Panel on Financial Affairs ( Minutes ) 1 Feb 99

LC Paper No. CB(1)1592/98-99
(These minutes have been seen by the Administration)

Ref : CB1/PL/FA/1

Legislative Council Panel on Financial Affairs

Minutes of meeting held on Monday, 1 February 1999, at 10:45 am in the Chamber of the Legislative Council Building

Members present :

Hon Ambrose LAU Hon-chuen, JP (Chairman)
Hon Eric LI Ka-cheung, JP (Deputy Chairman)
Hon Kenneth TING Woo-shou, JP
Hon James TIEN Pei-chun, JP
Hon David CHU Yu-lin
Hon Cyd HO Sau-lan
Hon NG Leung-sing
Hon Margaret NG
Hon Ronald ARCULLI, JP
Hon CHEUNG Man-kwong
Hon HUI Cheung-ching
Hon Bernard CHAN
Hon SIN Chung-kai
Hon Jasper TSANG Yok-sing, JP
Hon FUNG Chi-kin

Members attending :

Hon LEE Cheuk-yan
Hon Martin LEE Chu-ming, SC, JP
Hon LEE kai-ming, JP
Hon Fred LI Wah-ming
Hon CHAN Yuen-han
Hon CHAN Wing-chan
Hon CHAN Kam-lam

Members absent :

Hon Albert HO Chun-yan
Dr Hon David LI Kwok-po, JP
Hon James TO Kun-sun
Hon Ambrose CHEUNG Wing-sum, JP
Dr Hon Philip WONG Yu-hong
Hon Timothy FOK Tsun-ting, JP

Public officers attending:

Agenda item IV
Mr M M GLASS: Deputy Secretary for the Treasury
Mrs Lesley WONG: Principal Assistant Secretary for the Treasury
Agenda item V
Mrs Rebecca LAI: Deputy Secretary for Financial Services
Mr YEUNG Tak-keung: Assistant Secretary for Financial Services
(Companies) 1
Mr J S BUSH: Secretary for Standing Committee
on Company Law Reform
Mr Philip K F CHOK: Deputy Secretary for Education and Manpower (1)
Miss Erica NG: Principal Assistant Secretary for
Education and Manpower (4)
Mr Tsang Kin-woo: Assistant Commissioner for Labour
Agenda item VI
Mr David CARSE, JP: Deputy Chief Executive (Banking)
Hong Kong Monetary Authority
Mr Edmond LAU: Head (Banking Development)
Hong Kong Monetary Authority
Mr Peter LI: Senior Manager (Banking Development)
Hong Kong Monetary Authority
Miss Clara TANG: Principal Assistant Secretary for Financial Services
(Banking and Monetary)

Clerk in attendance :

Ms Estella CHAN: Chief Assistant Secretary (1)4

Staff in attendance :

Ms Pauline NG: Assistant Secretary General 1
Ms Connie SZETO: Senior Assistant Secretary (1)1

I Confirmation of minutes and matters arising
(LC Paper No. CB(1)815/98-99)

The minutes of the meeting held on 12 September 1998 were confirmed.

II Information paper issued since last meeting

2. Members noted that no information paper had been issued since last meeting.

III Items for discussion at the next meeting
(LC Paper No. CB(1)816/98-99(01))

3. Members agreed to discuss the following items at the next regular meeting scheduled for Monday, 1 March 1999, at 10:45 am -

Briefing on the meeting of the Chief Executive's Council of International Advisers; and
Progress of development of a Venture Board.

(Post-meeting note: At the request of the Administration and with the concurrence of the Chairman, item (b) above was deferred to a later meeting. Two other items were added to the agenda, ie. Securities and Futures Commission's budget for 1999-2000 and review of the tax reserve certificate system.)

4. The Chairman said that upon the Administration's request the item on progress of implementation of the Mandatory Provident Fund System would be deferred to the meeting in April 1999.

5. Members agreed on the meeting schedule for the period from April to July 1999 as follows -

Date	Time
13 April	2:30 pm
3 May	10:45 am
7 June	10:45 am
5 July	10:45 am

6. Members further agreed to visit the Stock Exchange of Hong Kong and Hong Kong Futures Exchange. The Clerk would liaise with the Administration and the two Exchanges on the arrangements and inform members accordingly.

(Post-meeting note: The visit to the two Exchanges had been held on 24 February 1999 from 2:15 pm to 5:15 pm)

IV Concessionary interest rates for certain government loan schemes
(LC Paper No. CB(1)816/98-99(02))

7. At the Chairman's invitation, the Deputy Secretary for the Treasury (DS/T) briefed members on the Administration's proposal of applying a new formula with effect from 1 April 1999 for determining the interest rate on Government loans granted on the "no-gain, no-loss" principle. He said that under the new formula, the basis of the interest rate for these loans would be changed from the existing 18-month time-weighted average return of the Exchange Fund (EF) to a market lending-based formula of a fixed percentage (X%) below the average best lending rates of the note issuing banks. Initially, "X" would be set at 2%. He remarked that the interest rate under the new formula was reasonable. The new formula was transparent and fair to both the Government and borrowers and would preserve the concessionary nature of the loan schemes.

8. In response to members' enquiries, DS/T confirmed that the "no-gain, no-loss" interest rate was applicable to the civil service housing loans, loans granted to civil servants under Civil Service Regulation (CSR) 633 (i.e. loans provided to eligible civil servants who proceeded on pre-retirement leave or terminal leave upon completion of agreement), housing loan to eligible former lecturing staff of Education Department transferred to the Hong Kong Institute of Education, Non-means-tested Loan Scheme for eligible students of Government-funded tertiary institutions (NTLS), and the Building Safety Improvement Loan Scheme (BSILS). He added that there were other Government loan schemes in operation which were granted on the basis of different considerations and criteria. The Government conducted regular reviews on the criteria and interest rates applied on these schemes.

9. Mr CHEUNG Man-kwong remarked that the existing formula was adopted since April 1998 partly to address the problem of high interest rates caused by increased volatility in the financial market since the second half of 1997. He was concerned that by linking the interest rate with the best market lending rate, there would be little improvement as the interest rate would still be affected by fluctuations in the market.

10. In response, DS/T explained the bases and rationale in setting the "no-gain, no-loss" interest rates during different periods. From 1981 to May 1995 the rate was set at the average of the six-month bank deposit rate and the best lending rate. From mid-1995 to March 1998, the rate was determined by taking the mean of one-year and two-year yields of the Exchange Fund Bills/Notes (EFB/N). This basis served to reflect the opportunity cost to Government in granting the loans. The formula was later revised in April 1998 to its present form to take account of the new arrangement for setting the investment return of the fiscal reserves as that achieved by the entire EF.

11. DS/T emphasized that while there were certain similarities between the approaches used in formulating the pre-1995 formula and the new formula as both were linked to the best lending rate, interest rates for the two formulas were calculated by different methodologies. In accordance with the pre-1995 formula, interest rate was set half-way between the six-month bank deposit rate and the best lending rate. As to the new formula, the rate would be the best lending rate minus 2% regardless of the movements in the bank deposit rate.

12. Noting that the new formula would no longer be directly related to the investment return on the fiscal reserves, Mr CHEUNG Man-kwong expressed concern that the new formula might not be able to uphold the "no-gain, no-loss" principle from Government's investment perspective. When Government investment performance was exceptionally good, a "loss" might be incurred as the opportunity cost to Government in providing the concessionary loans would become very high. Though in support of the new formula, Mr FUNG Chi-kin shared the view that by adopting the new formula, the Government seemed to have abandoned the "no-gain, no-loss" principle.

13. In response, DS/T stressed that the Administration had no intention to abandon the "no-gain, no-loss" principle in providing the concessionary loans. The new formula only represented another method for giving effect to the principle. He explained that the existing formula had given rise to conceptual and practical difficulties. Since the objective of the investment of the fiscal reserves was to maximize return on Government's assets, there was an inherent conflict in linking this to the interest rate payable under concessionary loan schemes. Although the existing time-weighted methodology had smoothed out fluctuations in the interest rate, given the increased volatility in the financial market, it was possible that the weighted return of EF and hence the interest rate on these loan schemes might fluctuate further in line with market conditions. By adopting a market lending-based formula, the interest rate would become more stable. The new formula would enhance equality and assurance to borrowers.

14. As regards possible loss to Government, DS/T said that it was difficult to predict with accuracy which way the interest rate would move in relation to the yield on EF. Historical data revealed that the best lending rate had a much lower volatility than EF's return. The latter fluctuated widely and the interest rate under the existing formula was predicted to exceed 10% per annum as from 1 April 1999. If the long term yield on EF after ironing out the volatility was to be around 5% - 6% and as long as the best lending rate did not fall below 7% - 8%, the "no-gain, no-loss" position for the Government would still be maintained in the long run.

15. Recognizing the difficulty in satisfying both the "no-gain, no-loss" principle from the Government investment's perspective and the concessionary nature of the loan schemes, Miss Margaret NG concurred that the new formula had the advantage of providing greater certainty in the interest rate which was of great concern to borrowers. Notwithstanding that the Government might incur some loss, if the amount was minimal, the new formula was still worth supporting.

16. In reply to the enquiry about results of consultation of staff unions on the new formula, DS/T advised that the Civil Service Bureau had consulted four central staff consultative councils and their reactions were mixed. Two councils were of the view that the new formula was appropriate. The third one considered that the approach was acceptable but the "X" factor should be higher than two percentage points in keeping with the trend rate in recent five years and to better reflect the concessionary nature of the loan schemes. The last opined that the new formula was worth pursuing on a trial basis for six months and a review should be conducted afterwards. He said that while the Administration appreciated views expressed by the staff councils, it maintained the position that it was appropriate to implement the new formula as a long term solution.

17. As regards views on setting a higher "X", DS/T explained that in the absence of any strong justification for using a particular value of "X", the Administration had adopted a practical approach in calculating the "X" in the new formula by pegging the value to the historical average differential between the "no-gain, no-loss" rates charged for the concessionary loan schemes and the best lending rates. The "no-gain, no-loss" rate as worked out based on this method over the ten-year period of 1989 to 1998 was 2%. Moreover, this rate was close to the average differential between the 12-month Hong Kong Dollar Inter-Bank Offered Rates and the best lending rates between 1993 and 1998. Hence, it also reflected the profit margin of banks over time and reinforced the "no-gain, no-loss" position in granting the loans.

18. Mr Martin LEE questioned the rationale for taking the ten-year period of 1989 to 1998 as the basis for calculating the value of "X" and enquired about the impact on the resultant value if a longer time span backward or a shorter time-frame, say the last five years, was adopted for the calculation.

19. In reply, DS/T explained that the ten-year period was the normal repayment period of civil servants housing schemes. When calculation was extended backward to cover the last 18 years since 1981 when the schemes were introduced, the resultant "X" was 1.8% which was close to 2% after rounding up. While it was true that a bigger value than 2% would be arrived at if calculation was based on statistics for the last five years, the wider margin between the Government interest rates and the best lending rates for this period was due to the adoption of various different formulas in mid-1995 and April 1998.

20. At Mr Martin LEE's request for calculation of the assumed "no-gain, no-loss" rate for the ten-year period of 1989 to 1998 by using the formula applied in mid-1995, i.e. mean of one-year and two-year yields of EFB/N, DS/T stressed that it would be fair and reasonable to determine the interest rate based on empirical and objective data rather than using assumptions or hypothetical data. The Administration was unable to provide statistics for the whole period as two-year EFB/N was only issued from mid-1993 onwards. He undertook to provide statistics for the available period after the meeting.

(Post-meeting note: The information was provided vide LC Paper No. CB(1)959/98-99 dated 3 March 1999.)

21. Mr Ronald ARCULLI sought the Administration's explanation on paragraph 8 of the paper where it was written "... setting too high an "X" could be to Government's disadvantage and could provide an opportunity for borrowers to make a profit by depositing the borrowed money with a bank to earn some interest." He was of the view that it was impossible for loan recipients to deposit the borrowed money with a bank to gain profit from the interest rate differentials since loans were granted for specific purposes and payment was often made in form of reimbursement.

22. The Principal Assistant Secretary for the Treasury (PAS/T) explained that while the situation referred to in paragraph 8 was more hypothetical than real and the Administration did closely monitor the operation of loan schemes to ensure that borrowers complied with all procedures and rules, it was still possible theoretically that borrowers could gain profits from the interest rate differentials if the "X" was set too high. For instance, as NTLS was non-means-tested, if a very low interest rate was set for NTLS, students who were not in need of loans might be tempted to borrow from the Government and on the other hand deposited their own moneys with banks to earn the interest differential. In this connection, Mr Ronald ARCULLI remarked that the Administration's concern was an enforcement issue which was irrelevant to the basis for determining the interest rate for concessionary loan schemes.

23. Mr FUNG Chi-kin pointed out that if it was possible for borrowers to gain profits by depositing the borrowed money with banks, the number and amount of Government loans made in 1998 might have increased significantly over the past years since the bank deposit rates shot up to unprecedented high levels as a result of speculative attacks on Hong Kong dollar. He requested the Administration to provide statistics on the various concessionary loan schemes for the past few years to facilitate such a comparison.

24. The PAS/T provided the following statistics on the five concessionary loan schemes for 1998 (up to 31 December 1998) -

Schemes	No. of approved cases	Total amount involved	Average amount per case
(a) BSILS	4	$0.122 million	$ 30,500
(b) Civil Servants Housing Schemes	14,600*	$8,000 million	$550,000
(c) NTLS	7,600	$271 million	$ 36,000
(d) Housing Loans to Hong Kong Institute of Education Staff	4*	$2.8 million	$700,000
(e) Loans granted under CSR 633	294*	$532 million	$1.81 million

(* denote total number of outstanding cases.)

She also undertook to provide relevant statistics on the above schemes for the past few years after the meeting.

(Post-meeting note: Statistics on loan schemes from 1995-1996 to 1998-1999 were circulated to members vide LC Paper No. CB(1)959/98-99. The statistics revealed that the number or amount of loans made had decreased over the last two years.)

25. While supporting the new formula as it would avoid wide fluctuations in the interest rate arising from volatility in Government investment performance, Mr NG Leung-sing suggested the Administration to consider using a time-weighted average of the best lending rates in the new formula to smooth out fluctuations in the interest rate and to ensure that the rate was kept under review in the light of changing market conditions.

26. DS/T re-iterated that wide fluctuations in the interest rate for concessionary loans could be avoided by adopting the new formula. While the Administration would consider Mr NG's suggestion further to review the interest rate over time, a proper review mechanism to be put in place should be able to strike a balance between administrative efficiency and the concern about possible frequent fluctuations. As regards review on the methodology for calculating the "X" factor, DS/T remarked that while regular reviews would be undertaken, the Administration was mindful of Miss Margaret NG's concern that too frequent reviews could adversely affect the stability and predictability of the system. Initially, the Administration considered that it would be appropriate to undertake a review every two years on the suitability of the "X" factor.

(Post-meeting note: The Administration informed vide LC Paper No. CB(1)959/98-99 that the interest rate would be adjusted if the rate calculated under the new formula differed from the prevailing by one percentage point or more, or when the prevailing rate had remained stationary for six months.)

27. Mr CHEUNG Man-kwong and Miss Cyd HO Sau-lan queried the rationale for charging a risk adjustment factor of 1.5% in addition to the concessionary interest rate for NTLS. DS/T explained that the additional interest rate for NTLS was to reflect the risk incurred in providing these loans on an unsecured basis. This was in contrast to BSILS where loans were secured by property put up as collateral.

V Consultation paper on Corporate Rescue and the Protection of Wages on Insolvency Fund
(LC Paper No. CB(1)678/98-99)

28. The Deputy Secretary for Financial Services (DS/FS) briefed members on the consultation paper which sought views on how employees' outstanding entitlements should be settled if a company which owed these debts initiated a corporate rescue procedure. She explained that such a procedure as recommended by the Law Reform Commission (LRC) involved the introduction of statutory "provisional supervision" (PS) of the company to allow for the working out of some arrangements that would assist a viable business to survive. During the PS, a moratorium initially for 30 days but could be extended up to 6 months or more subject to creditor or court approval, would be imposed against the company to prevent individual creditors including employees from exercising their normal right to take proceeding of winding-up the company. However, LRC's proposed treatment of debts owed to employees under these circumstances was incompatible with existing labour legislation namely, the Protection of Wages on Insolvency Ordinance (PWIO) (Cap.380) and the Employment Ordinance (EO) (Cap. 57). A total of four options had been put forward in the consultation paper for resolving the problem. The Administration maintained an open attitude towards these options and welcomed any views and suggestions from LegCo Members, professional bodies and the general public before the close of the public consultation exercise by 28 February 1999.

29. Members noted the main features of the four options as follows -

(a) Option A (LRC proposal)

Debts owed to employees of the company under PS were to be payable under the Protection of Wages on Insolvency Fund (PWIF). The ambit of PWIF had to be widened.

(b) Option B

Arrears of wages for employees had to be settled by the employer prior to the company undergoing corporate rescue.

(c) Option C

Employees were to be exempted from the moratorium.

(d) Option D

As a quick relief, employees were to be paid by PWIF. PWIF would seek full recourse from the company as a priority debt in a voluntary arrangement under the rescue plan.

30. Mr Eric LI Ka-cheung said that while the Hong Kong Society of Accountants (HKSA) was deliberating on the consultation paper and would make a formal submission to the Administration afterwards, he would like to make known HKSA's initial comments on the issues as presented in the paper submitted to the Panel. He briefed members on HKSA's views as follows -

Hong Kong needed to introduce a structured corporate rescue procedure. Besides assisting the re-structuring of businesses to enable them to face the changing environment, such a procedure was badly needed during the current economic downturn in order to preserve employment and to reduce the adverse knock-on effect arising from unemployment and business failures on the community.
corporate rescue plans, or similar schemes, were widely practised in various jurisdictions for years and had been proven successful in offering more benefits to shareholders of companies, employees and creditors than under a liquidation procedure; and
problems associated with options B, C and D would prevent them from bringing about a successful corporate rescue procedure. HKSA considered that Option A should be further explored to provide a workable solution. A revised version of this option as suggested by HKSA was for PWIF to pay laid off employees arrears of wages and to provide some immediate relief for employees who were retained. A contingent amount within PWIF should be earmarked to cover all arrears of wages for those employees retained prior to the adoption of their employment contracts by the Provisional Supervisor, to allow for the possibility that the rescue procedure failed and the company was wound up. The amount would become a priority debt recoverable by PWIF by subrogation, up to the statutory limits, under the liquidation process.

(HKSA's written views were circulated to members after the meeting vide LC Paper No. CB(1) 870/98-99 dated 5 February 1999.)

31. While pointing out that protection of employment was an important concern of employees and hence the principle of a corporate rescue plan was worth supporting, Mr LEE Cheuk-yan and Miss CHAN Yuen-han stressed that benefits and rights of employees must not be compromised under the procedure.

32. Mr LEE Cheuk-yan opined that all of the four options proposed had deficiencies and none of them could provide sufficient protection for employees' right and benefits. As there was a statutory limit in respect of claims under PWIF, arrears of wages could not be fully covered by the Fund and the options were unclear about the treatment of unsettled arrears of wages. The interests of retained employees would be further jeopardized when they continued to work for the company. Moreover, the options did not deal with other owed benefits to employees which were outside the ambit of PWIF, such as end-of-year payment.

33. DS/FS stressed that the Administration was fully aware that none of the options could resolve all problems. Nonetheless, it would closely adhere to the following four principles in developing a workable corporate rescue scheme -

a rescue scheme capable of securing continued employment for employees should be supported;
the level of protection for employees' rights and benefits obtained under a scheme should not be lower than what they were entitled to under the existing legislation;
the healthy financial status of PWIF should be maintained. A scheme which would have significant resource implications on the Fund should be carefully assessed; and
there should be no question of the use of public funds to bail out PWIF should its finances became inadequate as a result of its ambit expanded to facilitate company's rescue.

34. As regards the deficiencies associated with the options, DS/FS said that as a matter of principle, protection of employees' outstanding statutory entitlements in a corporate rescue scheme should be no less than those available to employees in case of insolvency of the company. As such, LRC considered that it would be desirable for employees who were to be laid off as a consequence of provisional supervision to be accommodated under the provisions of the PWIO. Before such legislative amendment was effect, LRC proposed that debts of employees which were preferential debts under section 265 of the Companies Ordinance be paid out of the company's assets in priority to all other debts. LRC further proposed that the benefits of retained employees should be protected under the voluntary arrangement agreed by creditors, which enabled the company to continue as a going concern. Arrears of wages due to the remaining employees for periods prior to the rescue, if any, should be of the same priority as the outstanding wages of those employees who had been laid off. In the event that provisional supervision did not result in a voluntary arrangement and the company went into liquidation, employees who remained employed with the company during provisional supervision should be able to claim in insolvency for any wages outstanding before the appointment of the provisional supervisor.

35. Mr LEE Kai-ming expressed strong disappointment on LRC's 1995 proposals which had completely ignored the protection of employees' rights. Although workers' unions had strongly urged LRC to consider the problem of incompatibility with existing legislation, it remained unresolved. Whilst he was supportive of HKSA's revised Option A and agreed that further study should be conducted, since the revised option required substantial amendment of PWIO involving an extension of PWIF's ambit which might have significant financial implications on PWIF entailing injection of public funds and/or upward adjustment to the current PWIF annual levy of $250 payable by employers as part of the business registration fees, it was doubtful whether the revised option would be acceptable to the Administration and the employers at large. He further remarked that as the establishment of PWIF in 1984 was contingent on the prevailing social and economic conditions of Hong Kong and the Fund was unique to Hong Kong, it would not be appropriate to draw references from overseas corporate rescue schemes for treatment of outstanding entitlements of employees in developing a suitable corporate rescue scheme for Hong Kong.

36. Whilst supporting in principle the concept of corporate rescue, the Deputy Secretary for Education and Manpower (DS/E&D) stressed that the Administration was mindful of the need to resolve the incompatibility between the proposed scheme and existing legislation. Options A and D which involved widening the ambit of PWIF would change fundamentally the rationale for which the Fund was set up, i.e. to provide prompt relief to employers in situations where the employers had become insolvent and owed employees wages and other statutory termination benefits. To make unconditional payment to employees laid off under PS would be tantamount to subsidizing the employers, and in effect turning the Fund into a "Corporate Rescue Fund". Moreover, there might be abuse of the scheme by unscrupulous employers who tried to evade such responsibility under the disguise of corporate rescue. There might also be significant financial implications on the Fund. In view of the complexity of the issues involved and the far-reaching implications, it was necessary for the Administration to consider the matter prudently.

37. Mr James TIEN Pei-chun concurred that none of the option was perfect. He opined that Option A would lead to the problem of moral hazard as honest employers might have to subsidize unscrupulous employers by paying higher PWIF levy. Option B was simply unworkable since it would be impractical to demand a financially troubled company to pay a lump sum upfront to clear its indebtedness to employees. Option C would defeat the purpose of corporate rescue as no court protection for the PS was guaranteed from the outset. As a result, he was inclined to support Option D and suggested that the Option be further explored. He remarked that by providing employees with immediate relief from PWIF, say up to the maximum amount of ex-gratia payment of $50,000 of arrears of wages per employee, their financial hardship would be eased without allowing the employers to evade their responsibilities.

38. Mr Eric LI cautioned that while Option D might provide employees with quick relief, as this option provided for PWIF payment to be treated as a priority debt in a voluntary arrangement under the rescue plan, which amounted to a substantial preference over all other creditors, other creditors might be reluctant to enter into a rescue agreement since they believed that they could be worse off in the rescue plan than in a liquidation. Hence, this option would undermine the success of a corporate rescue plan. He further re-iterated his support for a modified Option A and pointed out that concerns about the option could be dealt with satisfactorily. Firstly, the concern about the problem of moral hazard was not genuine. It was doubtful that an employer could take the advantage of a corporate rescue to evade from his statutory obligation of paying his employees termination benefits as the control of the company would be put into the hands of an independent third party, i.e. the Provisional Supervisor, who apart from being accountable to creditors, would also be subject to the oversight of the Official Receiver's Office. The employer would simply run the risk of committing commercial suicide in abusing a corporate rescue. Secondly, it should be noted that in other jurisdictions with similar corporate rescue schemes, the procedures were often regarded as akin to an insolvency or was deemed to be an insolvency from the point of view of triggering payments that might be made available to employees in an insolvency. Hence, there was much justification for expanding the ambit of PWIF to cover rescues. Thirdly, the concerns that because PWIF did not cover the full amount of the employees' statutory entitlements under EO, the expansion of PWIF's ambit to cover rescues might be in breach of EO would only ignore the fact that in practice the most likely alternative to a rescue was a winding up, under which clearly EO's entitlements would not be paid. On the contrary, if the company survived after the rescue, the employees from apart being able to retain employment, could also secure arrears wages. Lastly, a massive depletion of PWIF following expansion of its ambit was unlikely as any payments that were made from PWIF in a rescue should be regarded as monies paid out in a liquidation which would be the inevitable result should the rescue failed eventually. Hence, there would be no additional financial burden to PWIF. In view of the healthy financial position of PWIF with net assets amounted to $852 million as at the end of March 1998, there was no immediate need to inject additional fund or to increase the employer's levy. Notwithstanding that a moderate increase in the levy might be required, this would have a negligible effect on the operating costs of businesses. On the other hand, consideration would also be given to setting the levy on the basis of company size or designating a larger share of the business registration fee for the purpose of PWIF if it was considered necessary to relieve the possible financial burden on employers.

39. Mr LEE Cheuk-yan remarked that the crux of the matter in formulating a policy on corporate rescue was to identify the appropriate party to pay the employees' outstanding debts owed by a company which had been put under PS. He concurred that the suggestion of designating a large share of the business registration fee for PWIF should be further explored and sought the Administration's view on this aspect.

40. In reply, DS/FS re-iterated that the Administration was firmly of the view that there was no question of the use of public funds to "bail out" PWIF if its finances become inadequate as a result of its extended coverage for corporate rescue. She supplemented that PWIF levy of $250 was charged on each of the some 780,000 business registration certificates issued annually.

41. On Mr Kenneth TING's enquiry about possible impact of Options A, C, D and HKSA's revised Option A on the financial position of PWIF, DS/FS replied that since the Administration had not yet received HKSA's proposal, it had not performed any detailed calculations on the financial implications of various options. The Administration's position remained that despite PWIF had accumulated considerable reserves over the past years, the full impact of the recent downturn of the economy on the Fund had yet to be felt and hence, it was important for the Fund to maintain a healthy reserve to enable it to cope with all contingencies.

42. Miss CHAN Yuen-han re-iterated that if a corporate rescue scheme was to be introduced, it would only be fair that the level of protection that employees could obtain should be no less favorable that what they were entitled to under existing legislation. Since none of the options mentioned in the consultation paper could achieve this, employees were put in a dilemma. She was also concerned that in the likely event that problems remained unresolved, employees might be bearing all the blames for the failure in introducing a statutory corporate rescue scheme.

43. DS/FS stressed that there was overwhelming support to the principle of introducing a corporate rescue scheme in Hong Kong during the consultation of LRC's proposals in 1995, where out of a total of 30 submissions received only one was opposed to the principle. She assured members that the Administration, in collaboration with relevant parties, would continue to study the issues and work out a practicable solution acceptable to the parties concerned.

VI The Hong Kong Banking Sector Consultancy Study
(LC Paper No. CB(1)816/98-99(03), LegCo Brief - ref.: B9/4/5C)

44. At the Chairman's invitation, the Deputy Chief Executive (Bank), Hong Kong Monetary Authority (DCE(B)/HKMA) briefed members on the major findings and recommendations of the Hong Kong Banking Sector Consultancy Study (the Study). He stressed that the recommendations put forward were made by the consultants only and the Government had not yet taken a view on the individual recommendations. The recommendations had been released for public consultation which would last until the end of March 1999. DCE(B)/HKMA highlighted the following points in his presentation:

the purpose of the Study was to recommend adjustments to the HKMA's regulatory and supervisory framework to achieve benefits from global and local banking trends while limiting the risks associated with these trends;
to cope with the new emerging environment, the consultants had suggested four strategic mandates for HKMA namely, to ensure that the regulatory and supervisory framework remains appropriate, to improve the competitive environment and attractiveness of Hong Kong as a banking centre, to ensure risk is prudently managed and to increase the level of transparency; and
recommendations on changes were made for each of the above mandates and a three-phase implementation plan was suggested for bringing forward these changes from 1999 to 2002.

45. Noting that no further deregulation of the interest rate rules (IRR) was recommended during phase 1 of the implementation plan as a result of the expected difficult operating environment for the banking sector in 1999, Mr NG Leung-sing enquired about the objective criteria for assessing the operating environment for implementing the recommendation and the prospect of the deregulation programme should there be no improvement in the operating environment after 1999.

46. In response, DCE(B)/HKMA advised that in determining the timing of any further deregulation, the consultants had adopted the principle that changes should only be introduced after a specified period of stability, characterized by relative containment of risk. In view of the anticipated difficult operating conditions for banks during 1999, no deregulation was recommended for the time being. Whilst the recommended three-stage IRRs deregulation programme would begin in 2000 with the first two stages to be implemented in 2000-2001 and the last stage in 2001-2002, preparatory work for IRR deregulation should start in 1999 where containment of risk would be measured using a wide range of monetary, financial and market indicators including interest rate movements, trends in banks' profitability, presence of speculative attacks on Hong Kong dollar etc. These indicators would be closely monitored and kept under review throughout the stages to ensure that deregulation would commensurate with the operating environment and there would be no adverse impact on the stability of the banking system. Public views were also invited on possible methods and suitable indicators to be used for measuring system stability.

47. Pointing out that other major international financial centres either did not impose any IRR or had deregulated in this area for sometime, Mr CHEUNG Man-kwong considered the consultants' IRR deregulation programme too conservative. He urged HKMA to consider expediting the programme so that benefits associated with deregulation would be realized as soon as possible and Hong Kong would meet international standards in this area. Messrs Martin LEE and Fred LI Wah-ming concurred that the deregulation programme should be expedited and enquired about the industry's views on the implementation timetable. Mr Fred LI further enquired about the possibility of removing all remaining IRRs in one go as recommended in the Consumer Council's report in 1994.

48. DCE(B)/HKMA stressed that HKMA was committed to the principle of full deregulation of IRRs as evidenced by the substantial deregulation of IRRs in 1994 and 1995 following the 1994 report of the Consumer Council. The phased programme proposed by the consultants was a step forward in the same direction. Only IRRs for current accounts, savings accounts and time deposits up to 6-days were remained to be deregulated. While the consultants fully recognized the benefits of deregulation, which included more efficient intermediation and improved product choice for consumers due to enhanced competition, they were mindful that immediate full deregulation would have a significant adverse impact on the profitability of banks and that not all banks had the necessary systems and capabilities enabling them to compete in a fully deregulated interest rate environment. Referring to the table on page 33 of the Executive Summary of the Study illustrating the potential impact of relaxing the remaining IRRs under different scenarios, DCE(B)/HKMA pointed out that according to one of the scenarios presented by the consultations, deregulation of current accounts alone could lead to a drop of 7.6% (or 19 basis points) in the net interest margin for local banks. This represented a substantial reduction in profit margin as when put into context, the decline in net interest margins for all local banks during the Asian financial turmoil from June 1997 to June 1998 was only 17 basis points. IRRs were imposed in 1965 to address problems affecting the stability of the banking system at that time. The consultants considered it more prudent to implement further deregulation in phases over a period of time to avoid exerting further pressure on the profitability of banks, which had already suffered in the financial turmoil.

49. On IRRs of other international financial centres, DCE(B)/HKMA said that as monetary systems and banking supervisory regimes of individual centres were developed upon different conditions and circumstances unique to them, a simple comparison of the local systems with those of other centres would be inappropriate and results might be misleading. He further pointed out that overseas experience in IRRs deregulation, such as in the United Kingdom (UK) and Australia, revealed that unanticipated problems and consequences were encountered and the process was often accompanied by periods of instability. For instance, monetary deregulation in the UK in the early 1970s was shortly followed by a banking crisis and incidentally IRRs on current accounts was only removed in UK until mid 1980s some 15 years after the deregulation programme was implemented.

50. As regards views of the banking industry on the IRR deregulation programme, DCE(B)/HKMA said that the industry, in general, was fairly cautious about removing IRRs. Whilst the principle of deregulation had been widely accepted since deregulation took place in 1994 and 1995, the industry had mixed views on the pace of further deregulation. It would be pre-mature to predict the reactions from banks on the proposed deregulation programme. Nonetheless, if the consensus of the industry was that further deregulation should be expedited, HKMA would consider the views seriously to shorten the deregulation programme.

51. Responding to Mr Fred LI's enquiry about the recommendation to relax the "one-building condition" applied to foreign banks and foreign restricted licence banks, DCE(B)/HKMA said that the condition had been practised for over 20 years with a view to restricting entry of foreign banks to the local market so as to maintain the stability of the system. As the condition was inconsistent with a desire for open markets, the consultants recommended to relax the rule initially to allow foreign banks to operate three branches with a subsequent review on the number at a later date. The phased relaxation of the policy was a prudential move to minimize the risk of systemic instability.

52. On the issue of enhancing protection for depositors, Mr Martin LEE said that the Democratic Party had been urging for the introduction of an explicit depositor protection scheme in Hong Kong since early 1990's. He was disappointed that the Administration had not taken up the issue seriously and that no concrete proposal had been made by the consultants in this area.

53. DCE(B)/HKMA said that there was only lukewarm support for an explicit depositor protection scheme during the public consultation held in 1992. However, with the financial market becoming more volatile and systemic risk increasing as well as more international financial centres putting in place depositor protection systems, it was necessary to re-visit the subject. The consultants considered that an enhanced form of explicit depositor protection would be beneficial for Hong Kong. HKMA, in conjunction with the Government would conduct more detailed study on this area. Key issues to be examined would include, inter alia, the form of protection to be offered and the funding arrangement for the system.

54. Whilst expressing support for the consultants' recommendation for HKMA to adopt an enhanced risk-based supervisory approach in regulating banks, Mr CHEUNG Man-kwong enquired about possible measures to identify and monitor risks associated with banks' exposures to property and "red chip" companies, which had become the major lending business of banks since the booming periods in the property and stock markets prior to the Asian financial turmoil, with a view to ensuring the stability of the banking system.

55. DCE(B)/HKMA said that emphases of HKMA's prudential supervision over institutions for promoting systemic stability were on strengthening its risk identification system to understand the risks which banks were undertaking and improving bank's risk-management systems for proper control of identified risks. In view of the sharp rise in property prices and the fact that Hong Kong had become the most important fund raising centre for Mainland corporates in recent years, it would be impractical to restrict banks' lending activities in these areas, hence making it difficult to avoid the problem of over concentration of risk exposures. On the other hand, mortgages, indeed, had been the safest form of lending activities undertaken by banks in recent years as evidenced by the low default rates. One of the major issues identified in the Study relating to the strategic outlook for the Hong Kong banking sector was "what should be the sustainable source of business for the sector" . The issue was complicated by evolving global shaping forces and banking trends where technological innovations and changing customer demands necessitated banks to take on and develop new types of business, such as insurance, securities and personal wealth products, as alternatives to traditional lending business. In response to these changes, banks were required to adopt new risk-management and control systems, and HKMA also needed to improve its regulatory and supervisory framework in this respect.

56. In reply to Mr SIN Chung-kai's enquiry about factors to be considered in assessing the implementation of individual recommendations and the relevant timetable, DCE(B)/HKMA said that some comparatively less complex recommendations could be implemented fairly quickly. These included the financial disclosure requirements for foreign branch banks which had already been introduced and enhancement in the supervisory set-up of HKMA which required no consultation of the industry and therefore could be implemented without waiting for the full results of the public consultation. Other recommendations involving complex issues, such as simplifying the three-tier banking system, relaxing the remaining IRRs and enhancing depositor protection, had to be carefully studied along with comments and views received in the consultation exercise before major decisions on changes would be made. He stressed that HKMA was prudent in taking forward the recommendations to ensure that they would be implemented in a safe and sound manner without affecting the stability of the system.

VII Any other business

57. There being no other business, the meeting ended at 1:00 pm.

Legislative Council Secretariat
24 June 1999