PLC Paper No. CB(1) 551
(These minutes have been seen by the Administration)
Ref : CB1/PL/FA/1

Provisional Legislative Council
Panel on Financial Affairs

Minutes of Meeting held on Friday, 31 October 1997 at 11:30 a.m. in the Chamber of the Legislative Council Building

Members present :

    Hon Paul CHENG Ming-fun, JP (Chairman)
    Hon NGAN Kam-chuen (Deputy Chairman)
    Hon NG Leung-sing
    Hon Eric LI Ka-cheung, JP
    Hon Henry WU
    Hon CHAN Choi-hi
    Dr Hon Philip WONG Yu-hong
    Hon CHIM Pui-chung

Members attending :

    Hon WONG Siu-yee
    Hon James TIEN Pei-chun, JP
    Hon LEE Kai-ming
    Hon Allen LEE, JP
    Hon Henry TANG Ying-yen, JP
    Hon YUEN Mo
    Hon Mrs Sophie LEUNG LAU Yau-fun, JP
    Hon CHAN Wing-chan
    Hon CHAN Kam-lam
    Dr Hon Charles YEUNG Chun-kam
    Hon YEUNG Yiu-chung
    Hon Ambrose LAU Hon-chuen, JP
    Hon Timothy FOK Tsun-ting
    Hon KAN Fook-yee
    Hon CHOY So-yuk

Members absent :

    Dr Hon David LI Kwok-po, JP
    Hon Ronald ARCULLI, JP
    Dr Hon LAW Cheung-kwok

Public officers attending:

Mr Rafael HUI, JP
Secretary for Financial Services

Government Economist

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

Mr Anthony NEOH, SC, JP
Chairman, Securities and Futures Commission

Mr Michael WU, JP
Deputy Chairman, Securities and Futures Commission

Clerk in attendance :

Ms Estella CHAN
Chief Assistant Secretary (1)4

Staff in attendance :

Ms Pauline NG
Assistant Secretary General 1

Miss Anita HO
Assistant Legal Adviser 2

Mr Andy LAU
Senior Assistant Secretary (1)6

I. Briefing on the current financial crisis surrounding the Hong Kong dollar and the Hong Kong stock market

The Chairman said that the recent share market slump had sparked wide public concern about the state of the financial market, particularly the linked exchange rate. This special meeting was convened in order for members to discuss with the Administration measures to deal with the crisis.

2. The Chairman and some other members congratulated the Administration on the success in maintaining the stability of the Hong Kong dollar under the linked exchange rate system.

3. The Secretary for Financial Services (SFS) briefed members that the linked exchange rate system had proved to be effective as compared to other systems in cushioning the economy against economic shocks. The linked exchange rate system had served Hong Kong well over the years and would continue to do so. Given a service economy like Hong Kong in which many of our commodities were imported, depreciation of the Hong Kong dollar would bring harmful effects to our economy without necessarily benefitting exports. The Administration was therefore determined to maintain exchange rate stability, which was the anchor and key to Hong Kong's prosperity. He believed that this perception was well supported by the Central Government and the community at large.

4. The Chief Executive, Hong Kong Monetary Authority (CE/HKMA) advised that there had been some speculative activities in the foreign exchange market with people short selling Hong Kong dollars. Such activities had subsided quickly as a result of the sharp increase in short-term interest rates brought about by the money market operations. Due to the great demand for Hong Kong dollars, the overnight Hong Kong Interbank Offered Rate (HIBOR) soared up to 300 percent at one point but had presently returned to 4-5 percent. Regarding 1-month to 3-month HIBORs, banks were more inclined to take a prudent approach to prevent further speculation, and hence, the rates still stood at 11-12 percent. However, it was envisaged that the HIBOR would be resumed to normal in a few weeks?time. To defend the Hong Kong dollar, HKMA had also directly intervened in the foreign exchange market. In this regard, he confirmed that the Exchange Fund had recorded gains in the trading. For detailed information on the balance of the Exchange Fund, he referred members to the monthly announcements and the annual report of HKMA.

5. In response to a member, CE/HKMA said that it was not appropriate to disclose the trading activities between HKMA and individual banks nor to disclose the names of banks which had involved in the lending activities relating to the short selling of Hong Kong dollars. However, HKMA would remind the banks to organize their Hong Kong dollar funding prudently, otherwise they might face a high penal rate when they approached HKMA for Hong Kong dollars.

6. Most members questioned whether it was sufficient to rely purely on the interest rate as a weapon to deter speculation and maintain the stability of the Hong Kong dollar. Some expressed grave concern about the knock-on effect of the high interest rate on Hong Kong's economy albeit its effectiveness in maintaining currency stability. Some other members pointed out that the recent speculative activities were well-planned, and were not confined to the foreign exchange market but also spanned over the securities and the futures markets. As such, losses in the forex market did not necessarily mean that speculators were really suffering as short selling of stocks and/or Hang Seng Index Futures would on the other hand generate substantial profits. They therefore considered it necessary to review the defending mechanism in the light of the present experience in order to better prepare Hong Kong for future attacks. A member suggested setting up of a special task force comprising representatives of relevant parties to deal with the matter.

7. CE/HKMA responded that strategic uses of interest rates as a weapon against speculators?attacks had proved to be very effective, as experienced in Hong Kong and other international economies. He said that even in other floating exchange rate regimes in Asia, the authorities had to rely on interest rate adjustments to safeguard their currencies. In fact, this mechanism could be flexibly applied with varying degrees of intensity by squeezing the liquidity and, in turn, the interest rate, to achieve different effects. The monetary reform measures that had been introduced such as the Real Time Gross Settlement system and the Liquidity Adjustment Facility (LAF) had greatly strengthened HKMA's ability to maintain the stability of the Hong Kong dollar. Whilst increase of interest rate would inevitably affect the community and the economy as a whole, the impact would only be short term.

8. A member pointed out that in connection with the liquidity squeeze, holders of Exchange Fund Bills and Notes were also charged with a high penal rate when they approached HKMA for Hong Kong dollars. He therefore enquired whether this would affect the attractiveness of the Exchange Fund Bills and Notes and the notes subscription plan to be launched by the Hong Kong Mortgage Corporation Limited. In reply, CE/HKMA said that HKMA would like to remind licensed banks that it did not encourage repeated borrowings by licensed banks through LAF. Each licensed bank had to organize their Hong Kong dollar funding prudently and not be overly dependent upon the LAF for last resort liquidity support. In order to discourage licensed banks from repeated borrowings from LAF, penal LAF offer rates different from the advertised LAF offer rate would be determined on a case by case basis and at the absolute discretion of the HKMA for repeated borrowers. So there was no question of a reduction of attractiveness of the Exchange Fund Bills and Notes.

9. CE/HKMA further said that the penal rate of the LAF would not affect the acquisition of the notes to be launched by the Hong Kong Mortgage Corporation Limited. Since the Corporation was a fully owned company of the Hong Kong Government, the interest to be charged on lending would be dependent upon the credit ratings made by credit rating agencies. However, it was anticipated that the interest to be charged would be similar to that of the rate of the Exchange Fund Bills and Notes.

10. SFS said that although the recent financial turbulence was triggered off by the currency crisis in Asia, in particular, the depreciation of the Taiwan currency, it was considered more a result of the bubble economy which had emerged over the past two years in Hong Kong. He said that under the linked exchange rate system, should there be a disequilibrium between asset prices and economic fundamentals, price adjustments would be inevitable. Further, as the Hong Kong market became more global, asset prices would also be affected by financial activities in overseas economies. Although the trading volume and price volatility were unprecedented, the Administration should not intervene in the market. Rather, the fundamental concern of the Administration should be the provision of a favourable environment in the industry to facilitate trading. Over the past several trading days, the trading, clearing and settlement, and risk management mechanisms in place had enabled the markets to operate smoothly and efficiently, providing continuous liquidity to both domestic and international investors. The Chairman, Securities and Futures Commission (C/SFC) added that neither the Exchanges nor the Securities and Futures Commission had received any complaints from the investing public that there was a problem with executing orders. The clearing systems associated with the Stock and Futures Exchanges operated efficiently and effectively. All margins and intra-day marks were duly collected and that there were no defaults in any of the Clearing Houses.

11. Some members expressed grave concern that derivatives had already become an investment vehicle, albeit a rather speculative one, rather than a hedging instrument and asked if actions should be taken to alleviate the irregularities in this respect.

12. C/SFC said that derivatives were actually used quite widely for hedging against, and therefore minimizing, risks of price fluctuation in certain assets. The trading simply reflected the different perceptions of different investors over the future value of a stock. He said that as the Hong Kong market became more global with offshore trading in London and the existence of international participation in local trading, it would be in Hong Kong's interest to have a developed derivatives market. To this end, the fundamental concern should be the provision of a sound risk management system to enable safe and efficient trading. SFS added that speculation was inevitable in any open market. Whilst derivatives might aggravate market volatility, it would not be appropriate to impose too much restrictions on their trading, bearing in mind that the Government's policy objective was to maintain a free and an open economy. Notwithstanding the above, the Administration would, in the light of the present experience, review the operation of derivatives and their possible impact on the financial markets in times of crisis whilst continuing to maintain Hong Kong's position as a world class international financial centre.

13. A member pointed out that short selling of shares seemed to be highly concentrated in overseas market practitioners and asked if there was a need to review the rules so that locally incorporated authorized institutions would find it easier to participate in the activities. He also expressed concern about the manipulation of information by some large market practitioners to move the market situation to their benefits.

14. C/SFC responded that presently 241 shares were permitted to be shorted in the market but the trading volume was not great. Given the fact that short selling had to be backed by the same amount of stocks in hand, overseas market practitioners would be in a better position as they could borrow shares from other custodians in London. To change the settlement period would touch on other fundamental principles, such as whether short selling should be allowed without a backing of the same amount of stocks in hand, and thus would require further examination.

15. On members?concern about price fluctuations resulting from market manipulation, C/SFS said that in an open market, price fluctuations were inevitable. The industry had adopted an autonomous environment where investors were free to buy or sell underlying index stocks at agreed prices in an orderly manner. He stressed that a suitable regulatory framework to ensure fairness, efficiency, transparency and prudential risk management in the market was already in place. As to the allegation that Morgan Stanley manipulated the market by publicising its investment strategy, he explained that similar analysis about the reduction of investment in the Asian market had already been promulgated by other broker firms in the earlier part of the year. As such, the analysis was not a fresh idea. SFS added that the trading department of the company concerned did not position itself to profit from an anticipated market condition resulting from its analyst's publicized investment strategy and that there was no evidence to establish that the company had made use of dissemination of the information to profit for the company. In fact, the positions in recent trading days were scattered among local and foreign investors. He stressed that the regulatory bodies would take the necessary enforcement actions against market manipulation if it was substantiated.

16. A member pointed out that as the Hang Seng Index were heavily weighted towards a few stocks, the disclosure of unfavourable information about any of these stocks would easily result in a significant fluctuation in the Hang Seng Index. He therefore asked if it was necessary to review the constituent stocks of the Hang Seng Index so as to minimize the possibility of market manipulation. SFS advised that the Hang Seng Index Services Limited would review the constituent companies quarterly, taking into account their coverage and representativeness in the Hong Kong market. Although the index appeared to be dominated by a handful of stocks, it was not justified to revise the constituent companies on the basis of this factor alone. To preserve its credibility as an index, a scientific and objective approach should be adopted for the selection process.

17. On members?request to carry out a comprehensive review following the slump in the stock market, SFS said that it was the first time that financial turbulence in Hong Kong's market had affected markets around the world. This had shown clearly our close integration into the global network. In the light of this, it would be necessary to consider how to further improve our market systems and risk management measures. The Administration had no fixed timetable for such a task as it would have to wait until the situation was more stabilised. It was anticipated that leading economists, academics and businessmen would be invited to provide advice.

II. Date of next regular meeting

18. Members agreed that the next regular meeting would be postponed to 10 November 1997.

(Post-meeting note: With the concurrence of the Chairman, the meeting had been further postponed to 17 November 1997.)

III. Any other business

19. There being no other business, the meeting ended at 12:40 p.m.

Provisional Legislative Council Secretariat
1 December 1997

Last Updated on 5 December 1997