Management Summary
- Purpose / Background: This document, CA-G-5 Supervisory Review Process V.7, outlines the Hong Kong Monetary Authority's (HKMA) approach to conducting the Supervisory Review Process (SRP) under Pillar 2. It details the criteria for assessing an Authorized Institution's (AI) capital adequacy, including their Capital Adequacy Assessment Process (CAAP), to determine Pillar 2 capital requirements. The revised version, effective January 1, 2026, emphasizes the importance of AIs' CAAP and integrates its review into the SRP.
- One-line conclusion (what changed / what needs to be done): The HKMA's Supervisory Review Process (SRP) under Pillar 2 is updated to Version 7, effective January 1, 2026, with an increased focus on the quality and effectiveness of AIs' Capital Adequacy Assessment Process (CAAP).
- Key Changes (3-8 bullets):
- Enhanced emphasis on the review and assessment of AIs' Capital Adequacy Assessment Process (CAAP) as a key component of the SRP.
- Clarification of the operational framework for Pillar 2, distinguishing between P2A (risks not captured in Pillar 1) and P2B (stress buffer).
- Updated the capital hierarchy to reflect the positioning of P2A within the §97F minimum CAR and P2B in relation to buffer levels.
- Reinforcement of the MA's powers under §97F of the Banking Ordinance to impose Pillar 2 capital requirements and buffer levels based on AI-specific risk profiles.
- Introduction of detailed guidance on the assessment of specific risks within the CAAP and SRP, including counterparty credit risk and securitization activities.
- Updated definitions and terminology to align with current regulatory understanding.
- Key Dates / Deadlines:
- Effective Date: January 1, 2026.
- Applicability / Impact scope:
- All locally incorporated Authorized Institutions (AIs).
- Recommended management actions (3-7 actionable bullets):
- Review and update internal CAAP policies and procedures to align with the enhanced focus on CAAP assessment under SRP V.7.
- Ensure robust documentation of CAAP assumptions, methodologies, and outcomes for supervisory review.
- Conduct internal assessments and stress tests to proactively identify potential risks and capital needs that may influence Pillar 2 capital requirements.
- Train relevant personnel on the updated SRP framework, particularly concerning P2A and P2B components and their implications.
- Establish or review internal capital targets and monitoring tools to ensure proactive engagement with the HKMA if capital levels approach buffer zones.
- Pay close attention to the assessment criteria for counterparty credit risk, securitization, and risk concentrations detailed in the annexes.
Detailed Summary
- Document overview (nature, purpose, scope)This document, CA-G-5 Supervisory Review Process V.7, is a statutory guideline issued by the Monetary Authority (MA) under §7(3) of the Banking Ordinance. Its primary purpose is to set out the MA's approach to conducting the Supervisory Review Process (SRP) under Pillar 2. This includes the criteria and standards used for evaluating an AI's capital adequacy and the effectiveness of its Capital Adequacy Assessment Process (CAAP) for determining its Pillar 2 capital requirement. The document also describes how the Pillar 2 framework will operate within the broader capital adequacy framework. The scope of application is to all locally incorporated Authorized Institutions (AIs). This version supersedes previous iterations dating back to 2006.
- Main requirements (group by topic; state what must be done)
- Supervisory Review Process (SRP): The MA conducts the SRP to assess AIs' capital adequacy and determine if additional capital is needed for risks not covered or inadequately covered by Pillar 1. The SRP's scope is commensurate with the AI's nature, size, and complexity.
- Pillar 2 Capital Requirement: The MA can require AIs to observe a minimum Capital Adequacy Ratio (CAR) and/or buffer level exceeding the Banking (Capital) Rules (BCR) minimums, based on the AI's risk profile. This Pillar 2 capital requirement is derived from the SRP and forms the basis for the §97F minimum CAR and §97F buffer level.
- Capital Adequacy Assessment Process (CAAP): AIs are expected to conduct their CAAP in line with specified standards. The MA will attach increasing importance to reviewing the CAAP's adequacy and effectiveness. The MA's assessment of the CAAP feeds into the overall assessment of capital adequacy and may lead to changes in Pillar 2 capital requirements or supervisory measures.
- Pillar 2 Components (P2A and P2B):
- P2A: Reflects risks not captured or inadequately captured in Pillar 1. It is treated like Pillar 1 capital and included in the §97F minimum CAR.
- P2B: Provides a cushion for resilience in times of stress and can be used during such times. It is constituted solely by CET1 capital and should not overlap with the BCR buffer level.
- Capital Hierarchy: The document details the hierarchy of capital requirements, with §97F minimum CAR (including P2A) at the top, followed by the BCR buffer level or §97F buffer level (which may incorporate P2B). CET1 capital is applied first to meet the §97F minimum CAR, then the buffer level.
- Legal Framework: The Banking Ordinance provides the MA with powers to enforce SRP principles, including §97F for imposing Pillar 2 requirements and buffer levels, and §97D/E for notification and remedial actions. Directors and senior management have legal responsibility for compliance.
- Risk Assessment: The SRP involves reviewing the AI's risk profile, CAAP, and determining the §97F minimum CAR, §97F buffer level, and/or other supervisory measures.
- Supervisory Arrangements: Includes application to local banking groups and foreign bank subsidiaries, as well as notification, representation, and appeal procedures.
- Key changes (vs previous requirements)
- Increased focus on CAAP: Version 7 places significantly more emphasis on the MA's review of the AI's Capital Adequacy Assessment Process (CAAP), recognizing that AIs have had ample time since 2007 to develop and refine their CAAP capabilities.
- Structured Pillar 2 Capital: Explicit differentiation and definition of P2A (risks not covered by Pillar 1) and P2B (stress buffer), with specific treatments for each within the capital hierarchy. P2A contributes to the §97F minimum CAR, while P2B influences the §97F buffer level.
- Updated Capital Hierarchy Presentation: Table 1 clearly illustrates the updated positioning of Pillar 2 components (P2A and P2B) within the overall capital structure, relative to the §97F minimum CAR and BCR/§97F buffer levels.
- Refined Terminology and Definitions: Updated and clarified definitions for key terms such as CAR, capital add-on, P2A, P2B, and various buffer levels to ensure consistency and comprehension.
- Integration of Annexes: The document structure and annexes provide more granular guidance on the assessment of specific risk areas like counterparty credit risk (Annex H) and high-cost credit protection transactions (Annex G), which are integral to the SRP and CAAP reviews.
- Important dates & transition
- Effective Date: January 1, 2026. All provisions and requirements of this V.7 guideline come into effect on this date.
- Impact and risks (operations/compliance/IT/data/reporting)
- Operational Impact: AIs will need to ensure their CAAP is robust and well-documented, as it will be more rigorously reviewed. This may require enhancements to internal processes, data collection, and risk management systems.
- Compliance Risk: Failure to align CAAP practices with the enhanced standards or to meet any newly imposed Pillar 2 capital requirements or buffer levels could lead to supervisory actions, including penalties or increased capital obligations.
- IT/Data Requirements: Enhanced CAAP review may necessitate improved data management and IT infrastructure to accurately capture, measure, and report on risk exposures and capital adequacy, particularly concerning P2A and P2B components.
- Reporting: While the document outlines supervisory review processes, it implies the need for AIs to be prepared for more in-depth discussions and justifications regarding their capital adequacy and CAAP during supervisory engagements.
- Compliance action checklist (practical steps)
- Review and Update CAAP: Conduct a thorough review of the AI's current CAAP to ensure it meets the standards emphasized in this updated SRP guideline, particularly regarding risk identification, measurement, and capital assessment.
- Enhance Risk Management Systems: Assess and, if necessary, upgrade systems and processes for identifying, measuring, and managing risks that are not adequately covered by Pillar 1, as these will form the basis for P2A.
- Develop Stress Testing Capabilities: Strengthen stress testing frameworks and methodologies to effectively assess capital resilience under adverse scenarios, which is crucial for P2B assessment.
- Documentation and Record-Keeping: Ensure comprehensive and clear documentation of all aspects of the CAAP, including methodologies, assumptions, data sources, and results, to support supervisory reviews.
- Training and Awareness: Train relevant staff (including board members and senior management) on the updated SRP requirements, the P2A/P2B framework, and the heightened importance of CAAP.
- Capital Planning: Review and refine capital planning processes to ensure they adequately reflect potential Pillar 2 capital add-ons and buffer requirements derived from the SRP.
- Engage with HKMA: Proactively engage with the HKMA regarding internal capital targets and methodologies for setting them, as outlined in the document.
- Appendices/attachments summary (if any; 1-3 sentences each; total <= 20%)
- Annex A: List of major supervisory guidelines applicable to assessment of capital adequacy: Provides a reference list of other relevant HKMA guidelines that complement this SRP module for capital adequacy assessment.
- Annex B: Factors for assessing capital adequacy under SRP: Outlines the key factors the MA considers when assessing an AI's capital adequacy as part of the SRP.
- Annex C: Scoring worksheets to facilitate assessment under SRP: Offers tools to assist supervisors in the assessment process under the SRP.
- Annex D: Supervisory requirements on application of stress tests under CAAP: Details the MA's expectations and requirements regarding the use of stress tests within an AI's CAAP.
- Annex E: Assessment of risks arising from securitization activities under CAAP / SRP: Provides guidance on how risks from securitization activities are assessed under both the AI's CAAP and the MA's SRP.
- Annex F: Assessment of risk concentrations under CAAP: Focuses on the requirements and MA's approach to assessing risk concentrations within an AI's CAAP.
- Annex G: Assessment of high cost credit protection transactions under SRP: Addresses the MA's scrutiny of high-cost credit protection transactions used for capital arbitrage or risk mitigation within the SRP framework, highlighting potential issues and supervisory expectations.
- Annex H: Assessment of counterparty credit risk under CAAP / SRP: Guides AIs and the MA on the assessment of counterparty credit risk (CCR) within the CAAP and SRP, covering CCR management systems, models, and exposures to central counterparties.