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1
This module should be read in conjunction with the Introduction and with theGlossary which contains an explanation of abbreviations and other termsused in this Manual If reading on-line click on blue underlined headings toactivate hyperlinks to the relevant module
mdashmdashmdashmdashmdashmdashmdashmdashmdash
PurposeTo provide guidelines to AIs on the management of collateral andguarantees for credit risk mitigation
Classification
A statutory guideline issued by the MA under the Banking Ordinancesect7(3)
Previous guidelines superseded
Guideline 55 ldquoSection 80 of the Banking Ordinance Advance againstSecurity of Own Shares etcrdquo dated 101090
Application
To all AIs
Structure
1 Introduction
2 Policies and procedures
3 Acceptance criteria
31 Collateral
32 Guarantees
33 Concentration limits
4 Validity of collateral and guarantees
41 Enforceability
42 Title and ownership
5 Loan-to-value ratio
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6 Valuation
61 Basis of valuation
62 Valuersrsquo competence
63 Frequency of revaluation
64 Independence of valuation
65 Stress-testing
7 Safe custody and access controls
8 Top-up of collateral
9 Insurance
10 Disposals
11 Management information
mdashmdashmdashmdashmdashmdashmdashmdashmdash
1 Introduction
11 AIsrsquo primary consideration when approving credits should alwaysbe the borrowerrsquos financial strength and debt-servicing capacityIt is important that they do not rely solely on collateral or guarantees as the primary source of repayment or as asubstitute for evaluating the borrowerrsquos creditworthiness
12 Nevertheless collateral1
and guarantees if properly taken andmanaged do serve a number of important functions in credit riskmanagement These include
bull to mitigate credit risk by providing AIs with a secondarysource of repayment in the event that the borrower defaults on a credit facility
bull to gain control of the collateral which is the primarysource of repayment of a facility in default For examplea loan to a property developer secured on the propertybeing developed would be repaid by the sale proceeds of that developed property
1 ldquoCollateralrdquo has the same meaning as but is used in preference to ldquosecurityrdquo to avoidconfusion with stocks shares etc
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bull to provide early warning of a borrowers deterioratingrepayment ability (particularly for credit facilities such asmargin financing where top-up of collateral may berequired from time to time) and
bull to enable locally incorporated AIs to apply a lower capitalrisk weight to credits which are secured by collateral or guarantees as specified in the Third Schedule to theBanking Ordinance2
13 AIs that rely on collateral to provide secondary protection in theevent of a borrowerrsquos default in repayment however face twomajor risks
bull they may be unable to establish a title to the collateral for disposal and
bull the cash proceeds eventually realised by the disposal of the collateral may be less than its estimated value
14 It is therefore essential for AIs to set up appropriate systems andcontrols for the management of collateral and guarantees
15 For the purpose of this module guarantees refer to thoseaccepted by an AI to support the granting of credit facilities andreduce the underlying credit risk It does not cover thoseguarantees accepted simply as additional comfort for thefacilities granted
2 Policies and procedures
21 AIs should have in place written policies approved by their Board of Directors the Credit Committee or senior management
2
Such collateral or guarantees mainly include
bull cash deposits
bull residential mortgages within the meaning of the Third Schedule to the BankingOrdinance
bull securities or guarantees issued by the Exchange Fund the central government thecentral bank or public sector entities of a Tier 1 country or multilateral developmentbanks and
bull guarantees from AIs or banks incorporated in a Tier 1 countryPlease see the Third Schedule to the Banking Ordinance for details
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with delegated authority for the management of collateral andguarantees They should cover inter alia
bull criteria for the acceptance of collateral and guarantees
bull validity of collateral and guarantees
bull loan-to-value ratios
bull valuation
bull safe custody and access controls
bull top-up of collateral
bull insurance
bull disposals and
bull management information on collateral held
22 AIs should have detailed procedures for enforcing the abovepolicies
23 Internal Audit should carry out periodic checks to ensure that theabove policies and procedures are adhered to
3 Acceptance criteria
31 Collateral
311 AIs should ensure that assets accepted as collateralsatisfy the following criteria
bull the market value of the asset is readilydeterminable or can be reasonably establishedand verified
bull the asset is marketable and there exists a readilyavailable secondary market for disposing of theasset
bull the AIrsquos right to repossess the asset is legallyenforceable and without impediment
bull the AI is able to secure control over the asset if necessary In the case of a movable asset the AIshould either have physical custody of the asset(eg gold precious metal or taxi medallion) or have the means of locating its whereabouts (eg
vehicle machinery or equipment) and
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bull the AI has the expertise and systems to managethe asset concerned
312 Collateral which does not satisfy the above criteria maystill be accepted as additional comfort but the facilitiesconcerned should be regarded as unsecured
313 AIs should align the term of validity of the collateral withthat of the obligation it secures For example if aproperty development loan is collateralised on the
property being constructed the collateral right over theproperty should not be released before the loan is fullyrepaid
314 Collateral whose value has a material positive correlationwith the credit quality of the borrower (eg securitiesissued by the borrower or any related group entity) islikely to provide little credit protection to AIs They shouldnot therefore rely too much on such collateral for reducingcredit risk
315 For internal control purposes AIs should draw up the
types of asset acceptable as collateral and the maximumloan-to-value ratio for each of these assets (see section 5below) They should take into account the criteria set outabove and the following statutory restrictions under sect80of the Banking Ordinance
bull sect80(1) prohibits AIs from granting any creditfacilities against the security of their own shares
3
and
bull under sect80(2) prior written approval should beobtained from the MA if an AI wishes to grant any
credit facilities against the security of the shares of its holding company or a subsidiary of itself or itsholding company
32 Guarantees
3
A loan by an AI secured by an instrument creating a charge or other security over that AIrsquosown shares is illegal void and consequently unenforceable This could happennotwithstanding that the charge or security was over a portfolio of shares and the AIrsquosshares constituted only a portion of the shares In such circumstances it is unlikely that theillegal portion of the contract could be severed from the remainder The whole securitywould be void
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321 For the purpose of credit risk mitigation AIs shouldensure that guarantees accepted fulfil the followingcriteria
bull the guarantee should represent a direct claim onthe guarantor
bull the guarantee should be unconditional andirrevocable4
bull the guarantee should be properly documented andlegally enforceable
bull the guarantee should remain continuously effectiveuntil the facility covered by the guarantee is fullyrepaid or settled and
bull the financial strength of the guarantor should bethoroughly assessed and considered as adequatefor discharging the obligation under the guarantee
322 The creditworthiness of a guarantor should ideally not belinked to or affected by the financial position of the
borrower
323 Where an AI has accepted a guarantee the financialstrength of the guarantor should be reviewed whereappropriate (eg during the annual credit review) toensure that the guarantee remains valid for credit riskmitigation
324 Guarantees should not be regarded as collateral and thefacilities covered by them should be regarded asunsecured unless the guarantees are issued by thecentral government or the central bank of a country
without repayment difficulties an AI or an overseasincorporated bank which is under adequate supervision
33 Concentration limits
331 Taking the same type of asset as collateral or acceptingcollateral or guarantees from the same issuer or provider
4
In the case of a continuing guarantee (ie one securing both a specific sum and any further advances that may be made to the borrower in future) a guarantor may by giving notice tothe AI revoke his guarantee in respect of any new advances to be made to that borrowerNormally AIs will allow the guarantor to revoke his guarantee after a period of notice Suchrevocation will therefore only discharge the guarantorrsquos obligation in respect of newadvances made after the expiry of that period but not those outstanding prior to that
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creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
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422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
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6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
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estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
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the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
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73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
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bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
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Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
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Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
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CR-G-7 Collateral and Guarantees V1 ndash 290601
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6 Valuation
61 Basis of valuation
62 Valuersrsquo competence
63 Frequency of revaluation
64 Independence of valuation
65 Stress-testing
7 Safe custody and access controls
8 Top-up of collateral
9 Insurance
10 Disposals
11 Management information
mdashmdashmdashmdashmdashmdashmdashmdashmdash
1 Introduction
11 AIsrsquo primary consideration when approving credits should alwaysbe the borrowerrsquos financial strength and debt-servicing capacityIt is important that they do not rely solely on collateral or guarantees as the primary source of repayment or as asubstitute for evaluating the borrowerrsquos creditworthiness
12 Nevertheless collateral1
and guarantees if properly taken andmanaged do serve a number of important functions in credit riskmanagement These include
bull to mitigate credit risk by providing AIs with a secondarysource of repayment in the event that the borrower defaults on a credit facility
bull to gain control of the collateral which is the primarysource of repayment of a facility in default For examplea loan to a property developer secured on the propertybeing developed would be repaid by the sale proceeds of that developed property
1 ldquoCollateralrdquo has the same meaning as but is used in preference to ldquosecurityrdquo to avoidconfusion with stocks shares etc
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bull to provide early warning of a borrowers deterioratingrepayment ability (particularly for credit facilities such asmargin financing where top-up of collateral may berequired from time to time) and
bull to enable locally incorporated AIs to apply a lower capitalrisk weight to credits which are secured by collateral or guarantees as specified in the Third Schedule to theBanking Ordinance2
13 AIs that rely on collateral to provide secondary protection in theevent of a borrowerrsquos default in repayment however face twomajor risks
bull they may be unable to establish a title to the collateral for disposal and
bull the cash proceeds eventually realised by the disposal of the collateral may be less than its estimated value
14 It is therefore essential for AIs to set up appropriate systems andcontrols for the management of collateral and guarantees
15 For the purpose of this module guarantees refer to thoseaccepted by an AI to support the granting of credit facilities andreduce the underlying credit risk It does not cover thoseguarantees accepted simply as additional comfort for thefacilities granted
2 Policies and procedures
21 AIs should have in place written policies approved by their Board of Directors the Credit Committee or senior management
2
Such collateral or guarantees mainly include
bull cash deposits
bull residential mortgages within the meaning of the Third Schedule to the BankingOrdinance
bull securities or guarantees issued by the Exchange Fund the central government thecentral bank or public sector entities of a Tier 1 country or multilateral developmentbanks and
bull guarantees from AIs or banks incorporated in a Tier 1 countryPlease see the Third Schedule to the Banking Ordinance for details
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with delegated authority for the management of collateral andguarantees They should cover inter alia
bull criteria for the acceptance of collateral and guarantees
bull validity of collateral and guarantees
bull loan-to-value ratios
bull valuation
bull safe custody and access controls
bull top-up of collateral
bull insurance
bull disposals and
bull management information on collateral held
22 AIs should have detailed procedures for enforcing the abovepolicies
23 Internal Audit should carry out periodic checks to ensure that theabove policies and procedures are adhered to
3 Acceptance criteria
31 Collateral
311 AIs should ensure that assets accepted as collateralsatisfy the following criteria
bull the market value of the asset is readilydeterminable or can be reasonably establishedand verified
bull the asset is marketable and there exists a readilyavailable secondary market for disposing of theasset
bull the AIrsquos right to repossess the asset is legallyenforceable and without impediment
bull the AI is able to secure control over the asset if necessary In the case of a movable asset the AIshould either have physical custody of the asset(eg gold precious metal or taxi medallion) or have the means of locating its whereabouts (eg
vehicle machinery or equipment) and
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bull the AI has the expertise and systems to managethe asset concerned
312 Collateral which does not satisfy the above criteria maystill be accepted as additional comfort but the facilitiesconcerned should be regarded as unsecured
313 AIs should align the term of validity of the collateral withthat of the obligation it secures For example if aproperty development loan is collateralised on the
property being constructed the collateral right over theproperty should not be released before the loan is fullyrepaid
314 Collateral whose value has a material positive correlationwith the credit quality of the borrower (eg securitiesissued by the borrower or any related group entity) islikely to provide little credit protection to AIs They shouldnot therefore rely too much on such collateral for reducingcredit risk
315 For internal control purposes AIs should draw up the
types of asset acceptable as collateral and the maximumloan-to-value ratio for each of these assets (see section 5below) They should take into account the criteria set outabove and the following statutory restrictions under sect80of the Banking Ordinance
bull sect80(1) prohibits AIs from granting any creditfacilities against the security of their own shares
3
and
bull under sect80(2) prior written approval should beobtained from the MA if an AI wishes to grant any
credit facilities against the security of the shares of its holding company or a subsidiary of itself or itsholding company
32 Guarantees
3
A loan by an AI secured by an instrument creating a charge or other security over that AIrsquosown shares is illegal void and consequently unenforceable This could happennotwithstanding that the charge or security was over a portfolio of shares and the AIrsquosshares constituted only a portion of the shares In such circumstances it is unlikely that theillegal portion of the contract could be severed from the remainder The whole securitywould be void
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321 For the purpose of credit risk mitigation AIs shouldensure that guarantees accepted fulfil the followingcriteria
bull the guarantee should represent a direct claim onthe guarantor
bull the guarantee should be unconditional andirrevocable4
bull the guarantee should be properly documented andlegally enforceable
bull the guarantee should remain continuously effectiveuntil the facility covered by the guarantee is fullyrepaid or settled and
bull the financial strength of the guarantor should bethoroughly assessed and considered as adequatefor discharging the obligation under the guarantee
322 The creditworthiness of a guarantor should ideally not belinked to or affected by the financial position of the
borrower
323 Where an AI has accepted a guarantee the financialstrength of the guarantor should be reviewed whereappropriate (eg during the annual credit review) toensure that the guarantee remains valid for credit riskmitigation
324 Guarantees should not be regarded as collateral and thefacilities covered by them should be regarded asunsecured unless the guarantees are issued by thecentral government or the central bank of a country
without repayment difficulties an AI or an overseasincorporated bank which is under adequate supervision
33 Concentration limits
331 Taking the same type of asset as collateral or acceptingcollateral or guarantees from the same issuer or provider
4
In the case of a continuing guarantee (ie one securing both a specific sum and any further advances that may be made to the borrower in future) a guarantor may by giving notice tothe AI revoke his guarantee in respect of any new advances to be made to that borrowerNormally AIs will allow the guarantor to revoke his guarantee after a period of notice Suchrevocation will therefore only discharge the guarantorrsquos obligation in respect of newadvances made after the expiry of that period but not those outstanding prior to that
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creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
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422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
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6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
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10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
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the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
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73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
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bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
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Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
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Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
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bull to provide early warning of a borrowers deterioratingrepayment ability (particularly for credit facilities such asmargin financing where top-up of collateral may berequired from time to time) and
bull to enable locally incorporated AIs to apply a lower capitalrisk weight to credits which are secured by collateral or guarantees as specified in the Third Schedule to theBanking Ordinance2
13 AIs that rely on collateral to provide secondary protection in theevent of a borrowerrsquos default in repayment however face twomajor risks
bull they may be unable to establish a title to the collateral for disposal and
bull the cash proceeds eventually realised by the disposal of the collateral may be less than its estimated value
14 It is therefore essential for AIs to set up appropriate systems andcontrols for the management of collateral and guarantees
15 For the purpose of this module guarantees refer to thoseaccepted by an AI to support the granting of credit facilities andreduce the underlying credit risk It does not cover thoseguarantees accepted simply as additional comfort for thefacilities granted
2 Policies and procedures
21 AIs should have in place written policies approved by their Board of Directors the Credit Committee or senior management
2
Such collateral or guarantees mainly include
bull cash deposits
bull residential mortgages within the meaning of the Third Schedule to the BankingOrdinance
bull securities or guarantees issued by the Exchange Fund the central government thecentral bank or public sector entities of a Tier 1 country or multilateral developmentbanks and
bull guarantees from AIs or banks incorporated in a Tier 1 countryPlease see the Third Schedule to the Banking Ordinance for details
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with delegated authority for the management of collateral andguarantees They should cover inter alia
bull criteria for the acceptance of collateral and guarantees
bull validity of collateral and guarantees
bull loan-to-value ratios
bull valuation
bull safe custody and access controls
bull top-up of collateral
bull insurance
bull disposals and
bull management information on collateral held
22 AIs should have detailed procedures for enforcing the abovepolicies
23 Internal Audit should carry out periodic checks to ensure that theabove policies and procedures are adhered to
3 Acceptance criteria
31 Collateral
311 AIs should ensure that assets accepted as collateralsatisfy the following criteria
bull the market value of the asset is readilydeterminable or can be reasonably establishedand verified
bull the asset is marketable and there exists a readilyavailable secondary market for disposing of theasset
bull the AIrsquos right to repossess the asset is legallyenforceable and without impediment
bull the AI is able to secure control over the asset if necessary In the case of a movable asset the AIshould either have physical custody of the asset(eg gold precious metal or taxi medallion) or have the means of locating its whereabouts (eg
vehicle machinery or equipment) and
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bull the AI has the expertise and systems to managethe asset concerned
312 Collateral which does not satisfy the above criteria maystill be accepted as additional comfort but the facilitiesconcerned should be regarded as unsecured
313 AIs should align the term of validity of the collateral withthat of the obligation it secures For example if aproperty development loan is collateralised on the
property being constructed the collateral right over theproperty should not be released before the loan is fullyrepaid
314 Collateral whose value has a material positive correlationwith the credit quality of the borrower (eg securitiesissued by the borrower or any related group entity) islikely to provide little credit protection to AIs They shouldnot therefore rely too much on such collateral for reducingcredit risk
315 For internal control purposes AIs should draw up the
types of asset acceptable as collateral and the maximumloan-to-value ratio for each of these assets (see section 5below) They should take into account the criteria set outabove and the following statutory restrictions under sect80of the Banking Ordinance
bull sect80(1) prohibits AIs from granting any creditfacilities against the security of their own shares
3
and
bull under sect80(2) prior written approval should beobtained from the MA if an AI wishes to grant any
credit facilities against the security of the shares of its holding company or a subsidiary of itself or itsholding company
32 Guarantees
3
A loan by an AI secured by an instrument creating a charge or other security over that AIrsquosown shares is illegal void and consequently unenforceable This could happennotwithstanding that the charge or security was over a portfolio of shares and the AIrsquosshares constituted only a portion of the shares In such circumstances it is unlikely that theillegal portion of the contract could be severed from the remainder The whole securitywould be void
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321 For the purpose of credit risk mitigation AIs shouldensure that guarantees accepted fulfil the followingcriteria
bull the guarantee should represent a direct claim onthe guarantor
bull the guarantee should be unconditional andirrevocable4
bull the guarantee should be properly documented andlegally enforceable
bull the guarantee should remain continuously effectiveuntil the facility covered by the guarantee is fullyrepaid or settled and
bull the financial strength of the guarantor should bethoroughly assessed and considered as adequatefor discharging the obligation under the guarantee
322 The creditworthiness of a guarantor should ideally not belinked to or affected by the financial position of the
borrower
323 Where an AI has accepted a guarantee the financialstrength of the guarantor should be reviewed whereappropriate (eg during the annual credit review) toensure that the guarantee remains valid for credit riskmitigation
324 Guarantees should not be regarded as collateral and thefacilities covered by them should be regarded asunsecured unless the guarantees are issued by thecentral government or the central bank of a country
without repayment difficulties an AI or an overseasincorporated bank which is under adequate supervision
33 Concentration limits
331 Taking the same type of asset as collateral or acceptingcollateral or guarantees from the same issuer or provider
4
In the case of a continuing guarantee (ie one securing both a specific sum and any further advances that may be made to the borrower in future) a guarantor may by giving notice tothe AI revoke his guarantee in respect of any new advances to be made to that borrowerNormally AIs will allow the guarantor to revoke his guarantee after a period of notice Suchrevocation will therefore only discharge the guarantorrsquos obligation in respect of newadvances made after the expiry of that period but not those outstanding prior to that
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creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
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422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
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6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
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estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
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the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
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73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
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13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
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14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
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Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
4
with delegated authority for the management of collateral andguarantees They should cover inter alia
bull criteria for the acceptance of collateral and guarantees
bull validity of collateral and guarantees
bull loan-to-value ratios
bull valuation
bull safe custody and access controls
bull top-up of collateral
bull insurance
bull disposals and
bull management information on collateral held
22 AIs should have detailed procedures for enforcing the abovepolicies
23 Internal Audit should carry out periodic checks to ensure that theabove policies and procedures are adhered to
3 Acceptance criteria
31 Collateral
311 AIs should ensure that assets accepted as collateralsatisfy the following criteria
bull the market value of the asset is readilydeterminable or can be reasonably establishedand verified
bull the asset is marketable and there exists a readilyavailable secondary market for disposing of theasset
bull the AIrsquos right to repossess the asset is legallyenforceable and without impediment
bull the AI is able to secure control over the asset if necessary In the case of a movable asset the AIshould either have physical custody of the asset(eg gold precious metal or taxi medallion) or have the means of locating its whereabouts (eg
vehicle machinery or equipment) and
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CR-G-7 Collateral and Guarantees V1 ndash 290601
5
bull the AI has the expertise and systems to managethe asset concerned
312 Collateral which does not satisfy the above criteria maystill be accepted as additional comfort but the facilitiesconcerned should be regarded as unsecured
313 AIs should align the term of validity of the collateral withthat of the obligation it secures For example if aproperty development loan is collateralised on the
property being constructed the collateral right over theproperty should not be released before the loan is fullyrepaid
314 Collateral whose value has a material positive correlationwith the credit quality of the borrower (eg securitiesissued by the borrower or any related group entity) islikely to provide little credit protection to AIs They shouldnot therefore rely too much on such collateral for reducingcredit risk
315 For internal control purposes AIs should draw up the
types of asset acceptable as collateral and the maximumloan-to-value ratio for each of these assets (see section 5below) They should take into account the criteria set outabove and the following statutory restrictions under sect80of the Banking Ordinance
bull sect80(1) prohibits AIs from granting any creditfacilities against the security of their own shares
3
and
bull under sect80(2) prior written approval should beobtained from the MA if an AI wishes to grant any
credit facilities against the security of the shares of its holding company or a subsidiary of itself or itsholding company
32 Guarantees
3
A loan by an AI secured by an instrument creating a charge or other security over that AIrsquosown shares is illegal void and consequently unenforceable This could happennotwithstanding that the charge or security was over a portfolio of shares and the AIrsquosshares constituted only a portion of the shares In such circumstances it is unlikely that theillegal portion of the contract could be severed from the remainder The whole securitywould be void
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
6
321 For the purpose of credit risk mitigation AIs shouldensure that guarantees accepted fulfil the followingcriteria
bull the guarantee should represent a direct claim onthe guarantor
bull the guarantee should be unconditional andirrevocable4
bull the guarantee should be properly documented andlegally enforceable
bull the guarantee should remain continuously effectiveuntil the facility covered by the guarantee is fullyrepaid or settled and
bull the financial strength of the guarantor should bethoroughly assessed and considered as adequatefor discharging the obligation under the guarantee
322 The creditworthiness of a guarantor should ideally not belinked to or affected by the financial position of the
borrower
323 Where an AI has accepted a guarantee the financialstrength of the guarantor should be reviewed whereappropriate (eg during the annual credit review) toensure that the guarantee remains valid for credit riskmitigation
324 Guarantees should not be regarded as collateral and thefacilities covered by them should be regarded asunsecured unless the guarantees are issued by thecentral government or the central bank of a country
without repayment difficulties an AI or an overseasincorporated bank which is under adequate supervision
33 Concentration limits
331 Taking the same type of asset as collateral or acceptingcollateral or guarantees from the same issuer or provider
4
In the case of a continuing guarantee (ie one securing both a specific sum and any further advances that may be made to the borrower in future) a guarantor may by giving notice tothe AI revoke his guarantee in respect of any new advances to be made to that borrowerNormally AIs will allow the guarantor to revoke his guarantee after a period of notice Suchrevocation will therefore only discharge the guarantorrsquos obligation in respect of newadvances made after the expiry of that period but not those outstanding prior to that
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
7
creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
8
422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
9
6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
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CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
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13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
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14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
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15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
5
bull the AI has the expertise and systems to managethe asset concerned
312 Collateral which does not satisfy the above criteria maystill be accepted as additional comfort but the facilitiesconcerned should be regarded as unsecured
313 AIs should align the term of validity of the collateral withthat of the obligation it secures For example if aproperty development loan is collateralised on the
property being constructed the collateral right over theproperty should not be released before the loan is fullyrepaid
314 Collateral whose value has a material positive correlationwith the credit quality of the borrower (eg securitiesissued by the borrower or any related group entity) islikely to provide little credit protection to AIs They shouldnot therefore rely too much on such collateral for reducingcredit risk
315 For internal control purposes AIs should draw up the
types of asset acceptable as collateral and the maximumloan-to-value ratio for each of these assets (see section 5below) They should take into account the criteria set outabove and the following statutory restrictions under sect80of the Banking Ordinance
bull sect80(1) prohibits AIs from granting any creditfacilities against the security of their own shares
3
and
bull under sect80(2) prior written approval should beobtained from the MA if an AI wishes to grant any
credit facilities against the security of the shares of its holding company or a subsidiary of itself or itsholding company
32 Guarantees
3
A loan by an AI secured by an instrument creating a charge or other security over that AIrsquosown shares is illegal void and consequently unenforceable This could happennotwithstanding that the charge or security was over a portfolio of shares and the AIrsquosshares constituted only a portion of the shares In such circumstances it is unlikely that theillegal portion of the contract could be severed from the remainder The whole securitywould be void
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
6
321 For the purpose of credit risk mitigation AIs shouldensure that guarantees accepted fulfil the followingcriteria
bull the guarantee should represent a direct claim onthe guarantor
bull the guarantee should be unconditional andirrevocable4
bull the guarantee should be properly documented andlegally enforceable
bull the guarantee should remain continuously effectiveuntil the facility covered by the guarantee is fullyrepaid or settled and
bull the financial strength of the guarantor should bethoroughly assessed and considered as adequatefor discharging the obligation under the guarantee
322 The creditworthiness of a guarantor should ideally not belinked to or affected by the financial position of the
borrower
323 Where an AI has accepted a guarantee the financialstrength of the guarantor should be reviewed whereappropriate (eg during the annual credit review) toensure that the guarantee remains valid for credit riskmitigation
324 Guarantees should not be regarded as collateral and thefacilities covered by them should be regarded asunsecured unless the guarantees are issued by thecentral government or the central bank of a country
without repayment difficulties an AI or an overseasincorporated bank which is under adequate supervision
33 Concentration limits
331 Taking the same type of asset as collateral or acceptingcollateral or guarantees from the same issuer or provider
4
In the case of a continuing guarantee (ie one securing both a specific sum and any further advances that may be made to the borrower in future) a guarantor may by giving notice tothe AI revoke his guarantee in respect of any new advances to be made to that borrowerNormally AIs will allow the guarantor to revoke his guarantee after a period of notice Suchrevocation will therefore only discharge the guarantorrsquos obligation in respect of newadvances made after the expiry of that period but not those outstanding prior to that
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 715
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
7
creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
8
422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 915
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
9
6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1015
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1115
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
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CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
6
321 For the purpose of credit risk mitigation AIs shouldensure that guarantees accepted fulfil the followingcriteria
bull the guarantee should represent a direct claim onthe guarantor
bull the guarantee should be unconditional andirrevocable4
bull the guarantee should be properly documented andlegally enforceable
bull the guarantee should remain continuously effectiveuntil the facility covered by the guarantee is fullyrepaid or settled and
bull the financial strength of the guarantor should bethoroughly assessed and considered as adequatefor discharging the obligation under the guarantee
322 The creditworthiness of a guarantor should ideally not belinked to or affected by the financial position of the
borrower
323 Where an AI has accepted a guarantee the financialstrength of the guarantor should be reviewed whereappropriate (eg during the annual credit review) toensure that the guarantee remains valid for credit riskmitigation
324 Guarantees should not be regarded as collateral and thefacilities covered by them should be regarded asunsecured unless the guarantees are issued by thecentral government or the central bank of a country
without repayment difficulties an AI or an overseasincorporated bank which is under adequate supervision
33 Concentration limits
331 Taking the same type of asset as collateral or acceptingcollateral or guarantees from the same issuer or provider
4
In the case of a continuing guarantee (ie one securing both a specific sum and any further advances that may be made to the borrower in future) a guarantor may by giving notice tothe AI revoke his guarantee in respect of any new advances to be made to that borrowerNormally AIs will allow the guarantor to revoke his guarantee after a period of notice Suchrevocation will therefore only discharge the guarantorrsquos obligation in respect of newadvances made after the expiry of that period but not those outstanding prior to that
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
7
creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
8
422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
9
6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 715
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
7
creates a concentration risk AIs should consider formulating a policy with respect to the amount of concentration risk they are prepared to run
332 For example the limits on concentration risk could be inthe form of a cap on the amount of
bull lending secured by the same type of collateral
bull financial collateral taken from a particular issuer or market and
bull credit protection obtained from a particular guarantor
4 Validity of collateral and guarantees
41 Enforceability
411 AIs should ensure that credit documentation includingguarantees and pledge agreements is legallyenforceable in all relevant jurisdictions Whereappropriate AIs should obtain positive legal opinions tothis effect
412 The credit documentation should empower the AI to applythe collateral freely to discharge the borrowersobligations in so far as they are not discharged by theborrower in accordance with the loan agreement (egdue to breach of repayment terms liquidation or bankruptcy of the borrower)
413 Where the cost of liquidating collateral is to be borne bythe borrower this should be clearly stated in the relevantloan agreement to give the borrower notice and to avoidsuch a clause being unenforceable against a persondealing as a customer by virtue of the UnconscionableContracts Ordinance
414 AIs should comply with section 20 of the ldquoCode of Banking Practicerdquo in respect of guarantees and third partysecurity provided by individuals
42 Title and ownership
421 AIs should verify the existence and ownership of theassets being pledged before acceptance
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 815
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
8
422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 915
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
9
6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1015
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1115
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1215
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1315
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 815
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
8
422 AIs should ensure that there is no prior claim or claim of equal ranking by another party on the collateral
423 AIs should secure their control of the collateral prior to thedrawdown of credit facilities For example they shouldobtain customersrsquo authorization to transfer the legal titleto the pledged shares to them or receive their lawyersrsquoconfirmation of having taken possession of the originaltitle deeds for mortgaged properties
424 Where there is a need for the collateral to be held by athird party the AI should obtain that partyrsquos writtenconfirmation that it has no claim over the collateral
425 Charges on collateral should be registered promptly withthe relevant authorities (eg the Companies Registry)where appropriate
5 Loan-to-value ratio
51 AIs should specify the maximum loan-to-value ratio for major types of asset to be accepted as collateral Such ratios should
be commensurate with the relative risk of the assets and be ableto provide an adequate buffer against potential losses inrealising the collateral arising from the following
bull potential fluctuations in the market value of the collateral(or the exchange value for foreign currency assets)
bull the carrying costs of maintaining the repossessedcollateral before it is disposed of and
bull the costs incurred for disposing of the collateral (egauction fees of properties)
52 The HKMA has from time to time issued guidance on themaximum loan-to-value ratios that should be observed by AIs inrespect of some common types of secured financing (egresidential mortgages share margin financing taxi loans etc) AIs are expected to adhere closely to such guidance and will berequired to justify any departure from the maximum loan-to-value ratios prescribed
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 915
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
9
6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1015
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1115
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1215
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 915
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
9
6 Valuation
61 Basis of valuation
611 Valuation should be based on the current market value of the collateral and should not be biased in order to enablethe AI to grant a higher credit limit to the borrower or improve its internal credit rating make a smaller amountof provision or continue interest accrual for a problemcredit
612 AIs should ensure that the valuation method usedwhether internal or external is based on assumptions thatare both reasonable and prudent and all assumptionsshould be clearly documented
613 Collateral should be valued wherever possible at netrealisable value being the current market value less anypotential realisation costs (eg carrying costs of therepossessed collateral legal fees or other chargesassociated with disposing of the collateral)
614 Market value should be the price at which an asset mightbe sold at the valuation date assuming
bull a willing buyer and seller
bull the transaction is at arms length
bull a reasonable period has been allowed for the saleand
bull the asset is freely exposed to the market
615 To cater for collateral whose market value is highly
volatile AIs should apply a conservative haircut whenvaluing it for the purpose of determining the extent towhich an exposure is secured The quantum of thathaircut will depend on the price volatility of the collateralthe term of the exposure and whether the collateral isdenominated in a different currency to the underlying debt
616 A more conservative approach should be adopted for valuing the collateral of problem credits This is becausein practice the forced-sale value rather than the openmarket value is likely to be closer to what eventually may
be realised from an asset sale when the marketconditions are unfavourable Therefore a discount to the
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1015
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1115
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1215
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1315
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1015
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
10
estimated market value should be applied whereappropriate
617 In assessing the value of an asset temporary aberrationsshould be disregarded (eg a sudden rebound in themarket price)
62 Valuers competence
621 AIs should establish criteria for determining when to use
external valuers For assets without a readily availablemarket value (such as unlisted investments or a largecommercial complex) and assets which an AI does nothave the expertise to assess (such as fine arts andantiques) external valuation is called for
622 AIs should maintain a list of approved external valuersand surveyors They should be professionally qualifiedreputable experienced and competent Their performance should be regularly monitored and evaluated
623 AIs which have their own internal valuation unit shouldensure that the responsible staff possess sufficientknowledge and expertise to perform their duties
624 Procedures should be established to ensure that internalvaluations are not out of line with prevailing market valuesFor example internal valuations can be cross-checkedfrom time to time with professional valuations on asampling basis
625 Accuracy and effectiveness of methodology for conducting internal valuations should also be back-tested
by comparing the valuation with actual sale proceedsreceived on subsequent disposal of the assets
626 In cases where there is any doubt about the valuationmade by internal or external valuers the HKMA reservesthe right for the purpose of assessing the adequacy of provisions to request an AI to obtain an independentsecond valuation from another valuer
63 Frequency of revaluation
631 Collateral should be revalued on a regular basis though
the frequency may vary with the type of collateralinvolved and the nature and the internal credit rating of
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1115
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1215
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1315
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
11
the underlying credit For example AIs should mark tomarket their portfolio of shares pledged by marginfinancing customers at least on a daily basis At timeswhen the stock market is highly volatile this should beperformed intra-day at short notice (and margin paymentshould be demanded if appropriate) For large or problem exposures which are secured by propertiesthere should preferably be quarterly revaluations Thefrequency may need to be increased further to monthly if
the property market is declining rapidly
64 Independence of valuation
641 The back office5 is normally assigned with theresponsibility to perform periodic valuations of collateralStaff conducting internal valuations carrying out site visitsto collateralised properties or deciding on the use of external valuers should be independent of the marketingor credit initiation function
65 Stress-testing
651 AIs should monitor general trends in markets (egproperty price and stock indices) for the major types of collateral taken
652 AIs are recommended to conduct stress-tests andscenario analysis on their portfolio of collateral in order toassess the impact under unusual market conditions (ega significant decline in property or stock prices)
7 Safe custody and access controls
71 Authority and responsibility should be clearly delegated torelevant individuals and departments for approving theacceptance monitoring or safe custody of collateral
6and
guarantees
72 Collateral and guarantees received by AIs should be kept in afire-proof safe or vault
5
Please see Diagram 1 of CR-G-1 ldquoGeneral Principles of Credit Risk Managementrdquo for anillustration of functions typically performed by the back office
6 In this context the term ldquocollateralrdquo refers to both physical collateral (eg marketable shares)and any forms of document representing the legal title to the collateral (eg title deeds)
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1215
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
12
73 The location of collateral and guarantees placed in the custodyof AIs should be properly recorded and controlled to facilitateeasy retrieval in future
74 There should be dual control over the access to collateral andguarantees in particular where the collateral is in bearer formor can easily be sold in the market
75 Movements of collateral and guarantees should be dulyauthorized acknowledged by the persons taking possession of
them and properly recorded76 Collateral and guarantees withdrawn for processing should be
promptly returned to the officer in charge of their safe custodyThe officer should chase up collateral and guarantees withdrawnfor an unusually long period
77 Prior to the release of collateral or guarantees the officer incharge of their safe custody should ensure that
bull all conditions for release stipulated in the relevant loanagreements have been fully complied with and
bull the release has been properly authorized78 Once the conditions for release are satisfied collateral and
guarantees should be returned to the borrower promptly exceptin cases where it is stipulated in the relevant documentation thatthe guarantee remains the property of the AI after the principalindebtedness has been repaid
79 Confirmation of receipt should be obtained from the borrower upon the release of collateral and guarantees
710 In relation to the handling of collateral AIs should ensurecompliance with relevant laws and regulations eg AIs whichare exempt dealers should observe sect81A of the SecuritiesOrdinance for securities accepted as collateral
8 Top-up of collateral
81 Where it is anticipated that a borrower may need to provideadditional collateral the conditions warranting this action shouldbe clearly documented in the relevant agreement with theborrower
82 Cases where additional collateral may be required include
bull the value of the original collateral has fallen significantlydue to fluctuations in market price (eg of commodities)
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1315
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
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Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
13
bull a decline in the value of collateral has caused themaximum loan-to-value ratio for that type of collateral tobe exceeded (eg share margin financing)
bull the original collateral has become obsolete due to theintroduction of new substitutes or more superior models(eg hi-tech equipment) and
bull deterioration in the debt-servicing ability of the borrower
83 Procedures for requesting additional collateral should be clearlydocumented
9 Insurance
91 AIs should wherever possible take out insurance for collateralnaming the AI as the beneficiary
92 The cost of insurance unless borne by the borrower should befactored into the pricing of the credit
93 The insurer should be under adequate supervision7 financiallysound and independent of the borrower concerned If theinsurer is a related company of the AI it should also beoperationally independent of the AI (ie with a separatemanagement team) In addition the AI should consider takingappropriate measures (eg reinsurance) to ensure that thegroup as a whole is not exposed to undue risks
10 Disposals
101 All properties share capital and debt securities acquired by alocally incorporated AI in the course of the satisfaction of debts
due to it should be disposed of at the earliest suitableopportunity and not later than 18 months after its acquisition or within such further period as may be approved by the MAOtherwise the AI will be required to include the assets acquiredand held for more than 18 months or such further periodapproved by the MA in the computation of its exposure relatingto the following statutory limits
Type of collateral Statutory limit
Share capital and sect81(1) ndash Financial exposure to a person should not
7 This condition is satisfied in relation to insurance companies in Hong Kong by virtue of their supervision by the Insurance Authority
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1415
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
14
Type of collateral Statutory limit
debt securities of an issuer
exceed 25 of an AIrsquos capital base
Share capital sect87(1) ndash Aggregate value of an AIrsquos shareholding inother companies should not exceed 25 of the AIrsquoscapital base
Properties sect88(1) ndash Aggregate value of an AIrsquos interest in landshould not exceed 25 of the AIrsquos capital base
102 Disposal of collateral should be at armrsquos length and through atransparent process (such as a public auction or independentestate agents for foreclosed properties) to avoid complaints bythe original owner
103 AIs should ensure that the disposal of collateral is in compliancewith relevant laws and regulations For example AIs which areexempt dealers should observe sect81A of the SecuritiesOrdinance when disposing of securities pledged as collateral bytheir customers Where appropriate legal advice should besought
11 Management information
111 Management information on collateral should be producedperiodically to facilitate management of credit risk Informationrequired will depend on the nature and value of collateral takenby an AI AIs may wish to include where appropriate thefollowing information
Managementinformation
Proposedfrequency Purpose
Breakdown of credit exposureby type of collateral
Monthly For the identification of concentration risks in the poolof collateral accepted andstress-testing
Borrowingsexceedingmaximum loan-to-value ratio
Marginfinancingdaily
Othersmonthly
To highlight facilities requiringtop-up of collateral
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction
7292019 Collateral and Guarantees
httpslidepdfcomreaderfullcollateral-and-guarantees 1515
Supervisory Policy Manual
CR-G-7 Collateral and Guarantees V1 ndash 290601
15
Managementinformation
Proposedfrequency Purpose
Total currentmarket value of assets foreclosedin the course of satisfaction of debts
Monthly To facilitate formulation or modification of strategies for disposal of assets foreclosed(eg residential properties ndashwait for market to improve or sell immediately)
Comparison of latest assessedmarket valuewith actualproceeds of collateral sold
Monthly To facilitate evaluation of theaccuracy and validity of methodology for conductingcollateral valuations
Current marketvalue of collateralrelated to eachclassified credit
Quarterly For determining the amount of provision required for classifiedcredits
mdashmdashmdashmdashmdashmdashmdashmdashmdash
Contents Glossary Home Introduction