Settlement risks

inSight

01 Jun 2006

Settlement risks

Overseas and local investors can use our settlement systems to manage their settlement risks.

I have often emphasised the need, particularly for those engaging in large-volume trading in financial markets, to manage settlement risks. We all want to make sure that we get what we buy, but it has become increasingly important that this happens at the same time as we part with our money. Under normal market conditions, delivery of what we buy, albeit with a varying time lag, is not a problem and so not many people are concerned about it. Buyers often assume that sellers will deliver, and they usually do not mind parting with their money as if they have already got what they want. In this age of advanced information technology, money can be moved around and financial instruments transacted by touching a few buttons on a keyboard. But accidents do happen, for one reason or another, and these may be beyond the control of the seller or indeed of those running the delivery system. Imagine what could happen during the long time lag between parting with your money and receiving what you have bought. Hopefully, this will illustrate the need to manage settlement risks.

Fortunately, advanced information technology can also be used to manage settlement risks. Some readers may already be familiar with the following financial terms: real time gross settlement (RTGS), delivery versus payment (DVP) and payment versus payment (PVP). They are the tools that we have established in our financial infrastructure to manage settlement risks. Put simply, they make it possible for users to receive what they buy at the same time as they part with their money.

In an international financial centre like Hong Kong, numerous foreign exchange transactions are conducted everyday, involving not only the buying and selling of major foreign currencies against the Hong Kong dollar but also among the foreign currencies. Understandably the most popular foreign currencies traded are the US dollar and the euro, and to a lesser extent, the Japanese yen. To help eliminate settlement risks for transactions involving the US dollar and the euro, and because of the long time lag between Asia and the US and Europe, we have already introduced RTGS in Hong Kong for these two currencies. Together with Hong Kong dollar RTGS, PVP among the three currencies is possible. The case for having Japanese yen RTGS in Hong Kong is less strong, because Tokyo, where yen settlements are done, is only one hour ahead of Hong Kong. But we still want to include the yen in our payment infrastructure, or link our RTGS systems with those for the yen in Tokyo, to achieve RTGS and PVP for financial transactions involving the yen conducted in Hong Kong. Looking ahead, transactions denominated in the renminbi will probably increase, as capital account liberalisation on the Mainland proceeds in earnest. We have in fact made extensive preparations for introducing renminbi RTGS in Hong Kong. A specialised Renminbi Settlement System for cross-border renminbi payment functions was introduced in March this year. As soon as developments on the renminbi business front allow, we will be able to add renminbi RTGS functions to this existing system in about five weeks.

This sophisticated financial infrastructure is not only intended to serve the needs of Hong Kong. People in other jurisdictions operating in our time zone can also use it to manage settlement risks. We have been marketing our services in this region and we see increasing interest. We will be stepping up our marketing effort, particularly on the Mainland, where financial transactions involving foreign currencies are increasing. We and the People's Bank of China will jointly host a seminar next week in Beijing and Shanghai for the financial institutions active in the foreign exchange market, particularly the market makers. We are especially interested in providing settlement services for US dollar and euro transactions in the Hong Kong time zone, so that market participants do not have to wait until Europe and America open for business to settle the foreign currency legs of their increasing number of transactions. Ideally the renminbi leg of foreign exchange transactions should also be settled at the same time, that is, to achieve PVP for renminbi-foreign currency transactions. This is our long-term goal. But it is already a great step forward to be able to shorten the time lag between the settlements of the two legs of the transactions.

Joseph Yam

1 June 2006

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