Enhancing Hong Kong’s Role as a Centre for

Regional and International Financial

Institution Operations: Booking

September 2015

FSDC Research Paper No.15

TABLE OF CONTENTS

EXECUTIVE SUMMARY 1

I. INTRODUCTION AND KEY ISSUES 3

II. LIST OF RECOMMENDATIONS TO DEVELOP HONG KONG AS A PREFERRED

BOOKING CENTRE

8

III. BOOKING MODEL 10

A. Hong Kong as a Booking Centre from Current Economic Perspective 10

B. Reasons for Enhancing Hong Kong’s Attractiveness as a Booking Centre 11

C. ‘Push’ Factors 14

D. ‘Pull’ Factors 15

a. Regulatory Regime 15

b. Capital Rules and Capital Costs 19

IV. HONG KONG’S ROLE AS A RELATIONSHIP CENTRE 23

A. Maintaining Hong Kong’s Relationship Centre Status 23

B. Section 115 of SFO Considerations 23

V. OTHER CONSIDERATIONS 26

A. Resolution Regime 26

B. Holding Company and Tax Considerations 27

C. OTC Derivatives 29

D. Market Infrastructure 29

Appendix A. Current Economic Perspective : Hong Kong as a Booking Centre 30

Appendix B. Summary of Main Regulatory ‘Push’ Factors in US, UK and EU in Light

of Latest Regulatory Reforms

36

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EXECUTIVE SUMMARY

1. Traditionally, London and New York are the prime locations for booking banking

related, derivatives and securities transactions for major global financial

institutions. Although Hong Kong hosts many global financial institutions and

possesses a strong economic and business infrastructure, the level of booking

activity in Hong Kong lags behind London and New York. When it comes to

booking centres in Asia, Hong Kong also competes with Singapore and Tokyo.

2. This paper aims to provide recommendations for Hong Kong to further enhance

its financial markets and reputation as a preferred booking centre for regional (in

particular) and global financial institutions. 'Booking entity' here refers to the

entity to which a banking related, securities or derivatives transaction is

contracted, the entity with which the relevant account for a client or

counterparty is opened and maintained, and/or the entity which has the primary

obligation for delivery or payment with respect to a financial product.

3. We support Hong Kong in becoming a key booking centre because we believe it

would offer both quantitative and qualitative benefits for Hong Kong flowing

from greater economic activity. For example the increased asset allocation,

liquidity and volume of transactions will not only translate into significant

financial revenues for Hong Kong but will also promote an increased pool of

talent, and in turn, job creation in areas of operations, risk management and

compliance. However, there are also policy issues concerning Hong Kong's

potential to accumulate risk as a result of increased booking in the city, for which

the government would need to engage policies to mitigate that risk. Hong Kong

at the very least must encourage booking of transactions with a Hong Kong nexus

or connection, especially with respect to China-related transactions.

4. We have identified various 'push' factors which may potentially push financial

institutions to establish a new booking centre outside their current booking

location, and 'pull' factors which may attract financial institutions to establish a

booking centre in Hong Kong. Although Hong Kong has actively implemented

and proposed changes to its regulatory environment to align its standards with

international benchmarks1 since the financial crisis, inconsistencies still exist and

financial institutions may take advantage of potential regulatory arbitrage in 1 Currently, while the objectives remain consistent there are no commonly agreed upon

international standards for capital requirements, although since the financial crisis the international community under, for example, the auspices of the Basel Committee on Banking Supervision and International Organization of Securities Commissions (IOSCO), has been striving towards greater alignment of capital adequacy requirements.

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picking other more favorable booking locations. Separately, inconsistent regimes

also exist within Hong Kong, for example, financial institutions are subject to

different regulatory capital regimes administered by the Hong Kong Monetary

Authority (HKMA) and Securities and Futures Commission (SFC).

5. On a positive note, the SFC has recently published its Consultation Paper on

Proposed Changes to the Securities and Futures (Financial Resources) Rules in

the context of the over-the-counter derivatives licensing regime which is

anticipated to go a long way to enhancing the SFC’s regulatory capital regime to

achieve consistency with international standards2, as well as maintaining Hong

Kong's position as an international financial centre. Whilst the development in

the capital regime directly affects the ‘pull’ factor, any one regime cannot be

considered in isolation; the Government will need to ensure the enhancements

in interrelated regulatory regimes complement each other.

6. Although Hong Kong may not yet be a preferred booking centre, Hong Kong plays,

and will continue to play, a significant role as a relationship centre supported by

its sophisticated infrastructure, strong financial depth and strategically important

geographic location. When Hong Kong introduces changes to develop into a

major booking centre, authorities should be mindful that Hong Kong's status as a

preferred relationship hub must also remain equally important.

2 See footnote 1 above.

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I. INTRODUCTION AND KEY ISSUES

7. Hong Kong is one of the world's leading international financial centres. It

possesses a highly competitive economic and business infrastructure and a well-

developed regulatory framework. Many areas of the Hong Kong financial sector

(including banking and asset management) are strong, both in terms of

reputation and size. However, despite this, the level of bookings of banking-

related, derivatives and securities transactions (collectively, financial products) in

Hong Kong has traditionally lagged behind that of the major international hubs of

London and New York. Specifically, financial institutions ‘book’ far fewer

transactions in Hong Kong than in New York or London. In this context, it is

important to differentiate between traditional offshore booking centres on the

one hand and, on the other, the operational structure of major financial

institutions choosing where to amalgamate activities for regulatory purposes.

Historically, offshore booking centres allowed financial institutions to book

offshore transactions through their more lightly regulated jurisdictions. Prior to

the global financial crisis of 2008, major financial institutions focused their

operating structures on amalgamating their activities for regulatory objectives.

In general, the majority of major international financial institutions chose the UK

as the primary jurisdiction from which to base their international operations.

8. In this proposal, we consider ways to enhance Hong Kong's competitiveness as a

major jurisdiction for financial institutions' regional and international operations,

focusing both on its role as a booking centre and as a hub for financial

institutions' operations.

9. The first point to make is that, while there may be policy concerns about the

potential for risk accumulation in Hong Kong as a result of increased booking, the

major Mainland financial institutions are primarily looking to Hong Kong as an

operational hub for their international business, and not necessarily London or

New York. It is this aspect – Hong Kong's attraction as a major jurisdiction for

regional (and international) operations for financial institutions – that is the

focus of this proposal and not simply increasing Hong Kong's role as an offshore

booking centre, although the two go hand in hand.

10. The second point to make is that supporting Hong Kong in becoming the

preferred Asia-Pacific regional and, potentially, a key international booking

centre (especially for Mainland financial institutions) offers both quantitative and

qualitative benefits for Hong Kong. The increased asset pool, liquidity and

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number of banking/securities trading activities will encourage more economic

activities in Hong Kong which in turn will create additional job opportunities, not

only around the middle and back office but importantly, in respect of control

room functions including compliance and risk management. By way of

illustration, and referring to Figure 1 later in this paper, it can be seen that

historically Hong Kong’s legal and accounting sector accounted for lower levels of

employment than its peers London and New York, the more favorable booking

centres.

11. The latest sea of change in regulation and macroeconomic developments around

the world also creates new opportunities as well as challenges for Hong Kong, on

both a regional and global scale. Hong Kong needs to react and respond in order

to seize the opportunity to become a preferred booking centre. In particular,

considering Hong Kong's unique comparative advantage with its relationship

with the Mainland, Hong Kong should seek to become the first choice destination

in establishing a booking centre for Mainland financial institutions expanding

abroad, as well as other financial institutions (in particular those considering

Mainland Chinese securities market access) looking for an attractive centre in

place of their present booking centres.

12. Enhancing Hong Kong's role as a preferred booking centre will facilitate the long-

term development of Hong Kong's financial services industry and promote Hong

Kong's position and reputation as an international financial centre. However,

there is a clear need to balance opportunities and risks if we wish to increase

Hong Kong’s role as an international financial centre3.

13. This paper aims to provide recommendations for Hong Kong to further enhance

its financial markets and reputation as a preferred booking centre for financial

institutions (global or regional) in the Asia region. In preparing this paper, we

have assessed the existing position of Hong Kong from a global perspective and

have considered various 'push' factors (i.e. the existence of external global

regulatory or macroeconomic factors that may potentially push financial

institutions to establish a new booking centre in a new jurisdiction) as well as

'pull' factors (i.e. potential regulatory or macroeconomic initiatives that Hong

Kong may undertake to attract financial institutions to establish a booking centre

in Hong Kong). Particular areas of attention focus on capital requirements and

regulatory structure.

3 The recent speculation about HSBC relocating its headquarters from the UK back to Hong Kong

provides an apt example.

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14. One of the major hurdles we have identified in developing 'pull' factors for Hong

Kong is the existing separate capital requirement regimes for financial

institutions and the resulting inconsistencies across regimes. Currently,

authorized institutions (AIs) (i.e. licensed banks, restricted licence banks and

deposit-taking companies authorized under the Banking Ordinance) are subject

to the banking capital requirements supervised by the Hong Kong Monetary

Authority (HKMA). In contrast, licensed corporations (e.g. licensed securities

companies, brokerage companies, asset managers, etc.) licensed by the

Securities and Futures Commission (SFC) are subject to the capital requirements

under the financial resources rules supervised by the SFC. In addition, insurance

companies are subject to the rules of the Office of the Commissioner of

Insurance (OCI). This gives rise to complications when financial institutions seek

to establish a new booking centre in Hong Kong, as well as consideration such as,

for example, inconsistency with approaches in other major jurisdictions,

particularly the US and EU (increasing operational/compliance costs and

resources), choice of entity structure (branch vs subsidiary), and potential

regulatory arbitrage in 'picking' the more favourable capital regime.

15. The current regulatory capital regime of the SFC is liquid-asset based, which

tends to demand a higher capital requirement than other comparable financial

centres where the Basel type of risk-based capital regime is adopted. For

example, if a typical market access business is contemplated in a SFC licensed

corporation, approximately 1.2 times of trade notional amount will be required

for regulatory capital4 while it is comparably minimal in other markets such as

London or New York.

16. Thus there is a need to consider aligning the capital requirement regimes in Hong

Kong, particularly those for similar types of operations, and to achieve

consistency not only within Hong Kong, but also with other major jurisdictions, in

order for Hong Kong to maintain its competitiveness regionally and

internationally. Having made this point, on 17 July 2015 the SFC published its

Consultation Paper on Proposed Changes to the Securities and Futures (Financial

Resources) Rules (FRR Consultation) to update its financial resource

requirements in the context of the new over-the-counter (OTC) derivatives

licensing regime, and to update the requirements in certain areas of the FRR in

light of recent market developments. In drawing up its proposals the SFC has

4 For details, please refer to "Capital Rules and Capital Costs" under the 'Pull' Factors section where

market access business is used as an example to illustrate the regulatory capital requirement of major financial centres.

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conducted a detailed review of its FRRs by comparing the capital requirements

for OTC derivatives activities with similar capital requirements in other major

financial centres, including the US, UK, Australia and Singapore. The SFC also

referred to the capital rules for AIs authorized by the HKMA, the Hong Kong

Exchange and Clearing Limited (HKEx) Listing Rules' net asset requirement for

issuers of listed structured products, and the capital requirements of local and

overseas counterparties for their clearing members. The SFC notes that its

intention is to identify a suitable capital regime for its licensees engaging in OTC

derivatives activities which are commensurate with the risks they are

undertaking and to promote the adoption of more advanced risk management

standards and the conduct of business involving OTC derivatives activities in a

safer and sounder manner5.

17. As for the 'push' factors, there are of course factors that are outside the control

of Hong Kong which differ from market to market. While international capital

standard setters have been in discussion about developing approaches to align

capital adequacy requirements, it appears doubtful that this will be achieved in

the short term, although there are similarities in the different approaches which

generally have the same objective – to ensure a financial institution holds

sufficient capital to protect customers and creditors from losses and delays if it

were to fail.

18. In addition, ongoing discussions at the Financial Stability Board (FSB) and Basel

Committee on Banking Supervision regarding total loss absorbing capital (TLAC)

will also clearly impact Hong Kong’s regulation of cross-border financial

institutions' operations and provide further scope for consideration of gaps and

inconsistencies across regulatory standards impacting booking decisions.

19. Although this paper focuses on Hong Kong as a centre for the regional and

international operations of major financial institutions, Hong Kong also remains a

very important relationship centre where transactions are booked elsewhere.

Accordingly, Hong Kong needs to retain the flexibility where the relationships are

‘maintained’ in Hong Kong, albeit transactions are booked elsewhere, either

because clients actually contract directly with other centres but maintain front

office relationships with investment professionals in Hong Kong, or

arrangements are delegated or outsourced by the Hong Kong intermediary to

those other centres. In particular, there are different types of securities

transactions and activities that are currently typically booked to another centre,

5 In this paper we do not propose to analyze the proposals contained in the FRR Consultation.

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including for example, derivatives transactions, securities/equities transactions

(including margin transactions), futures, treasury, and private wealth

management. The same is true for asset management, where an asset

management group's expertise for a particular market, sector or type of financial

instrument (for example, US equities or fixed income) may be found outside

Hong Kong. Accordingly, and aside from regulatory factors and capital

requirements, booking in another centre may be due to other reasons, such as

client preference, established location of infrastructure and back office support,

development of relevant markets, operational structure of international financial

institutions, etc. at a time when clients and investors are increasingly looking for

customized investment solutions.

20. In this respect, it is important for Hong Kong to recognize the above while

developing itself as a preferred booking centre; it needs to maintain sufficient

flexibility from a regulatory perspective in allowing offshore booking models. In

particular consideration needs to be given to the application of Section 115 of

the Securities and Futures Ordinance (SFO) which imposes restrictions on

'actively' marketing regulated services by offshore entities in Hong Kong. This, in

turn, potentially restricts the ability of Hong Kong entities from ‘maintaining’

relationships with clients while transactions are booked to offshore entities – as

the offer of booking services by such offshore entities may be deemed to be

'actively' marketing a regulated service in Hong Kong.

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II. LIST OF RECOMMENDATIONS TO DEVELOP HONG KONG AS A PREFERRED BOOKING CENTRE

21. To develop Hong Kong as a preferred booking centre we make the following

recommendations:

(i) To align the regulatory capital regimes administered by the HKMA and

SFC in Hong Kong respectively and to achieve a level of consistency with

major international jurisdictions at the same time. Whilst the SFC has

proposed changes to its financial resource requirements in the context of

OTC derivatives licensing through its recently published FRR Consultation,

we need to keep a close eye on the conclusions of the consultation, and

especially when international capital standards are finalized, to see

whether more needs to be done6.

(ii) The SFC to provide additional guidance as to the permissibility of the

offshore booking model and clarification as to its position under Section

115 of the SFO; and, if necessary, consider amendments to Section 115.

(iii) To implement a consistent and consolidated resolution regime, applicable

to AIs and licensed corporations respectively (in particular as part of the

initiative under the ongoing Consultations on an Effective Resolution

Regime for Financial Institutions in Hong Kong), as part of bringing Hong

Kong's resolution framework into line with international standards and

agreements, of which TLAC may be an important aspect.

(iv) The HKMA and SFC to coordinate to ensure consistency of approach with

respect to the operational needs of the industry, whether HKMA or SFC

regulated, regarding booking models. This coordination will also need to

extend to the expected new Insurance Authority in due course.

(v) To review Hong Kong tax structure and deductions to incentivize, or

reduce deterrence for, financial institutions to set up booking entities in

Hong Kong.

(vi) To promote collaboration and discussion between the HKMA, SFC, HKEx,

OCI and financial institutions to develop action plans to further enhance

market infrastructure in Hong Kong for booking centre operations.

6 See the IOSCO Final Report dated February 2015: A Comparison and Analysis of Prudential

Standards in the Securities Sector.

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(vii) To enhance international cooperation with foreign regulators, to promote

a more joined up approach to supervising financial institutions with a

global footprint.

(viii) To actively promote Hong Kong's rule of law and well developed

regulatory framework.

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III. BOOKING MODEL

22. First, an important preliminary point is to recognize that the term 'booking' is a

term of art and not one that has any particular legal meaning. However, for the

purposes of this paper we use the term 'booking' to refer broadly to the entity to

which a banking related, securities or derivatives transaction (collectively,

financial products) is contracted, or the entity with which the relevant account

for a client or counterparty is opened and maintained, and/or the entity which

has the primary obligation for delivery or payment with respect to a financial

product. Financial institutions typically identify a booking entity within the group

in a particular jurisdiction to handle the booking process, where the transactions

in different financial products will be 'booked' to the balance sheet of such

booking entity.

23. From an operational perspective, clients (whether the actual underlying client or

an intermediary, including intra-group intermediaries, acting as agent on behalf

of an underlying client) will enter into direct contractual relationships with the

booking entity, such that 'accounts' will be opened and maintained with that

booking entity for trading and carrying out the booking process for the relevant

financial product. Such booking entity may act as principal (e.g. trading with the

clients as counterparty on a proprietary basis) or agent (e.g. trading as agent on

behalf of the client on market) when performing trades for the clients.

24. An international financial centre seeking to enhance its attractiveness as a

booking centre for financial transactions should focus on issues related to

various 'push' and 'pull' factors as discussed further below.

A. Hong Kong as a Booking Centre from Current Economic Perspective

25. Overall, Hong Kong is generally well-ranked in terms of international financial

transactions but, except in terms of overall external banking claims, its volumes

are far behind other major centres.

26. By way of background, indicators of Hong Kong's comparative standing are

shown in each case for the most recently available data period (between 2013

and 2014) in Appendix A. The data cover aspects of markets in external banking

claims, OTC derivatives, foreign exchange, equity issuance and exchange

turnover, and wealth management.

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B. Reasons for Enhancing Hong Kong's Attractiveness as a Booking Centre

27. While Hong Kong is playing host to a large, highly developed and sophisticated

financial services industry and is a major international financial centre with a

highly competitive economic and business infrastructure and a well-developed

regulatory framework, the level of bookings of financial products in Hong Kong

lags behind other major booking centres around the world. Hong Kong not only

competes with Singapore and Tokyo, but because most Asian trading books are

booked offshore, it also competes with London and New York.

28. As part of the development and reform to strengthen and enhance Hong Kong's

role as an international financial centre, it is important for Hong Kong to develop

as a preferred booking centre, at least for transactions, clients or counterparts

having some nexus or connection with Hong Kong. Hong Kong should allow

financial institutions to centre at least their regional operations for regulatory

and management purposes in Hong Kong, and potentially (particularly for

Mainland institutions) to centre their international operations (including from a

regulatory standpoint) in Hong Kong. There are both quantitative and qualitative

benefits derived from making Hong Kong the preferred booking centre for these

financial institutions.

29. In light of the sea change of regulation and macroeconomic developments

around the world in the wake of the 2008 global financial crisis, Hong Kong faces

new opportunities and challenges on both a regional and global scale. Hong

Kong should react and respond now if it wishes to seize the opportunity to

become a preferred booking centre for financial institutions being pushed out of

their existing booking centres. Failing to do so will mean that Hong Kong will

miss out on economic, reputational and other benefits which will instead be

enjoyed by other international booking centres. In particular, in the Financial

Services Development Council (FSDC) Research Paper "Development and Reform

of Mainland China's Financial Sector and the Strengthening and Enhancement of

Hong Kong's Pivotal Role as a Financial Centre", the comparative advantages of

Hong Kong as an international financial centre were highlighted, including (i)

favourable geographic location and time zone; (ii) unique political position; and

(iii) acting as the entrepot hub for the Mainland, as well as the centre of shipping,

tourism, exhibition and consumption. That research paper also highlighted the

choice of a development model that can bring the best out of Hong Kong's

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characteristic as an international financial centre – with the main feature being

‘Backed by the Mainland and Engaged Globally’.

30. As one prime example where Hong Kong is not maximizing its advantage, under

the Shanghai - Hong Kong Stock Connect program, financial institutions are

allowed to trade eligible shares listed on the Shanghai Stock Exchange as part of

their own trading positions and offer different types of service to clients such as

market access business. Generally, this type of business activity is booked in a

broker-dealer entity which is locally regulated and subject to regulatory capital

requirements prescribed by the respective regulator. It should be noted that

financial institutions are developing their business utilizing the Shanghai - Hong

Kong Stock Connect program through the use of swap or market access products

where these positions are being booked to the relevant financial institution's

booking centre, and not Hong Kong7. As demonstrated in the example set out in

the section "Capital Rules and Capital Costs" under the 'Pull' Factors section, a

typical market access business, if booked to a SFC licensed corporation, requires

approximately 1.2 times of trade notional amount for regulatory capital which is

less favourable than in other markets such as London or New York. With the

likelihood of similar arrangements in the future, including the Shenzhen – Hong

Kong Stock Connect, and ‘Bond Connect’, as well as the mutual recognition of

funds, there exist clear opportunities for Hong Kong in underpinning its role as

the major centre for finance, going both into and out of China.

31. The current regulatory capital regime of the SFC in Hong Kong is liquid-asset

based, which tends to demand higher capital requirement than other

comparable financial centres where the Basel type of risk-based capital regime is

adopted. For reference (albeit with certain assumptions), if a typical market

access business is contemplated in a Hong Kong SFC regulated entity,

approximately HK$1.2million regulatory capital (based on HK$1million trade

notional) will be required while it is comparably minimal in other markets, such

as London or New York. Internationally, under the auspices of IOSCO, concerns

have been raised on the lack of a uniform global standard for capital adequacy

within the securities sector – see the Final Report of IOSCO dated February 2015

on A Comparison and Analysis of Prudential Standards in the Securities Sector.

7 Other reasons to use swap or market access products to tap the China A-Share market include

operational reasons as well as PRC regulatory considerations.

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32. The point is that, currently, it is not capital-efficient for international groups to

book Stock Connect synthetic positions and conduct related business in Hong

Kong.

33. In addition, considering Hong Kong's unique comparative advantage due to its

relationship with the Mainland, it is important for Hong Kong to seek to become

the first choice destination for establishing a booking centre for Mainland

financial institutions expanding abroad, as well as for other financial institutions

looking for an attractive centre in place of their present booking centres

especially those showing interest in accessing the Mainland securities market.

34. The financial services industry is a major source of employment for Hong Kong,

accounting for 6.1% of the total labour force in 2013. The industry is

characterized by a high level of knowledge and skills, with 67% of workers with

post-secondary education, compared to 35% for the overall economy8. There

are both quantitative and qualitative benefits associated with promoting Hong

Kong as a preferred booking centre for Mainland and global financial institutions.

A drive in employment in the financial services sector will support Hong Kong as

a knowledge-based economy.

35. Apart from the legal and accounting sector, where Hong Kong currently

maintains lower levels of employment than its London and New York peers (see

Figure 1 below), there are also significant growth opportunities in back office,

operations and risk-management functions if the overall level of booking activity

is increased. Driving employment in the financial services sector plays a crucial

and strategic role in the Hong Kong economy, particularly in supporting the

economic integration between Hong Kong and Mainland, and reinforces Hong

Kong's status as an international financial centre.

36. Nonetheless, Hong Kong should not be indiscriminate in promoting itself as a

booking centre. There are clearly policy issues concerning the potential for risk

to accumulate in Hong Kong as a result of increased booking, including the

necessity to avoid a ‘too big to save’ scenario. Hong Kong must position itself so

as to make it efficient and, at the very least, encourage transactions with a Hong

Kong nexus or connection, including RMB transactions, to be booked to Hong

Kong9.

8 FSDC Paper No.13, “Developing Hong Kong's Human Capital in Financial Services”, January 2015

9 An interesting, and topical, case study is the discussion about HSBC relocating its headquarters

back to Hong Kong. HSBC's balance sheet at US$2.6 trillion is nearly eight times the size of Hong Kong's economic output.

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Figure 1: Share (%) of Total Employment for Hong Kong, London and New

York for Year 2000-2011

Source: Wojcik & Zhao (2014), calculations based on data from LEHD, Census Hong

Kong, and NomisWeb

C. 'Push' Factors

37. From an economic and operational perspective, maintaining a single booking

centre for a financial institution's global operations may be preferred as, in

theory, economies of scale can be achieved and it is easier operationally to

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maintain and support. However, differences in laws and regulations across

jurisdictions (including differences in regulators' risk-preferences) would still

create substantial road-blocks. Moreover, the extra-territorial application of

certain legislative provisions could make booking in any one jurisdiction harder.

38. Of course, Hong Kong cannot control these 'push' factors. Nonetheless,

Appendix B sets out a summary of the main regulatory 'push' factors in the US,

UK and EU in light of their latest regulatory reforms.

D. 'Pull' Factors

a. Regulatory Regime

39. Currently Hong Kong adopts separate regulatory regimes with respect to

financial institutions operating banking and securities trading business under the

Banking Ordinance and the HKMA on the one hand, and the SFO and the SFC on

the other (with insurance intermediaries being subject to a new regulatory

regime under the Insurance Companies (Amendment) Ordinance 2015), where:

(i) AIs (i.e. licensed banks, restricted licence banks and deposit-taking

companies authorized under the Banking Ordinance) are supervised by

the HKMA. This supervisory regime applies to banks operating via both

locally incorporated bank subsidiaries, and those operating via a local

branch of an overseas bank. The branch model is currently the

predominant model for global banks although there is a subsidiarisation

theme that has emerged.

(ii) Licensed corporations (e.g. licensed securities companies, brokerage

companies, asset managers, etc.) are supervised by the SFC.

(iii) AIs that also engage in securities business in Hong Kong would (a) register

with the SFC as registered institutions for the relevant regulated activities

(however the HKMA would remain the primary regulator) or (b) establish

a local subsidiary securities company to be licensed by the SFC (where the

SFC would be the primary regulator over such licensed subsidiary).

40. The majority of inbound global banks doing business in Hong Kong currently

operate via a business model whereby a SFC licensed corporation (being a

subsidiary of the bank entity) serves as the relationship entity (being the client

facing entity), but trades are ultimately booked offshore, either at the holding

company level or in a foreign banking entity (please also see discussion under

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"Hong Kong's role as a relationship centre" below). The principal rationale for

this model is that greater efficiency with respect to capital and funding, plus

benefits with respect to credit ratings and other regulatory constraints (e.g.

exposure limits) are achieved through booking into the large group booking

entity rather than a local subsidiary. However, the 'push' factors described

above are placing increasing pressure on the present global booking model

employed by many financial institutions, resulting in consideration of local

booking options whereby business originated in Asia Pacific would instead be

booked into a local entity.

41. The current regulatory regime in Hong Kong presents challenges to financial

institutions considering booking into this location, as the status quo does not

currently present a competitive proposition in comparison to either global hubs

(e.g. US or UK) or, in some key respects, regional competitors such as Singapore.

The separate regulatory regimes in Hong Kong could give rise to complications

when financial institutions seek to establish a new booking centre in Hong Kong

(including incentive for potential regulatory arbitrage in 'picking' the more

favourable regulatory regime), for example:

(i) The choice of entity structure is restricted for SFC licensed corporations in

practice. AIs under the Banking Ordinance can typically be established as

a branch or a Hong Kong subsidiary of an entity established outside Hong

Kong. However, there appear significant, albeit valid, practical obstacles

in granting licences to a non-bank entity established outside Hong Kong

but wishing to operate in Hong Kong through a branch. It is practically

very difficult to obtain a SFC licence for the Hong Kong branch of an

overseas company (albeit it continues to be relatively easier to register a

HKMA licensed bank with a Hong Kong branch10), it being the SFC's clear

preference to grant licences to separately incorporated Hong Kong

subsidiaries. In part, it is worth noting that the practical obstacles include:

(i) the set up of a branch in Hong Kong may affect the ability of the

overseas company to comply with requirements under the SFO and its

relevant rules11, in particular with respect to supervision and record

keeping; (ii) the overseas company will often have difficulties in compiling

10

This also comes at a time when the SFC is taking a more restrictive approach to Section 115 of the SFO.

11

In particular the SFC may conduct site inspection and gain access to relevant records under Section 180 of the SFO which may extend to the overseas parts of the company and the overseas company (as a whole) is also subject to notification obligations of any fitness and properness issues according to the Securities and Futures (Licensing and Registration) (Information) Rules.

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the relevant financial resources returns and audited accounts in

compliance with the Securities and Futures (Financial Resources) Rules;

and (iii) local auditor requirements.

(ii) Additional analyses are required in assessing the regulatory implications

for setting up a booking centre in Hong Kong as an AI versus a licensed

corporation. AIs are subject to the supervision of the HKMA (including

regulations, rules, codes and guidelines issued by the HKMA), while

licensed corporations are subject to the supervision of the SFC (involving

different regulations, rules, codes and guidelines issued by the SFC). In

particular AIs and licensed corporations are currently subject to a very

different capital requirement regime and the inconsistency with

international standards may increase operational/compliance costs and

resources for financial institutions setting up booking centres in Hong

Kong (see discussion further below).

(iii) Insurance companies are subject to the rules of the OCI.

42. The complexity of capital rules and level of capital costs are amongst the main

considerations for financial institutions in determining the establishment of a

new booking centre. Through its recently published FRR Consultation the SFC is

now seeking to enhance its regulatory capital regime to achieve consistency and

a level playing field with international standards, such that it maintains its

competitiveness internationally.

43. It is important to recognize that while international capital standard setters for

the securities industry have been in discussion about developing approaches to

align capital adequacy requirements, it appears doubtful that this will be

achieved in any meaningful way, at least in the short term. For example, the Net

Capital Rules (NCR) of the US Securities and Exchange Commission (SEC) for US

broker-dealers is primarily directed towards ensuring that securities firms have

sufficient balance sheet assets whereas the EU Capital Requirements Directive

(CRD) (which is founded on the Bond approach applicable to banks) is primarily

about solvency of firms. It is not clear there will be any further agreed alignment

between NCR and CRD (See IOSCO's February 2015 Final Report on A Comparison

and Analysis of Prudential Standards in the Securities Sector). Nonetheless, both

approaches contain the same objective, which is to ensure that securities firms

hold sufficient capital to protect customers and creditors from losses and delays

if they were to fail. Also, as noted above, with the consultation of the SFC's

financial resource requirements in the context of the new OTC derivatives

-18-

licensing regime in process, alignment to the HKMA's approach for banks is

already underway.

44. These all give rise to complications when financial institutions seek to establish a

new booking centre in Hong Kong – for example, inconsistency with approaches

in other major jurisdictions, particularly the US and EU (increasing

operational/compliance costs and resources), choice of entity structure (branch

vs subsidiary), and potential regulatory arbitrage in 'picking' the more favourable

capital regime.

45. In developing the ‘pull’ factors to make Hong Kong a more favorable booking

centre destination, the following are recommended, as a priority:

(i) Implement a consistent and consolidated resolution regime applicable to

AIs and licensed corporations respectively (in particular as part of the

initiative under the ongoing Consultations on an Effective Resolution

Regime for Financial Institutions in Hong Kong).

(ii) Further develop the coordination and communication between the HKMA

and the SFC. While the HKMA and SFC have dedicated resources to

coordinate their efforts in regulating the banking and securities industries

(e.g. in adopting memoranda of understanding between them and

establishing communication lines within their committees), the HKMA

and SFC could seek to devote additional resources to enhance the

coordination and communication between them. In this respect the

HKMA and SFC may seek to further develop the expertise and knowledge

of relevant case officers (both junior and senior officers) with respect to

the operational needs of the industry regarding booking models. This will

enhance the ability of the HKMA and SFC to provide clearer guidance on

the establishment of booking entities in Hong Kong covering areas such as

permissibility of booking models, processing time, and infrastructure

requirement.

(iii) In addition, if a specific remit for supervision of systemically important

financial institutions (SIFIs) were to be implemented (e.g. giving the

HKMA power to designate SIFIs and take the lead in their regulation,

similar to the approach being increasingly adopted internationally), this

could potentially address issues at least with respect to larger institutions

in terms of consistency of treatment. A more fundamental approach

would be consideration of the overall regulatory approach, as has been

done in the UK, EU and Australia, among others, with consolidation of

-19-

prudential regulation of major financial institutions under a single

prudential regulator (the Bank of England / Prudential Regulatory

Authority, European Central Bank and Australian Prudential Regulatory

Authority, respectively).

46. As a final point, encouraging the booking of transactions to Hong Kong also

provides regulators with more visibility over the activities being undertaken by

financial institutions in and from Hong Kong.

b. Capital Rules and Capital Costs

47. The majority of comparable financial centre regulatory capital regimes (including

the HKMA regime for banks) are based on the globally employed risk-based

capital regime established under the various Basel accords. While some local

variations exist within these Basel implementations, the fundamental approach

is consistent and variances in capital requirements across jurisdictions are

unlikely to be significant.

48. However, the current capital regimes in place for securities companies in Hong

Kong (supervised by the SFC) and the NCRs of US SEC for US broker-dealers

employ a liquid-asset based capital requirement which results in a much higher

level of required capital for comparable exposures.

49. The following table highlights the key components of capital regimes in place

within major financial centre jurisdictions and illustrates the outlying

characteristics of SFC and SEC standards12:

12

Consistent with Hong Kong, the US requires a SEC regulated corporation as the client facing

entity. However, globally, the impacts of the SEC requirements on booking model selection will

be limited in future as the majority of leading global banks active in the US and operating via a US

broker-dealer will also be subject to the US Intermediate Holding Company (IHC) rule described

above which will require a version of US Basel rules to be applied to the holding company

(including the broker-dealer) and as such the broker-dealer capital requirement will no longer in

itself be the binding constraint.

-20-

-21-

50. The comparative impact of this variation in regulatory capital approach on a

typical product portfolio can be illustrated in the following example:

(i) Market access business facilitates investors to gain access to the listed

equity exposure of a restricted market through a bank (B) and a broker-

dealer (B/D) who are licensed/registered to conduct the business locally.

Generally, B and B/D acquire the listed equity exposure and concurrently

sell a fully-funded derivative underlying the same listed equity to the

investor. There is neutral market risk to B and B/D while the investor

obtains the desired listed equity exposure from the derivative trade.

(ii) The table below indicates the current regulatory capital requirement of

such market access business as described above under Hong Kong,

Singapore, UK, and the USA regulatory capital regimes. The regulatory

capital requirement in the table is based on current provisions in the

respective regulatory capital rules applicable to all participants and does

not take into account modifications/exemptions allowed by respective

regulators on a case-by-case basis. In many jurisdictions, the regulatory

capital requirement may be reduced if modifications are approved. The

participants tend to seek risk-based modifications as the capital required

from capital regimes that are liquid-asset based (such as the current

capital regime applicable to B/D in Hong Kong) can be large.

Table 2: An Example of the Comparative Impact of Variation in Regulatory

Capital Approach on a Typical Product Portfolio

*For illustration, the trade notional is assumed at $1 million and the OTC equity option underlying the same quantity of listed equity that B and B/D holds is a delta one instrument,

-22-

where any change in the value of listed equity exposure will have the equivalent change in the value of derivative trade. And, there is no collateral requirement.

51. In identifying the appropriate minimum capital for licensed corporations under

its FRR Consultation the SFC's key objective has been to ensure that capital

requirements are in line with international standards to minimize the risk of

regulatory arbitrage. E.g. the SFC is proposing Basel-style risk-based capital

requirements for market risk and OTC derivatives related counterparty credit risk.

Should the aforementioned market access business be assessed according to the

SFC’s proposed changes to the FRR under consultation, the respective regulatory

capital requirement will likely be reduced.

-23-

IV. HONG KONG'S ROLE AS A RELATIONSHIP CENTRE

52. Although Hong Kong and other Asian locations have lagged behind London and

New York as international booking hubs, Hong Kong is widely recognised as a

leading international financial centre with leading global banks and other

intermediaries having established major presences in the city. Currently Hong

Kong plays a significant role as a relationship centre, supported by its

sophisticated infrastructure and strategically important geographic location.

Whilst there is a need for Hong Kong to introduce changes to address the

challenges and develop into a major booking centre, it is equally important that

Hong Kong's model as a relationship hub be maintained.

A. Maintaining Hong Kong's Relationship Centre Status

53. Apart from regulatory considerations, operational efficiency and business

considerations are also important when financial institutions decide on the

establishment of booking centre. Despite the push factors discussed above,

global financial institutions may still prefer to maintain a single booking centre

(in one jurisdiction or geographic region) for global operations rather than

setting up separate booking centres. In this respect, it is not uncommon for

global financial institutions operating various relationship centres (local or

regional) around the world while transactions are booked into a single booking

centre.

54. Although this paper focuses on Hong Kong as a booking centre, Hong Kong does

remain a very important relationship centre, where transactions in financial

products are booked elsewhere. Accordingly, Hong Kong needs to retain the

flexibility where the relationships are ‘maintained’ in Hong Kong albeit

transactions are booked elsewhere, either because clients actually contract

directly with other centres but maintain front office relationships with

investment professionals in Hong Kong or arrangements are delegated or

outsourced by the Hong Kong intermediary to those other centres.

B. Section 115 of SFO Considerations

55. In particular there are different types of transactions and activities in financial

products that are currently typically booked to other centres. In addition many

groups delegate some or substantial part of their activities to other group

entities where they maintain their centres of excellence. The same is true for

-24-

asset management, where an asset management group's expertise for a

particular market (for example the US or Europe), sector or type of financial

instrument (for example, equities or fixed income) is likely to be found elsewhere

outside Hong Kong. Accordingly, and aside from regulatory factors and capital

requirements, booking in another centre may be due to other reasons such as

client preference, established location of infrastructure and back office support,

development of relevant markets, operational structure of international financial

institutions, etc., at a time when clients and investors are increasingly looking for

customized investment solutions. In this respect, it is important for Hong Kong

to recognize this while developing itself as a preferred booking centre; it needs

to maintain sufficient flexibility from a regulatory perspective in permitting

offshore booking models to continue to operate. In particular consideration

needs to be given to the application of Section 115 of the SFO which imposes

restrictions on offshore entities 'actively' marketing regulated services in Hong

Kong.

56. Section 115 of the SFO has extra-territorial application and applies to any person

who ‘actively markets’ to the Hong Kong ‘public’ 13 any services (even if

performed outside Hong Kong) which, if provided in Hong Kong, would be a

regulated activity; in which case such person is required to be appropriately

licensed by the SFC. Section 115 is part of Hong Kong law, and the SFC is obliged

to enforce it.

57. However, Section 115 of the SFO may potentially restrict the ability of Hong Kong

entities from ‘maintaining’ relationships with clients while transactions are

booked to offshore entities – as the offer of booking services by such offshore

entities may be deemed to constitute marketing a regulated service in Hong

Kong. As noted above, Section 115 prohibits an overseas person (or a person in

Hong Kong on behalf of that overseas person) from actively marketing its

regulated services to the public in Hong Kong. The stress point comes when an

overseas group wishes to set up a presence in Hong Kong but does not wish,

perhaps initially, to set up a full service operation in Hong Kong and instead rely

on group companies elsewhere, often under a delegation model or as an

overseas booking centre. On the one hand, Section 115 prevents any active

marketing of the overseas affiliate's regulated services while on the other hand

the SFC in practice will not license a branch of that overseas affiliate. There are

many examples in both the securities and futures markets (where, for example,

13

Either by itself or through other persons on its behalf and whether that marketing takes place in Hong Kong or from a place outside Hong Kong but targeting Hong Kong.

-25-

clients want to trade the US or European markets and so need to enter

transactions through a US or European broker-dealer) and the asset

management industry (where, for example, an investor wants to invest in a

portfolio of UK equities and the experience and expertise for that strategy sits in

London). In part, Singapore addresses this issue through ‘paragraph 9

exemption’. However many financial institutions looking to establish a presence

in Hong Kong, but not a full service presence (with the investment cost

associated with that) at the outset, find Hong Kong virtually impossible. This is

one of Hong Kong's 'push' factors for new entrants to Asia looking at Hong Kong.

58. In this respect the SFC may provide additional guidance as to the permissibility of

the offshore booking model and clarification as to its position under Section 115

of the SFO. In particular the SFC should seek to update its Frequently Asked

Questions on what is ‘actively markets’ under Section 115 of the SFO. More

particularly, it may be that Section 115 needs to be amended (but not repealed,

as it does serve a useful purpose from an investor protection standpoint).

-26-

V. OTHER CONSIDERATIONS

59. Since the global financial crisis Hong Kong has actively implemented and

proposed changes to its regulatory environment to align its standards with

international benchmarks while maintaining a robust level of investor protection.

In promoting Hong Kong as the leading booking hub it is critical to consider the

interrelated regulatory regimes to ensure the enhancements complement each

other, otherwise Hong Kong's attractiveness as the prime booking centre may be

adversely affected. The relevant regimes are discussed below.

A. Resolution Regime

60. In January 2014, the Financial Services and the Treasury Bureau, the HKMA, the

SFC and the Insurance Authority jointly published the consultation paper on "An

Effective Resolution Regime for Financial Institutions in Hong Kong". The

proposals set out in the consultation paper seek to put in place for Hong Kong a

resolution regime encompassing all the key attributes required by the FSB to be

implemented in its member jurisdictions, including Hong Kong. In January 2015,

a second consultation paper "An Effective Resolution Regime for Financial

Institutions in Hong Kong" was issued, which also contains the conclusions from

the first consultation paper. This second consultation paper provides more in-

depth proposals on Hong Kong's resolution and recovery regime.

61. In this respect, while it is important to put in place an appropriate resolution

regime for financial institutions in Hong Kong, such resolution regime should

ensure a balance between the recoverability and resolvability of institutions, the

practical implications to institutions and comparability at an international level.

The consultation still requires a third stage consultation, with a view to

introducing a bill into the Legislative Council most likely in 2016. While the

January 2014 and January 2015 consultation papers set out the main framework

and proposals, and provide other proposals on, for example, what form the bail-

in powers will take, how counterparty rights (including those of early or

automatic termination) will be affected, how the interplay between existing

corporate insolvency proceedings and the resolution regime will work, what the

methodology will be for calculating compensation for creditors adversely

affected by resolution (and what rights there will be to appeal this), and how the

new law will interact with existing law in Hong Kong, we are still lacking detailed

concrete conclusions.

-27-

62. The first consultation paper introduced the concept of resolving at the level of a

locally incorporated holding company (HC) to improve resolvability. Whilst the

conclusions noted that a 'blanket' requirement for financial institutions to

establish a locally incorporated HC structure in Hong Kong should not be created,

the second consultation paper raised questions on the conditions at which

resolution should be undertaken with mixed activity groups namely locally

incorporated financial services holding company (FSHC) and locally incorporated

mixed activity holding company (MAHC). The authorities also proposed that it

should be possible to use resolution powers under the regime on affiliated

operational entities (AOEs), which are entities, regulated or not, providing critical

services to the failing financial institution.

63. It is important to keep in mind that the development of the resolution regime,

especially how the scope and the resolution authority powers are calibrated,

should not be in a way that will make Hong Kong unattractive as a booking

centre and at the same time achieve consistency with international standards for

Hong Kong to maintain its competitiveness internationally.

B. Holding Company and Tax Considerations

64. Becoming a preferred booking centre could also be achieved by attracting

financial institutions to set up their required holding company in Hong Kong. The

typical functions of a holding company include, but are not limited to, external

fund raising and provision of guarantees in respect of its subsidiaries, for which

incidental treasury and related functions will be required locally, leading to

additional job creation as a result.

65. Looking at the advantages or disadvantages for financial institutions to set up a

holding company or booking entity in Hong Kong, among other factors, tax

structure and deductions would be one of the main considerations.

66. Some considerations in the context of tax factors include:

(i) Interest expense of a Hong Kong booking entity: An entity which carries on

a business in Hong Kong and which is not considered to be a financial

institution for the purposes of the Inland Revenue Ordinance would be

subject to strict interest deduction rules. If the Hong Kong booking entity

is not a financial institution in Hong Kong (e.g. a SFC licensed corporation

which is not regulated by the HKMA), interest expenses of such Hong Kong

-28-

booking entity are generally not deductible if the interest is paid to

individuals, overseas group companies and overseas clients which are not

financial institutions, etc. This will significantly affect the tax costs of the

Hong Kong booking entity undertaking certain financial transactions in

Hong Kong, and also limit the choice of funding of the Hong Kong booking

entity if it is to avoid the additional tax burden.

(ii) Source of income of the Hong Kong booking entity: Hong Kong adopts a

territorial basis of taxation. In other words, only Hong Kong sourced profits

are subject to tax. This is a favourable factor for setting up a booking

centre in Hong Kong, as non-Hong Kong sourced profits would be exempt

from tax in Hong Kong. Nevertheless, the source of income, especially the

source of interest income of a non-financial institution (e.g. a SFC licensed

Hong Kong booking entity), is always a contentious issue. Removing the

uncertainties on source of income can help increase the attractiveness of

Hong Kong as a booking centre.

(iii) HK Double Tax Agreement (DTA) network: A DTA is a bilateral treaty

between two jurisdictions which provides relief against double taxation of

income. Furthermore, a DTA may provide a reduced rate of withholding

tax on certain types of income (e.g. interest and capital gain) derived by a

booking entity from its global clients. While the Hong Kong DTA network

has expanded in recent years, the number of jurisdictions with which Hong

Kong has concluded a DTA remains less than those of the other major

financial centres (e.g. UK, US, Singapore and Japan). Therefore, the

attractiveness of Hong Kong as a booking location can be enhanced if Hong

Kong can further expand its DTA network.

(iv) Incentives for the establishment of Hong Kong booking entities: There is

scope for tax reform in Hong Kong to introduce incentive programs to

encourage the establishment of booking entities in Hong Kong, such as

introducing an offshore banking unit regime which provides a concessional

tax rate to encourage genuine offshore banking activity with overseas

clients in Hong Kong.

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C. OTC Derivatives

67. Under the new Type 11 dealing in and advising on OTC derivatives licensing

regime in Hong Kong, there is no intra-group exemption, nor for that matter no

dealing as principal exemption (other than for price taker).

68. As a result, a purely internal risk management entity would be caught by the

Type 11 licensing regime by simply having intra-group derivative transactions (e.g.

to manage risk), notwithstanding that such entity may not face any external

client at all. Whilst there are various exemptions available under the regime,

these do not lend themselves easily to the fact pattern. Consequently, internal

risk management entities will likely have to apply for a Type 11 licence, and will

be subject to the relevant regulatory capital requirements. The cost of this is so

high that there is a very real risk that internal risk management entities will be

closed and the booking model and risk management model completely changed.

69. In contrast, in similar circumstances in Singapore, the proposed regulatory

regime includes a specific own account and intra-group exemption. A similar risk

management entity would not need to become licensed, and would therefore

not be subject to the regulatory capital requirements.

D. Market Infrastructure

70. Market infrastructure involving information system and operating procedures for

effecting securities transactions (in particular relating to cross-border

transactions) is also an important factor in setting up a booking centre. Effective

and efficient market infrastructure could allow buyers, sellers and intermediaries

effecting transactions (in particular on a cross-border basis) in a reliable and

economical manner. To enhance market infrastructure in Hong Kong for booking

centre operations this may involve the need to promote collaboration between

the HKMA, SFC, HKEx and financial institutions to develop action plans.

-30-

Appendix A. Current Economic Perspective: Hong Kong as a Booking Centre

A1. Indicators of Hong Kong's comparative standing are mixed. Hong Kong is well-

ranked as an internal lending hub, but with modest market shares of lending and

deposits (Table A); in common with other offshore centres, Hong Kong is less well-

ranked in terms of assets and liabilities from non-bank counterparties (Tables B and

D); and of substantive offshore centres, foreign currency assets and liabilities is a

high proportion of the total (Table C). Hong Kong is creditably-ranked as a centre

for offshore loans and deposits (Table E).

A. Share of total

banking assets and

liabilities reported to

BIS: External positions

of banks in all

currencies vis-à-vis all

sectors, end-September

2014

Source: BIS Locational

Banking Data (Table 2A)

Assets Liabilities

1. United Kingdom 16.9% 2. United States 11.2% 3. Japan 11.0% 4. France 8.4% 5. Germany 8.3% 6. Cayman Islands 4.9% 7. Netherlands 4.3% 8. Hong Kong 4.2% 9. Switzerland 3.3% 10. Singapore 2.6% 11. Luxembourg 2.5% 12. Belgium 2.4% 13. Italy 1.8% 14. Spain 1.6% 15. Canada 1.6% 16. All others 15.2%

1. United States 16.7% 2. United Kingdom 16.5% 3. France 8.7% 4. Germany 7.2% 5. Cayman Islands 5.5% 6. Japan 5.1% 7. Netherlands 4.1% 8. Hong Kong 3.5% 9. Switzerland 3.2% 10. Singapore 2.9% 11. Australia 2.7% 12. Italy 2.1% 13. Belgium 2.1% 14. Luxembourg 1.8% 15. Finland 1.7% 16. All others 16.1%

B. Proportion of

external positions of

banks in all currencies

vis-à-vis the non-bank

sector to all sectors,

selected domiciles, end-

September 2014

Source: BIS Locational

Banking Data (Table 2B)

Assets Liabilities

1. Japan 68.8% 2. Greece 65.7% 3. Bermuda 62.1% 4. Curacao 61.1% 5. Cyprus 56.2% 6. Bahrain 55.1% 7. Austria 54.5% 8. Korea 52.3% 9. Macau 49.5% 10. Spain 49.2% 11. Taiwan 48.9% 12. United Kingdom 47.2% 13. Canada 43.5% 14. Median 41.3% 15. Portugal 41.3% 20. Singapore 39.1% 21. Netherlands 38.8% 22. Germany 38.4% 23. France 38.3% 25. Guernsey 35.6% 26. United States 35.5% 29. Switzerland 33.4% 30. Luxembourg 30.7% 31. Hong Kong 29.6% 37. Cayman Islands 25.8%

1. India 82.2% 2. Isle of Man 67.2% 3. Bermuda 67.1% 4. Switzerland 59.7% 5. Cyprus 58.0% 6. Jersey 54.1% 7. Bahamas 52.2% 8. Curacao 52.2% 9. Panama 51.7% 10. Belgium 47.1% 11. Macau 47.0% 12. Bahrain 44.5% 13. Cayman Islands 42.1% 14. Hong Kong 38.5% 15. United Kingdom 38.3% 20. Median 31.6% 21. Singapore 31.2% 22. United States 31.0% 25. Luxembourg 30.3% 27. Spain 24.1% 28. Greece 23.9% 29. Malaysia 23.0% 32. France 21.2% 37. Germany 17.5% 40. Korea 12.2%

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C. Proportion of

external positions of

banks in foreign

currencies to all

currencies vis-à-vis all

sectors , end-

September 2014

Source: BIS Locational

Banking Data, (Table

2C)

Assets Liabilities

1. Bahrain 100.0% 2. Curacao 100.0% 3. Panama 100.0% 4. Singapore 100.0% 5. Cayman Islands 100.0% 6. Bahamas 99.9% 7. Bermuda 99.8% 8. Indonesia 99.6% 9. Korea 99.4% 10. Macau 99.1% 11. Taiwan 97.1% 12. India 96.5% 13. Brazil 95.6% 14. Hong Kong 93.8% 15. United Kingdom 90.7%

1. Bahrain 100.0% 2. Curacao 100.0% 3. Panama 100.0% 4. Singapore 100.0% 5. Cayman Islands 100.0% 6. Bahamas 100.0% 7. Brazil 98.6% 8. Bermuda 97.6% 9. Macau 97.0% 10. Korea 94.9% 11. Taiwan 92.4% 12. Turkey 88.1% 13. Hong Kong 87.4% 14. Chile 86.3% 15. United Kingdom 84.6%

D. Proportion of

external positions of

banks in foreign

currencies vis-à-vis the

non-bank sector,

selected domiciles, end-

September 2014

Source: BIS Locational

Banking Data (Table 2D)

Assets Liabilities

1. Bermuda 61.9% 2. Curacao 61.1% 3. Bahrain 55.1% 4. Japan 53.5% 5. Korea 51.7% 6. Macau 48.9% 7. Taiwan 47.5% 8. United Kingdom 42.1% 9. Panama 39.4% 10. Singapore 39.1% 11. India 37.2% 12. Mexico 35.9% 13. Canada 35.1% 14. Guernsey 30.6% 15. Cyprus 29.7% 16. Hong Kong 26.1% 17. All countries 25.8% 18. Cayman Islands 25.8% 40. United States 4.0%

1. Bermuda 64.7% 2. Curacao 52.2% 3. Bahamas 52.1% 4. Panama 51.7% 5. Switzerland 51.1% 6. Macao 46.0% 7. Bahrain 44.5% 8. Cayman Islands 42.1% 9. India 33.4% 10. United Kingdom 32.9% 11. Canada 32.4% 12. Cyprus 32.1% 13. Singapore 31.2% 14. Hong Kong 31.2% 15. Japan 29.7% 16. Jersey 29.1% 21. All countries 18.8% 25. Luxembourg 12.7% 45. United States 0.9%

E. Share of total

external loans and

deposits of banks in all

currencies vis-à-vis all

sectors end-September

2014

Source: BIS Locational

Banking Data (Table 7A)

Loans Deposits

1. United Kingdom 20.1% 2. United States 15.9% 3. Germany 8.0% 4. France 7.5% 5. Cayman Islands 6.3% 6. Japan 5.6% 7. Hong Kong 4.3% 8. Netherlands 3.6% 9. Singapore 3.2% 10. Luxembourg 2.7% 11. Switzerland 2.4% 12. Canada 2.0%

1. United Kingdom 19.8% 2. United States 19.6% 3. France 6.8% 4. Cayman Islands 6.3% 5. Japan 6.1% 6. Germany 5.0% 7. Hong Kong 3.9% 8. Singapore 3.5% 9. Netherlands 3.3% 10. Switzerland 2.9% 11. Luxembourg 2.1% 12. Spain 1.9%

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F. Share of total

external loans and

deposits of banks in

all currencies vis-à-vis

the non-bank sector

end-September 2014

Source: BIS Locational

Banking Data (Table

7B)

Loans Deposits

1. United Kingdom 22.8% 2. United States 15.9% 3. Japan 7.8% 4. Germany 7.5% 5. France 6.9% 6. Netherlands 4.7% 7. Cayman Islands 4.1% 8. Singapore 4.1% 9. Hong Kong 3.2% 10. Switzerland 2.9%

1. United Kingdom 21.6% 2. United States 16.6% 3. Cayman Islands 7.5% 4. France 6.4% 5. Japan 5.8% 6. Switzerland 4.8% 7. Netherlands 4.7% 8. Germany 4.3% 9. Hong Kong 4.3% 10. Singapore 3.1%

G. Share of total

international

positions by

nationality of

ownership of

reporting banks,

selected domiciles,

end-September 2014

Source: BIS Locational

Banking Data (Table

8A)

Assets Liabilities

1. Japan 13.3% 2. United States 12.0% 3. United Kingdom 11.2% 4. France 10.6% 5. Germany 10.4% 6. Switzerland 7.7% 7. Netherland s 5.3% 8. All Asia & Pacific 3.2% 9. Sweden 3.2% 10. Canada 3.1% 31. Singapore 1.1% 32. Hong Kong 0.2% 33. Luxembourg 0.2% 46. Cayman Islands 0.0%

1. United States 14.2% 2. United Kingdom 11.6% 3. France 10.6% 4. Germany 9.6% 5. Switzerland 8.2% 6. Japan 7.8% 7. Netherlands 5.1% 8. Sweden 4.0% 9. All Asia & Pacific 3.2% 10. Canada 3.0% 17. Singapore 1.1% 32. Hong Kong 0.2% 35. Luxembourg 0.1% 43. Cayman Islands 0.0%

A2. In volumes of trading in OTC derivatives, exchange-traded derivatives and foreign

exchange measured by aggregate transaction amounts, Hong Kong is well-ranked

within the leading ten centres but far behind the three leading centres in

transaction volumes, these being highly concentrated trading locations (Section H).

Hong Kong booked single currency interest rate swaps are transacted

overwhelming with professional counterparties, but mostly executed overseas.

Turnover is modest as a proportion of the total other than in HK dollar instruments,

and in those denominated in Asian currencies that are in some measures restricted

markets (Section I). No activity is observed in 25 denominations of the 41 reported

to the BIS.

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H. OTC single

currency interest rate

derivatives turnover

by country, April

2013, ‘net-gross’

basis, Daily averages,

in millions of US

dollars

Instruments comprise

swaps, forward rate

agreements & options

Source: BIS Triennial

Central Bank Survey,

December 2013

Total Share with reporting

dealers abroad

Share with other banks

1. United Kingdom 1,347,749 2. United States 628,153 3. France 202,210 4. Germany 101,347 5. Japan 67,136 6. Australia 66,184 7. Denmark 59,354 8. Singapore 37,143 9. Canada 33,975 10. Switzerland 32,618 11. Netherlands 28,693 12. Hong Kong 27,897

25.4% 25.0% 46.5% 18.2% 38.4% 54.4% 30.3% 62.7% 27.1% 79.1% 24.8% 66.0%

54.4%

44.5%

41.4%

79.9%

47.3%

19.8%

60.7%

27.4%

55.3%

17.6%

70.0%

26.8%

I. OTC single currency

interest rate

derivatives turnover

by country and

currency in April

2013, ‘net-gross’ basis

Daily averages,

US$ millions, 25

denominations not

shown, Hong Kong

having nil turnover

Source: BIS Triennial

Central Bank Survey,

December 2013

(Tables T 03 01-06)

Denomination HK turnover Total turnover HK share

AUD

CHF

CNY

EUR

GBP

HKD

IDR

INR

JPY

KRW

MYR

NZD

SGD

THB

TWD

USD

Total

7,342

9

2,038

923

78

1,773

1

1,999

2,401

4,116

843

556

568

1,508

138

3,482

27,897

102,405

17,025

15,503

1,336,075

206,643

2,752

126

7,875

84,335

16,448

2,592

7,377

4,650

3,704

912

776,268

2,758,583

7.2%

0.1%

13.1%

0.1%

0.0%

64.4%

0.4%

25.4%

2.8%

25.0%

32.5%

7.5%

12.2%

40.7%

15.2%

0.4%

1.0%

-34-

A3. Hong Kong foreign exchange activity is well-ranked but significantly less in volume

than the four leading centres where trading is concentrated (Section J).

J. Spot, outright

forwards, FX swaps,

currency swaps, FX

options

Daily averages, in

millions of US dollars

Source: BIS Triennial

Central Bank Survey,

Global foreign

exchange market

turnover in 2013,

(Table T 01 01),

February 2014

Total Share FX swaps Share

United Kingdom

United States

Singapore

Japan

Hong Kong

Switzerland

France

Australia

Netherlands

Other countries

Total

2,725,993

1,262,799

383,075

374,215

274,605

216,394

189,878

181,709

112,268

950,511

6,671,446

40.9%

18.9%

5.7%

5.6%

4.1%

3.2%

2.8%

2.7%

1.7%

14.2%

100.0%

1,126,586

340,991

172,787

169,558

174,130

131,535

134,921

115,243

43,254

521,938

2,930,943

38.4%

11.6%

5.9%

5.8%

5.9%

4.5%

4.6%

3.9%

1.5%

17.8%

100.0%

A4. Rankings of equity issuance and trading turnover are volatile, although recent data

show that Hong Kong is consistently well-ranked.

K. Stock market capitalisation

(US$ bn., end-2014)

Source: World Federation of

Exchanges

1. NYSE 19,351 2. NASDAQ OMX 6,979 3. Japan Exchange - Tokyo 4,378 4. London SE Group 4,013 5. Shanghai SE 3,933 6. Euronext 3,319 7. Hong Kong Exchanges 3,233 8. TMX Group 2,094 9. Shenzhen SE 2,072 10. Deutsche Börse 1,739

-35-

L. Value of share trading (turnover)

2014 (US$ bn)

Source: World Federation of

Exchanges

1. NASDAQ OMX 31,044 2. NYSE 18,234 3. BATS Global Markets - US 13,163 4. Shanghai SE 11,053 5. Shenzhen SE 5,912 6. BATS Chi-x Europe 6,877 7. Japan Exchange - Tokyo 4,756 8. London SE Group 3,493 9. NYSE 3,452 10. Euronext 2,938 11. Hong Kong Exchanges 1,630

M. No. of completed IPOs (2013)

Source: World Federation of

Exchanges

1. NYSE 140 2. Nasdaq US 116 3. Hong Kong Exchanges 109 4. TMX 90 5. Korea Exchange 85 6. ASX 61 7. TSE 46 8. LSE 36

N. No of listed companies (end-

2014).

Source: World Federation of

Exchanges; London Stock Exchange

1. BSE India 5,542 2. TMX Group 3,761 3. Japan Exchange - Tokyo 3,470 4. BME Spanish Exchanges 3,452 5. NASDAQ OMX 2,782 6. London SE Group 2,752 7. NYSE 2,466 8. Australian SE 2,073 9. Korea Exchange 1,864 10. Hong Kong Exchanges 1,752 11. NSE India 1,708 12. Shenzhen SE 1,618 13. Euronext 1,055 14. Shanghai SE 995 15. Bursa Malaysia 905

O. Exchange-traded funds, value

In only seven jurisdictions are more

than 180 ETF’s listed, Hong Kong

ranking twelfth with 122. London

SE, NYSE and Deutsche Börse each

list over 1,000 funds.

1. NASDAQ OMX 7,262 2. NYSE 4,383 3. London SE Group 340 4. Japan Exchange - Tokyo 276 5. Deutsche Börse 172 6. Shanghai SE 163 7. Hong Kong Exchanges 151 8. Korea Exchange 140 9. Euronext 122 10. SIX Swiss Exchange 91

P. Wealth management, shown by

estimates of assets under

administration or management

(US$ trillions, end-2014)

Deloitte Wealth Management

Centre Ranking 2015

1. Switzerland 2.04 2. UK 1.65 3. US 1.43 4. Panama & Caribbean 0.93 5. Hong Kong 0.64 6. Singapore 0.47 7. Luxembourg 0.29 8. Bahrain & UAE 0.06 9. Other 1.67

-36-

Appendix B. Summary of Main Regulatory 'Push' Factors in US, UK and EU in

Light of Latest Regulatory Reforms

Legislation/Regulation Features Push Factor

US - Dodd-Frank Wall Street

Reform and Consumer

Protection Act ("Dodd

Frank") - Volcker Rule

provisions and Swaps Push

Out provisions

UK – UK Financial Services

(Banking Reform) Act 2013

(Vickers)

EU – Liikanen proposals

Essentially, the new requirements will impose

restrictions on the permissible activities which can be

undertaken and booked into a banking entity, with the

principal overarching objectives of protecting deposit

taking entities from riskier, investment banking

activity.

The US Volcker Rule provisions under Dodd Frank

prohibit proprietary trading by a US banking entity.

The US Swaps Push Out provisions under Dodd Frank

prohibit booking of certain swaps transactions into

banking entities, requiring a separately capitalized

subsidiary.

The UK Financial Services (Banking Reform) Act

requires ringfencing of UK retail banking activities in

separate legal entities.

The EU Liikanen proposals would require separately

capitalized entities for investment banking activities

within a bank structure.

The requirements impact current

global booking models by limiting

products which can be booked

into parent banking entities. This

will affect the cost benefit

analysis for banks when they

consider developing /

restructuring new or existing

business activities.

-37-

Legislation/Regulation Features Push Factor

US - Dodd Frank Resolution

and Recovery Planning

Rules

UK - Banking Act 2009

EU - Bank Recovery and

Resolution Directive

Regulations requiring the development of recovery

and resolution plans or ‘living wills’ setting out how a

large and complex global bank would be resolved in an

orderly way in a crisis.

Two main aspects of resolution

regimes impact bank structural

and booking considerations:

1. Global regulators have

expressed concern around the

'resolvability' of global banks due

to the continuing complexity of

their legal entity structures. A

likely course of action will be

simplification of legal entity

structures to align more closely

to global lines of business. This

may have some impacts on

regional business models for

global banks and the creation of

Asian 'hub' entities.

2. Ongoing global concern

about the practicality of the

'single point of entry' resolution

mechanism whereby the global

'home' regulator would take the

lead in any global bank

resolution. This approach raises

inherent concerns for regional

jurisdictions such as Hong Kong

which have substantial inbound

foreign bank activity which is not

conducted through a local legal

entity. A public consultation in

Hong Kong is currently underway

in respect of a proposal to

establish an effective resolution

regime for financial institutions.

However, financial institutions

may consider segmenting their

businesses in different

jurisdictions in consideration of

the preferences of local clients

(e.g. clients in Asia may prefer

their assets to be subject to a

local resolution regime).

-38-

Dodd Frank - Foreign-Bank

Rule

New prudential standards for foreign banks with total

consolidated assets in the US of over US$50 billion –

this requires consolidation of non-branch US

operations under a holding company subject to

comparable regulation and a US bank including

regulation of capital, liquidity, leverage, risk

management, resolution plan, concentration limits,

credit exposure, etc.

Trapping of capital and liquidity

within the US holding company,

and ongoing compliance costs for

US operations may encourage

foreign banks to shift some US

operations to other jurisdictions

and further cause some

institutions to review their global

funding models.

-39-

Legislation/Regulation Features Push Factor

US – Dodd Frank – Over-

the-counter (‘OTC’)

regulations – Commodity

Futures Trading

Commission

EU – European Market

Infrastructure Regulation

(EMIR) / Markets in

Financial Instruments

Directive II (MiFID II) /

Markets in Financial

Instruments Regulations

(MIFIR) / Capital

requirements regulation

(CRR) and directive (CRD IV)

/ Market Abuse Directive

(MAD II) / Market Abuse

Regulation (MAR)

In essence the new requirements will affect the

operations of OTC derivative business/transactions in

the US/EU (to varying degrees) covering areas such as

capital requirements, risk management record

keeping, reporting requirements, operations, etc.

From the perspective of the

financial institutions, the

existence of an OTC derivative

regulatory framework does not

necessarily discourage the

development of new or existing

business activities. Similar to the

discussion relating to special

resolution regime above, the OTC

derivative regulatory framework

is also a global initiative. Hong

Kong is also establishing an OTC

derivative regulatory framework

covering areas such as licensing,

clearing, reporting, etc.

However, financial institutions

may consider segmenting their

OTC businesses in different

jurisdictions in consideration of

the preferences of local clients

(e.g. clients in Asia may prefer

their assets to be subject to a

local OTC reporting regime).

UK – Financial Conduct

Authority report on

outsourcing asset

management business

Identified resilience risk and oversight risk with respect

to the outsourcing activities of asset managers and

proposed adoption of more detailed contingency plans

and oversight arrangements.

The increase in compliance

efforts and costs may discourage

the handling of booking and

client relationships within the UK.

EU - Proposed Financial

Transaction Tax

Tax on financial transactions, including derivatives and

financial instruments.

This may discourage transactions

to be undertaken inside the EU.

UK (with similar regimes in

France and Germany as

well as similar or proposed

regimes in other EU

countries) – Bank levy

Tax on the global consolidated balance sheets of UK

banks / banking groups, as well as on the balance

sheets of foreign banks / banking groups with a UK

presence.

This may act as a disincentive for

banks to try to grow their balance

sheets in the UK / other EU

countries with similar regimes.

This is particularly applicable in

the UK where the rate applied to

global balance sheets held in the

UK has increased multiple times

since the introduction of the

Bank levy in 2011.

-40-

Legislation/Regulation Features Push Factor

EU – Alternative

Investment Fund Managers

Directive (AIFMD) –

restrictions on bonuses

EU – CRD IV – Bonus cap

Additional requirements imposed on remuneration

policy of alternative investment fund managers

including for example: (i) bonus to be paid out on

deferred basis, (ii) retention period requiring the

individual to hold shares/units used as part of bonus

payment, and (iii) deferred bonus granted to be

subject to performance conditions.

Bankers' bonuses are to be capped at 100% of fixed

compensation, which can be increased to 200% with a

66% shareholder vote.

Restrictions on payment of

bonuses and increased

shareholder involvement in

remuneration may cause banks

concern that they are unable to

put in place a competitive

remuneration policy to attract

and retain the best staff. This

may encourage banks to move

part of their operations outside

the EU (including relocation of

senior management).

HK-2000-OFF-15

About the Financial Services Development

Council, Hong Kong

Established in January 2013, the Financial Services

Development Council (FSDC), Hong Kong is a high-level and

cross-sector platform to engage the industry and formulate

proposals to promote the further development of Hong Kong’s

financial services industry and map out the strategic direction

for development. The FSDC will advise the Hong Kong SAR

Government on areas related to diversifying the financial

services industry, enhancing Hong Kong’s position and functions

as an international financial centre of our country and in the

region, and further consolidate our competitiveness through

leveraging the Mainland to become more global.

Contact us

Room 931 & 932, 9/F, West Wing, Central Government Office,

11 Ice House Street, Central, Hong Kong

(852) 2493 1313

www.fsdc.org.hk