The Development of Financial Centres - Policy and Prudential Issues
Speeches
01 Sep 1994
The Development of Financial Centres - Policy and Prudential Issues
Andrew Sheng, Deputy Chief Executive, Hong Kong Monetary Authority
(Speech at "Shanghai-Hong Kong Economic Co-operation Towards the 21st Century" Conference, Business and Professionals Federation of Hong Kong, 12 - 13 September 1994, Hong Kong)
- I am very honoured to be asked by Sir Q W Lee and Mr Vincent Lo
to address this important Conference. The theme of this Conference
is both timely and critical. We are witnessing today not only the
historic transformation of the Chinese economy, but also the
evolution of East Asia as a major economic and financial force in
world growth. Consider this:
- the countries in the East Asian corridor today account for
roughly 40% of the world's official foreign exchange reserves;
- East Asian financial centres, from Tokyo through Hong Kong and
Singapore through to Jakarta, account for three of the top seven
international financial centres of the world, measured by market
capitalization or trading volume; and
- More significantly, they are all in the same time zone.
- Shanghai will soon join the ranks of major financial centres.
The issue is not if, but when and how. I am sure that this
Conference will make a major contribution to clarify the way
forward.
- When Sir Q W Lee asked me to speak on this subject, we agreed
that Mr Paul Selway-Swift will talk on the commercial perspectives
of evolution of Shanghai as an international financial centre, and
the co-operative role of Hong Kong, while I will concentrate on the
policy and prudential aspects. To help focus our discussions, I
have set out the key financial indicators, comparing Shanghai, Hong
Kong and Singapore in Chart 1. As you can see, Shanghai has double
the population of Hong Kong, but the size of her financial markets
are still relatively small compared to Hong Kong or Singapore.
- In my past experience in the World Bank and central banking in
Malaysia, I have always been asked how, from a policy and
prudential point of view, a country can develop its financial
markets. The issues are clearly complex, but a simple way of
looking at the problem is to go to basics and ask what makes a
successful market. I believe the complex issues can be summed up in
what I call the 5 P's: a market comprises PEOPLE trading PRODUCTS,
under a POLICY and PRUDENTIAL framework, using an accepted
technological PLATFORM.
- I have used this framework to compare the stages of development
of Shanghai and Hong Kong, and as you can see from Chart 2, Hong
Kong is already an established international financial centre, with
a free port, free capital flows and currency convertibility, while
Shanghai is still developing the whole range of products, systems
and institutions.
- I will not spend too much time on the People and Products
issues (Chart 3), because Mr Selway-Swift is much better qualified
to talk about how the Hong Kong banking community can contribute to
the development of human skills and financial products. The point I
wish to make about the People/Skills area is that from a policy
point of view, you cannot train every skill you need internally. In
the experience of growth of every international financial centre,
the role of foreign banks and non-bank financial institutions has
been critical in the skills development and innovation area. This
was certainly true for Hong Kong.
- With regard to financial products, however, we often forget
that all financial products are essentially legal contracts (Chart
4). Financial markets therefore trade legal contracts involving
property rights and obligations. This clearly implies that there
must be a complete legal framework: the more complex the financial
instrument, the greater the need for comprehensive laws,
regulations, code of conduct and market practices. Local financial
centres can operate with a set of unique domestic rules and
regulations, but there can be no internationalization of trading.
Fortunately, you do not need to re-invent the wheel in devising new
laws and regulations and contracts. Increasingly, with
globalization, there are now International Foreign Exchange Master
Agreement (IFEMA), the ISDA Master Swap Agreement and Master REPO
Agreement that are rapidly being accepted around the world. Hong
Kong has good experience with these and can provide advice on their
use and adaptation.
Policy Framework
- The Policy framework for the development of financial markets
is critical to their success. Hong Kong is a clear example of how,
with the right policy framework, financial markets evolved
naturally to make Hong Kong an international financial centre,
without deliberate government intervention. This is not to say that
direct government efforts to promote an international financial
centre has not worked, such as the efforts in Singapore. However,
even in the case of Singapore, several key policy elements were
present: these include, a stable macro-economic
environment, disciplined fiscal policy; minimal directed credits;
and supportive financial and prudential policies that encourage
financial discipline, and general policy credibility and
consistency (Chart 5). Without these key elements, many
attempts to create international or regional financial centres in
developing countries have not succeeded.
- The experience from Hong Kong is that if you maintain a
market-friendly policy environment, the markets can evolve quite
quickly on their own account, without the need for subsidies or
government intervention. With a clear level playing field, an
equitable and credible tax and regulatory regime, the financial
markets will respond to the opportunities in the environment.
- In certain areas, for example, some market promotion activities
which do not involve any subsidies can help give the market a nudge
in the right direction. For example, the issue of Exchange Fund
Bills and Notes, even though the government has no need to borrow,
has helped to create a benchmark for HK$ debt paper and has overall
promoted the deepening of the HK$ debt market. Since it was created
in 1990, the Exchange Fund Bills and Notes Programme has grown to
an outstanding size of HK$45 billion, with a daily turnover of
around HK$20 billion, one of the most active government debt
markets in the world.
Prudential Framework
- The international experience, including that of Hong Kong, is
that financial markets work well where there is a firm legal and
prudential framework that protects property rights, and market
participants from unfair practices. This calls for not only a good
set of contract, commercial, banking and land laws and regulations,
that are accepted by all market participants as open, fair and
equitable, but also a court and arbitration system that will
enforce contracts firmly and fairly (Chart 6). Hong Kong has all
these laws - the Common Law - and systems in place, which have made
domestic and foreign market participants - investors, issuers,
intermediaries and the general public - confident that contract
disputes will be dealt with fairly and expeditiously, while illegal
and unfair practices would be punished according to the law. This
set of laws is well understood and accepted by all international
market participants.
- In addition, the supervisory framework for different markets
should be in place for the banking, insurance and the securities
sectors. Hong Kong applies the highest international prudential
standards in ensuring that all financial market participants can
trade in Hong Kong under protection of the law, without fear or
favour. We have struck a clear balance between the need for
prudential regulation without stifling the innovative and
entrepreneurial spirit of the market place.
- In this regard, it is particularly important that the
regulatory bodies are strong professionally and are able to
exercise their enforcement action without any market perception of
political interference. The policy commitment to this aspect of the
regulatory framework cannot be underestimated, as the market cannot
succeed well in an unlevel and non-transparent playing field.
- We are indeed fortunate that the constant process of market
consultation, both formal and informal, between the market
participants and the regulatory authorities in Hong Kong have
ensured that the regulatory framework is responsive to changes in
the market place, without sacrificing the need to protect the
public interest.
Technological Platform
- Before I end this presentation, I would like to say a few words
about the technological platform (Chart 7), by which I mean the
manual, mechanical or electronic procedures and systems that are
needed to facilitate trading, clearing and settlement. The core
element of this is the payment system. The subsidiary elements are
the securities trading, clearing and settlement systems that are
increasingly being automated. In many developing countries, the
market cannot develop because of outdated processing and delayed
payments which stifle trading and create opportunities for fraud. A
clear example is the securities problems in Bombay a few years
ago.
- In international financial centres, it has become recognized
that in a global trading environment, payment and securities system
- i.e. the technological platform - cannot afford to fail. They
have to be both efficient and robust, and because of international
linkages, they must not only comply with international standards,
but also be fail-proof. Otherwise, failures in one centre because
of platform disasters could have chain-reaction effects on other
financial centres. Markets will shift clearly to those centres that
offer both efficient and robust technological platforms. Even
though Hong Kong has a highly automated and effective payment
system, we have recently decided to move towards Real Time Gross
Settlement (RTGS), to meet the latest international standards, so
as to facilitate Delivery versus Payment (DvP) and Payment versus
Payment (PvP), in readiness for global 24-hour trading and
payments. We are delighted to know that by 1996, China would also
have RTGS, which should benefit Shanghai significantly.
Challenges
- I should like to end this survey of the policy and prudential
aspects of financial market development by giving a few personal
observations about Shanghai and Hong Kong co-operation in the years
ahead.
- First of all, I do not see the rise of Shanghai as a threat to
Hong Kong, more as an opportunity (Chart 8). As Shanghai grows in
strength and stature, there will be an acceleration in
inter-financial centre trading in the same East Asian time zone,
since finance always follows the growth in trade and investments.
The growth of the East Asian financial centres can only be
complementary to each other, not competitive. In our eagerness to
compete, we tend to forget that trade in financial products is no
different from trade in physical goods: it is mutually beneficial
and is not a zero sum game. We are looking at trade creation, not
trade diversion. You always need a counterparty to trade in
financial products, be it shares or foreign exchange. What better
counterparty is there for Shanghai than Hong Kong?
- From a policy perspective, it is my personal belief that for
some time to come, Shanghai will be different from Hong Kong. Hong
Kong will retain, and indeed, enhance its role as an international
financial centre, because of its solid commitment, through the
Joint Declaration and the Basic Law, to its free market economy. On
the other hand, Shanghai has to play a major role in the
transformation of the Chinese economy, particularly in the reform,
restructuring and upgrading of the enterprise sector into
internationally competitive firms, and to assist in mobilizing
domestic RMB finance for the huge investments required for
infrastructure development. All these will require policy
considerations that may involve policy-based lending or pricing
issues that has to take into consideration the needs of the whole
economy, and not just one financial centre. I see these issues not
as constraints, but as major challenges for Shanghai.
- In the desire for fast growth, certain choices have to be made.
It would certainly not be possible to develop the full range of
financial products, institutions, prudential framework and policy
credibility overnight. Even Singapore has taken nearly 30 years to
reach its status today. The comparative advantage of Shanghai will
be its RMB business, and it is well known that corporate or
enterprise finance and infrastructure finance have huge demands
that have to be met. My humble opinion is that one of the biggest,
if not the biggest, challenge in domestic financing in China in the
years to come is the housing finance market. As national income
increases, so does the growth of home ownership and the need for
residential home finance. In the United States, residential
mortgages account for just under 50% of GDP, while in Hong Kong,
the equivalent is 30%. In China, the residential mortgage market -
a RMB market - is only just beginning. If this reaches 20% of GDP,
for example, that is a RMB630 billion (US$73 billion) market.
Shanghai's role in this will be unrivalled.
- In the challenging years ahead, I would just like to say that
the HKMA, and the financial community in Hong Kong, would be quite
pleased to provide whatever advice we can in our respective fields
in making both cities amongst the strongest and most vibrant
financial centres in the world.
- Thank you for giving me an opportunity to participate in this
stimulating and important occasion.
Chart 1 - Key Financial Indicators, 1993
|
Unit |
Singapore |
Hong Kong |
Shanghai |
Population |
mn |
2.851 |
5.92 |
12.94 |
GDP |
US$ bn |
55.6 |
108.7 |
17.4 |
GDP per capita |
US$ |
19,500 |
18,364 |
1,343 |
Share of financial services (including insurance) in GDP |
|
---- |
9.4%2 |
7.6% |
Percentage of persons employed in financial services (including
insurance) |
|
---- |
6.0%6 |
0.6%3 |
No. of Foreign Banks |
|
118 |
140 |
284 |
Exports |
US$ bn |
74.7 |
134.1 |
7.38 (ex Shanghai)
14.0 (via Shanghai) |
Imports |
US$ bn |
86.0 |
137.5 |
5.34 (to Shanghai)
17.0 (via Shanghai) |
StockMarket Capitalization |
US$ bn |
150.6 |
298.1 |
22.05 |
Average Daily Foreign Exchange Transcations |
US$ bn |
85.4 |
60.97 |
0.15-0.208 |
Government Bonds
- Outstanding
- Average Daily Turnover |
US$ bn
US$ bn |
10.6
0.23 |
6.39
3.011 |
6.010
0.112 |
- Resident population which includes only Singapore citizens and
permanent residents
- 1991 figure
- 1992 figure
- As of mid-1994. Include only foreign bank branches, but not
representative offices.
- July 1994 figure
- Includes only private sector
- April 1992 figure
- August 1994 figure
- August 1994 figure. Include government bonds, Exchange Fund
Bills and Notes
- 1992 figure
- August 1994 figure
- For the first half of 1994
Chart 2 - Financial Centres: Hong Kong vs Shanghai
|
Hong Kong |
Shanghai |
People/Skills |
Developed |
Developing |
Products |
Full range |
Evolving |
Policy |
Free Market |
Planned |
Prudential Framework |
International Standards |
Evolving National Regulations |
Platform (Technology) |
In place |
Building |
Chart 3 - People
- Need full range of skills - financial, legal, accounting,
trading, regulatory, and support services
- Develop specialist skills - brokers, dealers, underwriters,
actuaries, asset management etc.
- Need training and manpower planning programme
- Cannot do this wholly in-house - need input from foreign
financial institutions
Chart 4 - Financial Products
- All financial products are LEGAL CONTRACTS,
e.g. deposit contract, loan contract, leasing contract;
- Hence importance of LEGAL and
PRUDENTIAL FRAMEWORK;
- GLOBALIZATION requires global contract
standards, e.g. IFEMA, ISDA Master Agreement, Master REPO Agreement
etc.;
- Cannot develop all product range at the same time.
Chart 5 - Policy Framework
- Financial Development needs Stable Macro-economic
Framework
- Disciplined Fiscal Policy
- No tax or stamp duty distortions
- No unequal tax rates against any sector
- No excessive borrowing by state
- Supportive Financial Sector Policy
- Minimal directed credit/interest subsidy policies
- Encourage financial discipline, e.g. allow bankruptcy of failed
firms
- Establish benchmark pricing for government bonds
- Allow free markets to determine prices of financial
products
- Level playing field - no discriminatory restrictions against
foreign investments, either portfolio or direct investments in
financial or non-financial institutions
- Encourage freedom of entry and exit
- Transparent and Timely Information Disclosure
- Accounting and auditing according to GAAP & IAS
- Timely disclosure of financial statements of listed companies
and major financial institutions
- Policy credibility
Chart 6 - Prudential Framework
- Adopt laws and legal system that protects property rights,
right to contract, sell or trade, and enforce contracts
- Need for efficient and fair court/arbitration system to cope
with contractual disputes, bankruptcies
- Adopt international standard codes of conduct and market
practices
- Apply international standards of prudential supervision, e.g.
Basle Capital Adequacy, IOSCO standards
- Create professional and strong regulatory bodies that are free
from political interference
- Create close dialogue between financial sector and regulators
to ensure market-friendly development in sound, safe and equitable
manner
Chart 7 - Technological Platform
- Efficient telecommunications and information network linked
internationally
- Robust and efficient payment and settlement system
- Robust and efficient securities trading, clearing and
settlement system
- Software/Hardware for front office/back office
- Compatible standards with international networks, e.g.
SWIFT
Chart 8 - Challenges
- Hong Kong complements Shanghai growth, not a competitor
- Role of Shanghai in enterprise financing and reform
- Priority development areas - policies, products and
institutions
- Concentrate on strengths - develop RMB business
- HKMA can help in developing prudential framework