Hong Kong: Towards a New Financial Era

Ladies and gentlemen,

1. The Hong Kong Monetary Authority is very honoured to join the Securities and Futures Commission, the Stock Exchange of Hong Kong and the Hong Kong Futures Exchange in hosting this seminar. We are also grateful to the People's Bank of China and the China Securities Regulatory Commission for agreeing to act as co-organisers of this function.
2. In less than 400 days, sovereignty over Hong Kong will be returned to China. This will mark the beginning of a new era for Hong Kong. This will also mark the beginning of a new financial era for the financial sector of Hong Kong. I wish to take this opportunity to consider how we in Hong Kong should position ourselves so as to prosper in this new financial era.
3. Well before 1997, it has been manifestly clear that the future of China will have a strong bearing on the future of Hong Kong and the prosperity of Hong Kong is inextricably bound to that of China. There is no doubt that there will be closer interface between the financial systems of China and Hong Kong. I would therefore also like to share with you today some of my personal views concerning the relationship between the two financial systems in this new financial era under the framework of "one country, two systems".

A new financial era

4. Let me start off by focusing on the characteristics of the new financial era, as I see it from Hong Kong. They present, without doubt, a very bright scenario.
   
   First, Hong Kong and China are located in East Asia: the fastest growing region in the world. Between 1996 and 2005, the World Bank estimates that the region will be growing at twice the world average. Much of the impetus to this rapid growth stems from the economic reform and liberalisation of China, of which Hong Kong will become an integral part after 1 July 1997.
   
   Second, to facilitate economic development, the region, in particular China, needs efficient financial systems to channel savings effectively to investments. The role of financial intermediation is of crucial importance to economic development in this region. The demand for financial services will grow at an even more rapid rate than economic growth.
   
   Third, the money of this world is increasingly concentrated in this region. Private sector saving rates are high, on average exceeding 30%. Official reserves are also abundant. Five out of the seven largest foreign currency reserve holders in the world are in this region. In 1997, I expect foreign currency reserves of China and Hong Kong will total more than any other country in this world. Along with money come of course opportunities for financial business.
   
   Fourth, Hong Kong is the eighth largest trading economy in the world, while China is the eleventh. Together and including cross border trade, China and Hong Kong will be the fourth largest trading economy in the world.
   
   Fifth, given the size of its population, China is an enormous market with huge potential. With continued reform and liberalisation of the Chinese economy, this potential will increasingly materialise into very profitable business opportunities. Those who are in a position to understand China and cater for China's needs will have a competitive advantage over others in tapping that market.
   
   Sixth, sometime within the next century, in terms of numbers and by value, China will surely become one of the biggest markets in the world in many areas. For example, I am confident that it will have the largest housing and mortgage market in the world. With the pace of financial liberalisation we have been seeing, it may even have one of the largest equity markets in the world. In fact, on 1 July 1997, China will have, in the form of Hong Kong, the fifth largest international banking centre, the fifth largest foreign exchange market, the seventh largest derivatives market, the eighth largest stock market in the world, and the most vibrant and liquid bond market in Asia.
5. Against this background, it is not difficult to see the role that Hong Kong, as an international financial centre, can play in this region, in particular in China. The opportunities are clearly there and Hong Kong is in an advantageous position, geographically and in terms of technical ability, to benefit from those opportunities. But I think the situation is a little more complicated than that and so I would caution against complacency. I think we must be alert to the market environment that we face and make a conscious effort to position ourselves strategically if we are to take full advantage of the opportunities ahead of us in this new financial era.

The market environment

6. The market environment that we face in this region is a peculiar one. Two phenomena stand out. The first concerns the inadequacy or the lack of efficiency of financial intermediation in this region. This seems to be a strong accusation, particularly in the presence of leading members of our financial community. No such accusation is intended. The point can best be illustrated by referring back to what I said earlier about the high private sector savings rates and the high foreign currency reserves in this region, and ask the question as to where does the money go. If financial intermediation in the region is efficient, then I would have expected that a large part of this savings and reserves would be channelled effectively into productive investments in this region, given the higher rates of return available. Indeed, there is no lack of demand for funds for productive investments, such as infrastructure investment. This however has not been the case. While information on where private sector savings go in the region is scanty, the majority of official foreign currency reserves very clearly are invested in developed markets in Europe and America. Ironically, at the same time, economies in this region are trying very hard to attract foreign direct investment and portfolio investment from the developed markets in order to promote and sustain economic development.
7. For those who are successful in attracting foreign investment funds, through, amongst other things, financial liberalisation, chances are that they often face a second phenomenon. This takes the form of a surge in volatile, cross border capital flows which they often find difficult to cope, resulting in greater financial market volatility, including exchange rate and interest rate volatility, leading possibly to systemic instability and a greater level of perceived risk.

Risk management

8. We must try and understand the reasons behind these peculiar phenomena before we can position ourselves in this new financial era advantageously. Obviously, money is invested and stays in a market when the return in that market is attractive; but equally important, if not more important, is that it must be clear to investors what risks are involved in participating in that market, and whether or not there are facilities for managing these risks. For example, as the authority responsible for the management of the Exchange Fund of Hong Kong, I can say that I would have no difficulty in diverting some of our reserves into financial markets and instruments in this region if there is an adequate mechanism in the financial systems of this region for clearly identifying and prudently managing the risks involved in making such investments.
9. The risks that I, and I imagine the majority of other institutional investors, would try to identify and manage include market risks, legal risks, payment and settlement risks, liquidity risk, exchange risk, etc. I am sure the nature of these risks is very familiar to all.

Strategic considerations

10. In positioning ourselves strategically for this new financial era, we must therefore bear in mind the fact that investors, particularly investors in financial markets, while interested in the attractive returns inherent in the growth potential of economies in this region, are also risk averse. Competitiveness of financial centres now hinges quite crucially on whether there is a suitable environment for investors to identify and manage the variety of risks in a manner acceptable to them. Regulatory authorities have an important responsibility here. Indeed, this is one important consideration influencing how we in the Hong Kong Monetary Authority approach our work. We feel that we must:
    
    First, ensure that our policies in the monetary and financial areas are clear and predictable, and that our operations in financial markets as Monetary Authority are highly transparent.
    
    Second, ensure that our financial systems and markets command a high degree of integrity through the adoption of internationally accepted regulatory standards.
    
    Third, ensure that the infrastructure of our financial markets is robust, our markets are efficient, not only in terms of the pricing of financial products, but also in the provision of a wide spectrum of instruments with liquidity.

Action agenda

11. We have translated these strategic considerations into an action agenda which is now quite familiar to the financial community in Hong Kong.
    
    First, we will firmly adhere to our macro monetary policy of maintaining exchange rate stability through the linked exchange rate system. A stable exchange rate of course minimises exchange risks for investors.
    
    Second, we will continue to subject ourselves firmly to the strong fiscal discipline that has served Hong Kong well in the past. This is clearly essential to support of our monetary policy and enhancing its credibility.
    
    Third, we will continue to manage skilfully and prudently our very substantial foreign currency reserves in the form of the Exchange Fund as a comfortable backup for our exchange rate policy.
    
    Fourth, we will maintain a banking supervisory system that matches the best world standards.
    
    Fifth, we will continue to devote considerable efforts to build up expertise in the monetary, banking and financial markets areas. This will enable us to discharge our responsibilities as Monetary Authority professionally and in a manner that commands the confidence of the financial community, domestically and internationally. We will further volunteer our expertise to China if this would be helpful to the modernisation of the monetary and banking systems of China.
    
    Sixth, by the end of this year, we will have in place one of the most modern and streamlined RTGS large value payment systems in the world that is fully integrated with an automated book-entry bond clearing and settlement system - the proven and tested CMU system. Once linked with the Chinese Automated Payment System, as well as other RTGS systems, it will form part of the future global network of payments that will facilitate trade and investments.
    
    Seventh, we will continue with our efforts to develop the debt markets in Hong Kong and the region. The Financial Secretary has recently announced tax incentives for the floatation of long-term bonds in Hong Kong. We have recently advocated the establishment of a regional network of bond clearing and settlement systems in Asia called "AsiaClear".
    
    Eighth, subject to favourable response to the consultation we are currently conducting, we will establish a mortgage corporation in Hong Kong. Not only will it enable the strong demand for mortgage funds to be met, it will enhance monetary stability, reduce the concentration risk of mortgage lending by banks, and improve their liquidity management ability. Once proven, it will be a helpful model for the mortgage market in China.
    
    Ninth, we are studying in depth the rapid innovation in financial technology and instruments in the world, and their implications for financial development and stability as a whole. The coming of smart cards, electronic cash, Internet banking, derivatives and futures will have profound impact on the banking and financial markets in the 21st century. China has the potential to leapfrog in such financial technology through the window of Hong Kong.
    
    Finally, my colleagues in the securities and futures industries will have more to say the areas in which Hong Kong can bring in terms of financial service to China and the region. Hong Kong today is irreversibly a service economy. Our livelihood depends on ability to provide sound and trustworthy service to our clients. Unquestionably, our biggest client will be the rest of China.

Relationship between the two financial systems under "one country, two systems"

12. Let me turn to my personal views concerning the relationship between the two financial systems in this new financial era for Hong Kong under "one country, two systems". Notwithstanding the lack of natural resources, the people of Hong Kong, being innovative and dynamic, have created economic success that is the envy of many. But the success of today does not guarantee continued success for tomorrow. With ever increasing competition and political transition, we need increasingly to rely on our innovative and dynamic spirit to maintain and strengthen Hong Kong's status as an international financial centre. In this connection, the spirit of "one country, two systems" does give Hong Kong ample room fully to be creative and ensure the continued prosperity of Hong Kong. This in turn will provide much impetus to reform and liberalization of China.
13. On how the concept of "one country, two systems" would be applied to the financial area, in particular on the relationship between the two financial systems, the Basic Law has laid down a clear legal foundation. After 1 July 1997, the HKSARG shall on its own formulate monetary and financial policies. The Hong Kong dollar, as the legal tender in the HKSAR, shall continue to circulate. No exchange control policies shall be applied in the HKSAR. The Hong Kong dollar shall be freely convertible. The HKSAR shall safeguard the free flow of capital within, into and out of the Region. The Exchange Fund shall be managed and controlled by the government of the Region.
14. Deputy Governor Chen Yuan put it well in his speech at a conference here in Beijing on 26 October 1995. He said that these legal provisions in the Basic Law in effect established the principle of one country, two currencies, two monetary systems and monetary authorities, and laid down clearly the legal basis for the development of the financial relationship between mainland China and Hong Kong in the future. He further said that the nature of this financial relationship may be defined as a relationship between two mutually independent monetary systems under different social and economic regimes within a sovereign state. In another speech at the conference organized by the Preliminary Working Committee on 18 June 1995, he also said that, as after 1997 Hong Kong will retain its mutually independent monetary system, it will be essential for the monetary authorities to be mutually independent.
15. As the monetary relationship between China and Hong Kong becomes closer, the two monetary authorities obviously should strengthen communication and co-operation. This has in fact been developing smoothly in the past few years. For example, the People's Bank of China and the HKMA are discussing how the RMB and Hong Kong dollar real time payment systems, when completed, should be linked up with each other. There is also close cooperation on the supervision of banks. There is obviously a need to exchange views on matters that may have a significant effect on each other's monetary and financial systems. It should be emphasised that such cooperation should be conducted strictly in accordance with the principle and spirit of one country, two systems, in order not to give unhelpful suggestion that Hong Kong's autonomy is being undermined or questioned.
16. There is a requirement in the Basic Law that the HKSAR shall provide an appropriate economic and legal environment for the maintenance of the status of Hong Kong as an international financial centre. To achieve this, the supervisory authorities in Hong Kong must be able to keep up with developments in the financial areas, including trends in financial supervision. They must therefore be able to participate fully in activities of international financial organizations. Hong Kong has been gaining increasing respect in the international financial community by virtue of the professionalism, innovation and openness with which we approach matters discussed. We should clearly continue to participate in such activities if we are to consolidate and further develop Hong Kong as an international financial centre.

Conclusion

17. Ladies and gentlemen, in conclusion I am happy to say that the financial framework of Hong Kong are already well positioned to welcome the new financial era under "one country, two systems". With close co-operation and communication between regulators and participants of the two mutually independent financial systems, I am confident that Hong Kong will benefit enormously in this new financial era; so will China, from the financial services and expertise of world class standards that Hong Kong can offer as an international financial centre in China.
18. I would also like to record my sincere thanks to the leaders in the Mainland for the support and understanding that they have so kindly and unconditionally extended to the HKMA in recent years. I look forward to the continuation of such excellent relationship, which is highly essential as we march into the new financial era. Thank you.