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the outlook for hong kong as asias financial centre by andrew

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					Speech: The Outlook for Hong Kong as Asia's Financial Centre

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The Outlook for Hong Kong as Asia's Financial Centre By Andrew Sheng Deputy Chief Executive Hong Kong Monetary Authority Symposium on Financial Co-operation and Development Between Hong Kong and Shanghai "Liberalization of the Shanghai Financial Markets: A Host of Opportunities"
Ladies and gentlemen, Good morning. I am honoured to speak to such a distinguished audience on this very important and interesting subject of "The Outlook for Hong Kong as Asia's Financial Centre". Hong Kong is widely recognised as one of the world's leading financial centres. Here we offer a wide range of financial services and products. Our financial markets rank high in depth and liquidity. In world terms, we are the fifth largest in both external banking assets and forex turnover, and the seventh largest in derivatives turnover. In terms of market capitalization, our stock market is the second largest in Asia after Japan. Our debt market, though relatively small, has attained impressive growth in recent years. We play the role as the major conduit for flow of funds across the Asia-Pacific region. The plentiful of our financial innovations helps the dynamic expansion of the region's economies. The phenomenal growth of our neighbours, in turn, feeds back to the further development of our financial intermediary role. New initiatives will continue to come about, all of which are aimed at improving the financial infrastructure and enhancing our competitiveness as an international financial centre. Before I talk about the outlook for Hong Kong as Asia's financial centre, let me first take stock of what we have so far achieved in the five major financial markets and their recent developments: the banking sector, the foreign exchange and derivatives markets, the money market and the debt market. (I would not, however, cover the stock market, as I understand that Mr. Herbert Hui of the stock exchange of Hong Kong will be talking about this market later this morning.)

Financial Markets
Banking Sector I would like to begin with the banking sector. Our banking industry is highly internationalised, with about 500 banks from more than 40 different countries operating business here. Of the top one hundred banks in the world, 80 have a presence in Hong Kong. This high international element not only provides competition as a driving force for local banks, it also introduces new ideas and banking products into Hong Kong. Electronic banking products is a typical example of recent product innovations in the banking industry.

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The development of electronic money no doubt has wide implications for the financial industry. The regulatory framework will be further refined as the market develops and new products emerge. As banking products further develop, the banking sector continues to achieve solid growth. And along with this healthy expansion of business, major local banks have registered an increase of 20-30% in their 1996 interim profits. In the first nine months of the year, net interest margins of locally incorporated banks have further improved to 2.6%, from 2.2% and 2.3% in the previous two years. The impressive performance over the past years, which is likely to continue in the years to come, had allowed Hong Kong banks to build up a very strong capital base: the capital adequacy ratio of locally incorporated institutions stood at 17.5% at end-1995, significantly higher than the Basle minimum requirement of 8%.

Foreign Exchange and Derivatives Markets
Let me now turn to the foreign exchange and derivatives markets. The foreign exchange market in Hong Kong is very active, with turnover of US$91 billion per day, the fifth largest by international comparison. The expansion of the market reflects growth in external trade as well as the financial sector in Hong Kong. While the growth in merchandise and services trade has led to increased volume of foreign exchange transactions, the marked rise in portfolio and direct investment in the region has also contributed. Geographically, Hong Kong's strategic location as the gateway to mainland China offers tremendous potential for future growth. As mainland China moves towards full current account convertibility this year and, at a later stage, full capital account convertibility, trading in the renminbi is likely to increase and Hong Kong should attract a share of this, particularly by acting as a bridge between the nascent forex markets in China and those in the rest of the world. Located within the Asian time zone, Hong Kong complements New York and London to form a global network in foreign exchange transactions. We do, however, face intense competition from other regional centres. In this connection, the HKMA has been working closely with the Hong Kong Association of Banks at levelling the legal playing field. For example, we issued last year the Hong Kong version of International Foreign Exchange Master Agreement, that would harmonise the legal agreement and framework for forex trading. The recent launch of Real Time Gross Settlement system should have also provided a better clearing and settlement infrastructure to attract forex business to Hong Kong. A closely related market is the derivatives market. The derivatives market comprises two components: over-the-counter trading and exchange trading. Over-the-counter trading accounted for more than 80% of the total trading. Exchange-traded derivatives markets, on the other hand, are much less developed in Hong Kong. Trading is mainly concentrated in foreign exchange and interest rate derivatives, which are held on a much larger scale than derivatives on equities, stock indices and commodities. This is quite similar to the global pattern. According to the 1995 BIS survey, the average turnover of foreign exchange and interest rate derivatives was US$74 billion in terms of notional amount per business day during April 1995 in Hong Kong, while the notional amount of outstanding derivatives contracts booked in Hong Kong totalled US$1.6 trillion at end March 1995.

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Money Market
Another market I would like to talk about is the money market. The HK dollar interbank market is a sizable and active money market where wholesale HK dollar funds are traded among authorised institutions in Hong Kong and also with banks outside Hong Kong. To give you a feel of the size of the market: its daily gross transactions amounted to $156 billion, almost half the total turnover of the clearing house and over 20 times the local stock exchange turnover. Over the past few years, we have introduced a number of measures to strengthen the HKMA's ability to influence interbank interest rates, for the purpose of achieving exchange rate stability. In particular, Exchange Fund Bills and Notes provide a cost effective tool for managing the level of interbank liquidity. Also, under the Liquidity Adjustment Facility (LAF), banks may obtain liquidity assistance from the HKMA through a Sale and Purchase Agreement involving eligible securities, and they may also place excess liquidity with LAF's deposit facility. Moreover, to meet international standards and minimise settlement risks, we have just introduced one of Asia's most modern, streamlined Real Time Gross Settlement (RTGS) system, which moves us away from the next day net settlement system. So far, the performance of the RTGS system has been satisfactory. I would also like to point out that the RTGS system not only allows real time payment versus payment (PvP) in foreign exchange transactions, but it also facilitates real time delivery versus payment (DvP) for sale or purchase of securities. On the point of DvP, the RTGS system includes an efficient interface with the HKMA's Central Moneymarkets Unit (CMU) Service, a paperless securities clearing and settlement system which is linked to Euroclear and Cedel to facilitate investor access to Hong Kong markets. Such a robust debt securities clearing and settlement system is an important piece of infrastructure essential to the development of debt market in Hong Kong.

Debt Market
This brings us to the debt market, the development of which has been slow until recent years due to Hong Kong's sustained fiscal surpluses, which obviated the need to issue government bonds. However, in view of the vast funding requirement in the region, there is a clear need for the development of longer term funding vehicles, in particular fixed income instruments. The HKMA has, therefore, taken steps to promote the debt market through providing market infrastructure, such as the CMU Service, and issuing progressively longer term Exchange Fund paper to provide a benchmark yield curve for debt issues. Hong Kong is responding to the demand for long term funds with rapid growth of its debt market, from only 5% of GDP in 1989 to 18% in 1995. In the first nine months this year, the HK dollar debt market further expanded by 19%. About one quarter of the outstanding issues are government bonds, with total outstanding debt amounting to $73 billion at end November. These papers are actively traded, with around one fifth to one third of the outstanding amount being traded every day, making it one of the most actively traded government securities in the world. Presently, the size of debt market was about one-sixth of the HK dollar money supply and about one-tenth of the HK dollar denominated assets of the entire banking sector. To further widen and deepen the debt market, we have recently undertaken a

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number of initiatives. These include: First, issuing longer term Exchange Fund Notes, the maturity of which has just been extended to 10 years. We now have a smooth and reliable benchmark yield curve for HK dollar debt up to the 10-year area. All new issues of Exchange Fund Notes now straddle over 1997 and were heavily oversubscribed. The spreads over the US Treasuries stand currently at 29 basis points for three years and 105 basis points for ten years. The narrow spreads clearly suggest that the market is not demanding a risk premium on the Hong Kong paper. Second, widening the scope of repo securities eligible for discounting under the Liquidity Adjustment Facility, which will raise the demand for high quality, marketable HK dollar-denominated paper issued by the private sector. Third, promotion of mortgage-backed securities (MBS). We are establishing a secondary mortgage corporation, which is to play a crucial role in developing the debt market through supplying paper either in the form of unsecured debt securities or MBS. The mortgage corporation will also help improve market efficiency and stimulate the development of the secondary mortgage market. Fourth, enhancement of payment and settlement system. The CMU Service of the HKMA provides an important platform on which the debt market can be built, efficiently and soundly. The CMU Service has international linkage and is also hooked up with the RTGS system. Fifth, tax advantage is given to investment in government bonds and high quality debt instruments. These have reduced the borrowing costs of debt issuers and encouraged them to issue more in Hong Kong. The prospects for the debt market development are very favourable. With rapid economic development, Asia has an immense need for infrastructural investments. The World Bank has estimated that the infrastructure needs of East Asia alone amount to US$1.5 trillion in the decade to 2004. Here in Hong Kong, apart from the funding needs of its own investment, a major potential growth area is the financing of China's infrastructure development. Somebody suggested that China would require about US$700 billion for infrastructure projects over the next decade. A significant proportion of the necessary funds will be raised from international markets, especially through Hong Kong. With the expected rapid growth in insurance and pension funds, underpinned by the Mandatory Provident Fund Scheme, demand for fixed income securities will increase in vast multiples.

Regional Competitiveness
Our success as a prominent international and regional financial services centre is no miracle. Hong Kong is highly competitive. This is clearly confirmed by the World Economic Forum's 1996 Global Competitive Report, which ranks Hong Kong as the second most competitive economy in the world, just after Singapore. Compared with the ranking in the 1995 report, Hong Kong moves one place up, indicating that Hong Kong's international competitiveness has improved somewhat over the past year. Separately, the International Institute for Management Development in its World Competitiveness Report 1996 ranks Hong Kong as the world's third most competitive economy, only after the US and Singapore. Hong Kong has long been a leading financial services centre both globally and in Asia. We possess the best conditions and ingredients for success:

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First, Hong Kong benefits from its strategic geographical location of being not only at the centre of the fastest growing region in the world but also as the gateway to China. Located within the Asian time zone, Hong Kong complements New York and London to form a global network in providing financial services. Second, we have a clear, fair and predictable legal system. Our laws and regulations measure up to international standards; they are clear, fair, transparent and consistent. The Government has provided the rule of law to protect the interests of depositors, investors, shareholders, insurance policy holders and members of occupational retirement schemes. It also makes full efforts to ensure all market participants compete on equal terms. Third, our tax system is renowned for its simplicity and low rates. Companies are free to enter and to do business in Hong Kong, as long as they meet some minor requirements and observe Hong Kong laws. And ancillary institutions, such as accounting and legal firms and information suppliers, provide world class support services. Fourth, Hong Kong enjoys an excellent technological platform and physical and financial infrastructure: We are completing in 1998 one of the most modern airports in the world. We also provide one of the most advanced and competitive telecommunication systems. The Central Moneymarkets Unit (CMU) Service is already a well accepted paperless securities clearing and settlement system, with linkages to Euroclear and Cedel and is fully integrated into the RTGS system. We are considering to establish linkages with other domestic clearing systems such as the Central Clearing And Settlement System for stocks. We are also advocating the buildup of AsiaClear, a regional network of bond clearing and settlement systems in Asia. The idea is to settle Asian and international bonds in our time zone. We are keenly aware that with rising labour costs and rents, competitiveness could be eroded. An Informal Working Group on Financial Technology Infrastructure is looking at how improved information technology at the infrastructure level can help increase productivity and reduce costs. Fifth, our workforce is highly educated, flexible and proficient in the use of English. There are few barriers to the entry of overseas specialist staff. The quality of life is conducive to attract and retain experienced staff. Sixth, Hong Kong enjoys a strategic advantage of being the key financial centre for China. We are close to China. We do understand Chinese businesses and the Chinese culture, including the language. Hong Kong's unique position under the concept of "one country, two systems" makes it the most ideal place for facilitating foreign investments in China. As China opens up its financial markets, the demand for financial services such as securities trading, investment banking, and related accounting and legal services will expand exponentially. The business opportunities for Hong Kong in meeting these demands will be immense. However, the world is dynamic. It is true that the fast growth and liberalisation in regional economies will create new opportunities. At the same time, it is also this liberalisation and development of our neighbours that could threaten our status as the financial centre for the region. It is, therefore, of vital importance not only

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to maintain but also to enhance the comparative advantages of Hong Kong as an international financial centre. We in the HKMA are devoted to preserve these ingredients for success in Hong Kong after 1997, as is required of us in the Basic Law. Specifically, the Basic Law states that: "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 outlook for Hong Kong as Asia's financial centre is promising. Hong Kong as Asia's financial centre is thriving. We must keep this up. We will have to provide a continued open, fair and reliable operating environment in which Hong Kong's financial services and businesses can flourish. We compete by making the markets work better. We must work hard and work together to strengthen our world-class market infrastructure. Thank you. Updated on 18 Dec 1996

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