The Medium of Transaction and Hong Kong as an IFC

inSight

11 Aug 2005

The Medium of Transaction and Hong Kong as an IFC

The greater use of foreign currencies for international financial transactions in Hong Kong will facilitate risk management and the development of our position as an international financial centre.

One of the functions of a currency is to serve as a medium of transaction. Instead of the rather inefficient barter system where, for example, a pig might be exchanged for three suits and a pair of shoes, in a monetary economy the values of all goods and services are monetised and transacted in a currency. It is of course necessary for the currency to be acceptable to all parties to the transactions, hence the need for a sound monetary policy to maintain currency stability.

In Hong Kong, the currency that everybody uses as the medium of transaction is of course the Hong Kong dollar. Indeed, it is, as provided in Article 111 of the Basic Law, the legal tender in Hong Kong, meaning in layman's terms that when someone pays you Hong Kong dollars in Hong Kong for goods or services, you have to accept it. Salaries are paid in Hong Kong dollars. Your household bills and other day-to-day expenses are also paid in Hong Kong dollars. Our monetary policy has the clear objective of maintaining currency stability and, because Hong Kong is such an externally-oriented economy where everybody is directly or indirectly doing business with the rest of the world, currency stability is further defined as a stable exchange rate between the Hong Kong dollar and the US dollar.

But there are many transactions that take place in Hong Kong other than those arising from activities in the domestic economy. With Hong Kong being an international financial centre, as provided in Article 109 of the Basic Law, foreign investors come to Hong Kong to access financial instruments issued by those in need of funds, notably from the Mainland. While the Hong Kong dollar can and does serve as a medium of transaction for international financial business organised in Hong Kong, such as the initial public offerings (IPOs) of H-shares, its use is not a requirement. It may be more convenient for foreign investors, for example those from the US, if IPOs and subsequent trading in the secondary market are denominated in US dollars. Equally, it may be more convenient for H-share companies to issue shares in renminbi or indeed US dollars. Such flexibility would save the companies the trouble of having to convert the proceeds of the IPOs back into renminbi for use on the Mainland or into US dollars for funding their international business.

The status of the Hong Kong dollar as the legal tender in Hong Kong does not mean that all transactions have to be denominated in Hong Kong dollars. Where the parties to the transaction agree, they can use whatever currency they like, or no currency at all and go back to barter. I would argue that, if we are serious about providing "an appropriate economic and legal environment for the maintenance of the status of Hong Kong as an international financial centre" (Article 109 of the Basic Law again) then it is essential for Hong Kong to be able to offer the parties to international financial transactions a platform for conducting those transactions in a currency of their choice.

There is the additional consideration of currency stability in Hong Kong. A successful platform, which provides a meeting place for people from other jurisdictions with surplus money and those in need of funds, involves large volumes of financial transactions. For all these to be converted into and out of Hong Kong dollars will present considerable challenges for monetary management in Hong Kong. Readers may recall that a few large IPOs in the past destabilised, however temporarily, monetary conditions in Hong Kong. Although refinements to our monetary system have helped Hong Kong to cope with these large capital flows, risks of instability in our currency would be avoided altogether if the transactions concerned were denominated in foreign currencies. As mentioned earlier, this may also be the preferred arrangement for foreign investors and fund raisers.

Greater use of foreign currencies for international financial transactions in Hong Kong will not undermine the status of the Hong Kong dollar as the currency for domestic transactions; it is the legal tender here in any case. The use of other currencies for international transactions will enhance the status of Hong Kong as an international financial centre. That is why we have been so keen on developing the financial infrastructure – the payment, clearing and settlement systems – that supports the use of other currencies, including the renminbi, in Hong Kong, to facilitate international finance and other cross-border activities. And specifically in respect of enhancing our financial infrastructure to handle renminbi transactions, our aim should be a platform to serve not only financial intermediation between the Mainland and the rest of the world but also between Mainland investors and Mainland issuers. We have the sophisticated capital markets that are lacking on the Mainland and the difficulties arising from geographical boundaries against capital mobility can be overcome with co-operation between the regulatory authorities.

 

Joseph Yam

11 August 2005

 

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Last revision date : 11 August 2005