisory policies to promote the
safety and soundness of the banking sector, and
 The Banking Development Department formulates policies to promote the
development of the banking industry.
Three-tier Banking System
Hong Kong maintains a three-tier system of deposit-taking institutions, namely, licensed
banks, restricted licence banks, deposit-taking companies. They are collectively known as
authorized institutions (A.I.) under the banking Ordinance.
Only licensed banks may operate current and savings accounts and accept deposits of any
size and maturity. Restricted licence banks are principally engaged in merchant banking
and capital market activities. They may take deposits of any maturity of HK$500,000
(approx. US$ 64,103.) and above. Deposit-taking companies are mostly owned by, or
associated with banks. They engage in a range of specialized activities, including
consumer finance and securities business. These companies may take deposits of HK
$100,000 (approximated US$12,821) or above, with an original term to maturity of at
least of three months.
Hong Kong has one of the highest concentrations of banking institutions in the world. 73
of the largest 100 banks in the world have an operation in Hong Kong. At the end of May
2003, there were 135 licensed banks, 43 restricted licence banks and 40 deposit-taking
companies in business. They are totally 218 authorized institutions. In addition, there are
92 local representative offices of overseas banks in Hong Kong.
Supervision of authorized institutions
Under the Banking Ordinance, the HKMA is the licensing authority responsible for the
authorisation, suspension and revocation of all three types of authorised institutions. The
HKMA conducts periodic reviews of the authorisation criteria and, when necessary,
introduces amendments to reflect the changing needs of the regulatory environment and
to meet new international standards. It also ensures that only fit and proper institutions
are entrusted with public deposits.
Regulatory Framework
The Banking Ordinance provides the legal framework for banking supervision in Hong
Kong. Under section 7(1) of the Ordinance, the principal function of the Monetary
Authority is to promote the general stability and effective working of the banking system.
In 1999 , the Hong Kong Monetary Authority (HKMA) has complies with the Core
Principles of international standards suggested by the Basle Committee on Banking
Supervision ("Basle Committee").
Continuous Supervisory Approach
The supervisory approach of HKMA is based on a policy of "continuous Supervision". It
involves on-going monitoring of institutions using a wide variety of techniques which are
aimed at detecting any problem at an early stage.
Here is the operational supervision conducted by HKMA.
1. On-site examinations
including those on:
- money laundering (tier-two exams for 2002)
- treasury
- securities
- e-banking
- review of business continuity plans
- overseas examinations
2. Off-site reviews and prudential interviews
3. Tripartite meetings
4. Meetings with the boards of directors of AIs
5. Approval of applications to become controllers,
directors, chief executives, alternative chief
executives of AIs
6. Reports commissioned under Section 59(2) of
the Banking Ordinance
7. Cases considered by the Banking Supervision
Review Committee
2001
2002
232
(58)
(10)
(17)
0
0
(11)
236
78
19
440
285
(32)
(11)
(10)
(30)
(20)
(12)
215
78
21
318
5
0
9
10
(Source: HKMA Annual Report 2002)
Risk-based supervision
The HKMA is also developing a more formalized risk assessment approach and quality
assurance programme. The approach puts emphasis on evaluation of the quality of risk
management practices and internal controls of various types of risks faced by the
institutions.
Here are the risks they may consider:
 Credit Risk - The risk arising from the potential that a borrower or counter-party will
fail to perform on an obligation.
 Interest Rate Risk - The risk to an institution's financial condition resulting from
adverse movements in interest rates.
 Market Risk - The risk to an institution's condition resulting from adverse
movements in market rates or prices, such as foreign exchange rates, or
commodity/equity prices. Liquidity Risk - The risk that an institution will be unable
to meet its obligations as they come due.
 Operational Risk - The risk arising from the potential that inadequate information
systems, operational/transactional problems (relating to service or product delivery),
breaches in internal controls, fraud or unforeseen catastrophes.
 Reputation Risk - The risk that negative publicity regarding an institution's business
practices.
 Legal Risk - The risk arising from the potential that unenforceable contracts,
lawsuits or adverse judgements
 Strategic Risk - The current and prospective impact on earnings or capital arising
from adverse business decisions, improper implementation of decisions, or lack of
response to industry changes.
CAMEL Rating
The HKMA has adopted the CAMEL rating system to assess the financial condition and
overall soundness of authorised institutions in Hong Kong. "CAMEL" rating system is an
internationally recognised framework for assessing the Capital adequacy, Asset quality,
Management, Earnings and Liquidity of banks.
The primary purpose of CAMEL is to help identify institutions whose weaknesses in
financial condition, compliance with laws and regulations, and overall operating
soundness require special supervisory attention. The overall rating is expressed on a scale
of one to five in ascending order of supervisory concern: "1" indicates the highest rating
and least degree of concern; "5" represents the lowest rating and highest degree of
concern.
Capital Adequacy Ratio (CAR)
It is the ratio of an authorised institution's capital base to its risk-weighted credit
exposures. The method and components used in the calculation are specified in the Third
Schedule to the Banking Ordinance.
Locally incorporated authorised institutions are required to adhere to the minimum 8%
capital adequacy ratio, but the HKMA may increase the ratio to: (a) not more than 12% in
the case of a bank; or (b) not more than 16%, in the case of a deposit-taking company or a
restricted licence bank. Each locally incorporated authorised institution is assigned a
minimum ratio on an unconsolidated (solo) basis or on a consolidated and unconsolidated
basis within the range specified by the Ordinance.
Supervision of Liquidity
The HKMA assesses the adequacy of an institution's liquidity by examining six factors,
including liquidity ratio, maturity mismatch profile, ability to borrow in the interbank
market, intra-group transactions, loan to deposit ratio, and diversity and stability of the
deposit base. This approach aims at ensuring, as far as possible, that institutions can meet
their obligations when they fall due in normal circumstances and that an adequate stock
of high quality liquid assets is maintained to provide them with a breathing space in the
event of a liquidity crisis.
Loan Classification System
In December 1994, the HKMA introduced a loan classification system requiring
authorised institutions to report their assets on a quarterly basis according to a
standardized framework. Under the system, loans are classified as Pass, Special Mention,
Substandard, Doubtful or Loss, with the latter three categories collectively regarded as
"classified assets".
Derivatives and Risk Management
The HKMA adopts a three-pronged approach in developing its supervisory framework
for managing the risks of Authorised Institutions derivatives activities:
 Controls (to ensure that AIs have adequate internal control systems to manage the
risks of their derivatives activities);
 Capital (to ensure that AIs have adequate capital to support possible losses in their
derivatives business); and
 Capability (to ensure that there is adequate expertise within the HKMA to develop
risk management policies and to supervise AIs' derivatives activities).
Financial Disclosure
Increased transparency in financial reporting serves to enhance Hong Kong's position as
an international financial centre, demonstrating the financial strength of Hong Kong's
banks as well as providing relevant and comparable information to financial analysts and
credit rating agencies. As a result, in addition to the annual disclosure standards for
locally incorporated authorized institutions, the HKMA has also issued guidance in
respect of the interim financial disclosure by locally incorporated institutions and the
half-yearly financial disclosure by overseas incorporated institutions.
Under this guideline, authorised institutions incorporated in Hong Kong (except for the
smaller restricted licence banks and deposit-taking companies) are required to disclose
certain financial information, including:
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income statements,
balance sheets,
cash flow statements,
asset quality, in particular information on overdue and rescheduled assets,
off-balance sheet exposures,
maturity profiles,
segmental information,
foreign currency exposures,
risk management,
capital adequacy; and
liquidity information.
SFC
Historical background of SFC
In 1987, the deficiencies in the structure were made all too apparent by the October crash,
which resulted in the closure of both the Hong Kong stock and stock index futures
markets for four days. After the crash, a six-member committee, the Securities Review
Committee was created to examine Hong Kong's regulatory structure and how they could
be improved, to minimise the chances of a repeat of the disruption of October 1987. In
May 1988, the Committee released its report. The Securities Review Committee
recommended existing structure should be replaced with a single statutory body outside
the civil service.
The Securities and Futures Commission (SFC), which is the regulator of HK Securities
Industry, was born in 1989 under the Securities and Futures Commission Ordinance. SFC
is an independent, non-governmental statutory body. The SFC regulates the securities and
futures markets in Hong Kong and oversees the development of these markets. The
chairman of SFC and executive directors were appointed by the government.
Roles and functions:
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Licensing and supervision of intermediaries and focus on secondary market;
Encouraging market development; and
Protecting investors.
Regulatory objectives:
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Maintain and promote the fairness, efficiency, competitiveness, transparency and
orderliness of the securities and futures industry;
Promote understanding by the public of the operation and functioning of the
securities and futures industry;
Provide protection for members of the public investing in or holding financial
products;
Minimize crime and misconduct in the securities and futures industry;
Reduce systemic risks in the securities and futures industry; and
Assist the Financial Secretary in maintaining the financial stability of Hong Kong by
taking appropriate steps in relation to the securities and futures industry.
Operational divisions in SFC
Corporate Finance Division
 Administer the Takeovers and Mergers Code and Share Repurchases Code;
 Promote fair and equal treatment of public shareholders;
 Raise standards of investor protection and corporate governance;
 Oversee the Stock Exchange's listing-related functions and responsibilities;
 Review and recommend changes to the Listing Rules;
 Administer securities and company legislation relating to listed and unlisted
companies;
 Facilitate the development of effective and efficient capital markets for issuers,
including Mainland enterprises; and
 From 1 April 2003 onwards, review prospectuses and other documents sent by listed
companies to their shareholders.
Intermediaries and Investment Products Division
 The Licensing Department acts as the gatekeeper of the industry, ensuring that only
fit and proper individuals and organisations are allowed to deal with investors and
other market participants.
 The Intermediaries Supervision Department monitors and supervises the financial
viability and business conduct of intermediaries; raises the standards of control and
risk management of intermediaries to protect investors; devises balanced policies
and regulations to promote market integrity and development; and maintains
ongoing dialogue with market participants to uplift industry standards.
 The Investment Products Department authorises investment products for sale to the
Hong Kong public in accordance with product codes and industry standards;
monitors marketing materials and disclosures of funds; formulates policies for the
development of new products; strengthens international regulatory co-operation in
relation to collective investment schemes and their operators; and conducts annual
survey on the fund management activities in Hong Kong.
Supervision of Markets Division
 Supervise and monitor the activities of the exchanges and clearing houses;
 Facilitate the development of and encourage participation in the Hong Kong markets;
Strengthen market infrastructure; and
 Oversee and manage Hong Kong's investor compensation funds.
Enforcement Division
 Enforce laws relating to the securities and futures industry, leveraged foreign
exchange trading, and investment arrangements;
 Report suspected insider dealing to the Financial Secretary;
 Inspect books and records of listed companies if impropriety is suspected;
 Enforce disclosure of interests of substantial shareholders, directors and chief
executives of listed companies;
 Suppress illegal or improper practices in trading, investment arrangements and the
provision of advice or other financial services; and
 Co-operate with domestic and overseas regulatory bodies in investigations in Hong
Kong and overseas.
Responsibility of SFC
The Securities and Futures Commission exercises prudential supervision over the
securities, futures and financial investment industries in Hong Kong. All rules made by
the two Exchange and the Clearing Houses are subject to SFC approval.
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To administer requirements to ensure full disclosure and fair treatment of the
investing public;
To monitor trading on the securities and future markets to detect possible
malpractices;
To conduct periodic inspection visits of registered persons and makes inquiries in
response to public complaints about misconduct;
To inspect a listed company’s books and records if its directors are suspected
improperly in the management of affairs;
To regulate the takeovers and merger activity; regulation of offers of investment
products; financial intermediaries other than SEHK and HKFE members.
To handle any dissatisfied party and disciplinary matters by the Takeovers and
Mergers Panel.
Powers in relations to offences and misconduct
The SFC has three methods to take actions when there are companies who misconduct
their behaviours by:
 Prosecution,
 Court order, and
 Revocation.
Disciplinary actions and civil and criminal actions range from private or public censure to
revocation of a license. Regarding criminal actions, SFC is responsible for the
investigation of various criminal offences and while it prosecutes minor offences, serious
matters are prosecuted at the independent discretion of the Director of Public
Prosecution.
On summary conviction
 Fine $100,000
 6 months’ imprisonment
On indictment
 Fine $ 10,000,000
 7 years’ imprisonment