Ways to link the financial markets of the Mainland and Hong Kong.
Last week I argued that it would be in the interests of the country to create a channel between the financial markets of the Mainland and Hong Kong to allow them to function as one, much larger market with greater liquidity, more efficient price discovery, and better market discipline and risk management. I promised to give some thoughts this week on how this might be done.
As always in the area of finance, there is no easy answer for an apparently simple question. In many cases, we can and should leave things to the market and let all concerned pursue their own interests to arrive at the most efficient outcome. But for good reasons relating to the need to manage systemic risks, protect investors and depositors, and promote monetary and financial stability, the operation of market forces in financial markets often has to be regulated. And the level of regulation differs between the Mainland and Hong Kong systems. If we are to achieve that channel between the Mainland and Hong Kong financial markets, it will be necessary for the authorities in both jurisdictions to establish a working relationship between the two financial systems that will enable the country to benefit from the opportunities arising from the differences between them.
The Focus Group on Financial Services, formed at the Economic Summit organised by the Chief Executive of the Special Administration Region last September, expressed the view in its report that the working relationship between the two financial systems should be complementary, co-operative and interactive. I agree entirely with this, and the HKMA will play its part in developing that relationship as far as our areas of responsibility are concerned, as we have in fact been doing so for some time.
One of the things that needs to be addressed in linking the two financial markets is that the restrictions on currency convertibility, particularly in the capital account, on the Mainland, and other limitations relating to prudential or financial-stability concerns, mean that the mobility of users and providers of financial services, and of capital and financial instruments, between the two jurisdictions is restricted. The working relationship between the two financial systems therefore needs to focus on creating a channel between the two to restore that mobility through arrangements that, as Premier Wen has put it, have a high degree of controllability, and can be introduced pro-actively and gradually. Supported by the necessary links between the financial infrastructures of the two systems, including the payment, settlement, clearing and custodian systems, the channel would have the effect of pooling the various financial markets of the two jurisdictions, providing much greater liquidity and much more efficient price discovery.
As an illustration of how such a channel could be built, and using arrangements already familiar to readers, the approval process of the Qualified Foreign Institutional Investor schemes could be synchronised with that of the Qualified Domestic Institutional Investor schemes, either to bring about a zero net inflow and outflow of funds, or, if necessary, to allow a net inflow or a net outflow to achieve a better balance of international payments. Another example is the creation of derivative instruments in the form of, say, certificates of ownership of shares listed on the Shanghai, Shenzhen and Hong Kong stock exchanges, and have them traded in both markets with an arbitrage mechanism to equalise prices.
I am sure there are many fine financial architects capable of designing a channel to link the two financial systems, making them work in the best interests of the country. Admittedly, there are many policy issues to deal with. But now is the time to do it. The Mainland faces a number of imperatives: to improve financial efficiency, achieve a better balance in its international payments, relieve the pressure on the renminbi to appreciate, earn greater returns for domestic savings, lower the savings rate, and achieve more balanced and sustainable growth. There is also the need to avoid falling into the habit of organising international financial activities outside the country, which might ultimately deprive the country of its own international financial centre, capable of serving its needs for risk management, price discovery and standard setting much better than overseas centres – the kind of international financial centre that a country taking on an ever-increasing role in global economic and financial affairs needs.
Joseph Yam
1 February 2007
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