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Strengthening of currency board arrangements in Hong Kong
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The Hong Kong Monetary Authority (HKMA) strongly
reiterates that there will be no foreign exchange controls
in the Hong Kong Special Administrative Region (HKSAR).
Article 112 of the Basic Law clearly specifies that no
foreign exchange control policies shall be applied in the
HKSAR. Furthermore, the HKSAR Government is fully
committed to the maintenance of the linked exchange rate
system and the adherence to the discipline of the currency
board arrangements under that system.
To further strengthen the currency board arrangements
and make them less susceptible to manipulation by
speculators to produce extreme conditions in the interbank
market and interest rates, the HKMA today (Saturday)
announced a package of seven technical measures, which
include the following :
(1) the HKMA providing a clear undertaking to all licensed
banks in Hong Kong to convert Hong Kong dollars in their
clearing accounts into US dollars at the fixed exchange
rate of HK$7.75 to US$1. This explicit Convertibility
Undertaking is a clear demonstration of the Government's
commitment to the linked exchange rate system. It is the
intention of the HKMA to move the rate of the
Convertibility Undertaking to 7.80 when market
circumstances permit;
(2) removing the bid rate of the Liquidity Adjustment
Facility (LAF). As the improved efficiency of the
interbank payment system has facilitated liquidity
management of licensed banks, the need for the LAF deposit
facility to facilitate orderly interbank market activities
has fallen away;
(3) replacing LAF by a Discount Window with the Base Rate
(formerly known as the LAF Offer Rate) to be determined
from time to time by the HKMA. In determining the Base
Rate, the HKMA will ensure that interest rates are
adequately responsive to capital flows while allowing
excessive and destabilizing interest rate volatility to be
dampened;
(4) removing the restriction on repeated borrowing in
respect of the provision of overnight Hong Kong dollar
liquidity through repo transactions using Exchange Fund
Bills and Notes. Allowing for freer access to day end
liquidity through the use of Exchange Fund paper which is
fully backed by foreign currency reserves will make Hong
Kong's monetary system less susceptible to manipulation
and dampen excessive interest rate volatility without
departing from the discipline of the Currency Board
arrangement;
(5) new Exchange Fund paper to be issued only when there
is an inflow of funds. This will ensure that all new
Exchange Fund paper will be fully backed by foreign
currency reserves;
(6) introducing a schedule of discount rates applicable
for different percentage thresholds of holdings of
Exchange Fund paper by the licensed banks for the purpose
of accessing the Discount Window. This will ensure that
the interest rate adjustment mechanism to be fully kicked
in when the Hong Kong dollar is under significant
pressure; and
(7) retaining the restriction on repeated borrowing in
respect of repo transactions involving debt securities
other than Exchange Fund paper. No new issues of paper
other than Exchange Fund paper will be accepted at the
Discount Window. This will prevent significant liquidity
to be provided to licensed banks against paper not backed
by foreign currency reserves.
In addition to the above measures, the HKMA will work
towards producing an Exchange Fund balance sheet showing
Currency Board operations and have this published as
frequently as it is technically feasible.
The seven technical measures and the move towards
greater disclosure have been approved by the Exchange Fund
Advisory Committee (EFAC), upon the recommendation by its
Subcommittee on Currency Board Operations. The
Subcommittee has been set up recently to oversee the
operation of the currency board arrangements in Hong Kong.
In commenting on the seven measures, Mr Donald Tsang,
Financial Secretary, said, "The package of technical
measures will strengthen our defence against manipulation
by the speculators in our foreign exchange and money
markets. They should also help instill greater confidence
in our full commitment to the currency board system."
Mr Joseph Yam, Chief Executive of the HKMA, said,
"These measures aim at strengthening Hong Kong's currency
board arrangements and achieving an even higher degree of
transparency and disclosure. They will enhance the
robustness of Hong Kong's monetary arrangement,
characterized by the linked exchange rate system. They
should also help to reduce excessive volatility in
interest rates."
A technical note on the package of technical measures
as well as the composition and the terms of reference of
the EFAC Subcommittee on Currency Board Operations is
attached.
Strengthening of Currency Board Arrangements in Hong Kong
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Introduction
The Hong Kong Special Administrative Region
Government is firmly committed to the maintenance of the
linked exchange rate system and the adherence to the
discipline of the Currency Board arrangements under that
system. This policy has served Hong Kong extremely well
over the past fifteen years. The linked exchange rate
system has also proven to be the linchpin of financial
stability in Hong Kong, and beyond, against the worst
financial turmoil in the history of Asia. It has the wide
support of the community of Hong Kong and the
international financial community, particularly in
official circles.
Recent developments in the global financial system,
encouraged by financial liberalization and the advancement
of information and telecommunications technology, have
been characterized by very high volatility in
international capital flows. This can be very
destabilizing and presents tremendous risks for the world
economy, in particular for the small open economies, as is
clearly demonstrated by events in the past year or so.
These risks have to be properly managed and financial
stability ensured so that the benefits in the freedom of
capital flows can be fully realized.
Hong Kong does not believe in exchange controls.
Indeed, the Basic Law specifies clearly that no foreign
exchange control policies shall be applied in the Hong
Kong Special Administrative Region. Hong Kong is further
determined and is very well prepared to bear the pain of
adjustments, including interest rate adjustments, under
the linked exchange rate system. But in managing the
risks of free capital flows, including the possibility of
financial markets being subject to manipulation that
exacerbates financial volatility and hence the severity of
economic adjustment, there is a need now to strengthen
further the Currency Board arrangements in Hong Kong's
linked exchange rate system.
Seven Technical Measures
Against this background, the Hong Kong Monetary
Authority (HKMA) announced today a package of seven
technical measures to strengthen the Currency Board
arrangements in Hong Kong. After consulting with the
Exchange Fund Advisory Committee (EFAC), the Financial
Secretary has given his approval for the implementation of
the package.
The first technical measure is in the form of a clear
undertaking from the HKMA to licensed banks to convert
Hong Kong dollars in their clearing accounts into US
dollars at the fixed exchange rate of HK$7.75 to US$1 (the
Convertibility Undertaking). This explicit Convertibility
Undertaking is a clear demonstration of the Government's
commitment to the linked exchange rate system. The rate
of 7.75 has been chosen because it is the current
intervention rate of the HKMA. However, it is the clear
intention of the HKMA, when market circumstances permit,
to move the rate of the Convertibility Undertaking to
7.80, which is the fixed exchange rate of our linked
exchange rate system applicable to the issue and
redemption of Certificates of Indebtedness backing the
bank notes. This will be done at a time when the market
exchange rate is trading consistently at a level
significant stronger than 7.75.
With effect from the opening of the market in Hong
Kong on Monday 7 September 1998, all licensed banks will
be able to take advantage of the Convertibility
Undertaking, on their own or on behalf of their customers
should they find themselves in a position to do so. They
must, however, ensure that they have the necessary Hong
Kong dollars in their clearing accounts on settlement day
to effect settlement. In order to monitor how
transactions under the Convertibility Undertaking are
being conducted and ensure that the arrangement is not
being abused, there will be a need to seek relevant
information from licensed banks. This will be a subject
to be addressed separately, possibly with licensed banks
on an individual basis.
The second technical measure involves the removal of
the bid rate of the Liquidity Adjustment Facility (LAF).
The LAF was introduced in 1992 when the former Accounting
Arrangements were in place to facilitate, amongst other
things, orderly interbank market activities. The
Accounting Arrangements have, since the end of 1996, been
replaced by the requirement whereby all licensed banks
maintain a clearing account with the HKMA, on the occasion
of the introduction of RTGS in Hong Kong. The improved
efficiency of the interbank payment system has facilitated
liquidity management of licensed banks. The need for the
HKMA bidding money at the end of the day through LAF has
fallen away as a result.
The third technical measure deals with the
determination of the LAF offer rate which is to be renamed
the Base Rate. LAF will also be renamed as the Discount
Window. The Base Rate will form the foundation on which
different discount rates are computed and for use in the
overnight repurchase agreements (repos) through the
Discount Window in respect of different percentage
thresholds of Exchange Fund paper held by licensed banks.
In determining the Base Rate, it is obviously essential,
on the one hand, to ensure that interest rates are
adequately responsive to capital flows and, on the other
hand, to allow excessive and destabilizing interest rate
volatility to be dampened. The methodology for doing so
will need to be developed and refined in the light of
experience. But it is the intention of the HKMA to be as
transparent as possible in this task and eventually to go
for a methodology that involves as little discretion on
the part of the HKMA as practicable. One way of doing so,
at least initially, might be to take the average of the
overnight and one-month HIBOR of the previous day as
reference for determining the Base Rate for the day. As
from Monday 7 September, the HKMA will announce each day
before the market opens in Hong Kong the Base Rate
applicable for the day. It is likely that there will,
from then on, be rather frequent changes in the Base Rate.
The fourth technical measure concerns the manner in
which Exchange Fund paper can be used by licensed banks to
obtain overnight Hong Kong dollar liquidity from the HKMA
at the close of the money market in Hong Kong through the
Discount Window. Given that the Exchange Fund paper is in
effect fully backed by Foreign Reserves, the HKMA is
prepared to allow for greater access by licensed banks to
day end liquidity through repos at the Discount Window
using the paper. Subject to the provisions in the sixth
measure, the restriction in which the HKMA imposes penal
interest rates on repeated borrowers through the repo of
Exchange Fund paper will be removed as from Monday 7
September 1998.
The fifth technical measure is in the form of a clear
commitment from the HKMA that new Exchange Fund paper will
only be issued when there is an inflow of funds enabling
the additional paper to be fully backed by Foreign
Reserves. This is to ensure that the repo of Exchange
Fund paper through the Discount Window does not involve
any departure from the discipline of the Currency Board
system. Existing issues of Exchange Fund paper
outstanding, which are already backed by Foreign Reserves,
will be rolled over as and when they mature.
The sixth technical measure spells out, for the
purpose of accessing the Discount Window, a schedule of
discount rates applicable for different percentage
thresholds of holdings of Exchange Fund paper by licensed
banks, as follows:
Percentage of Exchange Applicable Discount Rate
Fund paper held
by a licensed bank
First 50 percent Base Rate
Next 50 percent Base Rate plus 5 percent
or overnight HIBOR for the
day, whichever is higher
The seventh technical measure deals with the position
of the existing eligible paper for LAF other than Exchange
Fund paper. Overnight repos using such paper will still
be allowed. For triple-A rated paper and Specified
Instruments(1)* , the schedule of discount rates
applicable to Exchange Fund paper will apply. For other
eligible paper, the schedule of discount rates will be at
a premium of 0.25% over those applicable to the discount
of Exchange Fund paper. Repeated borrowings, in
accordance with the existing definition, using eligible
paper other than Exchange Fund paper will continue to be
discouraged through the charging of a penal rate by HKMA.
To prevent significant liquidity to be provided to
licensed banks against paper not backed by Foreign
Reserves, no new issues of paper other than Exchange Fund
paper will be eligible for acceptance at the Discount
Window.
Greater Transparency and Disclosure
Apart from the package of seven technical measures,
the HKMA also announced a voluntary move towards even
greater transparency and disclosure on its Currency Board
operations. Information on the Aggregate Balance in the
clearing accounts of licensed banks maintained with the
HKMA is already available almost on real time and this is
unparalleled in any other jurisdiction. The HKMA will
further work towards identifying clearly that part of the
Exchange Fund balance sheet showing Currency Board
operations. The relevant information will be published as
frequently as it is technically feasible to do so, at
least along with, and perhaps ahead of, the monthly
publication of the balance sheet of the Exchange Fund as
from the beginning of next year. The information will
show, on the asset side, Foreign Reserves designated to
back, on the liability side, the Monetary Base (which
includes bank notes and coins issued, and the Aggregate
Balance) and all the Exchange Fund paper outstanding. It
will further show, over time, how the HKMA is adhering to
the discipline of a Currency Board system.
Points to Note
The package of seven technical measures introduced by
the HKMA and the voluntary move towards greater disclosure
and transparency are clearly aimed at the strengthening
Hong Kong's Currency Board arrangements. These measures
will enhance the robustness of the linked exchange rate
system with a fixed exchange rate for the Hong Kong dollar
against the US dollar at 7.80. They will also dampen
excessive and destabilizing volatility in interest rates.
In the operation of the Currency Board arrangement with
these technical measures introduced, there are three
points that the HKMA would wish the banking community to
note specifically.
First, the Discount Window, like LAF, is not to be
used by licensed banks to facilitate manipulation that may
destabilize the currency or money markets. A licensed
bank will be restricted access to the Discount Window if
there is reason to believe that it has been engaging in
such activity.
Second, the state of the public finances of the
Government would from time to time require the HKMA, as
the agency managing the fiscal reserves and providing
assistance in the cash flow of the Treasury, undertaking
certain activities in the foreign exchange and money
markets. In all such activities, for example in the
funding of the rare budget deficits through the use of
foreign reserves, the HKMA would ensure that there is no
departure from the discipline of the Currency Board
arrangements.
Third, the HKMA clearly has a responsibility to
ensure that the money market functions in an orderly
manner. There have been occasions when large scale Hong
Kong dollar transactions (such as in the case of large
Initial Public Offerings) created extreme conditions in
the interbank market. In a statement made on 3 March
1998, Mr Joseph Yam, Chief Executive of the HKMA, has made
it clear that, in these circumstances, the HKMA may lend
to or borrow from the interbank market to dampen extreme
conditions. This policy remains unchanged.
Currency Board Operations Sub-Committee
The package of technical measures to strengthen the
Currency Board arrangements of Hong Kong has earlier been
examined closely by a Sub-Committee on Currency Board
Operations of the EFAC established recently with the
approval of the Financial Secretary. The Sub-Committee is
chaired by the Chief Executive of the HKMA Mr Joseph Yam.
The other members of the Sub-Committee are:
The Hon David K.P. Li
Mr Marvin Cheung
Professor Y.C. Jao
Mr Mervyn Davies as Chairman of the Hong Kong Association
of Banks
Mr David Carse, Deputy Chief Executive, HKMA
Mr Andrew Sheng, Deputy Chief Executive, HKMA
Mr Norman Chan, Deputy Chief Executive, HKMA
The terms of reference of the EFAC Sub-Committee on
Currency Board Operations are:
(a) to ensure that the operation of the Currency Board
arrangements in Hong Kong is in accordance with the
policies determined by the Financial Secretary in
consultation with the Exchange Fund Advisory Committee;
(b) to report to the Financial Secretary through the
Exchange Fund Advisory Committee on the operation of the
Currency Board arrangements in Hong Kong;
(c) to recommend, where appropriate, to the Financial
Secretary through the Exchange Fund Advisory Committee,
measures to enhance the robustness and effectiveness of
the Currency Board arrangements in Hong Kong;
(d) to ensure a high degree of transparency in the
operation of the Currency Board arrangements in Hong Kong
through the publication of relevant information on the
operation of such arrangements; and
(e) to promote a better understanding of the Currency
Board arrangements in Hong Kong.
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*(1) Notes issued by Hong Kong Mortgage Corporation,
Airport Authority and Mass Transit Railway Corporation
under their respective Notes Issuance Programmes arranged
by the Hong Kong Monetary Authority.
End/Saturday, September 5, 1998
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