LC Paper No. CB(1)700/98/99
(These minutes have been
seen by the Administration)

Ref : CB1/PL/FA/1

Legislative Council
Minutes of Special Meeting held on
Thursday, 17 September 1998 at 4:30 pm
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 Albert HO Chun-yan
Hon NG Leung-sing
Hon Margaret NG
Hon Ronald ARCULLI, JP
Hon James TO Kun-sun
Hon CHEUNG Man-kwong
Hon HUI Cheung-ching
Hon Bernard CHAN
Hon SIN Chung-kai
Hon Jasper TSANG Yok-sing, JP

Members attending :

Hon LEE Wing-tat
Hon Martin LEE Chu-ming, SC, JP
Hon Fred LI Wah-ming
Hon MA Fung-kwok
Hon CHAN Yuen-han
Hon CHAN Kam-lam
Hon Gary CHENG Kai-nam
Hon LAU Kong-wah
Hon Emily LAU Wai-hing, JP
Hon LAW Chi-kwong, JP

Members absent :

Dr Hon David LI Kwok-po, JP
Hon Ambrose CHEUNG Wing-sum, JP
Dr Hon Philip WONG Yu-hong
Hon Timothy FOK Tsun-ting, JP

Public officers attending :
Item I

Mr Donald TSANG, JP
Financial Secretary

Mr Joseph YAM, JP
Chief Executive, Hong Kong Monetary Authority

Mrs Rebecca LAI, JP
Secretary for Financial Services (Acting)
Clerk in attendance :
Ms Estella CHAN
Chief Assistant Secretary (1)4
Staff in attendance :
Ms Pauline NG
Assistant Secretary General 1

Mr KAU Kin-wah
Assistant Legal Adviser 6

Ms Connie SZETO
Senior Assistant Secretary (1)1

I Actions taken by Government in the foreign exchange, stock and futures markets

(LC Paper No. CB(1) 172 -Strengthening of currency board
arrangements in Hong Kong,

LC Paper No. CB(1) 175 -Measures to strengthen the order and
transparency of securities and
futures markets,

LC Paper No. CB(1) 185 -Arrangements for settlement of unsettled
CNS short positions for trades done on 27
and 28 August 1998)

The Chairman welcomed the Financial Secretary (FS), the Chief Executive of the Hong Kong Monetary Authority (CE/HKMA) and the Acting Secretary for Financial Services (SFS (Atg)) to the meeting, which was the fourth of the series of meetings to discuss recent actions taken by Government in the financial market. He asked members to refer to the list of questions tabled at the meeting, which included the questions raised but not answered at the meeting on 12 September 1998 and those received by the clerk after the meeting.

(Post-meeting note: Mr Philip WONG Yu-hong had requested written answers to his questions. The Administration's reply was tabled at the meeting and circulated to members vide LC Paper No. CB(1) 216/98-99.)

Justifications for Government's actions in August 1998

2. Some members expressed support to Government's actions in the financial market and they acknowledged that the actions taken in late August had helped prevent a possible collapse of the stock and futures markets, hence avoiding a further threat to the confidence in the Hong Kong dollar. Some members however queried the justifications for spending huge sums of public funds in the financial market. They also questioned whether the Government had acted outside the scope of its authority provided under the law in the control of the Exchange Fund or Land Fund.

3. FS responded that the Government had announced on 14 August 1998 that it had started to take action in the securities market to thwart manipulation, with the full intention of releasing to the public the reasons and details of its actions when the market situation stabilized. Subsequently, on 7 September 1998, at the first meeting of this series of the Panel, he provided members with the full picture of Government's actions. He stressed that the ultimate objective of Government's operations was to restore order in the markets by combating cross-market manipulation. Such operations were vital to maintaining the linked exchange rate (LER) system and Hong Kong's economic stability. Government's operations were in line with the Basic Law and consistent with section 3 of the Exchange Fund Ordinance (Cap 66) (EFO), which provided that the Exchange Fund "shall be under the control of the Financial Secretary and shall be used primarily for such purposes as the Financial Secretary thinks fit affecting, either directly or indirectly the exchange value of the currency of Hong Kong and for other purposes incidental thereto."

4. In response to Mr Martin LEE's question on whether Government's action had aimed at sustaining the Hang Seng Index (HSI) at a particular level, CE/HKMA explained that Government's action was to frustrate the manipulators' intention to reap profits in the HSI futures market by short selling stocks, so that they would leave the markets. Decisions to procure particular stocks were made after careful analyses of their respective market prices and values, and the portfolio of the stocks acquired followed basically the weightings of the 33 constituent stocks in the HSI.

5. Responding to Mr CHAN kam-lam's enquiry on whether any banks had provided the manipulators with funds to attack the Hong Kong dollar, CE/HKMA advised that it was observed that speculators had in the past shorted the Hong Kong dollar and funded themselves by borrowing from banks. As a result, high interest rates were effective in deterring speculation. However, in the first eight months of 1998, the manipulators had prefunded themselves and borrowed over HK$30 billion Hong Kong dollar at low interest rates through swaps with supranationals that issued Hong Kong dollar debt. It was therefore not necessary for them to borrow from banks in the recent currency attack.

Accountability of HKMA and conflict of interest

6. Regarding the possible role conflict of the Government as both a market player and a regulator, FS re-iterated Government's intention to set up a separate company under the Exchange Fund (EF) for the management of the stocks acquired in the operations. The operation of the company would be kept at a distance from the Administration and would be subject to all securities related legislation, and other rules and regulations of the financial market which governed the operations of companies engaged in similar business.

7. As to whether the persons involved in the operations would make use of the sensitive information for their own benefits, FS said that there were clear guidelines on declaration of interests for civil servants to prevent conflict of interests. Senior officials dealing with financial matters were required to disclose all of their private investments. With such safeguards in the system, the integrity of public officers was beyond doubt and it would not be necessary to require public officers to appoint independent companies to manage their private investments. So far as confidentiality of the operations was concerned, FS said that relevant information was classified and access was restricted to a limited number of officials strictly on a need-to-know basis. Every care had been taken in the process to ensure utmost confidentiality. CE/HKMA further advised that HKMA staff engaged in banking supervision were excluded from the recent operations. The broker firms responsible for the purchase of stocks were also required to arrange designated staff to handle transactions for the Government.

8. Ms Emily LAU Wai-hing opined that to enable the Legislative Council (LegCo) to monitor HKMA's work, the CE of HKMA should brief LegCo Members on a regular basis. FS responded that the Government had always been concerned about its accountability and openness. While he was fully accountable for the authority provided to him under the EFO, the HKMA, being an integral part of the Administration reporting to him, should be allowed full autonomy in carrying out its functions. Concurring that enhanced contact between LegCo and HKMA would be beneficial, CE/HKMA said that HKMA had all along maintained a high degree of transparency in conducting its business and that regular publications on its work were made available to the public.

Measures to strengthen the order and transparency of securities and futures markets

9. On the implementation of the improvement measures for the markets, FS advised that the Securities and Futures Commission (SFC) would work closely with the Stock Exchange of Hong Kong (SEHK), the Hong Kong Futures Exchange (HKFE) and the Hong Kong Securities and Clearing Company Limited (HKSCC) towards the common goal of maintaining a level playing field and protecting public interests. While some of the measures had already been put into practice, some were under active discussion or consultation with parties concerned. Apart from making legislative proposals to increase the penalties for malpractices in the markets, the Government would also examine the need to enlarge its power to give directions to the concerned bodies under extreme market conditions.

10. Regarding the progress of setting up a cross-market surveillance committee to exchange market information among HKMA, SFC, SEHK, HKFE and HKSCC on a regular basis, the Acting Secretary for Financial Services advised that it would be a standing committee comprising top level representatives from these bodies and chaired by the Secretary for Financial Services. The committee would meet regularly to study market trends and take follow-up actions as necessary. The first meeting would be held by late September 1998.

11. Mr James TIEN enquired if the Government had suffered any loss due to the failure to enforce the T+2 settlement rule for the shares it acquired on the last two trading days in August. CE/HKMA confirmed that HKMA was aware of the Central Clearing and Settlement System (CCASS) rules and the practice of allowing a grace period before compulsory buy-in on behalf of a selling broker who failed to deliver the shares. While there was no problem in the settlement of trades transacted from 14 August 1998, it was clear to HKMA that in view of the exceptionally high turnover in the stock market as well as short selling trades on 28 August 1998, it was highly unlikely that the trades conducted on this day could be settled by T+2. The Financial Services Bureau immediately alerted HKSCC of its concern, and HKSCC, on 31 August 1998, issued a notice to all brokers stating that with effect from 1 September 1998, HKSCC would enforce the compulsory buy-in after T+2 for any selling brokers who failed to deliver the shares on T+2. HKMA was disappointed when it was later advised that this circular would not apply to the settlement of the trades taken place on 28 August 1998. Nonetheless, HKMA appreciated that HKSCC could not act outside what was permissible under its rules and regulations, and was pleased to note that HKSCC had already agreed to implement the Government's proposal to enforce strictly the T+2 settlement rule to remove any potential uncertainty or unfairness that might arise from failed settlement of share transactions.

12. As regards loss incurred by the Government as a result of delayed settlement of shares, CE/HKMA said that the Government had not suffered from any pecuniary loss but theoretically, there would have been interest forgone on the funds paid on T+2 to settle the shares purchased or income foregone from the lending of shares that could have been effected if the shares were received on T+2. He further advised that the Government was considering the possibility of seeking remedies for the loss. Initial legal advice was that it might not be possible to lodge claims as there was no provision for compensation of this kind under HKSCC's rules.

Measures to strengthen the currency board arrangements

13. In reply to enquiries about the measure of the Convertability Undertaking (CU), CE/HKMA explained that the CU was a clear undertaking from HKMA 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. The rate of 7.75 was chosen because it was the current intervention rate of HKMA. Although HKMA had made it very clear on 14 September 1998 that the rate would be kept at 7.75 at least for six months and be reviewed thereafter, its intention had remained that where market situation permitted, the rate be moved to 7.80, which was the fixed exchange rate of the LER system applicable to the issue and redemption of Certificate of Indebtedness backing the Hong Kong dollar. For a smooth transition to the rate of 7.8, HKMA was in the process of formulating its plans which would be disclosed soon.

14. Some members expressed concern about CE/HKMA's reported comments on 14 September 1998 regarding an imminent move of the rate to 7.8, which triggered a net sales of Hong Kong dollars of about $9.3 billion on that day. In response, CE/HKMA stressed that the statement made by HKMA on 14 September 1998 was the same as the message conveyed in HKMA's press release on 5 September 1998 that the rate of the CU would be moved to 7.8 as soon as market circumstances permitted. While it was not expected that the move of the CU to 7.8 would have a significant impact on the economy, the recent announcement of maintaining the CU rate at 7.75 for six months would allow more time for financial institutions to unwind their stop loss orders which might be triggered by a move back to the 7.8 level. He added that the outflow of HK$9.3 billion had already been recycled back into the banking system since the announcement was made; and that the episode indicated that the system, strengthened by the technical measures, worked well under stress.

15. On some members' concern that with the introduction of the technical measures, HKMA's functions had increasingly resembled those of a central bank, CE/HKMA responded that it was not unusual for a monetary authority to also take up certain functions of a central bank. As far as the monetary policy of HKMA was concerned, the objective was to maintain a stable exchange rate of the Hong Kong currency within the framework of the LER system under the currency board arrangements. While it performed central bank functions such as banking supervision, reserves management and market infrastructure development, HKMA would not perform any function which would conflict with its role as a currency board. For instance, it would not make use of the interest rate or manipulate the level of money supply to achieve such economic aims as combating inflation or stimulating employment. The HKMA had attached great importance to enhancing the transparency of its currency board operations as well as reducing the discretionary power that it might have. Apart from releasing information on the aggregate balance of the banking system which was already made available to the public almost on real time, HKMA would further work towards identifying and showing clearly that part of the Exchange Fund balance sheet relating to the currency board operations.

16 Referring to the press release issued by HKMA on 5 September 1998, where it was mentioned that a bank would be restricted from accessing the Discount Window if there was reason to believe that it had been facilitating manipulation of the curreny or money markets, Miss Cyd HO Sau-lan expressed concern about HKMA's discretion in this respect and enquired whether there were any objective criteria for imposing the restriction. CE/HKMA explained that HKMA in fact had very little discretionary power compared with its counterparts in other jurisdictions. If speculative manipulation was detected in institutions under HKMA's supervision, it should be able to conduct investigations on the matter. As far as the determination of the Base Rate of the Discount Window was concerned, HKMA was consulting academics and practitioners concerned on a methodology for developing the Base Rate which would require as little discretion on the part of HKMA as practicable. On the need to seek relevant information from banks in order to ensure that the CU was not being abused, he assured that while HKMA welcomed useful information for detecting manipulative activities, disclosure of clients' information was not a prerequisite for access to the CU.

International concerns and Government's credibility

17. Mr Eric LI Ka-cheung expressed support to recent actions taken by Government in the financial market. However, he opined that the Administration should from then on assess the extent to which the measures for strengthening the financial system would alleviate the need for future actions in the markets and consider using systematic reform and/or negotiation rather than direct confrontation as strategies for combating manipulation. Some members expressed concern about the reaction of overseas investors and governments to the recent Government operations and urged the Administration to take steps in restoring Hong Kong's international reputation and credibility and remove doubts about Hong Kong's determination to maintain a free-market economy.

18. FS re-iterated that the critical circumstances in the markets since early August 1998 had led to the extraordinary actions taken by the Government. The Government had thoroughly considered the pros and cons of the actions and possible ramifications at the global level before taking the operations. While there was increasing support and understanding from academics and market players both local and overseas, senior government officials would, during a series of overseas visits, continue to explain to foreign investors and governments the background leading to the operations, the improvement measures for strengthening the financial system and the SAR Government's full commitment to maintaining an open and free market economy and the LER system. The Government would also urge international attention to the need to regulate international fund flows for eliminating manipulative attacks on economies.

19. Referring to the adverse comments made by Mr Alan Greenspan, Chairman of Board of Governors of the US Federal Reserve System, on Government's recent involvement in the markets, CE/HKMA remarked that the comments reflected the lack of a full appraisal of the background to the actions taken. He had already written to Mr Greenspan explaining the background leading to the operations and that the Government's intention was to curb cross-market manipulation in order to protect the integrity of the local monetary system and the interest of the investing public.

Possibility of further actions in the markets

20. On members' concern about the depletion of government reserves and whether Government would take further actions in the markets, CE/HKMA assured that with the improvement measures for strengthening the financial system, the need for further actions in the markets would be much reduced. Since the introduction of the seven technical measures for strengthening the currency board arrangements, interbank interest rates had come down and outflowed funds had returned. As to the level of Hong Kong's reserves, he advised that there were still abundant foreign exchange reserves for defending the currency with total foreign currency assets standing at eight times the local currency in circulation. The 100% backing of the Hong Kong dollar by US dollar would not be affected in any way by money invested in the markets and the purchases made by the Government were in fact good quality investments.

21. FS further advised that the Government's actions in the markets had already stopped and the markets had stabilized since September 1998. Nonetheless, Government would remain vigilant and closely monitor changes in the markets, and appropriate actions would be taken should extreme conditions arise. As to the actual amount of funds employed in the operations, FS confirmed that the actual amount had slightly exceeded the original estimate. He re-iterated that further details of the amount of funds involved in the operations would be announced once the company for managing the assets acquired was formed. He thanked members for the support to the LER system and he hoped that members would also support the forthcoming legislative proposals to complement the improvement measures to the financial system.

II Any other business
(LegCo Paper No. CB(1)156/98-99(01))

Next meeting

22. Members agreed to discuss the following items at the next regular meeting of the Panel scheduled for 5 October 1998 at 10:45 am :
  1. Securities and Futures Commission 1997-98 Annual Report;

  2. Report on Financial Market Review; and

  3. Exemption from rates of unoccupied properties.

23. The meeting ended at 6:50 pm.

Legislative Council Secretariat
31 December 1998