Role of the Market Practices Committee in Foreign Exchange Market Development

Mr Chairman, Distinguished Guests,

It is an honour to be invited to give this Luncheon Talk. I would like first of all to thank the Forex Association for its whole-hearted support to the recent Seminar on "Development of the Foreign Exchange Market in China", which was held in Shenzhen last week. The ideas generated at this Seminar will help lay the foundations for the development of what promises to be possibly one of the largest forex markets in world, and Hong Kong will have a major role to play in its development.

I thought this might be a good opportunity to share with you some of my thoughts regarding the role of the Market Practices Committee in the development of our own foreign exchange market. The first rule of economics is that there is no free lunch, and therefore I hope I will be able to earn my keep and not send most of you to sleep after such an excellent lunch.

The foreign exchange market is the world's largest and most efficient market. Daily trading volume has risen from less than US$1 billion in 1974 to over US$1 trillion today. Based on the April 1992 BIS survey of nine major markets, spot trades accounted for 47% of total turnover, swaps 39%, with currency futures and options 14%. Hong Kong ranked sixth in terms of turnover at US$ 61 billion daily, an increase of over 24% from the survey done in 1989. The largest market remains in London (US$300 billion), New York (US$192 billion), Tokyo (US$128 billion), Singapore (US$74 billion) and Zurich (US$68 billion). In Hong Kong, spot trade accounted for 52%, forward 47% and futures and options 1% of total turnover, thus indicating that we were slightly behind the curve in the usage of the more sophisticated derivative products in 1992. I am sure that the next survey in 1995 would show an improved picture.

The global wholesale foreign exchange market is also unusual in that it is an over-the-counter (OTC) market without central clearing. The transactions are dominated by trades between the major banks and their customers through brokers and dealers, with electronic broking playing an increasingly important role. What this implies is that except for final settlement of the domestic currency leg of the forex trade in a particular market, cross-currency trade has no loyalty to any particular centre. It can be booked in any global location, making the market extremely open and competitive.

Given this market structure, the supervision and regulation of the global wholesale forex market is rather special because it is essentially self-regulated. Of course, home-country supervisors would monitor the net foreign exchange positions of their banks, mainly relative to capital, as part of the normal supervisory process for licensed or authorized institutions. But by and large, through sheer competition, players in the global forex market have to have the strong capital base, the professionalism and the technology to stay in the game.

Historically, the global foreign exchange market evolved offshore largely because of restrictive domestic regulations or for tax reasons. For example, Regulation Q on interest rate caps was largely responsible for the development of the Eurodollar market in the 1960s. Given this background, market supervisors have been aware that the best way to approach the foreign exchange market is to encourage the development of "best practice". This has been the approach taken in Hong Kong.

The Hong Kong Foreign Exchange and Money Market Practices Committee (MPC) was set up in March 1992 with the following terms of reference:

• to recommend guidelines and common practices for the market including matters such as a code of conduct for brokers and dealers;
• to examine allegations of malpractice or non-compliance with the code of conduct;
• to consider matters relating to the well-being, efficiency and future development of the market including training needs of the industry.

The MPC succeeded the previous Hong Kong Association of Banks/Hong Kong Foreign Exchange and Deposit Brokers Association Liaison Committee but with a broader base of representation. Its membership includes representatives from Hong Kong Monetary Authority (chairman), Hong Kong Association of Banks (secretary), Hong Kong Deposit Taking Companies Association, Hong Kong Forex Association, Hong Kong Foreign Exchange and Deposit Brokers' Association and Hong Kong Society of Accountants.

The MPC has a useful role in maintaining the integrity of the FX and money market as well as promoting Hong Kong's competitiveness as an international financial centre. Its work underpins the self-regulatory framework for the foreign exchange market brokers which is currently functioning very well.

The MPC meets every quarter. Over the last 2 years since its establishment, it has successfully issued the Hong Kong Code of Conduct with a market guide to standard documentation. While it is a non-statutory body with no executive powers, it complements the self-regulation of the market by bringing together the best minds of the market participants and professionals to consider the development of sound market practice. It is an extremely useful forum to discuss what is happening in the money and foreign exchange markets in Hong Kong and abroad, and the appropriate direction of evolution of the market. I can illustrate the work of the MPC by saying a few words about its current thinking.

In recent years, the major traders in the foreign exchange markets have been concerned with legal risks. Because you are trading in different markets in different currencies and legal jurisdiction, the counter-parties may have misunderstandings on contract terms and the applicability of different sovereign laws. An International Foreign Exchange Master Agreement (IFEMA) has now evolved in New York, London and Tokyo. The IFEMA contains provisions which reflect the best FX practices and enable the non-defaulting party, in the event of default by the other party, to close out and liquidate its trading positions. The parties concerned will be in a better position to take measures to quantify and control the risks that may occur. Because the legal position with respect to netting has not always been clear in many jurisdictions, FX business will naturally gravitate towards those markets with greater legal robustness.

Because of this competitive concern, the MPC has worked closely with HKAB, the Forex Association and their legal experts to work on a Hong Kong version of IFEMA. We are seeking legal opinion on the robustness of bilateral netting, and have consulted both the legal experts in Hong Kong, as well as our counterparts in London and Tokyo. The Hong Kong IFEMA is close to finalisation. The aim is to provide a common set of terms for FX spot and forward transactions that will apply equally to such transactions in each of the major FX trading centres such as New York, London and Tokyo where IFEMA has been adopted.

The second area of work that we are thinking a lot about is the development of human skills. Hong Kong has a rich pool of very skilled forex traders, but we cannot afford to be complacent. The fact that a number of Hong Kong personnel occupy top positions in foreign exchange desks in New York, London and Singapore suggest that other markets have succeeded in attracting away our talent to their advantage. That is the market working, but we cannot underestimate the competition, especially since forex markets are developing rapidly around the Region, not least in Singapore.

However, to stay on top of the game, we have to continually upgrade our skills at all levels. The MPC is discussing ways and means to do this, particularly since the FX market in China is about to take off, and demand for market skills will be greater than ever. Because the FX market is also international in nature, we need to take into consideration training not only in front-office skills, but also expertise in back-office settlement areas and in the English language. We know that most of this training is on-the-job, but co-operative efforts to develop training curricula, and possibly certification for new entrants who go through certain courses, would be most helpful. We would be delighted to receive ideas and suggestions on how to move this area forward.

In all these areas, the MPC has received, and I hope to continue to receive, the whole-hearted support of the Forex Association. Hong Kong has maintained, and indeed, enhanced, its status as an international financial centre, mainly because of her open and free market approach to competition. We hope, with your help and co-operation, we will maintain our leading edge in innovation and financial market development.

Thank you.