Hong Kong's new euro clearing system has been in operation since 28 April 2003. Since the system eliminates Herstatt risk in transactions in Hong Kong involving the euro, it is surprising that financial institutions are not making greater use of it.
The Real Time Gross Settlement (RTGS) system for the euro has been in operation for a few weeks now. So far, everything in the new system has been working smoothly. This is to be expected given the experience that has already been built up in the construction and operation of RTGS systems for the Hong Kong dollar and the US dollar. Further, the seamless linkages in the RTGS systems between the three currencies, which enables synchronised "payment versus payment" (PVP) settlement in real time of foreign exchange transactions among the three currencies, has also been working smoothly. Financial market participants are familiar with Herstatt Risk - the risk involved in handing over one currency a few hours before receiving the other currency because of the time difference in the operation of the domestic payment systems of the currencies concerned. Conducting the foreign currency transaction and settling it in Hong Kong enables the risk to be eliminated. Hong Kong scored a first in the elimination of Herstatt Risk for Hong Kong dollar versus US dollar transactions. We have now extended this robust service to transactions between the Hong Kong dollar and the euro and, of much greater international significance, between the US dollar and the euro.
The need to eliminate settlement risk for cross currency transactions, arising from the time difference in the operation of domestic settlement systems, has regrettably not been given the attention it deserves. This is true not only for the occasional users of, and investors in, foreign exchange, but also for the financial institutions providing the service and engaging in trading and market making. I must say that I find this somewhat disappointing. The fact that defaults of financial institutions active in international financial transactions are rare does not mean that they will not occur. If this happens when one leg of a transaction but not the other has been settled, who then is entitled to the money? There has always been a tendency for financial institutions to devote more attention to product innovation than to risk management. There have been cases, even in the recent past, of serious lapses requiring intervention, in one form or another, from the authorities in various jurisdictions to prevent financial meltdown. The application of modern information technology to international finance, which has spurred globalisation, means that such a tendency, if not checked, will breed lapses that will be even more costly to global financial stability. Information technology has valuable applications also in risk management and we have in Hong Kong so applied it to enable RTGS for transactions in three currencies and RTGS PVP for cross currency transactions involving the three currencies.
I would therefore urge all those in Hong Kong, in particular the banks, once again to consider making fuller use of the RTGS payment services in the three currencies. With the recent strength of the euro, I imagine there are many Hong Kong investors becoming active in that currency, whether trading in it against the US dollar or against the Hong Kong dollar, or simply buying and holding it on deposit. Investors, and particularly high net worth investors, may have an interest to ensure that their bankers have access to the local RTGS systems so that foreign exchange transaction services can be provided in a safe and efficient manner. For the financial controllers of the many corporations with frequent transactions in the three currencies, do you not have the responsibility to your board and your shareholders to minimise settlement risks and to better manage liquidity, particularly when there is such a convenient and robust service available locally? For the treasurers of banks, and here I speak as the banking supervisor, would it not be in the interests of banking stability and of your own bank to pay greater attention to the management of settlement risks?
I understand that the liquidity in the markets for deposit, bond and other financial instruments (as against liquidity in the foreign exchange market) of the currencies concerned may have a bearing on the extent to which the respective RTGS payment systems are used. But I believe that, even just in Hong Kong, these markets in the US dollar and the euro do have considerable liquidity. And the fact that there is available in Hong Kong RTGS PVP for a US dollar versus euro foreign exchange transaction should be an attractive feature not just for Hong Kong but for others in this time zone, for example, for the Mainland. This would itself enhance liquidity in those markets in this time zone. The potential is certainly there for growth in activity in those markets. After all, the lion's share of the world's foreign reserves is held by economies in this time zone.
29 May 2003
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