THE UNIVERSITY OF HONG KONG LIBRARIES. Hong Kong Collection. gift frxm Hcng Kong Monetary Authority

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3 THE UNIVERSITY OF HONG KONG LIBRARIES Hong Kong Collection gift frxm Hcng Kong Monetary Authority

4 Fact Sheet 1 HONG KONG MONETARY AUTHORITY THE HKMA's ROLE AND POLICY OBJECTIVES Functions and Objectives The Hong Kong Monetary Authority (HKMA) was established on 1 April 1993 by merging the Office of the Exchange Fund with the Office of the Commissioner of Banking. The functions and objectives of the HKMA are: to maintain currency stability, within the framework of the linked exchange rate system, through sound management of the Exchange Fund, monetary policy operations and other means deemed necessary; to promote the safety and stability of the banking system through the regulation of banking business and the business of taking deposits, and the supervision of authorised institutions; and to enhance the efficiency, integrity and development of the financial system, particularly payment and settlement arrangements. These functions and objectives are generally common to central banks around the world. Unlike many other central banks, however, the HKMA does not carry out the following functions: Banknote Issue. This is currently undertaken by three commercial banks. They are the Hongkong and Shanghai Banking Corporation Limited, the Standard Chartered Bank and the Bank of China. Banker to the Government. Although the bulk of the fiscal reserves are held by the Exchange Fund, which is managed by the HKMA, the HKMA does not act as the banker to the Government, a function which has been carried out historically by commercial banks. The HKMA is organised into six departments: Banking Supervision Department, Banking Policy Department, External Department, Reserves Management Department, Monetary Policy and Markets Department, and Research Department, in addition to a Legal Office. Integral part of the Government The HKMA is an integral part of the Hong Kong SAR Government, but is able to employ staff on terms different from those of the civil service in order to attract personnel of the right experience and expertise. The Chief Executive, appointed by the Financial Secretary, remains a public officer, as do his staff. The Financial Secretary is advised by the Exchange Fund Advisory Committee (EFAC) on matters relating to the use of the Exchange Fund and the operation of the HKMA. The Committee functions very much as a management board of the HKMA and, among other things, advises the Financial Secretary on the HKMA's annual budget. The HKMA is accountable to the public through the Financial Secretary, who appoints the Monetary Authority, and through the laws passed by the Legislative Council that set out the HKMA's powers and responsibilities. Enhanced transparency and accessibility The HKMA also recognises a broader responsibility to promote a better understanding of its role and objectives and to keep itself informed of community concerns. In its day-to-day operations and in its wider contacts with the community, the HKMA pursues a policy of transparency and accessibility. A number of recent initiatives under this policy have made the HKMA one of the most transparent organisations of its kind in the world. These initiatives include the HKMA's disclosure, since 1996, on a virtually real-time basis of information about the Aggregate Balance of the clearing accounts maintained by banks with the HKMA, and the daily publication, since November 1998, of the size of the monetary base and its components. With the aim both of further increasing transparency and of encouraging public interest in the workings of Hong Kong's currency board system, the records of the new EFAC Sub-Committee on Currency Board Operations have, since November 1998, been published.

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6 Fact Sheet 2 HONG KONG MONETARY AUTHORITY EXCHANGE FUND AND RESERVES MANAGEMENT History of the Exchange Fund The Hong Kong SAR Government's Exchange Fund (the Fund) was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance) to provide backing to the banknotes issued. The Fund was originally held in gold, silver and British pounds. In 1976, the role of the Fund was expanded to include the management of the official reserves when the assets of the Coinage Security Fund (which held the backing for coins issued by the Government) and the bulk of foreign currency assets held in the Government's General Revenue Account were transferred to the Fund. In addition, from 1976 onwards, the Government began to transfer its fiscal reserves to the Fund. The Fund now holds the official reserves of Hong Kong predominantly in foreign currency assets including cash, short-term deposits, foreign government bonds, equities and gold. Management of the Fund The Fund is managed by the Hong Kong Monetary Authority (HKMA) under powers delegated by the Financial Secretary to the Monetary Authority under the Exchange Fund Ordinance. Uses of the Fund The main uses of the Fund as stipulated in the Exchange Fund Ordinance are to safeguard the exchange value of the Hong Kong dollar, and to maintain the stability and integrity of the monetary and financial systems of Hong Kong, with a view to maintaining Hong Kong as an international financial centre. The Fund is used, when necessary, to undertake intervention and open market operations to maintain monetary stability. Investment strategy The key objectives of the Fund's investment strategy are: to preserve capital; to ensure that the entire monetary base will be at all times fully backed by highly liquid short-term US dollar denominated securities; to ensure sufficient liquidity for the purpose of maintaining monetary and financial stability; and to achieve an investment return that will preserve the long-term purchasing power of the assets. To achieve these objectives, the funds are managed in two separate portfolios: a Backing Portfolio holding short-term, highly liquid US dollar denominated securities to fully back the monetary base; and an Investment Portfolio engaging in longer-term investments to preserve the value of the Fund for the future benefit of the people of Hong Kong. The Backing Portfolio, which accounts for about 30% of the assets of the Fund, is managed internally by the direct investment division of the HKMA. The Investment Portfolio is jointly managed by the direct investment division and about 30 external managers appointed by the HKMA. These external fund managers, given their deeper experience in specific markets and their presence in other time zones, complement the work of the internal direct investment division. The HKMA regularly reviews its investment strategy and operations. In line with the statutory purposes for which the Exchange Fund was created and maintained, the investment style and strategy are similar to those of comparable central banks and monetary authorities. An investment strategy appropriate for a long-term fund - such as a benchmark approach and a greater use of the long-term capital markets - has been adopted,

7 Fact Sheet 2 HONG KONG MONKTXRY UJTHOHITY and the range of currencies and instruments used has also been increased. At the beginning of 1999, the Exchange Fund adopted a new long-term asset allocation strategy, commonly known as an investment benchmark, which includes 80% allocation to bonds and 20% allocation to equities. In terms of currencies, the investment benchmark includes 80% in the US dollar bloc, 15% in the European bloc and 5% in the Yen bloc. Increased transparency Prior to 1992, the accounts of the Fund were confidential. However, in keeping with the commitment to greater transparency in disclosure, the Government started publishing the accounts of the Fund annually in Bi-annual accounts have been published since June 1995 and headline figures for the foreign exchange reserves have also been released monthly since January The Financial Secretary has decided to publish on a monthly basis, from 1999, an abridged balance sheet of the Fund and a set of Currency Board Accounts. The first set of monthly figures, for the end of January 1999, was released in February. Merger of the assets of the Land Fund into the Exchange Fund Upon the establishment of the Special Administrative Region on 1 July 1997, the assets of the Land Fund Trust were vested in the Hong Kong SAR Government. Between 1 July 1997 and 31 October 1998, under the direction of the Financial Secretary, the fund was managed by the HKMA as a portfolio separate from the Exchange Fund. Effective 1 November 1998, the assets of the Land Fund were merged into the Exchange Fund and managed as part of the Investment Portfolio of the Exchange Fund. Following the merger, the Land Fund remains a separate government fund to be managed in exactly the same way as other fiscal reserves placed with the Exchange Fund. This will enable the Land Fund to achieve a more optimal and stable investment return under profit sharing arrangements similar to those for the fiscal reserves placed with the Exchange Fund. Furthermore, the Land Fund will continue to be administered in accordance with the Resolution of the Provisional Legislative Council in July The alignment exercise will not pre-empt consideration of the long-term use of the Land Fund, and any proposal in this regard is subject to approval by the Legislative Council in accordance with the Resolution establishing the Land Fund. The acquisition of Hong Kong Equities and the establishment of Exchange Fund Investment Limited As a result of the Government's operations in the stock market in August 1998, the Exchange Fund acquired a substantial portfolio of Hong Kong equities. Exchange Fund Investment Limited (EFIL) was established on 14 October 1998 to manage the Hong Kong equity portfolio purchased in August together with the Hong Kong equities transferred from the Land Fund. EFIL has been charged with the responsibility of recommending and executing a disposal programme under which the bulk of these Hong Kong equities will be returned to private sector hands in an orderly manner without disrupting the market. With the adoption of the new investment benchmark of the Exchange Fund, which includes a 5% allocation to the Hong Kong equity market, the HKMA has also asked EFIL to manage, through external managers, the Hong Kong equities to be held as a long-term investment portfolio. Enquiries about the HKMA's work should be directed to the Resource Centre, HKMA, 8/F, 3 Garden Road, Hong Kong. Tel: (852) Fax : (852) hkma@hkma.gov.hk Website :

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9 Fact Sheet 3 HONG KONG MONETVRY AUTHORITY equivalent amount of US dollars from the Exchange Fund. In the case of coins, which are issued by the HKMA, transactions between the HKMA and the agent bank responsible for storing and distributing the coins to the public are settled against US dollars at the rate of HK$7.80 to one US dollar. Operating under the rule-based currency board system, the Aggregate Balance varies in accordance with the flow of funds into and out of the Hong Kong dollar. In September 1998, the HKMA provided a clear undertaking to licensed banks to convert Hong Kong dollars in their clearing accounts into US dollars at the fixed exchange rate of HK$ to one US dollar. Starting from 1 April 1999, this convertibility exchange rate in respect of the Aggregate Balance has been moving from by 1 pip per calendar day for a 500-day period to , where it will converge with the convertibility rate for Certificates of Indebtedness. The proceeds from the issue of Exchange Fund Bills and Notes have over time been switched into US dollar assets. The HKMA has also given the undertaking that additional Exchange Fund paper will only be issued either when there is an inflow of funds (thus ensuring full backing by foreign currency reserves) or, starting from 1 April 1999, in order to absorb the interest payments on such paper. The latter procedure also complies fully with the currency board principles since the interest payments on Exchange Fund paper are fully backed by interest income from US dollar assets backing the monetary base. Under the currency board system, Hong Kong dollar exchange rate stability is maintained through the interest rate adjustment mechanism. The monetary base increases when the foreign currency (in Hong Kong's case, US dollars), to which the domestic currency is linked, is sold to the currency board for the domestic currency (capital inflow). It contracts when the foreign currency is bought from the currency board (capital outflow). The expansion or contraction in the monetary base causes interest rates for the domestic currency to fall or rise respectively, creating the monetary conditions that automatically counteract the original capital movement, and thereby stabilising the exchange rate. The Currency Board Account and Backing Portfolio The HKMA publishes the Currency Board Account on a monthly basis to demonstrate compliance with currency board principles. The Currency Board Account shows on its liabilities side the monetary base and on its assets side the backing assets. The backing assets represent the specific portfolio of US dollar assets designated for backing the monetary base (the backing portfolio) which was established in October The backing assets provide 110.3% backing for the monetary base as at the end of June The excess of assets in the backing portfolio over the monetary base provides a prudent cushion against possible fluctuations in the market value of the monetary base and the backing assets. Although specific assets of the Exchange Fund have been earmarked to back the monetary base, the whole of the Exchange Fund, and not just the backing portfolio alone, continue to be available for the purpose of supporting the exchange value of the Hong Kong dollar under the linked exchange rate system. At the end of July 1999, the total foreign currency assets of the Exchange Fund amounted to US$89.1 billion, representing over three times the monetary base. Sub-Committee on Currency Board Operations under the Exchange Fund Advisory Committee The operations of the currency board system are overseen by the Sub-Committee on Currency Board Operations under the Exchange Fund Advisory Committee, which was established in August This Sub- Committee is chaired by the Chief Executive of the HKMA. Other members of the Sub-Committee include market professionals, academics and senior officials of the HKMA. The Sub-Committee also recommends, where appropriate, measures to enhance the robustness and effectiveness of Hong Kong's currency board arrangements. The Sub-Committee has examined different aspects of the currency board arrangements in Hong Kong. As a result of its recommendations, a number of reform measures have been introduced to strengthen the system. Enquiries about the HKMA's work should be directed to the Resource Centre, HKMA, 8/F, 3 Garden Road, Hong Kong. Tel: (852) Fax : (852) hkma@hkma.gov.hk Website :

10 Fact Sheet 4 HONG KONG MONETARY AUTHORITY DEBT MARKET DEVELOPMENT IN HONG KONG In the course of the last decade, the Hong Kong Monetary Authority (HKMA) has taken a number of steps to develop the infrastructure and assist in the growth of the debt market in Hong Kong These measures have included the introduction of the Exchange Fund Bills and Notes Programme, the creation of a benchmark yield curve extending to 10 years, the establishment of an efficient central clearing and custodian system for debt securities (the Central Moneymarkets Unit - the CMU) and linking it to Euroclear, Cedel and other central securities depositories in the Asian Pacific region, the granting of profits tax exemption/concession for qualifying debt securities, the extending of the market making system for Exchange Fund paper to debt securities established by statutory corporations, the use of Exchange Fund paper as margin collateral for trading in stock options and futures the listing and trading of Exchange Fund Notes on the Stock Exchange of Hong Kong, the implementation of the Real Time Gross Settlement (RTGS) System, and the establishment of the Hong Kong Mortgage Corporation Partlv as a result of these measures, the debt market in Hong Kong has developed rapidly The total outstanding public and private sector debt issues has increased more than fifteenfold from about HK$27 billion at end-1989 to HK$407 1 billion at the end of June 1999 Exchange Fund Bills and Notes Exchange Fund Bills and Notes are Hong Kong dollar debt securities issued by the HKMA to provide a cost-effective instrument for conducting money market operations The issue of Exchange Fund Bills and Notes has also facilitated the development of the local debt market by increasing the supply of high quality Hong Kong dollar debt paper and establishing a reliable benchmark yield curve for Hong Kong dollar debt (Chart 1) The Exchange Fund Bills programme was introduced in March 1990 Under this programme, bills of 91, 182- and 364-day maturity are put up for tender regularly Two-year and three-year Exchange Fund Notes were introduced in May 1993 and October 1993 respectively This was followed by the inaugural issue of five-year Exchange Fund Notes in September 1994, seven-year Exchange Fund Notes in November 1995, and ten-year Exchange Fund Notes in October 1996 At the end of June 1999, the total amount of Exchange Fund Bills and Notes outstanding was HK$98 8 billion (US$12 7 billion) Trading in these instruments is highly active, with a daily average turnover of HK$16 8 billion (US$2 2 billion), which represents about 17 0% of the outstanding amount Central Moneymarkets Unit The HKMA operates the Central Moneymarkets Unit (CMU), which was set up in 1990 to provide a computerised clearing and settlement facility for Exchange Fund Bills and Notes In December 1993, the HKMA extended the service to other Hong Kong dollar debt securities It offers an efficient, safe and convenient clearing and custodian system for Hong Kong dollar debt instruments Since December 1994,

11 Fact Sheet 4 HONG KONG MONETARY AUTHORITY the CMU has been linked to Euroclear and Cedel. This helps promote Hong Kong dollar debt securities to overseas investors. In January 1996, the CMU Service was further extended to cover non-hong Kong dollar debt securities. The CMU handles debt instruments which are either immobilised or dematerialised, and transfer of title is effected in computer book entry form. At the end of June 1999, 822 private debt issues, with a total nominal value of HK$226.6 billion (US$29.1 billion) were lodged with the CMU, an increase of 17.4% compared with the end of In December 1996, a seamless interface between the CMU and the newly launched Real Time Gross Settlement (RTGS) interbank payment system was established. The CMU system now provides real time and end-of-day Delivery versus Payment (DvP) services. In April 1997, an agreement was reached between the HKMA and the Reserve Bank of Australia (RBA) for the CMU of the HKMA to join the RBA's Reserve Bank Information and Transfer System (RITS) which is the central clearing and settlement system for Australian government paper. Subsequent to the linkage with Australia, the CMU set up a securities link with the Austraclear New Zealand System, a clearing system operated by the Reserve Bank of New Zealand (RBNZ), in April The bilateral linkage was established on a reciprocal basis. Both the HKMA and the RBNZ have become members of each other's clearing system. The bilateral linkages between Hong Kong and Australia and New Zealand will help to broaden the investor base of the debt markets in these economies by facilitating crossborder trading and holding of securities. The third bilateral securities link in the region, with South Korea, commenced operation on 8 September Granting of profits tax exemption/concession for qualifying debt securities As a measure to promote the development of a high quality debt market, Exchange Fund Bills and Notes have been exempted from profits tax. Since 1992, the SAR Government has also granted the exemption of profits tax on Hong Kong dollar debt securities issued by the multilateral agencies with top credit ratings. To date, ten multilateral agencies have been granted tax-exempt status. At the end of June 1999, the outstanding amount of Hong Kong dollar debt securities issued by the multilateral agencies was HK$68.9 billion. In addition, since May 1996, interest income and trading profits derived from eligible debt securities can enjoy a concessionary tax rate equal to 50% of the standard profits tax rate. All debt instruments, regardless of their currency denomination, will qualify for the tax concession if they fulfill the eligibility criteria. There are two such types of eligible securities: debt instruments issued by the MTRC, KCRC, AA and HKMC, lodged with and cleared through the CMU, with a minimum denomination of HK$50,000 or its equivalent in a foreign currency, with an original maturity of not less than five years, and issued to the public in Hong Kong; and debt instruments lodged with and cleared through the CMU, with an investment grade rating specified by the HKMA, with a minimum denomination of HK$50,000 or its equivalent in a foreign currency, with an original maturity of not less than five years, and issued to the public in Hong Kong.

12 Fact Sheet 4 HONG KONG MONETARY AUTHORITY #?i4msrtff Jt/4 Promotion of a deep and liquid domestic bond market Following the HKMA's Note Issuance Programme on behalf of the MTRC in 1995 and the Airport Authority in 1997, the HKMA arranged a similar programme for the HKMC in January 1998 and for the KCRC in March Under this Programme, the HKMA acts as the arranger, custodian, agent and operator for the debt issues. The securities are covered by the existing market making arrangements for Exchange Fund Bills and Notes, which should help improve their secondary market liquidity. The first issue under the HKMC Note Issuance Programme was successfully launched in May New initiatives have recently been launched to further develop the local debt market. With effect from 1 April 1999, new Exchange Fund paper is being issued in line with interest payments on existing Exchange Fund paper. This will allow the size of Exchange Fund paper to grow gradually, and will be conducive to the development of the local debt market. Another initiative is to allow use of Exchange Fund paper as margin collateral for trading in stock options and futures. This can enhance liquidity management by participants in the stock options and futures exchange. It can also promote market-wide use of Exchange Fund paper, increase the liquidity of fixedincome market, and help reduce systemic risk. With a view to enhancing the liquidity of the secondary market for Exchange Fund Notes and facilitating access by retail investors to the Exchange Fund Notes market, the HKMA has listed the Notes on the Stock Exchange of Hong Kong. Trading in these Notes on the Stock Exchange began on 16 August The listing and trading of Exchange Fund Notes also paves the way for the listing and trading of Hong Kong dollar bonds issued by government-owned corporations, such as the HKMC, MTRC, AA and KCRC, and eventually corporate bonds. Payment system To help Hong Kong maintain its competitiveness as an international financial centre, the HKMA has been working closely with the banking industry to enhance the efficiency and robustness of the interbank payment system. The successful launch in 1996 of the new Real Time Gross Settlement (RTGS) system, one of the most advanced in Asia was an important milestone in the development of Hong Kong's interbank payment system. With the implementation of the RTGS system, real time DvP capability has been achieved for all debt securities transactions cleared and settled through the CMU. The Hong Kong Mortgage Corporation The Hong Kong Mortgage Corporation (HKMC), which was incorporated in March 1997, plays an important role in promoting banking stability, monetary stability and home ownership. The HKMC also helps stimulate the development of the local debt market through the supply of high quality paper to meet the rising demand from institutional investors, such as pension and insurance funds. The HKMC is now a major supplier of high quality Hong Kong dollar debt securities. It was one of the most active corporate issuers in If market conditions permit, the HKMC will also consider the feasibility of launching its Mortgage-backed Securities Programme in More information on the HKMC can be found in Fact Sheet 6.

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14 Fact Sheet 5 HONG KONG MONETARY AUTHORITY THE REAL TIME GROSS SETTLEMENT SYSTEM Hong Kong's interbank payment system entered a new era on 9 December 1996 with the launch of the Real Time Gross Settlement (RTGS) system by the Hong Kong Monetary Authority (HKMA) and the Hong Kong Association of Banks (HKAB). The new system is one of the HKMA's major initiatives to enhance the robustness of the financial infrastructure and the competitiveness of Hong Kong as an international financial centre. It is one of the most advanced interbank payment systems in the Asia Pacific region. RTGS - a simple and direct system Prior to the establishment of the RTGS system, the Hongkong and Shanghai Banking Corporation Ltd (HSBC) was the Management Bank responsible for all interbank payment and settlement arrangements. Some 171 licensed banks needed to go through 10 designated banks, called the Settlement Banks, which would in turn clear payments with the HSBC. Under the new RTGS system, which is simple, robust and in full compliance with international standards, all licensed banks in Hong Kong are required to open settlement accounts directly with the HKMA and have direct access to the system. A new company, Hong Kong Interbank Clearing Ltd, jointly owned by the HKMA and HKAB, was set up to replace the HSBC as the operator of the clearing house to settle all interbank payments (Chart). Automated intraday repurchase (repo) arrangement While no daylight overdraft is allowed, banks can obtain intraday liquidity through intraday repo arrangement with the HKMA, using mainly government paper, i.e. Exchange Fund Bills and Notes. The intraday repo transactions are fully automated. When a bank does not have sufficient balance in its account to effect an outgoing payment but has sufficient eligible securities in its intraday repo account, the system will automatically trigger an intraday repo transaction to generate the required amount of credit balance to cover the shortfall. A bank with excess liquidity in its settlement account may reverse the repo transaction any time. The HKMA's functions Under the RTGS system, the HKMA performs the following roles: acting as the settlement institution for all licensed banks in Hong Kong; operating the Central Moneymarkets Unit system, which is a computerised clearing and settlement facility for debt securities; providing intraday liquidity through intraday repos to prevent payment gridlocks; and overseeing the operation and development of Hong Kong's interbank payment system. Measures to improve payment flows To address concerns among some banks about other banks holding on to liquidity until late in the afternoon and the risk of technical default of time-critical bulk clearing payments, the HKMA has introduced several liquidity management measures under the RTGS system. These include: a guideline implemented in December 1996 by the HKMA to encourage all banks to make payments in a timely and orderly manner throughout the day. A bank is required to release and settle 35% by noon and 65% by 2:30 p.m. the value of its total daily Clearing House Automated Transfer System payments; and

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16 Fact Sheet 6 HONG KONG MONETARY AUTHORITY THE HONG KONG MORTGAGE CORPORATION Hong Kong offers fertile ground for the development of a secondary mortgage market, as has been shown by the strong increase in outstanding residential mortgage loans from 8% of GDP in 1980 to 40% in A properly developed secondary mortgage market can play a useful role in channelling long-term funds, such as insurance and pension funds, to meet the rising demand for long-term home financing. The Hong Kong Mortgage Corporation Limited (HKMC) was incorporated in March 1997 with the mission of developing Hong Kong's secondary mortgage market. The HKMC is a public limited company, wholly owned by the Government through the Exchange Fund, and incorporated under the Companies Ordinance. The HKMCs business is being developed in two phases. The first phase involves the purchase of mortgage loans for its own portfolio, funding the purchases largely through the issuance of unsecured debt securities. In the second phase, the HKMC will securitise the mortgages into mortgage-backed securities (MBS) and offer them for sale to investors. Since commencing business in October 1997, the first phase of the HKMCs business plan has proceeded smoothly. On the mortgage purchase side, the outstanding principal balance of the Corporation's mortgage portfolio expanded quickly to HK$10.59 billion, as of 30 June Following a successful six-month pilot scheme, the purchase programme for fixed-rate mortgages was introduced as a standard programme in September Because of the HKMC's prudent purchasing criteria, the mortgages in its portfolio are of excellent asset quality. As of 30 June 1999, the delinquency ratio of loans overdue for more than 90 days was 0.02%, substantially below the industry average of 1.14%. On the funding side, the Corporation successfully issued a total of HK$5.2 billion of unsecured debts in 1998 through its HK$20 billion Note Issuance Programme (NIP) and HK$20 billion Debt Issuance Programme (DIP), making it one of the most active issuers of Hong Kong dollar fixed-rate securities during the year. This momentum was maintained in Ten private placements under the DIP and one public issue under the NIP were made in the first four months of 1999, and a total of HK$1.75 billion was raised through these issues. The HKMC debt securities were well received by financial institutions and institutional investors. The average oversubscription rate for these NIPs was more than five times the notes issued. The HKMA acted as arranger, custodian, agent and operator for these NIPs. Mortgage Insurance Programme On 3 December 1998, the Board of Directors of the HKMC gave its approval in principle for the Corporation to partner with mortgage insurers to launch a Mortgage Insurance Programme to enable home buyers to secure mortgage loans of up to 85% loan-to-value ratio. Under the Programme, the HKMC provides mortgage insurance at a fee to the lending bank for an amount up to 15% of the value of the property. The HKMC will fully hedge the exposure of the mortgage insurance by taking out re-insurance of an equal amount with a mortgage insurer. The Programme, launched on 31 March 1999, has been well received by banks and homebuyers. By 30 June 1999, 38 of the HKMCs 40 Approved Sellers had signed the Master Mortgage Insurance Policy. Up to the same date, the HKMC had received 789 applications from 24 Approved Sellers, involving a total mortgage amount of HK$1,658 million. More than 90% of the applications were for secondary accounts, indicating that the Programme has served to improve liquidity in the secondary market.

17 Fact Sheet 6 HONG KONG MONETARY AUTHORITY The Corporation will consider launching an inaugural issue of mortgage-backed securities in 1999, a core component of the second phase of its business plan, if market conditions permit. The Hong Kong Mortgage Corporation: Facts and Figures Ownership 100% owned by the Government through the Exchange Fund Share Capital Authorised share capital of HK$3 billion (US$0.38 billion). HK$2 billion (US$0.26 billion) already paid up with the balance of HK$1 billion (US$0.13 billion) on a callable basis. Capital-to-assets ratio as at 30 April 1999 is 9.9%. Structure Limited company registered under the Companies Ordinance, with participation from the public and private sectors on the Board of Directors. Business strategy Business scope to be expanded in phases, starting with the purchase of mortgage loans for retained portfolio funded largely by the issue of unsecured paper, followed by the issue of mortgage-backed securities. Enquiries about the HKMAs work should be directed to the Resource Centre, HKMA, 8/F, 3 Garden Road, Hong Kong. Tel: (852) Fax : (852) hkma@hkma.gov.hk Website :

18 Fact Sheet 7 HONG KONG MONETARY AUTHORITY BANKING POLICY AND SUPERVISION The three-tier banking system Hong Kong maintains a three-tier system of deposit-taking institutions, namely, licensed banks, restricted licence banks and deposit-taking companies. They are collectively known as authorised institutions (AIs) under the Banking Ordinance. Only licensed banks may operate current and savings accounts, and accept deposits of any size and maturity. Restricted licence banks are principally engaged in merchant banking and capital market activities. They may take deposits of any maturity of HK$500,000 (approximately US$64,103) and above. Deposit-taking companies are mostly owned by, or otherwise associated with, banks. They engage in a range of specialised activities, including consumer finance and securities business. These companies may take deposits of HK$100,000 (approximately US$12,821) or above with an original term to maturity of at least three months. Hong Kong has one of the highest concentrations of banking institutions in the world. At the end of June 1999, there were 166 licensed banks, 59 restricted licence banks and 86 deposit-taking companies in business. Between them, these 311 authorised institutions operate a comprehensive network of 1,583 local branches. Of these 311 AIs, 279 are beneficially owned by interests from over 30 countries. There are, in addition, 131 representative offices of overseas banks in Hong Kong. A local representative office is not allowed to engage in any banking business. Its role is confined mainly to liaison work between the bank and its customers in Hong Kong. Authorisation The authorisation criteria for licensed banks, restricted licence banks and deposit-taking companies seek to ensure that only fit and proper institutions are entrusted with public deposits. The Hong Kong Monetary Authority (HKMA) conducts periodic reviews of the authorisation criteria and, when necessary, introduces amendments to reflect the changing needs of the regulatory environment and to meet new international standards. Under the Banking Ordinance, the HKMA is the licensing authority responsible for the authorisation, suspension and revocation of all three types of authorised institutions. Checks and balances are provided in the Ordinance with the requirement that the HKMA consult the Financial Secretary on important authorisation decisions, such as suspension or revocation. The Chief Executive-in-Council is the appellate body for hearing appeals against decisions made by the HKMA. Authorised institutions have to comply with the provisions of the Banking Ordinance which, among other things, require them to maintain adequate liquidity and capital adequacy ratios, to submit periodic returns to the HKMA on required financial information, to adhere to limitations on loans to any one customer or to directors and employees, and to seek approval for the appointment of controllers, directors and senior management. Overseas-incorporated banks licensed in and after 1978 and overseas-incorporated restricted licence banks authorised in and after 1990 were previously subject to the one-building condition, which effectively restricts these institutions to operate out of one branch. The original intention of imposing branching

19 Fact Sheet 7 HONG KONG MONETARY AUTHORITY restriction on foreign banks was to avoid over-crowding in the retail banking market Having regard to the latest developments in the banking market, the HKMA is now of the view that this policy has outlived its usefulness and is becoming less relevant to the banking development in Hong Kong Accordingly, the onebuilding condition was relaxed in September 1999, and from that time onwards, foreign banks are allowed to carry out their business in not more than three buildings In addition, the restriction on the number of regional and back offices that overseas-incorporated institutions can maintain was lifted at the same time The HKMA will review the situation and consider further relaxation of this policy in 2001 In view of the increasing interest in the issue of multi-purpose stored value cards with the potential to substitute to a significant degree for cash and cheques, the Banking (Amendment) Ordinance 1997 was enacted to empower the HKMA to regulate the issue of these cards The Ordinance provides that only licensed banks should have the ability to issue multi-purpose cards that are unrestricted in terms of the goods and services which they can be used to purchase The objectives are to maintain the stability of the payment system and provide a measure of protection to cardholders A non-bank service provider may, however, be authorised as a deposit-taking company whose principal business is to issue or facilitate the issue of multi-purpose cards which are more limited in scope of usage Furthermore the new legislation provides for the HKMA to grant exemption from the approval process to certain types of multi-purpose cards where the risk to the payment system and to cardholders is considered to be slight The Banking (Amendment) Ordinance 1997 also established the legal framework for the authorisation of money brokers operating in the wholesale foreign exchange and deposit markets Only persons who satisfy the fit and proper criteria set out in a Schedule to the Ordinance will be approved as money brokers Among other things, approved money brokers will be required to comply with relevant codes and guidelines on the conduct of business Regulatory framework The Banking Ordinance provides the legal framework for banking supervision in Hong Kong The HKMA seeks to establish a regulatory framework which is fully in line with international standards, especially those recommended by the Basle Committee on Banking Supervision (Basle Committee) The objective is to devise a prudential supervisory system to help preserve the general stability and effective working of the banking system, while at the same time providing sufficient flexibility for authorised institutions to take commercial decisions In response to the Basle Committee's paper on the Core Principles for Effective Banking Supervision, the HKMA carried out a self-assessment of the position of Hong Kong in 1997 The assessment revealed that Hong Kong's supervisory framework substantially complies with the Core Principles The enactment of the Banking (Amendment) Ordinance 1999 in July 1999 brings Hong Kong's framework of banking supervision fully in line with the Core Principles Approach to supervision The supervisory approach of the HKMA is based on a policy of'continuous supervision' This involves the on-going monitoring of institutions using a wide variety of techniques which are aimed at detecting any problem at an early stage At the core of this approach is the on-site examination of individual institutions Depending on the risk assessment of the institution concerned, the scope of an examination may range from an investigation of specific areas to a comprehensive review of an institution's operations On-site examinations provide a valuable opportunity to assess at first hand how an institution is managed and controlled They are particularly useful for verifying asset quality However, they are periodic in nature and, to achieve 'continuous supervision', on-site examination is supplemented by on-going off-site analysis of the financial

20 Fact Sheet 7 HONG KONG MONETARY AUTHORITY condition of individual institutions and the assessment of the quality of their management, including the systems for controlling exposures and limiting risk. The scope of off-site analysis varies from regular analysis of statistical returns covering various aspects of the operations of individual institutions to an extensive annual review of their performance and financial position. Off-site reviews may be followed by a prudential interview with senior management. Frequent contacts are also made with individual institutions at various levels of management as specific issues arise. In the continuous assessment of the performance of individual institutions, close attention is paid to capital, liquidity, earnings, asset quality, loan loss provisioning, concentration of risks, interest rate risk, risk management systems and internal controls. Discussion with both internal and external auditors is another important aspect of the supervisory process. Annual tripartite discussions are held with institutions and their auditors, normally following the annual audit. Matters discussed typically include the annual audit, adequacy of provisions and compliance with prudential standards. The HKMA regularly makes use of its powers under the Banking Ordinance to commission reports from auditors on the accuracy of prudential returns and the adequacy of institutions' systems to compile prudential returns. Additionally, the HKMA may commission reports from auditors on the internal control systems of individual institutions. Given the evolving financial and economic environment, there is an on-going need for the HKMA to enhance the supervisory process for maintaining the stability of the banking system. To ensure the effectiveness of its supervisory framework, the HKMA is developing a more formalised risk assessment approach and quality assurance programme. Risk-based supervision The HKMA continues to refine its risk-based supervisory approach, which is similar to that found in the advanced economies that are used for benchmarking purposes. These include a more systematic risk assessment framework and organisational changes designed to increase staff capabilities and provide more comprehensive career development. The HKMA has initiated work on mapping out a plan for implementing the recommendations in the Banking Sector Consultancy Study report (see the last section), including the establishment of the Licensing and Compliance Division. This will enable the HKMA to focus more clearly its attention on risk areas of individual institutions as well as the sector as a whole. The HKMA expects to adopt a fully-fledged risk-based supervision approach within two years. Capital adequacy The internationally accepted capital adequacy framework proposed by the Bank for International Settlements (BIS) in 1988 has been applied in Hong Kong since the end of 1989, against the Basle Committee's deadline for full implementation before the end of The consolidated capital adequacy ratio for locally incorporated institutions as a whole was 19.5% at end-june 1999, well in excess of the minimum international standard of 8% set by the BIS. The HKMA has developed a market risk capital adequacy regime in Hong Kong based on the Amendment to the Capital Accord to incorporate market risks issued by the Basle Committee in January The market risk capital adequacy regime has been in effect since 31 December The HKMA has adopted a three-tier approach in implementing the regime, namely the standardised approach, the models approach (the use of which is subject to the HKMA's approval) and a de minimis exemption. Supervision of liquidity The HKMA assesses the adequacy of an institution's liquidity by examining a number of criteria, including the institution's liquidity ratio, maturity mismatch profile, ability to borrow in the interbank market,

21 Fact Sheet 7 HONG KONG MONETARY AUTHORITY diversity and stability of the deposit base, loan-to-deposit ratio and intra-group transactions. This approach aims to ensure, as far as possible, that institutions can meet their obligations when they fall due in normal circumstances and that an adequate stock of high quality liquid assets is maintained to provide them with a breathing space in the event of a liquidity crisis. Financial disclosure In line with the international trend towards greater transparency and accountability, the HKMA supports greater disclosure by authorised institutions in Hong Kong. The standard of financial disclosure in Hong Kong has been brought substantially in line with that of other major financial centres following institutions' adoption in 1994 of the Best Practice Guide on Financial Disclosure issued by the HKMA. Authorised institutions incorporated in Hong Kong (except for the smaller restricted licence banks and deposit-taking companies) are required to disclose adequate financial information, including profit and loss accounts, balance sheets, cash flow statements and off-balance sheet exposures in their audited annual accounts and their annual reports. Further steps were taken by the HKMA in 1998 to increase the transparency of the financial position of Als and hence to enhance market discipline among these institutions. For local banks, the focus of the 1998 disclosure package was on the quality of banks' loan portfolios. Institutions are required to disclose more detailed information on overdue and rescheduled assets. Disclosure requirements in relation to the Year 2000 problem have also been enhanced. Overseas incorporated Als are required to disclose on a half-yearly basis selected key financial information drawn from the Best Practice Guide on Financial Disclosure by Als. Local institutions are required to make interim disclosures with effect from June This brings the frequency of disclosure by non-listed local institutions in line with that for listed local institutions and institutions incorporated outside Hong Kong. Interest rate deregulation Historically, interest rates paid to depositors on all Hong Kong dollar deposits of up to HK$500,000 (approximately US$64,103) and with a maturity of less than 15 months were governed by the Interest Rate Rules (IRR) of the Hong Kong Association of Banks (HKAB) of which all licensed banks are members. The IRR were partially liberalised in phases starting from 1 October With the implementation of the final phase of deregulation on 1 November 1995, all small time deposits fixed for 7 days or more have been deregulated. The IRR now apply only to current accounts, savings accounts and time deposits with a maturity or call period below seven days. In July 1999, the HKMA announced a plan to remove the remaining IRR by a two-phase approach (see the last section). Electronic banking The Banking Sector Consultancy Study has advised that technology will be one of the major driving forces for longer-term changes in the financial services industry globally and in Hong Kong. It has also revealed that a high proportion of local banks has plans to launch internet banking services in the next five years. In fact, the HKMA has issued a series of circulars on its supervisory policy with respect to internet banking and a number of banks are now offering internet banking services of various kinds. Meanwhile, the Government is establishing a safe and secure environment for the conduct of electronic transactions over the internet, in the form of a local public key infrastructure and the necessary legal framework in Hong Kong. The HKMA will continue to keep abreast of technological developments and will refine as appropriate its regulatory framework to continue to provide a sound and secure basis for the development of internet banking in Hong Kong.

22 Fact Sheet 7 HONG KONG MONKTARY AUTHORITY Derivatives and risk management The HKMA continues to take a proactive approach in the supervision of authorised institutions' derivatives activities The HKMA adopts a three-pronged approach in developing its supervisory framework for managing the risks of AIs' derivatives activities They are controls (to ensure that AIs have adequate internal control systems to manage the risks of their derivatives activities), capital (to ensure that AIs have adequate capital to support possible losses in their derivatives business), and capability (to ensure that there is adequate expertise within the HKMA to develop risk management policies and to supervise AIs' derivatives activities) In December 1994, the HKMA adopted as an industry guideline the Basle recommendation on risk management of derivatives, which focuses on high level controls by board and senior management In March 1996, a more detailed operational guideline on financial derivatives was issued which drew on, among other things, observations from internal control reviews, treasury visits to AIs, and the lessons from the Barings and Daiwa Bank incidents Since 1994, a specialised team has been formed to examine the derivatives and trading activities of institutions which are active in this business, as well as the adequacy of their risk management systems Supervisory co-operation To ensure supervisory co-operation the HKMA entered into a Memorandum of Understanding (MOU) with the Securities & Futures Commission (SFC) in October 1995 In 1996, with the assistance of the SFC, the HKMA developed an on-site examination guide on the securities activities of AIs and formed a specialised team to conduct examinations of institutions active in securities activities The HKMA and the SFC currently meet once a month to discuss supervisory issues and cases of mutual interest The exposure of banks to new types of risk around the world has increased the need for supervisors to cooperate with one another, both geographically and functionally To enhance the exchange of supervisory information and co-operation, the HKMA has entered into MOUs with supervisory authorities in Thailand, Indonesia, Macau, the United States and the United Kingdom The HKMA continues to participate in this process by extending its bilateral co-operation with banking supervisors in other countries The HKMA also holds regular meetings with the People's Bank of China to discuss matters of common interest The HKMA plays an increasingly active role in international and regional forums of banking supervision It currently chairs the Executives' Meeting of East Asian-Pacific Central Banks' (EMEAP) Study Group on Banking Supervision and was one of the participants in a working group formed by the Basle Committee to draft the Core Principles for Effective Banking Supervision Further development and reform of the banking sector Early in 1998, the HKMA commissioned a consultancy study on the Hong Kong banking sector aimed at developing an appropriate strategy to effectively supervise and regulate the sector for the next five years The study was completed in December 1998 Given the new emerging financial environment, the consultancy study suggested four strategic mandates for the HKMA in promoting future developments of the banking sector These are to ensure that the regulatory and supervisory framework for Hong Kong remains appropriate, to improve the competitive environment to ensure the positive benefits of global and local trends are developed in the Hong Kong market, to ensure that increasing levels of risk associated with global and local trends are prudently managed, and to increase the level of transparency allowing the forces of market discipline to work more effectively

23 Fact Sheet 7 HONG KONG MONETARY 4UTHORITY Having regard to the recommendations of the study and the views received from a three-month public consultation exercise, the HKMA will undertake a package of policy initiatives, as set out below, to reform and further develop Hong Kong's banking system: (a) Overall approach: encourage market liberalisation and enhance the level of competitiveness of the Hong Kong banking sector in order to promote greater efficiency and innovation in the market; in parallel with the item above, strengthen the banking infrastructure with a view to enhancing the safety and soundness of the sector; and by gradual elimination of regulatory barriers, allow market forces to play a greater role in determining the appropriate number of institutions in the banking sector. (b) Market reform and liberalisation measures: subject to a monitoring process, adopt a two-phased approach to deregulate the remaining Interest Rate Rules with the first phase to begin on 1 July 2000 with the remaining regulated time deposits with a maturity of below seven days. The second phase is expected to begin on 1 July 2001 with deregulation of savings and current account deposits; relax the one branch policy in the second half of 1999 by allowing foreign banks currently subject to the one building condition to open up to three branches initially to which customers have access (full relaxation of this policy will be considered upon a review in 2001); subject to appropriate contractual arrangements being agreed with Hong Kong Interbank Clearing Limited, allow access by restricted licence banks to the Real Time Gross Settlement system in the second half of 1999 for the purpose of settling CHATS payments; conduct a detailed review in the second half of 2000 on ways to reform the three-tier authorisation system into a two-tiered system and review the minimum paid-up capital requirements for different tiers of authorised institutions at the same time; and review the existing market entry requirements for a local banking licence towards the second half of (c) Safety and soundness enhancement measures: conduct a detailed study in the first half of 2000 on the issue of establishing an explicit depositor protection scheme in Hong Kong and review the desirability of setting an asset maintenance requirement for banks in Hong Kong in relation to the Priority Payment Scheme for small depositors under the Companies Ordinance; clarify HKMA's role of lender of last resort for banks in Hong Kong; continue the efforts to improve the financial disclosure requirements for banks in line with international best practices; develop a more formal risk-based supervisory system in Hong Kong; conduct a detailed feasibility study in the first half of 2000 on a commercial credit register for the banking system in Hong Kong; and promote high standards of corporate governance within the banking system. This package of policy initiatives has been endorsed by the Government. The overall timetable would envisage these policy initiatives to be completed over a period of around three years. Enquiries about the HKMA's work should be directed to the Resource Centre, HKMA, 8/F, 3 Garden Road, Hong Kong. Tel: (852) Fax : (852) hkma@hkma.gov.hk Website :

24 Fact Sheet 8 HONG KONG MONETARY AUTHORITY BANKNOTES AND COINS Currency and coins in circulation The Government, through the Hong Kong Monetary Authority (HKMA), has given authorisation to three commercial banks, the Hongkong and Shanghai Banking Corporation Limited, the Standard Chartered Bank and the Bank of China, to issue currency notes in Hong Kong (Chart 1). Authorisation is accompanied by a set of terms and conditions agreed between the Government and the three note-issuing banks. Banknotes are issued by the three banks, or redeemed, against payment to, or from, the Governments Exchange Fund in US dollars, at a specified rate of US$1 to HK$7.80 under the linked exchange rate system. Banknotes issued by the three commercial banks are printed in Hong Kong by Hong Kong Note Printing Limited (HKNPL). Currency notes in everyday circulation are $10, $20, $50, $100, $500 and $1,000. The $10 notes are gradually being phased out and replaced by the $10 coin, a process which began in November The one-cent note was demonetised and ceased to be legal tender on 1 October The Government issues coins of $10, $5, $2, $1, 50 cents, 20 cents and 10 cents. Until 1992 these coins were embossed with the Queens Head. In 1993, a programme was initiated to replace the Queens Head series with a new series depicting the Bauhinia flower. The first Bauhinia coins, the $5 and $2 coins, were issued in January New $1, 50 cents and 20 cents coins were issued in October 1993, and a new 10 cents coin in May The $10 coin, the last of the Bauhinia series of coins, was issued in November Since the beginning of the coin replacement programme in 1993, about 549 million coins of Queens Head design have been withdrawn from circulation. The Queens Head coins remain legal tender while the replacement programme continues. At the end of 1998, the total value of banknotes in circulation in Hong Kong was HK$86,465 million, while coins in circulation amounted to HK$5,554 million (excluding commemorative coins), representing about 6% of total currency in circulation (Charts 2 & 3). To commemorate the establishment of the Hong Kong Special Administrative Region on 1 July 1997, the HKMA, on behalf of the Government, issued a HK$ 1,000 commemorative proof gold coin, a proof set and a brilliant uncirculated set of seven coins with the same denominations as the coins currently in circulation. On the obverse side of each of these seven coins is the standard Bauhinia design, with its own special commemorative design and denomination on the reverse. To mark the opening of the Hong Kong International Airport in July 1998, a commemorative $1,000 commemorative proof gold coin was issued. The gold coin features a design symbolising Hong Kong's ascent into the new century and bears the standard Bauhinia design on the obverse side. Banknote printing In April 1996, the HKMA acquired the note printing plant from the De La Rue Group of the UK on behalf of the Government. The plant has been operating under the name of HKNPL since then. The acquisition of the plant enables the Government, through the HKMA, to be direcdy involved in the production of Hong Kong currency notes, which is in line with the responsibilities conferred upon the Government under the Legal Tender Notes Issue Ordinance and the Basic Law. In March 1997, the Government sold 15 percent of its shareholding in HKNPL to the China Banknote Printing and Minting Corporation, a PRC state-owned enterprise. In October 1997, the Government sold to the three note-issuing banks, each 10 percent of HKNPLs issued shares. The Government continues to exercise management control and maintains a majority stake in HKNPL, with the Chief Executive of the HKMA as the Chairman of the company.

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26 Fact Sheet 9 HONG KONG MONETARY AUTHORITY HONG KONG'S MONETARY SYSTEM AND THE 'ONE COUNTRY, Two SYSTEMS' PRINCIPLE Under the principle of 'one country, two systems' enshrined in the Smo-Bntish Joint Declaration and the Basic Law (Annexes 1 & 2), Hong Kong enjoys a high degree of autonomy except in foreign affairs and defence matters In particular, Hong Kong's monetary system remains separate from that of the Mainland of China, and the Government of the Hong Kong Special Administrative Region (HKSAR) formulates its own monetary and financial policies The Hong Kong dollar, as the only legal tender in the HKSAR, remains freely convertible The free flow of capital within, into and out of the HKSAR is guaranteed and no exchange control policies may be applied in Hong Kong The Hong Kong dollar continues to circulate as a freely convertible currency, and the authority to issue Hong Kong currency is vested in the HKSAR Government Hong Kong's foreign exchange reserves, held in the Exchange Fund, are managed and controlled by the Government of the HKSAR primarily for regulating the exchange value of the Hong Kong dollar Mutually independent monetary systems These provisions form the foundation for Hong Kong's monetary and financial arrangements between the Mainland of China and Hong Kong The People's Bank of China (PBoC) has pledged that under the 'one country, two systems' principle, there will be 'two currencies, two monetary systems and two monetary authorities which are mutually independent' This means that neither has precedence over the other, neither is superior to the other, and neither takes instructions from the other The PBoC has pledged its readiness to use China's foreign reserves to support the currency stability of Hong Kong when necessary at the request of the Hong Kong Monetary Authority (HKMA) But China will not draw on or resort to Hong Kong's own reserves or other assets in any way, or for any reason Financial institutions from the Mainland of China are treated in the same way as any other foreign institutions in Hong Kong and do not enjoy any special privileges Like any other organisations with a presence in Hong Kong, these Mainland financial institutions are required to abide by the laws of Hong Kong and be regulated by the relevant supervisory authorities in Hong Kong Co-operation between the HKMA and PBoC Co-operation between the two central banking institutions - the PBoC and the HKMA - has been strengthened in recent years In February 1996, the two institutions signed a repurchase agreement in respect of US dollar government securities to provide liquidity on a bilateral basis Both sides have also agreed in principle to the linkage of their respective interbank payment systems Co-operation between the two authorities in other areas, including the supervision of banks, is being further enhanced, in strict accordance with the principle and spirit of 'one country, two systems'

27 Fact Sheet 9 HONG KONG MONETARY AUTHORITY Monetary relations between the Mainland and Hong Kong 1. The monetary and currency systems of the Mainland and Hong Kong are mutually independent. The Renminbi and the Hong Kong dollar circulate as legal tender in the Mainland and Hong Kong respectively and will be regarded as foreign currencies in each other's territory. 2. The HKMA and the PBoC maintain a mutually independent relationship. The HKMA is accountable only to the Government of Hong Kong. 3. The financial supervisory authorities of the Mainland and Hong Kong co-operate with each other on a number of issues. 4. The PBoC will provide support for maintaining the currency stability of Hong Kong if necessary and only at the request of the HKMA. 5. All financial claims and liabilities between the Mainland and Hong Kong are handled in accordance with internationally accepted rules and practices. 6. Mainland financial institutions operating in Hong Kong are supervised by the relevant regulatory authorities in Hong Kong. Enquiries about the HKMA's work should be directed to the Resource Centre, HKMA, 8/F, 3 Garden Road, Hong Kong. Tel: (852) Fax : (852) hkma@hkma.gov.hk Website :

28 Fact Sheet 9 HONG KONG MONETARY AUTHORI1Y Annex 1 The Joint Declaration of the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the People's Republic of China on the Question of Hong Kong (Annex I: Part Vand Part VII) (Signed on 19 December 1984) Part V. FINANCE Budget The Hong Kong Special Administrative Region shall deal on its own with financial matters, including disposing of its financial resources and drawing up its budgets and its final accounts The Hong Kong Special Administrative Region shall report its budgets and final accounts to the Central People's Government for the record. Taxation and public expenditure The Central People's Government shall not levy taxes on the Hong Kong Special Administrative Region. The Hong Kong Special Administrative Region shall use its financial revenues exclusively for its own purposes and they shall not be handed over to the Central People's Government The systems by which taxation and public expenditure must be approved by the legislature, and by which there is accountability to the legislature for all public expenditure, and the system for auditing public accounts shall be maintained Part VII. MONETARY SYSTEM Previous monetary and financial systems The Hong Kong Special Administrative Region shall retain the status of an international financial centre The monetary and financial systems previously practised in Hong Kong, including the systems of regulation and supervision of deposit taking institutions and financial markets, shall be maintained Monetary and financial policies The Hong Kong Special Administrative Region Government may decide its monetaiv and financial policies on its own It shall safeguard the free operation of financial business and the free flow of capital within, into and out of the Hong Kong Special Administrative Region No exchange control policy shall be applied in the Hong Kong Special Administrative Region Markets for foreign exchange, gold, securities and futures shall continue Hong Kong dollar The Hong Kong dollar, as the local legal tender, shall continue to cnculate and remain freelv convertible The authority to issue Hong Kong currency shall be vested in the Hong Kong Special Administrative Region Government The Hong Kong Special Administrative Region Government may authorise designated banks to issue or continue to issue Hong Kong currency under statutory authority, aftei satisfying itself that any issue of currency will be soundly based and that the arrangements for such issue are consistent with the object of maintaining the stability of the currency Hong Kong currency bearing references inappropriate to the status ot Hong Kong as a Special Administrative Region of the People's Republic of China shall be progressively replaced and withdrawn from circulation Exchange Fund The Exchange Fund shall be managed and controlled by the Hong Kong Special Administrative Region Government, primarily for regulating the exchange value of the Hong Kong dollar

29 Fact Sheet 9 HONG KONG MONETARY AUTHORITY Annex 2 Basic Law of the Hong Kong Special Administrative Region of the People's Republic of China (Article 106 and Articles 109 to 116) (promulgated on 4 April 1990) Article 106 The Hong Kong Special Administrative Region shall have independent finances The Hong Kong Special Administrative Region shall use its financial revenues exclusively for its own purposes, and they shall not be handed over to the Central People's Government The Central People's Government shall not levy taxes in the Hong Kong Special Administrative Region Article 109 Article 110 The Government of the Hong Kong Special Administrative Region shall provide an appropriate economic and legal environment for the maintenance of the status of Hong Kong as an international financial centre The monetary and financial systems of the Hong Kong Special Administrative Region shall be prescribed by law The Government of the Hong Kong Special Administrative Region shall, on its own, formulate monetary and financial policies, safeguard the free operation of financial business and financial markets, and regulate and supervise them in accordance with law Article 111 The Hong Kong dollar, as the legal tender in the Hong Kong Special Administrative Region, shall continue to circulate The authority to issue Hong Kong currency shall be vested in the Government of the Hong Kong Special Administrative Region The issue of Hong Kong currency must be backed by a 100 per cent reserve fund The system regarding the issue of Hong Kong currency and the reserve fund system shall be prescribed by law The Government of the Hong Kong Special Administrative Region may authorize designated banks to issue or continue to issue Hong Kong currency under statutory authority, after satisfying itself that any issue of currency will be soundly based and that the arrangements for such issue are consistent with the object of maintaining the stability of the currency Article 112 No foreign exchange control policies shall be applied in the Hong Kong Special Administrative Region The Hong Kong dollar shall be freely convertible Markets for foreign exchange, gold, securities, futures and the like shall continue The Government of the Hong Kong Special Administrative Region shall safeguard the free flow of capital within, into and out of the Region Article 113 Article 114 Article 115 Article 116 The Exchange Fund of the Hong Kong Special Administrative Region shall be managed and controlled by the government of the Region, primarily for regulating the exchange value of the Hong Kong dollar The Hong Kong Special Administrative Region shall maintain the status of a free port and shall not impose any tariff unless otherwise prescribed by law The Hong Kong Special Administrative Region shall pursue the policy of free trade and safeguard the free movement of goods, intangible assets and capital The Hong Kong Special Administrative Region shall be a separate customs territory The Hong Kong Special Administrative Region may, using the name ' Hong Kong, China, participate in relevant international organisations and international trade agreements (including preferential trade arrangements), such as the General Agreement on Tariffs and Trade and arrangements regarding international trade in textiles Export quotas, tariff preferences and other similar arrangements, which are obtained or made by the Hong Kong Special Administrative Region or which were obtained or made and remain valid, shall be enjoyed exclusively by the Region

30 Fact Sheet 10 HONG KONG MONETARY AUTHORITY HONG KONG As AN INTERNATIONAL FINANCIAL CENTRE Hong Kong is one of the worlds major financial centres. It has achieved this position through its strategic geographical location, a liberal economic policy, the free flow of capital and information, a diligent workforce, a sound legal system, a low tax rate (Chart 1), and an efficient physical infrastructure. Banking is the linchpin of financial activities in Hong Kong. About 440 authorised institutions (including licensed banks, restricted licence banks and deposit-taking companies) and representative offices of banks from 42 countries operate in Hong Kong (Chart 2). Of the worlds top 100 banks, 76 have established business in Hong Kong: 71 of these operate with a full banking licence. Around 60% of banking business is denominated in foreign currencies (Chart 3). Hong Kong is the seventh largest foreign exchange trading centre in the world (Chart 4). The average daily turnover (as at April 1998) is around US$79 billion. The absence of exchange controls and the favourable time zone location have helped to stimulate the development of the foreign exchange market in Hong Kong. Hong Kong also has a well developed interbank money market, where wholesale Hong Kong dollars are traded among banking institutions. The average daily turnover in the Hong Kong dollar interbank market in 1998 was HK$156 billion (US$20.1 billion). Hong Kong is among the worlds largest gold bullion markets. Its stock market is Asia's second largest after Tokyo, with capitalisation of about US$344 billion at December 1998 (Chart 5). The stock market not only serves Hong Kong, but also acts as an important source of funding for companies in the Asian region, particularly in Mainland China. At present, there are 41 Mainland Chinese companies listed on the Stock Exchange of Hong Kong (known as H-shares). These companies have raised about HK$61 billion (US$7.9 billion) for enterprises operating in China. The debt market has grown rapidly in recent years. The size of the debt market (as at end-june 1999), as measured by the outstanding amount of Hong Kong dollar debt securities, is HK$407.1 billion (US$51.6 billion). Of this, Exchange Fund Bills and Notes amount to HK$98.8 billion (US$12.7 billion) (Chart 6).

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32 Fact Sheet 10 Hong Kong's external relations and the HKMA Hong Kong maintains close and active co-operation with the international financial community and with multilateral and regional forums. These contacts are crucial to Hong Kong's ability to maintain its competitiveness and to its role as an international financial centre. The establishment of the Hong Kong Monetary Authority (HKMA) has enabled Hong Kong to strengthen its contacts with other central banks and multilateral financial organisations and to promote Hong Kong's standing as an international financial centre. Such contacts enable the HKMA: to promote international understanding of, and support for, monetary and banking matters in Hong Kong; to share information with other central banks about financial developments so as to facilitate the proper regulation of financial markets and the prudential supervision of financial institutions; to improve understanding of international economic and financial trends so as to facilitate more effective policy formulation in the HKMA, particularly in monetary management and reserves management; to improve the HKMA's access to the technical expertise available in major central banks and multilateral institutions, which helps keep Hong Kong in the forefront of financial innovation and institutional development; and to help other central banks and institutions to obtain a better understanding of monetary and general economic developments in Hong Kong and the region. The HKMA pursues these aims through the following activities: (a) Active and autonomous participation in central banking forums Hong Kong is a member of the Asian Development Bank, the Bank for International Setdements, the South East Asia, New Zealand and Australia Group of Central Banks and Monetary Authorities (SEANZA) and the Executives' Meeting of East Asian-Pacific Central Banks (EMEAP). It also actively participates in the activities of the World Bank, the International Monetary Fund (IMF), South East Asian Central Banks (SEACEN), and other central banking forums. In 1997, the HKMA became one of the 25 participants in the New Arrangements to Borrow, a standby credit facility extended to the IMF for use in stabilising the global monetary system. (b) Strengthening of the international financial architecture As a leading international financial centre, Hong Kong participates in a number of international and regional initiatives to reform the international financial architecture. The focus has been on enhancing the transparency and accountability of the public sector, the private sector and international financial institutions to make the global economy more resilient to volatile capital flows. Throughout 1998, the HKMA was engaged in the G22 process and its working groups: it cochaired the Working Group on Transparency and Accountability and participated in the Working Group on International Financial Crises. The HKMA is also a member of the Working Group on Enhanced Disclosure by Individual Institutions and the Working Group on Enhanced Transparency Regarding Aggregate Positions, which are sub-groups of the Basle-based Committee on the Global Financial System (formerly known as Euro-currency Standing Committee). In summer 1999, Hong Kong, along with Singapore, Australia and the Netherlands were invited to participate in the G7 Financial Stability Forum. The HKMA is also a member of the Working Group on Highly Leveraged Institutions (HLIs) formed by the Forum. The Group is mandated to study the activities of HLIs and will produce a final report around the spring of 2000.

33 Fact Sheet 10 HONG KONG MONETARY AUTHORITY Hong Kong has actively contributed to promoting the development of bond markets in the region. Under the auspices of Asia-Pacific Economic Co-operation (APEC), Hong Kong, China co-ordinates the Collaborative Initiative on Development of Domestic Bond Markets. The Collaborative Initiative has recendy published a Report on the Compendium of Sound Practices, which provides guidelines to facilitate the development of domestic bond markets in APEC member economies. A total of 36 essential elements under five inter-related areas of Government Policies, Regulatory Framework, Market Infrastructure, Liquidity and Risk Management have been identified in the Compendium. They are intended to encourage relevant authorities to adopt policies conducive to the development of domestic bond markets. Hong Kong will continue to participate in other initiatives aimed at fostering the development of bond markets. (c) Regional monetary co-operation and participation in multilateral agencies The HKMA continues to pursue relationships with regional central banks and multilateral agencies through organising various meetings, seminars, workshops and by participating in regional and international forums. (d) Transparency and information dissemination The HKMA is committed to transparency and public access to economic data by meeting the international standards expected of a leading international financial centre. Accordingly, Hong Kong subscribed to the IMF Special Data Dissemination Standard in November 1996 and started providing economic data in the IMF International Financial Statistics in July Enquiries about the HKMA's work should be directed to the Resource Centre, HKMA, 8/F, 3 Garden Road, Hong Kong. Tel : (852) Fax : (852) hkma@hkma.gov.hk Website :

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