China : One Country, Two Financial Systems
by Norman T.L. Chan, Deputy Chief Executive, Hong Kong Monetary Authority
(Speech at China : The Promise of Partnership Seminar)
22 September 1997
Not long ago, the world witnessed the historic event of Hong Kong's return to China. Indeed, the handover ceremony took place here in this magnificent building.
Almost three months have now passed and the Annual Meetings of the World Bank\IMF provide another opportunity for the world's financial leaders to come to Hong Kong to see how Hong Kong is doing in a new era - an era governed by the "one country, two systems" principle enshrined in the Basic Law, the constitution of the HKSAR.
The Basic Law stipulates that the HKSAR shall maintain its previous social, financial and monetary systems. Building on the "one country, two systems" principle, the Basic Law also stipulates that the HKSAR shall enjoy a high degree of autonomy other than foreign affairs and defence.
In the financial and monetary areas, the HKSAR shall formulate its own monetary and financial policies. The Hong Kong dollar shall remain the only legal tender in the HKSAR, shall remain freely convertible and no exchange control policy shall apply in Hong Kong. And the HKSAR is required by the Basic Law to safeguard the free flow of capital. The assets of the Exchange Fund, which stood at HK$66 billion as at end of July 1997, shall continue to be managed by the HKSAR Government on its own. The HKSAR shall have independent finances and the CPG shall not levy taxes in the HKSAR.
These arrangements are designed to ensure that the social, financial and monetary systems in Hong Kong will remain separate from those in the Mainland China. Hong Kong, one of the freest economies in the world with highly developed and very sophisticated financial markets is operating on very different foundations from the Mainland China and the two places are undergoing very different stages of development. It is in recognition of these differences that the unique concept of "one country, two systems" was formulated to maintain the long term stability and prosperity of Hong Kong. In the financial and monetary areas, this concept can be summarised as "one country, two currencies, two monetary systems and two monetary authorities".
In this context, "two currencies" means that HKD shall remain the only legal tender in Hong Kong whereas RMB will continue to be regarded as a foreign currency in Hong Kong. At the same time, HKD will also be regarded as a foreign currency in the Mainland China.
Corresponding to the two mutually independent currencies are two mutually independent monetary systems. To ensure that the two mutually independent monetary systems are properly managed, it is essential that the two monetary authorities, the PBoC in the Mainland and the HKMA in the HKSAR, would remain separate and mutually independent.
While I have explained the importance to maintain the separateness of "Two systems", one should not overlook the "one country" dimension in the "one country, two systems" formula. It would be wrong to assume that Hong Kong's prosperity as a trading, service and financial centre in Asia emanated entirely from its own economic strength.
Over the years, close links have developed between the economies and financial markets of Hong Kong and Mainland China. Following the return of Hong Kong to China, I expect a further strengthening of these links which provides considerable synergy of mutual benefit to the development of Hong Kong and the Mainland. Let me give a few examples:
|(a)||trade and investment - HK and Mainland China have become each others' largest trading and investment partners. From late 1970s to end-1996, HK accounted for 57% of total FDIs in China (US$100 bn). In 1996, HK's trade with Mainland China amounted to 36% of HK's total trade (US$136 bn).|
|(b)||financial intermediation - over the past few years, HK has become the major funding centre for China. This has brought about enormous business opportunities for the banking sector and capital markets in HK. By end-1996, total loans to Mainland China by banks in HK amounted to US$46 bn. 32 Chinese SOEs have made their IPOs in HK in the form of the issue of shares. Through these IPOs, US$1.67 bn has been raised in HK while another US$4.6 bn has been raised through global placements.|
|In seeking to be listed on the HK Stock Exchange, Mainland enterprises are required to comply with all the listing rules and other relevant regulations in HK. No favoritism or preferential treatment has been or will be given to Mainland companies. Thus, in addition to fund raising, the listing of Mainland companies in HK also facilitates the upgrading of their corporate governance in line with the international standards practised in HK. Through this process, HK has played a strategic role in the reform of the SOEs in the Mainland. At the same time, the stock market in HK will grow and strengthen while more Mainland companies are being listed locally.|
|(c)||banking - the number of branches established by HK banks in the Mainland has more than doubled in the last five years to about 30. 35 Mainland-owned banking institutions are also operating in Hong Kong. In 1996, these Mainland-owned banking institutions accounted for 23% of customer deposits and 10% of loans extended by the banking sector in HK. Again, it is important to note that Mainland banks in HK are treated as foreign banks and are required to meet the licensing criteria applicable to all foreign banking institutions seeking to operate here. At the same time, HK banks are regarded as foreign institutions in Mainland China and are licensed and regulated in exactly the same way as foreign banks from other countries.|
|(d)||supervisory cooperation - in order to have effective regulation on Mainland companies listed here, the Securities and Futures Commission of HK entered into a Memorandum of Regulatory Cooperation with the China Securities Regulatory Commission in 1993. This was followed by another Memorandum signed in 1995 in relation to futures trading activities. Similarly, the HKMA and the PBoC liaise and cooperate closely in cross-border banking supervisory issues.|
|(e)||international central banking forums - with China support, the HKMA has been admitted into a number of important international central banking forums, including the Bank for International Settlements, Executive Meeting of East Asia and Pacific Central Banks and SEANZA (comprising 18 central banks in the Asian Pacific region). In these forums, the HKMA attends in its own right and along with the PBoC. The HKMA and the PBoC have also signed a bilateral repurchase agreement which enhanced the liquidity of foreign currency reserves in maintaining currency stability.|
|(f)||market infrastructure - in anticipation of the rapidly increasing economic activities between HK and the Mainland, the HKMA and the PBoC have agreed to link up the HKD payment system, which has been operating on a real time gross settlement basis since December 1996, and the RMB payment system in Mainland China. This linkage, which is a form of Payment versus Payment (PvP) facility, will reduce significantly settlement risks in foreign exchange transactions involving HKD and RMB. We expect to be able to start the PvP link as soon as the PBoC introduces real time gross settlement for its payment system in 1999. This PvP link will be of strategic importance in facilitating the cross-border fund flows arising from the increasing trade, investment and financial activities between HK and the Mainland.|
In concluding my remarks, I would like to emphasise that the "one country, two currencies, two monetary systems and two monetary authorities" is no doubt an innovative and unique concept not practised elsewhere before. Understandably, there are people who have expressed doubts on whether this concept will or can work. However, you can see for yourself during the Annual Meetings how this unique concept is being put into practice. You can also see for yourself that Hong Kong remains as vibrant, dynamic and interesting as ever.
People in Hong Kong are confident on the future stability and prosperity of Hong Kong as the premier international financial centre in the region. The financial markets also signal its confidence in Hong Kong : HKD has remained remarkably stable under the linked exchange rate system, notwithstanding the recent turmoil of the Asian currency markets. [The 10-Year Hong Kong Government bonds, which are known as Exchange Fund Notes, are only trading 60 b.p. above 10-Year US Treasuries, which is a very narrow spread indeed. This reflects a high degree of market confidence in Hong Kong and its future.]
Looking ahead, with the rapid and steady growth in economy in Mainland China, Hong Kong is likely to do even better in the years ahead in meeting the huge funding requirements and contributing to the reform process of Mainland China. Hong Kong's position is complementary to that of Shanghai, which has developed as the biggest domestic financial centre for China. At least until RMB becomes fully convertible, Hong Kong will continue to be China's prominent international financial centre.