On 13 Dec 2024, the HKMA issued CA-S-10 Fair Value Practices (V.3), superseding prior guidelines, to mandate robust governance, controls, and valuation adjustments for fair value measurements. The guidance requires AIs to implement monthly independent price verification, systematic valuation uncertainty assessment, and mandatory capital adjustments for illiquid positions, directly impacting Common Equity Tier 1 capital for Hong Kong-incorporated institutions. It emphasizes alignment with HKFRS 13 and Basel Framework standards while strengthening supervisory oversight of valuation processes.
This article was generated using SAMS, an AI technology by Timothy Loh LLP.
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Introduction and Purpose
On 13 Dec 2024, the Hong Kong Monetary Authority (HKMA) issued CA-S-10 Fair Value Practices (V.3), superseding previous guidelines CA-S-9 (2006) and CA-S-10 (2013), to establish updated supervisory expectations for Authorized Institutions (AIs) regarding governance, controls, and risk management systems for fair value valuation of financial instruments. The guidance aims to ensure robust valuation processes for regulatory capital adequacy, risk management, and financial reporting, particularly for complex and illiquid instruments.
Scope and Key Supervisory Expectations
The guidance applies to all AIs for instruments measured at fair value in both banking and trading books, consistent with Banking (Capital) Rules (BCR) requirements. Key supervisory expectations include: (1) board-level governance ensuring valuation processes are integrated with risk management; (2) senior management oversight of valuation policies, model validation, and independent price verification (IPV) conducted at least monthly; (3) rigorous assessment of valuation uncertainty and systematic use of relevant, reliable inputs (prioritizing Level 1 inputs per HKFRS 13); and (4) mandatory valuation adjustments for illiquidity or complexity in regulatory capital calculations for AIs incorporated in Hong Kong.
Valuation Adjustments and Capital Impact
For regulatory capital purposes, AIs incorporated in Hong Kong must implement valuation adjustments for less liquid or complex positions (e.g., securitization exposures, n-to-default credit derivatives) to reflect current illiquidity, irrespective of accounting treatment. These adjustments directly impact Common Equity Tier 1 capital. The guidance mandates explicit assessment of adjustment factors including position aging, market concentration, bid/offer volatility, and model risk, with ongoing review requirements. Failure to comply may trigger HKMA supervisory actions, including capital adjustments or restrictions on fair value use.
Audit and Reporting Requirements
Internal and external auditors must rigorously test valuation controls, model validation, and IPV processes annually, with periodic reviews based on risk assessment. AIs must provide transparent external disclosures under Banking (Disclosure) Rules (BDR) and HKFRS 13, detailing governance, valuation techniques, inputs, assumptions, and sensitivity analyses. HKMA will assess disclosure adequacy, requiring alignment with risk management practices and balanced qualitative/quantitative information to support decision-making.
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