International Fund Flows and Payment Systems

inSight

09 Sep 2004

International Fund Flows and Payment Systems

Efficient payment systems in a variety of currencies can help minimise financial market volatility created by international fund flows.

One characteristic of an international financial centre with a liquid platform, which attracts foreign savings looking for investment opportunities in different jurisdictions, is that its financial markets tend to be more reactive to external events. This is the case for Hong Kong. There are substantial savings (domestic as well as foreign) flowing into financial instruments structured upon investment opportunities on the Mainland that are traded in Hong Kong. One good example is the investment of foreign funds in the H-shares or red chips listed in Hong Kong. So, significant events on the Mainland that affect the economic and financial outlook there, for example the implementation of macro-economic adjustments measures, may lead to sharp movements in the stock market in Hong Kong.

There is a need for financial market participants, whether they are retail investors or banks providing finance, to be alert to this characteristic inherent in our markets, and the associated risks that they are correspondingly exposed to. Unlike other international financial centres, the Hong Kong financial platform plays the additional, important role of marrying savings and investments that are both foreign. This probably makes Hong Kong unique, for I am not aware of any other international financial centre playing this additional role in a significant way. In that sense, Hong Kong is arguably more of an international (meaning across financial jurisdictions) financial centre than New York, where the marrying of savings and investments, if there is an international dimension involved, usually has US interests as one of the two parties to the marriage. But this also means that Hong Kong's financial markets may not reflect the general economic prospects here.

Furthermore, with capital controls continuing on the Mainland, and Hong Kong serving as the "offshore" centre for international financial intermediation involving the Mainland, operating outside these controls, formally or informally, the financial market dynamics can be quite complex. There are two special factors at work here. First, policy changes on the Mainland - and these are quite frequent and unpredictable because of continuing financial reforms, sometimes by trial and error - may disrupt investment fund flows in either direction through Hong Kong, thus creating volatility. Secondly, Hong Kong's financial markets are also frequently used to hedge against exposures to the Mainland, particularly when it is not possible for foreign investors to do so on the Mainland markets. Thus, when there are potential or actual events that affect the business environment on the Mainland, to the extent that hedging becomes necessary, sharp movements may also occur in the financial markets in Hong Kong.

Such volatility may or may not have significant implications for Hong Kong, depending on how the relevant financial products are structured, including their currency denomination. Increasing political pressure for a more flexible renminbi exchange rate in the second half of last year, for example, affected Hong Kong. The freely convertible Hong Kong dollar was used as a proxy for hedging against, or speculating on, a possible appreciation of the renminbi. Substantial fund inflows increased the Aggregate Balance and pushed Hong Kong dollar interest rates at the short end down to zero. In the event, the resulting very easy monetary conditions, which still prevail, now have been helpful, in terms of getting deflation out of the system. (But in other times they could well affect Hong Kong in an unfavourable way.) At the same time, the matter has also led to very sharp fluctuations in the fairly sizeable non-deliverable renminbi forward market in Hong Kong. But since this market is very much one for professionals, who are able to manage their own financial risks, the volatility has had no effect on Hong Kong.

The financial platform in Hong Kong, which facilitates the marriage of savings and investments both of outside origin, should be structured in a way that provides various options of currency denomination for financial products. This is both for the convenience of the market participants, in terms of risk management (the elimination of exchange risk of the Hong Kong dollar), and in the interest of maintaining monetary and financial stability in Hong Kong. This is why we have developed efficient payment systems in different currencies and hope of course to include the renminbi when circumstances permit. And we have no objection to the pricing of financial products, for example the listing and trading of shares, in different currencies, if this is considered appropriate.

 

Joseph Yam

9 September 2004

 

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