HKMA Capital Instrument Issuance for Banks: Conditions for Eligible Regulatory Capital

In late 2024, the Hong Kong Monetary Authority (HKMA) released its updated Supervisory Policy Manual module CA-G-5 on “Eligible Regulatory Capital for Authorized Institutions”. This revision, effective from 1 January 2025, tightens the conditions under which capital instruments—such as Additional Tier 1 (AT1) perpetual bonds and Tier 2 subordinated notes—qualify as regulatory capital for banks operating in Hong Kong. For any authorized institution (AI) planning a capital raise in 2025 or 2026, the window for grandfathering legacy instruments has narrowed. The HKMA now requires explicit contractual terms ensuring full loss absorption at the point of non-viability (PONV), aligning Hong Kong’s framework with the Basel III finalisation standards adopted by the Basel Committee in 2017 and phased in globally through 2023. Failure to comply means the instrument will not count toward the AI’s minimum capital adequacy ratio (CAR) as prescribed under the Banking (Capital) Rules (Cap. 155L). This article sets out the statutory conditions, procedural steps, and documentary requirements for issuing capital instruments that the HKMA will recognise as eligible regulatory capital. It does not constitute legal advice. Consult a solicitor for your specific case.

The Statutory Framework for Regulatory Capital Under Cap. 155L

The Banking (Capital) Rules (Cap. 155L) provide the primary legal basis for determining which capital instruments an AI may count toward its CAR. The Rules transpose the Basel III framework into Hong Kong law, with specific modifications for locally incorporated AIs.

Classification by Tier

Cap. 155L divides regulatory capital into three tiers. Common Equity Tier 1 (CET1) capital includes ordinary shares, retained earnings, and accumulated other comprehensive income. Additional Tier 1 (AT1) capital comprises instruments that are perpetual, fully discretionary in coupon payments, and capable of absorbing losses on a going-concern basis. Tier 2 capital covers instruments with a minimum original maturity of five years, subordinated to depositors and senior creditors, and subject to amortisation in the final five years to maturity.

The HKMA’s Supervisory Policy Manual module CA-G-5 (2024 revision) specifies that for an instrument to qualify as AT1 or Tier 2, its terms must include a contractual write-down or conversion mechanism triggered by the earlier of: (a) a decision by the HKMA that a write-down or conversion is necessary to prevent the AI from becoming non-viable; or (b) a decision by the relevant resolution authority that public sector injection is required. The HKMA circular of 15 November 2024, “Amendments to the Supervisory Policy Manual Module CA-G-5”, confirmed that all new issuances from 1 January 2025 must contain these PONV trigger clauses. Instruments issued before that date but without such clauses are grandfathered only until 1 January 2028.

Minimum CAR and Buffer Requirements

The Banking (Capital) Rules set minimum CAR thresholds. For a locally incorporated AI, the minimum CET1 ratio is 4.5% of risk-weighted assets (RWA). The minimum Tier 1 ratio is 6.0%, and the total CAR is 8.0%. In addition, the HKMA imposes a capital conservation buffer of 2.5% of RWA, a countercyclical capital buffer (currently set at 1.0% for Hong Kong exposures as of Q1 2025), and a systemic risk buffer for systemically important AIs. These buffers must be met with CET1 capital. An AI that falls below the combined buffer requirement faces restrictions on discretionary distributions.

The HKMA’s 2024 annual banking stability report stated that the aggregate CAR of the Hong Kong banking sector stood at 21.3% as of 30 September 2024. This is well above the regulatory minima, but individual AIs planning to issue new instruments must still demonstrate that the issuance improves their capital quality—not just quantity.

Conditions for an Instrument to Qualify as Eligible AT1 Capital

Issuing an AT1 instrument requires compliance with a set of conditions that go beyond the standard terms of a corporate bond. The HKMA examines both the contractual documentation and the issuer’s overall capital position.

Perpetuity and Coupon Flexibility

The instrument must have no maturity date and no step-up clauses that would create an expectation of redemption. The HKMA’s CA-G-5 module states that any call option must be at the sole discretion of the AI, and the AI must not create any expectation that the call will be exercised. The coupon must be fully discretionary: the AI may cancel payment at any time, and cancellation does not constitute an event of default. The HKMA will treat any contractual obligation to pay a coupon as disqualifying the instrument from AT1 status.

The Banking (Capital) Rules, section 62, require that the instrument’s terms explicitly state that the AI has no obligation to make a distribution. The terms must also prohibit any alternative means of satisfying the payment obligation, such as paying-in-kind or issuing additional shares.

Loss Absorption Mechanism

The AT1 instrument must include a contractual write-down or conversion provision. Under the HKMA’s 2024 revision, the write-down must be permanent—the AI cannot reinstate the principal amount after a write-down event. If the instrument converts to ordinary shares, the conversion price must be set at a level that does not compensate the holder for the loss incurred. The HKMA’s circular of 15 November 2024 specified that the conversion price must be no higher than the lower of: (i) the volume-weighted average price of the AI’s ordinary shares over the 20 trading days preceding the trigger event; or (ii) the volume-weighted average price over the 5 trading days after the trigger event.

The instrument must also be subordinated to all senior creditors, including depositors and general unsecured creditors. The Banking (Capital) Rules, section 60, require that the subordination clause be expressed in the instrument’s terms and conditions, and that the instrument rank pari passu with all other AT1 instruments of the same AI.

Documentation and Legal Opinions

An AI seeking HKMA approval for an AT1 issuance must submit the draft offering circular, the terms and conditions, and a legal opinion from a Hong Kong-qualified solicitor confirming that the instrument meets the conditions in Cap. 155L and CA-G-5. The HKMA’s processing timeline is typically 8 to 12 weeks from submission of a complete application. The HKMA will review whether the instrument’s loss absorption mechanism is enforceable under Hong Kong law and whether the subordination clause is valid.

Conditions for an Instrument to Qualify as Eligible Tier 2 Capital

Tier 2 instruments serve as gone-concern capital, absorbing losses after a bank has failed. The conditions are less restrictive than AT1 but still require careful drafting.

Minimum Maturity and Amortisation

The instrument must have an original maturity of at least five years. The Banking (Capital) Rules, section 64, provide that in the final five years before maturity, the instrument’s value for regulatory capital purposes is amortised on a straight-line basis. For example, a 10-year Tier 2 note issued on 1 January 2025 will have its full principal recognised for the first five years. From 1 January 2030, the recognised amount will decrease by 20% per year, reaching zero at maturity.

The instrument must not contain any step-up clauses or other incentives to redeem. The HKMA’s CA-G-5 module states that any call option must be at the AI’s sole discretion and must not be exercisable within the first five years after issuance. If the AI exercises a call before maturity, it must replace the redeemed instrument with capital of equal or higher quality.

Subordination and PONV Trigger

Tier 2 instruments must be subordinated to senior unsecured creditors. The Banking (Capital) Rules, section 63, require that the instrument rank junior to all claims of depositors and general creditors of the AI. The subordination clause must be explicit in the terms and conditions.

The HKMA’s 2024 revision to CA-G-5 extended the PONV trigger requirement to Tier 2 instruments issued on or after 1 January 2025. Previously, only AT1 instruments required a contractual PONV clause. The HKMA’s rationale, stated in the 15 November 2024 circular, is that Tier 2 instruments must also be capable of absorbing losses at the point of non-viability to ensure that Hong Kong’s framework is fully compliant with the Basel III finalisation standard. The trigger event is the same as for AT1: the earlier of an HKMA determination of non-viability or a resolution authority decision.

Documentation Requirements

The application for Tier 2 recognition requires the same documentation as AT1: offering circular, terms and conditions, and a legal opinion. The HKMA also requires a certification from the AI’s board of directors that the instrument’s terms do not contain any prohibited features, such as a credit rating downgrade trigger that would accelerate repayment. The HKMA’s typical review period is 6 to 8 weeks for Tier 2 instruments, shorter than for AT1 because the conditions are less complex.

Procedural Steps for Issuing a Capital Instrument

An AI must follow a structured process to obtain HKMA recognition for a new capital instrument. The steps below apply to both AT1 and Tier 2 issuances.

Step 1: Pre-Issuance Consultation

Before drafting the instrument, the AI should submit a preliminary proposal to the HKMA’s Banking Supervision Department. The proposal should describe the instrument’s key features—maturity, coupon rate, call options, loss absorption mechanism—and explain how it meets the conditions in Cap. 155L and CA-G-5. The HKMA will provide informal feedback within 4 to 6 weeks. This step is not mandatory but is strongly recommended. The HKMA’s 2024 annual report noted that AIs that engaged in pre-issuance consultation had a 90% approval rate for their formal applications, compared to 72% for those that did not.

Step 2: Drafting and Legal Review

The AI must engage a Hong Kong-qualified solicitor to draft the terms and conditions and the offering circular. The solicitor must also prepare a legal opinion addressing the enforceability of the loss absorption mechanism, the validity of the subordination clause, and compliance with the Banking (Capital) Rules. The HKMA will reject an application if the legal opinion is qualified or if it identifies any material legal risk.

Step 3: Formal Application

The AI submits the formal application to the HKMA, including the draft documents, the legal opinion, and a board resolution authorising the issuance. The HKMA charges an application fee of HK$50,000 for AT1 instruments and HK$30,000 for Tier 2 instruments, as set out in the Banking (Capital) Rules (Fees) Notice (Cap. 155M). The HKMA will issue a decision within 8 to 12 weeks for AT1 and 6 to 8 weeks for Tier 2.

Step 4: Issuance and Post-Issuance Reporting

After receiving HKMA recognition, the AI may proceed with the issuance. The AI must notify the HKMA within 7 business days of the closing date, providing the final terms and conditions, the placement memorandum, and a confirmation that the instrument was issued as approved. The AI must also report any subsequent amendments to the instrument’s terms, such as a change in the coupon rate or the exercise of a call option.

Common Pitfalls and How to Avoid Them

The HKMA’s enforcement actions and supervisory findings provide guidance on what not to do. The HKMA’s 2023 enforcement report cited two cases where AIs had to restructure their AT1 instruments because the loss absorption mechanism was not enforceable under Hong Kong law. In both cases, the legal opinion had failed to address the interaction between the contractual write-down clause and the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32).

Incomplete Loss Absorption Clause

The most frequent deficiency is a loss absorption clause that does not specify the trigger event with sufficient precision. The HKMA’s CA-G-5 module requires that the trigger event be defined as “the earlier of: (a) a determination by the HKMA that a write-down or conversion is necessary to prevent the AI from becoming non-viable; or (b) a decision by the relevant resolution authority that public sector injection is required.” Any deviation from this language, such as adding a materiality threshold or a grace period, will result in rejection.

Subordination Language That Is Too Narrow

Some AIs have drafted subordination clauses that only rank the instrument junior to depositors, omitting reference to general unsecured creditors. The Banking (Capital) Rules, section 63, require that the instrument rank junior to all claims of depositors and general creditors. The clause must also state that in a winding-up, the instrument will be repaid only after all senior claims have been satisfied in full.

Actionable Takeaways

1. For any AI planning a capital instrument issuance in 2025 or 2026, engage the HKMA in pre-issuance consultation at least 12 weeks before the proposed issuance date to reduce the risk of rejection.
2. Ensure that the instrument’s loss absorption clause uses the exact language from the HKMA’s CA-G-5 module, including both trigger events, without any additional conditions or materiality thresholds.
3. Obtain a legal opinion from a Hong Kong-qualified solicitor that explicitly addresses the enforceability of the write-down or conversion mechanism under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32).
4. For Tier 2 instruments issued on or after 1 January 2025, include a contractual PONV trigger clause identical to that required for AT1 instruments, as the HKMA’s 2024 revision to CA-G-5 now mandates this.
5. Verify that the instrument’s subordination clause ranks the instrument junior to both depositors and general unsecured creditors, and that the clause is expressed in the terms and conditions without any exceptions.

This does not constitute legal advice. Consult a solicitor for your specific case.