The Hong Kong Monetary Authority (HKMA) strongly reiterates that there will be no foreign exchange controls in the Hong Kong Special Administrative Region (HKSAR). Article 112 of the Basic Law clearly specifies that no foreign exchange control policies shall be applied in the HKSAR. Furthermore, the HKSAR Government is fully committed to the maintenance of the linked exchange rate system and the adherence to the discipline of the currency board arrangements under that system.
To further strengthen the currency board arrangements and make them less susceptible to manipulation by speculators to produce extreme conditions in the interbank market and interest rates, the HKMA today (5 September 1998) announced a package of seven technical measures, which include the following :
- the HKMA providing a clear undertaking to all licensed banks in Hong Kong to convert Hong Kong dollars in their clearing accounts into US dollars at the fixed exchange rate of HK$7.75 to US$1. This explicit Convertibility Undertaking is a clear demonstration of the Government's commitment to the linked exchange rate system. It is the intention of the HKMA to move the rate of the Convertibility Undertaking to 7.80 when market circumstances permit;
- removing the bid rate of the Liquidity Adjustment Facility (LAF). As the improved efficiency of the interbank payment system has facilitated liquidity management of licensed banks, the need for the LAF deposit facility to facilitate orderly interbank market activities has fallen away;
- replacing LAF by a Discount Window with the Base Rate (formerly known as the LAF Offer Rate) to be determined from time to time by the HKMA. In determining the Base Rate, the HKMA will ensure that interest rates are adequately responsive to capital flows while allowing excessive and destabilizing interest rate volatility to be dampened;
- removing the restriction on repeated borrowing in respect of the provision of overnight Hong Kong dollar liquidity through repo transactions using Exchange Fund Bills and Notes. Allowing for freer access to day end liquidity through the use of Exchange Fund paper which is fully backed by foreign currency reserves will make Hong Kong's monetary system less susceptible to manipulation and dampen excessive interest rate volatility without departing from the discipline of the Currency Board arrangement;
- new Exchange Fund paper to be issued only when there is an inflow of funds. This will ensure that all new Exchange Fund paper will be fully backed by foreign currency reserves;
- introducing a schedule of discount rates applicable for different percentage thresholds of holdings of Exchange Fund paper by the licensed banks for the purpose of accessing the Discount Window. This will ensure that the interest rate adjustment mechanism to be fully kicked in when the Hong Kong dollar is under significant pressure; and
- retaining the restriction on repeated borrowing in respect of repo transactions involving debt securities other than Exchange Fund paper. No new issues of paper other than Exchange Fund paper will be accepted at the Discount Window. This will prevent significant liquidity to be provided to licensed banks against paper not backed by foreign currency reserves.
In addition to the above measures, the HKMA will work towards producing an Exchange Fund balance sheet showing Currency Board operations and have this published as frequently as it is technically feasible.
The seven technical measures and the move towards greater disclosure have been approved by the Exchange Fund Advisory Committee (EFAC), upon the recommendation by its Subcommittee on Currency Board Operations. The Subcommittee has been set up recently to oversee the operation of the currency board arrangements in Hong Kong.
In commenting on the seven measures, Mr. Donald Tsang, Financial Secretary, said, "The package of technical measures will strengthen our defence against manipulation by the speculators in our foreign exchange and money markets. They should also help instill greater confidence in our full commitment to the currency board system."
Mr. Joseph Yam, Chief Executive of the HKMA, said, "These measures aim at strengthening Hong Kong's currency board arrangements and achieving an even higher degree of transparency and disclosure. They will enhance the robustness of Hong Kong's monetary arrangement, characterized by the linked exchange rate system. They should also help to reduce excessive volatility in interest rates."
A technical note on the package of technical measures as well as the composition and the terms of reference of the EFAC Subcommittee on Currency Board Operations is attached.
Hong Kong Monetary Authority
5 September 1998
Strengthening of Currency Board Arrangements in Hong Kong
Introduction
The Hong Kong Special Administrative Region Government is firmly committed to the maintenance of the linked exchange rate system and the adherence to the discipline of the Currency Board arrangements under that system. This policy has served Hong Kong extremely well over the past fifteen years. The linked exchange rate system has also proven to be the linchpin of financial stability in Hong Kong, and beyond, against the worst financial turmoil in the history of Asia. It has the wide support of the community of Hong Kong and the international financial community, particularly in official circles.
Recent developments in the global financial system, encouraged by financial liberalization and the advancement of information and telecommunications technology, have been characterized by very high volatility in international capital flows. This can be very destabilizing and presents tremendous risks for the world economy, in particular for the small open economies, as is clearly demonstrated by events in the past year or so. These risks have to be properly managed and financial stability ensured so that the benefits in the freedom of capital flows can be fully realized.
Hong Kong does not believe in exchange controls. Indeed, the Basic Law specifies clearly that no foreign exchange control policies shall be applied in the Hong Kong Special Administrative Region. Hong Kong is further determined and is very well prepared to bear the pain of adjustments, including interest rate adjustments, under the linked exchange rate system. But in managing the risks of free capital flows, including the possibility of financial markets being subject to manipulation that exacerbates financial volatility and hence the severity of economic adjustment, there is a need now to strengthen further the Currency Board arrangements in Hong Kong's linked exchange rate system.
Seven Technical Measures
Against this background, the Hong Kong Monetary Authority (HKMA) announced today a package of seven technical measures to strengthen the Currency Board arrangements in Hong Kong. After consulting with the Exchange Fund Advisory Committee (EFAC), the Financial Secretary has given his approval for the implementation of the package.
The first technical measure is in the form of a clear undertaking from the HKMA to licensed banks to convert Hong Kong dollars in their clearing accounts into US dollars at the fixed exchange rate of HK$7.75 to US$1 (the Convertibility Undertaking). This explicit Convertibility Undertaking is a clear demonstration of the Government's commitment to the linked exchange rate system. The rate of 7.75 has been chosen because it is the current intervention rate of the HKMA. However, it is the clear intention of the HKMA, when market circumstances permit, to move the rate of the Convertibility Undertaking to 7.80, which is the fixed exchange rate of our linked exchange rate system applicable to the issue and redemption of Certificates of Indebtedness backing the bank notes. This will be done at a time when the market exchange rate is trading consistently at a level significant stronger than 7.75.
With effect from the opening of the market in Hong Kong on Monday 7 September 1998, all licensed banks will be able to take advantage of the Convertibility Undertaking, on their own or on behalf of their customers should they find themselves in a position to do so. They must, however, ensure that they have the necessary Hong Kong dollars in their clearing accounts on settlement day to effect settlement. In order to monitor how transactions under the Convertibility Undertaking are being conducted and ensure that the arrangement is not being abused, there will be a need to seek relevant information from licensed banks. This will be a subject to be addressed separately, possibly with licensed banks on an individual basis.
The second technical measure involves the removal of the bid rate of the Liquidity Adjustment Facility (LAF). The LAF was introduced in 1992 when the former Accounting Arrangements were in place to facilitate, amongst other things, orderly interbank market activities. The Accounting Arrangements have, since the end of 1996, been replaced by the requirement whereby all licensed banks maintain a clearing account with the HKMA, on the occasion of the introduction of RTGS in Hong Kong. The improved efficiency of the interbank payment system has facilitated liquidity management of licensed banks. The need for the HKMA bidding money at the end of the day through LAF has fallen away as a result.
The third technical measure deals with the determination of the LAF offer rate which is to be renamed the Base Rate. LAF will also be renamed as the Discount Window. The Base Rate will form the foundation on which different discount rates are computed and for use in the overnight repurchase agreements (repos) through the Discount Window in respect of different percentage thresholds of Exchange Fund paper held by licensed banks. In determining the Base Rate, it is obviously essential, on the one hand, to ensure that interest rates are adequately responsive to capital flows and, on the other hand, to allow excessive and destabilizing interest rate volatility to be dampened. The methodology for doing so will need to be developed and refined in the light of experience. But it is the intention of the HKMA to be as transparent as possible in this task and eventually to go for a methodology that involves as little discretion on the part of the HKMA as practicable. One way of doing so, at least initially, might be to take the average of the overnight and one-month HIBOR of the previous day as reference for determining the Base Rate for the day. As from Monday 7 September, the HKMA will announce each day before the market opens in Hong Kong the Base Rate applicable for the day. It is likely that there will, from then on, be rather frequent changes in the Base Rate.
The fourth technical measure concerns the manner in which Exchange Fund paper can be used by licensed banks to obtain overnight Hong Kong dollar liquidity from the HKMA at the close of the money market in Hong Kong through the Discount Window. Given that the Exchange Fund paper is in effect fully backed by Foreign Reserves, the HKMA is prepared to allow for greater access by licensed banks to day end liquidity through repos at the Discount Window using the paper. Subject to the provisions in the sixth measure, the restriction in which the HKMA imposes penal interest rates on repeated borrowers through the repo of Exchange Fund paper will be removed as from Monday 7 September 1998.
The fifth technical measure is in the form of a clear commitment from the HKMA that new Exchange Fund paper will only be issued when there is an inflow of funds enabling the additional paper to be fully backed by Foreign Reserves. This is to ensure that the repo of Exchange Fund paper through the Discount Window does not involve any departure from the discipline of the Currency Board system. Existing issues of Exchange Fund paper outstanding, which are already backed by Foreign Reserves, will be rolled over as and when they mature.
The sixth technical measure spells out, for the purpose of accessing the Discount Window, a schedule of discount rates applicable for different percentage thresholds of holdings of Exchange Fund paper by licensed banks, as follows:
The seventh technical measure deals with the position of the existing eligible paper for LAF other than Exchange Fund paper. Overnight repos using such paper will still be allowed. For triple-A rated paper and Specified Instruments , the schedule of discount rates applicable to Exchange Fund paper will apply. For other eligible paper, the schedule of discount rates will be at a premium of 0.25% over those applicable to the discount of Exchange Fund paper. Repeated borrowings, in accordance with the existing definition, using eligible paper other than Exchange Fund paper will continue to be discouraged through the charging of a penal rate by HKMA. To prevent significant liquidity to be provided to licensed banks against paper not backed by Foreign Reserves, no new issues of paper other than Exchange Fund paper will be eligible for acceptance at the Discount Window.
Greater Transparency and Disclosure
Apart from the package of seven technical measures, the HKMA also announced a voluntary move towards even greater transparency and disclosure on its Currency Board operations. Information on the Aggregate Balance in the clearing accounts of licensed banks maintained with the HKMA is already available almost on real time and this is unparalleled in any other jurisdiction. The HKMA will further work towards identifying clearly that part of the Exchange Fund balance sheet showing Currency Board operations. The relevant information will be published as frequently as it is technically feasible to do so, at least along with, and perhaps ahead of, the monthly publication of the balance sheet of the Exchange Fund as from the beginning of next year. The information will show, on the asset side, Foreign Reserves designated to back, on the liability side, the Monetary Base (which includes bank notes and coins issued, and the Aggregate Balance) and all the Exchange Fund paper outstanding. It will further show, over time, how the HKMA is adhering to the discipline of a Currency Board system.
Points to Note
The package of seven technical measures introduced by the HKMA and the voluntary move towards greater disclosure and transparency are clearly aimed at the strengthening Hong Kong's Currency Board arrangements. These measures will enhance the robustness of the linked exchange rate system with a fixed exchange rate for the Hong Kong dollar against the US dollar at 7.80. They will also dampen excessive and destabilizing volatility in interest rates. In the operation of the Currency Board arrangement with these technical measures introduced, there are three points that the HKMA would wish the banking community to note specifically.
First, the Discount Window, like LAF, is not to be used by licensed banks to facilitate manipulation that may destabilize the currency or money markets. A licensed bank will be restricted access to the Discount Window if there is reason to believe that it has been engaging in such activity.
Second, the state of the public finances of the Government would from time to time require the HKMA, as the agency managing the fiscal reserves and providing assistance in the cash flow of the Treasury, undertaking certain activities in the foreign exchange and money markets. In all such activities, for example in the funding of the rare budget deficits through the use of foreign reserves, the HKMA would ensure that there is no departure from the discipline of the Currency Board arrangements.
Third, the HKMA clearly has a responsibility to ensure that the money market functions in an orderly manner. There have been occasions when large scale Hong Kong dollar transactions (such as in the case of large Initial Public Offerings) created extreme conditions in the interbank market. In a statement made on 3 March 1998, Mr Joseph Yam, Chief Executive of the HKMA, has made it clear that, in these circumstances, the HKMA may lend to or borrow from the interbank market to dampen extreme conditions. This policy remains unchanged.
Currency Board Operations Sub-Committee
The package of technical measures to strengthen the Currency Board arrangements of Hong Kong has earlier been examined closely by a Sub-Committee on Currency Board Operations of the EFAC established recently with the approval of the Financial Secretary. The Sub-Committee is chaired by the Chief Executive of the HKMA Mr Joseph Yam. The other members of the Sub-Committee are:
- The Hon David K.P. Li
- Mr Marvin Cheung
- Professor Y.C. Jao
- Mr Mervyn Davies as Chairman of the Hong Kong Association of Banks
- Mr David Carse, Deputy Chief Executive, HKMA
- Mr Andrew Sheng, Deputy Chief Executive, HKMA
- Mr Norman Chan, Deputy Chief Executive, HKMA
The terms of reference of the EFAC Sub-Committee on Currency Board Operations are:
- to ensure that the operation of the Currency Board arrangements in Hong Kong is in accordance with the policies determined by the Financial Secretary in consultation with the Exchange Fund Advisory Committee;
- to report to the Financial Secretary through the Exchange Fund Advisory Committee on the operation of the Currency Board arrangements in Hong Kong;
- to recommend, where appropriate, to the Financial Secretary through the Exchange Fund Advisory Committee, measures to enhance the robustness and effectiveness of the Currency Board arrangements in Hong Kong;
- to ensure a high degree of transparency in the operation of the Currency Board arrangements in Hong Kong through the publication of relevant information on the operation of such arrangements; and
- to promote a better understanding of the Currency Board arrangements in Hong Kong.
Hong Kong Monetary Authority
5 September 1998
