An important step to help maintain Hong Kong's status as an IFC.
The Chief Executive in Council approved on 28 April a proposal to implement a Government Bond Programme. This follows the announcement by the Financial Secretary in his 2009-10 Budget Speech that the Government intended to launch such a programme. Resolutions will be introduced into the Legislative Council to authorise the Government to borrow – in this case, to issue bonds – and to set up a fund to manage sums raised under the programme. This may seem unusual to some readers: after all, the Hong Kong Government has ample reserves and surely does not appear to have financing needs. In fact, the proposal is an initiative to develop the local bond market rather than a way of supporting Government expenditure.
The Hong Kong bond market, especially the Government-bond sector, is small when compared with those of some of our neighbours in the region and other advanced economies. At the end of 2007, the total outstanding amount of debt securities issued by the Government or the HKMA represented about 10% of GDP, which is quite modest compared with Singapore, Australia, the US and the Euro area. This leads to something of a chicken-and-egg problem: the modest development of the bond market restricts the size of the investor base, which in turn discourages corporations from using the bond market as a channel to raise funds.
Up to now, the market for Exchange Fund Bills and Notes (EFBNs) is the only substantive market in which banks trade fixed-income instruments issued by the public sector in Hong Kong. But banks mainly use the EFBNs for the rather technical purpose of helping to manage their liquidity positions and obtain funding from the Discount Window operated by the HKMA by using the EFBNs as collateral. The EFBN market is essentially operated with the overriding objective of maintaining exchange-rate stability, and its size is largely subject to flows of US dollars into and out of Hong Kong according to the Currency Board arrangements.
The Government sees a need for a sustainable, systematic Government bond programme to broaden and deepen the local debt market. Though public debt programmes implemented by other economies are commonly driven by the need to finance government expenditure, some are not and yet are equally successful. The experience of Singapore is a case in point. Singapore has operated substantial fiscal surpluses for many years and accumulated sizeable reserves. Maintained for market development purposes, the Singapore Government Securities programme, under which government debt instruments are issued, has grown substantially in scale since its launch. The market perceives the programme as pivotal to encouraging the development of the bond market in Singapore in recent years.
A well developed local bond market in Hong Kong with a critical mass established in terms of issuance size and diversity of products will have a number of benefits. It will help ensure a steady and consistent supply of high-quality public debt paper to the market, helping to satisfy the investment demand of institutional investors such as pension funds and insurance companies that need to match their long-term Hong Kong-dollar liabilities, and the demand of retail investors for high-quality, stable fixed-income investments. It will also help broaden the investor base of Hong Kong-dollar bonds and improve liquidity in the secondary bond market. Once it reaches a certain size, it may also be recognised by and become a constituent of the various global bond-market benchmark indices, thereby attracting foreign investors into the Hong Kong market. Perhaps most importantly, a well developed bond market represents an alternative channel for financial intermediation, in addition and complementary to the equity market and the banking system, giving fund-raisers another option during times of stress and helping to maintain financial stability. Of course, all of this will strengthen Hong Kong's position as an international financial centre.
Initially bonds with tenors of two to ten years will be issued under the Programme. In future, issuance of bonds with tenors of 15 years or longer will also be considered based on market demand in order to supplement the existing yield curve of the EFBN programme which stops at a tenor of 15 years. The Programme will target both institutional and retail investors. Initial views from market participants indicate that the market may be able to absorb up to $10 billion to $20 billion in the first year. Of course, when approaching the launch of the bond Programme, the Government will conduct a more detailed assessment taking into account the prevailing market conditions and other relevant factors in determining the actual issuance size. According to the Government's proposal, the Programme is subject to a ceiling of $100 billion total outstanding principal at any time, which will obviously take some time to reach, probably around five to ten years. The $100 billion figure provides an indication of the potential scale of the Programme and assures investors that this Programme will be in place for years to come, thus encouraging more active market participation.
The money raised under the Programme will be credited to a special Bond Fund to be established under the Public Finance Ordinance. The Fund will not be treated as part of the fiscal reserves, and it will be accounted for separately from the general revenue. It will be used to repay principal and to meet the financial obligations and liabilities associated with the Programme. It will also be invested. It is prudent to adopt a long-term and conservative investment strategy in managing the Fund having regard to the objectives of preserving capital and generating reasonable investment returns to cover the necessary financial obligations and liabilities arising from the Programme. Some readers may note that such investment strategy is largely in line with that of the Exchange Fund which is under the management of the HKMA. There is thus synergy in placing the proceeds raised under the Programme with the Exchange Fund for management and sharing the same "fixed rate" return applicable to the placement of fiscal reserves with the Exchange Fund. Such an arrangement should allow the Bond Fund to benefit from the economy of scale of the Exchange Fund. The substantial size of the Exchange Fund will also provide sufficient investment diversification to achieve a stable investment return for the Bond Fund.
As the project continues to develop, more details will be announced. The HKMA, which has been tasked to co-ordinate the offering of the Programme, will do its best to support the initiative, which is important for the development and maintenance of Hong Kong’s status as an international financial centre in the longer term, one of the key objectives of the HKMA.
Eddie Yue
Deputy Chief Executive
7 May 2009
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