This year marks the tenth anniversary of the launch of Exchange Fund Notes (EFN). EFNs are already actively traded among institutional investors. Given the growing retail investor interest in bonds, the HKMA is introducing on 1 August a pilot scheme to facilitate retail investment in EFNs.
With the low interest rate environment in Hong Kong, more investors are becoming interested in bond investments. For Hong Kong-dollar denominated retail bonds, recent issues by public sector bodies like the MTRC, KCRC, Airport Authority and the Hong Kong Mortgage Corporation have been very well received. We at the HKMA welcome this additional channel of intermediation of savings, which is beneficial to the financial stability of Hong Kong.
However, despite the popularity of retail bonds in the primary market, liquidity in the secondary market is generally low. Perhaps this is because some bond investors tend to buy and hold till maturity. The secondary market transaction cost is also generally considered high, with a wide spread between buy/sell prices, a complicated fee structure and a lack of market makers standing ready to offer buy/sell quotes upon request from customers.
There is indeed room to introduce measures to facilitate retail participation in the primary and secondary markets. This should help to make bonds a more liquid investment instrument. We intend to operate a pilot scheme from 1 August 2003 to gauge market responses.
EFNs carry a minimum denomination of HK$50,000 and have maturity of 2, 3, 5, 7 and 10 years (known as the "benchmark issues" because they provide a benchmark for Hong Kong dollar interest rates for other bond issuers). The indicative prices for EFNs are posted every day on the HKMA website, Reuters and several financial information systems.
Under the pilot scheme, we appoint several EFN Recognised Dealers to be Retail EFN Distributors and they undertake to abide by certain unified practices in the primary and secondary markets. Currently, retail investors bidding for EFNs through Recognised Dealers in the primary market need to specify the price at which they bid for the new EFN issue. However, this competitive tender requires a certain sophistication on the part of the investors in deciding on their bid price. To simplify matters, we will offer retail investors an alternative to submit "non-competitive" bids that do not specify the bid price. We will, as a start, reserve a proportion of 2-year and 3-year EFNs (issued quarterly) for non-competitive tender. This will improve the chances of retail investors winning allocation in EFN tenders. For the winning non-competitive bids, the EFN allocated to them will be at the average price accepted for the tender exercise.
In addition, the EFN Distributors undertake to simplify their fee structure and to charge only a single handling fee for processing the initial subscription in the primary tender and a custodian fee for keeping stock of the EFN. There will be no subsequent charges for interest collection and redemption of the bond. This helps to make the cost of bond investment more transparent. However, there may still be a service charge by the Distributors if an investor opts to transfer his bond holding to an account with another Recognised Dealer.
The Distributors also undertake to make market by offering buy/sell quotes for all current benchmark issues. So investors need not wait for an EFN tender to acquire EFNs and can enter the market at any time. The Distributors also agree to quote a reasonable bid/ask spread, having regard to market liquidity and conditions. For EFNs purchased through a Distributor, even though such issues ceased to be benchmark issues, the Distributor undertakes to quote a bid price to buy back such EFNs from the investors.
For this pilot scheme, the HKMA has conducted a tendering exercise and has selected three Recognised Dealers to be the Distributors - the Bank of East Asia, DBS Bank (Hong Kong) and Wing Lung Bank. The number of Distributors can be increased after the one-year trial period if supported by the market demand. In fact, other Recognised Dealers can also adopt most of the practices cited above, other than submission of non-competitive bids. They are, in fact, welcome to adopt such practices to improve market transparency and discipline.
Details of the arrangement for the pilot scheme together with some frequently asked questions about bond investment can be found at a new section "Exchange Fund Notes: Information for Investors" on the HKMA website. We have also published a new information pamphlet on EFN containing information about the scheme. Direct enquiries to the HKMA are welcome.
It should always be remembered bonds are less liquid than savings deposits with banks, and bond prices can go up as well as down. Investors may suffer losses on their principal if they need to sell a bond prior to its maturity. In addition, there is the credit risk that the borrower may fail to honour its repayment obligations.
Joseph Yam
31 July 2003
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