FRSGlobal : Risk Analysis and Regulatory Reporting

Regulators in Hong Kong

The Hong Kong financial sector is supervised by three bodies:

• The Hong Kong Monetary Authority (HKMA)
• The Securities and Futures Commission (SFC)
• Hong Kong Deposit Protection Board (DPS)

FRSGlobal in Hong Kong

Hong Kong has a free market economy highly dependent on international trade and finance – this meant that the economy was shaken by the financial crisis and the plunge in global trade that unfolded from 2008 through early 2009. As a result exports, consumption and fixed investment contracted sharply and Hong Kong's open economy was left exposed to the global economic slowdown.

With its increasing integration with China, Hong Kong was able to recover from the downturn more quickly than many observers anticipated.

Despite the fact that the Hong Kong regulatory environments are the most mature and stable in their regions, banks still have a number of onerous regulatory reporting requirements to meet. The most difficult include:

• Large exposure returns which require firms to:
  • Aggregate both direct and indirect exposure by bank, non-bank and connected party group on a daily basis
  • Accumulate the daily group exposure data
  • Find out which groups have the highest top 10 exposures during the quarter

This process is highly complex and time consuming. Banks usually spend a lot of time in compiling this report.

• Liquidity reporting requires capturing information on institutions’ liquidity ratio and funding sources.
  • Compute liquidity ratio every Wednesday and month end. Liquidity ratio refers to the ratio of total liquefiable assets over total qualifying liabilities
  • Identify all liquefiable assets which generally refers to assets mature or readily realisable within one month
  • Identify all qualifying liabilities which generally refers to liabilities mature and likely to crystallise within one month
  • Special processing requires to offset the eligible loan under liquefiable assets vs. pledged deposits under qualifying liabilities and net amount be reported accordingly
  • HKMA has its own maturity band definition which is not the same as normal business convention. E.g. one month from reporting date of 28 Feb 2010 is 28 Mar 2010.

• Maturity profile reporting requires collecting information on the maturity profile of assets and liabilities of authorised institutions
  • Split the assets and liabilities into different product nature
  • Identify the actual or projected cash flow and slotted into different maturity bucket according to the actual or estimated maturity date
  • Ensure the total outstanding reported for each line items tied back to the balance sheet

Regulatory Environment — Hong Kong

FRSGlobal reporting solution for Hong Kong is designed to satisfy the reporting requirements of the Hong Kong Monetary Authority (HKMA) for Hong Kong Authorised Institutions including licensed banks, restricted licensed banks and deposit-taking-companies.

Statutory

Balance sheet reporting

Balance sheet reporting provides information on the financial position of a bank and is required by the HKMA on a monthly and quarterly basis. Under this type of reporting all the banks in Hong Kong are required to submit the reports on assets and liabilities in Hong Kong and in overseas branches as well as all the supplementary information.

Profit and loss reporting
The profits gained or losses incurred in a quarter needs to be reported to the HKMA on a quarterly basis.

Prudential

Capital adequacy reporting
This type of reporting is mainly concerned with risk incurred by banks and is centred around risk reporting. The HKMA uses the Basel II framework to calculate the capital adequacy requirements. Capital adequacy reporting collects the information on market risk exposures, operational risk as well as the existing credit risk.

Liquidity reporting
The liquidity position of the bank, maturity profile and selected data for stress testing is needed for reporting to the HKMA on a monthly and quarterly basis in order to analyse the positions of the banks in the country.

Interest rate risk reporting
The banks need to report the interest rate risk exposures on a quarterly basis as well as the supplementary information on the weighted average interest costs of interest bearing liabilities denominated in Hong Kong dollars of authorised institutions on a monthly basis to the HKMA.

Loans and advances and provisions reporting
The authorised institution’s (AIs) which provide loans and advances for use in Hong Kong as well as the analysis of the performance of an institution’s selected assets (mainly loans and advances) and off balance sheet exposures are included in this report . It is submitted to the HKMA at the end of every quarter.

Large exposures reporting
The banks need to report to the HKMA information on large exposures to banks, non-banks and connected parties. ‘Exposure’ means all potential losses which might result if a counter party defaults. The reporting needs to be done on a quarterly basis.

Return of Renminbi (RMB) business activities
The authorised institution’s (AIs) which are engaged in the RMB business need to report to the HKMA details of all RMB-denominated on- and off- balance sheet items, money exchange, RMB remittances, RMB credit cards, quality of RMB assets, RMB current accounts, RMB negotiable debt instruments and memorandum items on a monthly basis.

Foreign currency position reporting
The banks which have transactions in foreign currency positions (including options) need to submit a report on all the open positions on a monthly basis in order to check the foreign exchange risk. The banks need to submit a report to the HKMA on a monthly basis.

Transactional (Operational)

External position reporting
This type of reporting is mainly concerned with the international transactions. It covers detailed information on the financial position like external liabilities, claims and cross border claims which need to be reported to the HKMA and submitted on a quarterly basis.

Direct transactional reporting
This typically includes reports on recapitulation of business, insurance and mandatory provident fund related activities along with returns on securities and debt related activities submitted on a semi-annual basis. It also includes Hong Kong Dollar interbank transactions business activities reports submitted on a monthly basis. We also support semi-annual survey reports on Off-balance sheet exposures in derivatives and securitization transactions (Annex A) and selected debt securities held (Annex B) in addition to regular returns.

What’s Coming Up – Hong Kong

Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance

The HKMA issued a circular on July 8, 2011 informing all authorized institutions that the Anti-Money laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (the Ordinance) was gazetted after its passage by the legislative council. The legislation will come into effect on April 1, 2012.

To provide guidance to authorized institutions on the legislative requirements, the HKMA will issue guidelines and will conduct industry legislation also later in this year.

http://www.gld.gov.hk/egazette

Supervisory Policy Manual (SPM) CG-6 “Competence and Ethical Behavior”

The HKMA informed all Authorized Institutions (AIs) about the issue of the SPM, which is to reiterate the supervisory expectation that AIs should engage and deploy personnel with sufficient skills, knowledge, experience and soundness of judgment for the discharge of the particular duties and responsibilities allocated to them and, to this end, the module sets out measures that AIs can adopt in monitoring and maintaining the competence levels and ethical behavior of their staff.

AIs are expected to establish and implement policies and procedures for monitoring, developing and maintaining competence levels and ethical behavior of their staff with regard to the size, scope, nature and complexity of their business. The module covers the following four areas:

1. Responsibility to ensure staff competence
The responsibilities of an AI’s Board of Directors and senior management in ensuring staff competence and ethical behavior, including the adoption of appropriate policies and procedures, training, monitoring and review the knowledge, skills and performance to ensure continuing competence of their staff.

2. Assessing competence
This module covers the component elements of an AI’s control process to assess the competence of staff members, including the drawing up of job specifications and competence criteria for ongoing assessment of competence.

3. Maintaining competence
This module emphasizes the need for an AI to maintain adequate systems of control to monitor and review regularly and frequently the competence of its staff members.

4. Ethical behaviour
This module reiterates the necessity for ethical behaviour by all levels of staff within an AI. This is fundamental in maintaining an AI’s reputation and AIs should take steps to ensure that their employees fully recognise their personal accountability in this regard.

Renminbi (RMB) business – position squaring with the Clearing Bank and net open position

The HKMA issued a circular on July 28, 2011 to Authorized Institutions (AIs) for monitoring the RMB business and the assessment of market feedback in this regard, with a view to achieving orderly development of business in an environment of controllable risks. The HKMA considered appropriate to introduce some refinements to the existing arrangements regarding position squaring with the RMB Clearing Bank and net open position. These refinements are set out below and shall take effect immediately.

Position squaring with the RMB Clearing Bank

In handling cross-border trade settlement business in RMB, a participating AI is allowed to consolidate the RMB trade positions of banks outside Hong Kong that are in the same bank group of the AI concerned with its own RMB trade position for the purpose of position squaring with the RMB Clearing Bank on a net basis. “RMB trade positions” in this context refer to RMB positions derived from RMB exchange transactions with customers under the RMB cross-border trade settlement regime that meet the requirements set out in the HKMA circular of 23 December 2010.

A participating AI that intends to conduct such RMB trade position squaring on a group basis must maintain effective systems and controls to monitor and ensure compliance by the relevant overseas banks. The participating AI should include relevant controls and procedures in the internal guidelines for RMB business and submit them to the HKMA within 14 days of the commencement of such activities. The HKMA may request for review of such records and documentation and must be available within a reasonably short period of time.

RMB net open position

RMB net open position is the difference between on-balance sheet RMB assets and liabilities, but excluding any RMB structural position (e.g. investment in Mainland subsidiary banks). The updated arrangement is set out below.

• The principal requirement on RMB net open position remains unchanged, i.e. the net open position should be within 10% of the size of the AI’s RMB balance sheet subject to a de minimis exemption of RMB50 million.
• If the net open position exceeds the 10% limit, an AI can exclude its actual amount of investments under the Mainland Qualified Foreign Institutional Investors regime and position arising from RMB bond market-making activities.
• The excess can also be offset against any net RMB deliverable forward position in the opposite direction excluding that portion relating to RMB bond market-making activities that has already been taken into account as set out in the preceding point.
• If the resulting net open position is still beyond the 10% limit, the AI concerned should approach the HKMA to discuss and justify the mode and scale of its RMB business.

The HKMA will continue to gauge market views on the development of RMB business in Hong Kong. It does not expect any AI to use the above refinements in such a way that may undermine the proper development of RMB business in Hong Kong and appropriate risk management by AIs regarding their RMB positions.

Asset & Liability Management (ALM)

ALM is being embraced as more than just a tool to monitor and manage interest rate risk in banking books. It is a process for managing balance sheets against other risks that affect earnings and portfolio valuations of banks, shifts in customer behaviour, future balance sheet growth and impact of business strategies (pricing, hedging, growth and planning).

In light of the recent financial crisis, firms of all shapes and sizes are re-evaluating their ALM model. In order to earn an adequate return, the need to assess and mitigate the adverse value and income impact of changes in the market has become even more vital.

So how do different types of financial institutions manage their ALM requirements today?

Large, tier 1 firms typically develop their ALM systems in-house; a luxury few smaller firms can’t afford. These systems typically include sophisticated and finely tuned functionality for Value exposure, Value at risk, Dynamic simulation, Earnings at risk and Treasury view.

In the past, smaller firms have found solutions for meeting ALM requirements to be over-complicated, difficult to integrate with incumbent systems, resource-dependent and cost-prohibitive. For these reasons they have resorted to using alternative methods such as spreadsheets or independent consultants, neither of which is ideal.

Until now the sheer cost of developing and supporting an in-house ALM system has been prohibitive to smaller firms but the need to have accurate visibility into the future position of the firm is critical.

Our heritage and in-depth knowledge of market have enabled the configuration of our solution to be so flexible that it meets the needs of ALL firms; from those with highly complex derivatives to those with a vanilla approach.

Our ALM solution provides a comprehensive range of capabilities that cover the following areas:

• Value exposure / market risk (static)
  For a consistent and comprehensive assessment of the adverse value impact of changes in market risk factors based on common pricing models using gap analysis and analytical/numerical stress testing analysis
• Value at risk / market risk (static)
  To calculate the loss potential of a specific portfolio or the total balance sheet over a given time horizon and confidence level
• Dynamic simulation (“what if” NII analysis)
  To assess and manage income, using a dynamically modelled balance sheet and market environment
• Earnings at risk (interest rate models)
  To calculate the potential to lose income, and to value it in a dynamically modelled balance sheet and market environment
• Treasury view
  To assess the exposure and risk position of Treasury, using the risk management techniques applied by the firm

And for the smaller firm

Our rich ALM solution offers a functionally that require immediate return on investment by taking a ‘compact’ approach with risk management features that absorb complexity. Along with evaluating a mismatch between assets and liabilities, our ALM solution also manages risks arising due to liquidity and interest rate in banking books.

With our ALM solution firms can:

• Quantify the value impact of interest rate changes over the total balance sheet based on regulatory requirements
• Conduct stress testing / value impact of any risk factor change over the total balance sheet
• Benefit from robust processes with audit ability and traceability, reverse processing from results to initial input using modelling (strategies & scenarios)
• Meet processing times / frequency of analysis and reduce manual work
• View Balance Sheet value impacts from interest rate moves in terms of sensitivity, liquidity and margin
• Utilise a simple financial analysis framework
• Make use of a flexible reporting tool and standard export to standard formats (Excel, PDF, HTML, XML)

FRSGlobal 6-step process for ALM

Basel II

Embracing advanced Basel II approaches and capital management practices

While some countries in Asia-Pacific and Japan were initially content with implementing basic and standardised approaches to Basel II, the trend towards more complex approaches to credit risk and market risk management has evolved as the Basel Committee on Banking Supervision continued to enhance its guidance for more sophisticated approaches to managing market, credit, and operational risk.

Hong Kong proactively adopted Basel II for all Authorized Institutions (AIs) from 1 January, 2007. The Hong Kong Monetary Authority (HKMA) believes that Basel II implementation is an important element in maintaining Hong Kong’s position as a reputable and well-supervised international financial centre. It is also an important framework for strengthening risk management practices for banks.

Hong Kong has implemented the simplest as well as at least one advanced approach for risk calculation. Unlike other developed countries, the Hong Kong Monetary Authority (HKMA) has decided to stay with the Internal rating Based (IRB) approach for calculating operational risk rather than adopting the Advanced Measurement Approach (AMA).

The FRSGlobal solution provides a sophisticated Basel II module with the ability to calculate the capital charge for market and credit risk as required under Pillar 1. For Pillar 2, interest rate risk in the banking book, liquidity risk and concentration risk are covered. DataFoundation enables the reporting requirements set out in Pillar 3. The Basel II compliance can be used as an independent stand alone solution or in combination with all the other FRSGlobal RiskPro and RegPro modules.

Capital Adequacy Reporting Videos

A series of videos explaining various aspects of Capital Adequacy Reporting.

• What is Capital Adequacy Reporting?



• What is the purpose of Basel?



• RiskPro or RegPro?



• What does the FRSGlobal solution cover?



• What are the analysis methods?

Adoption of the IFRS7 and IAS 32, 39

Employ dynamic ALM for better balance sheet management

Several Asian Countries: Malaysia, Indonesia, Thailand and South Korea have introduced adoption plans for member banks to comply with international accounting treatments (or slight variations of them). The standards include information on how to value, categorise and account for financial instruments. In addition, the standard gives details of the accounting treatment for positions that qualify for hedge accounting. As these standards continue to evolve, it is incumbent that banks have a process in place to keep up with the latest developments.

The FRSGlobal IFRS solution is made up of both RiskPro and RegPro elements. FRSGlobal RiskPro enables the classification of financial instruments and the calculation of the valuation using either fair value or amortised cost as appropriate. RiskPro also supports several methods for testing and estimating impairment as required by IAS 39.

FRSGlobal RegPro uses ReportGenerator to produce standard IFRS report definitions with country adaptations as well as ReportBuilder to build additional standardised reports.

Read more about the FRSGlobal IFRS solution here.

Hong Kong LM2 Overview

Background

The global financial crisis in 2007 exposed key deficiencies in the global banking risk management system. In response to the situation, the HKMA issued a Liquidity Management 2 (LM2) document last year to all Authorized Institutes (AIs) in Hong Kong. The LM2 initiative is closely aligned with international practices in liquidity risk management.

In summary, an AI’s liquidity risk management framework should enable the AI to identify, measure, monitor and control liquidity risk, and to maintain adequate liquidity resources to cover the nature and level of liquidity risk to which it is or may be exposed. The framework should also be comprehensive and commensurate with then nature, scale and complexity of the AI’s business activities, and should comprise the following areas:

Governance of liquidity risk management
At the governing level, there is a need for the Board of Directors of an AI to determine and articulate the “liquidity risk tolerance” under both normal and stressed conditions. Senior management in banks are expected to put in place, a process for measuring and attributing liquidity costs, benefits and risks to relevant business activities so that line management incentives are consistent with the AI’s liquidity risk tolerance.

Identification, measurement and control of liquidity risk
An AI’s effectiveness in monitoring and controlling liquidity risk depends first and foremost on its ability to accurately measure net funding requirements along different time horizons of its cash-flow projections (or maturity profiling). The size of net funding requirements should be controlled by limits that reflect the AI’s stated risk tolerance. Liquidity positions of the AI should be monitored against these limits with the support of reliable management information systems that provide the Board and senior management with timely and relevant information.

• Cash-flow projections should address both contractual and behavioural considerations and be based on well-documented and realistic assumptions. Where appropriate, an AI is required to make projections on individual major currencies to which it has significant exposure to gauge the extent of its reliance on foreign exchange swap markets for liquidity.
• This requires an effective liquidity risk management process that addresses intragroup liquidity, intraday liquidity, and the management of collateral positions for day-to-day operations as well as the maintenance of an adequate stock of unencumbered, high-quality liquid assets (i.e. liquidity cushion) to meet funding needs in a range of stressed conditions.
• Stress-testing should be conducted based on severe but plausible stress scenarios covering, at a minimum, institution-specific stress and general market-wide stress.

Liquidity risk disclosure

Added to the above is the need for an AI to make pertinent disclosure about itsliquidity risk management framework and liquidity risk position. Adequate public disclosure helps reduce market uncertainty concerning an AI’s financial condition and enables relevant stakeholders to make an informed judgement of the AI’s ability to meet its liquidity needs, both in times of stress and normal circumstances. The HKMA will in due course consider setting minimum disclosure requirements (e.g. through amending the Banking (Disclosure) Rules) to reinforce the effectiveness of the standards.

Application

Under HKMA guidelines, all local incorporated AIs and AIs that are foreign banks operating in Hong Kong through branches will be expected to apply the LM2 standards to their Hong Kong operations, depending on their nature and systemic importance of their local operations to Hong Kong; effectiveness of their risk management policies and framework; the overall liquidity risk position of their banking group; and the relevant home country supervising the liquidity risk of their banking group on a consolidated basis.

Implementation

The HKMA expects all AIs to complete all necessary changes in different areas of LM2 Governance within 12 months agreed with AIs from mid- 2011, i.e. mostly within 2012(except Liquidity Cushion, to be decided).