COVID-19 Coronavirus - Liquidity Issues in Hong Kong

In the midst of the current market volatility in Hong Kong, tumbling oil prices and recent U.S. stock market turbulence, one may say that the markets are in “stressed” conditions. As the impacts of the COVID-19 pandemic on the global economy are surfacing, liquidity risks are increasingly prevalent. Hong Kong’s prudential regulator has adopted measures to ensure that banks are properly prepared for such risks. At the same time, fund managers are also reminded of their obligations to manage the liquidity of funds given the present volatility of the local and international markets.

Banking Sector

Generally, to ensure that banks are adequately prepared for market turmoil and capable to manage risks, including liquidity risk,¹ banks in Hong Kong are expected to integrate stress-testing into their risk governance and management processes and conduct stress tests on a regular basis.² Such tests are designed to provide a forward-looking assessment of a bank’s vulnerability (e.g., with regards to its profitability, liquidity and capital adequacy) in “stressed” scenarios such as during liquidity crisis.³

In this regard, the Hong Kong Monetary Authority (“HKMA”) plays a supervisory role in assessing the stress-testing practices of banks and whether they are appropriate and effective.⁴ If the HKMA’s assessment reveals material shortcomings in the bank’s stress-testing programme, it is expected for the bank to provide a detailed plan of corrective actions and follow-up on its implementation.⁵ In addition to monitoring internal stress-testing practices, the HKMA also conducts its own stress tests on banks’ liquidity positions.⁶

So far, we have not seen any banks in Hong Kong nor the HKMA announcing any liquidity issues. However, in light of the present turbulences and in preparation of worsening conditions, it is open for the HKMA to request banks to conduct additional stress tests based on scenarios determined by the HKMA.⁷

Asset Management Industry

For the asset management industry, the Securities and Futures Commission (“SFC”) recently issued a circular to management companies, trustees and custodians of SFC-authorized funds,⁸ informing them that the SFC has stepped up the monitoring of SFC-authorized funds in light of the current market conditions and that management companies are expected to fully cooperate with the SFC on the heightened reporting requirements. Management companies are reminded to:⁹

• closely monitor the dealing and trading of the funds under their management;
• keep investors informed at all times and immediately report to the SFC any untoward circumstances relating to the funds under their management, including the use of liquidity risk management tools such as increase or apply swing pricing factor (i.e. anti-dilution levy) beyond the extent disclosed in the offering documents and any deferment or suspension of redemption;
• ensure that all assets of the funds are fairly and accurately valued in good faith and in the best interests of investors and in accordance with the offering documents as well as applicable laws and regulations;
• consider the need for any fair value adjustment (particularly in respect of less liquid or suspended securities such as high yield bonds or fixed income instruments and suspended stocks) and constantly review fair value adjustment policies and procedures to ensure their continued appropriateness and effective implementation in light of the rapidly changing market conditions;
• exercise due care, skill and diligence in managing liquidity of funds and ensure that in meeting redemption obligations, managers are not causing any material adverse impacts on the fund and its remaining investors; and
• use appropriate liquidity risk management tools to properly allocate the costs of redemption to the redeeming investors and ensuring fair treatment to investors who remain in the funds.

In response to the volatility and uncertainty in local and international financial markets caused by the outbreak of COVID-19, the SFC have also reached out to management companies to notify them of enhanced reporting requirements in respect of their daily and weekly large redemption reporting obligations relating to SFC-authorized funds.

Finally, trustees and custodians of SFC-authorized funds are reminded that they have a duty to safeguard fund assets and provide independent oversight of the management of the funds, which includes the valuation of the funds and use of liquidity risk management tools.

Footnotes

1. HKMA Supervisory Policy Manual, “IC-5 Stress-testing.” paragraph 1.
2. HKMA Supervisory Policy Manual “IC-5 Stress-testing.” paragraph 4.1.2
3. HKMA Supervisory Policy Manual, “IC-5 Stress-testing.” paragraphs 1.1.1, 1.2.2, 3.3.3
4. HKMA Supervisory Policy Manual, “IC-5 Stress-testing.” paragraph 4.2.1
5. HKMA Supervisory Policy Manual, “IC-5 Stress-testing.” paragraph 4.2.5.
6. HKMA Supervisory Policy Manual, “LM-1 Regulatory Framework for Supervision of Liquidity Risk.” paragraphs 2.2 and 2.3.
7. HKMA Supervisory Policy Manual, “IC-5 Stress-testing.” paragraph 4.3.1. 
8. SFC Circular, “Circular to management companies and trustees and custodians of SFC-authorized funds.” 27 March 2020.
9. See above.