Measures to tighten up securities and futures markets

Measures to tighten up securities and futures markets ***************************************************** The Government is absolutely determined to protect the stability and integrity of the currency and financial markets of Hong Kong, the Financial Secretary, Mr Donald Tsang, said today (Monday). The Government continues to be fully committed to its free economy policy and there will be no foreign exchange controls in Hong Kong, Mr Tsang said categorically. "The Government will uphold the linked exchange rate system and firmly adhere to the currency board discipline," Mr Tsang added. Mr Tsang today briefed the Financial Affairs Panel of the Legislative Council on a series of measures aiming to tighten up market discipline and restoring market order in the securities and futures markets. At the panel meeting, the acting Secretary for Financial Services, Mrs Rebecca Lai, outlined a 30-point programme to tighten up the disciplines in the securities and futures markets. The programme involves a total of five bodies including the two Exchanges (the Stock Exchange of Hong Kong (SEHK) and the Hong Kong Futures Exchange (HKFE)), Hong Kong Clearing (HKSCC), the Securities and Futures Commission (SFC) as well as the Financial Services Bureau itself, and aims to, inter alia, strengthen regulation and enforcement on short selling, enhance risk management across the financial markets and step up enforcement on T+2 settlement rules. The programme also calls for heavier penalties on breaches of securities legislation and market rules in relation to naked and unreported short selling and default in settlement. It also commissions urgent studies on regulation over custodians and registrars as well as over stock lending and borrowing activities, the feasibility of full investor participation in Central Clearing and Settlement System (CCASS) and a scripless securities market in Hong Kong. Preliminary reports will be submitted to the Financial Secretary in three months' time. To facilitate cross-market communication and co- ordination, a new inter-agency committee, comprising top level representatives of the HKMA, SFC, SEHK, HKFE and HKSCC, will be set up under the Financial Services Bureau. The Financial Services Bureau will also consider possible legislation to empower the Chief Executive to give direction to the exchanges and clearing houses where the stability and integrity of the monetary system is under threat. The programme, together with the seven technical measures announced by the HKMA last Saturday regarding the strengthening of the currency board arrangements, form a comprehensive plan to improve the ability of Hong Kong's monetary and financial systems to withstand cross-market manipulation by market players, Mr Tsang said. The comprehensive checklist of the 30-point programme and the seven technical measures announced by the HKMA last Saturday are attached. --------- Attachment A: Measures to Strengthen the Order and Transparency of Securities and Futures Markets Hong Kong Stock Exchange Short selling 1. SEHK in conjunction with SFC will step up inspection and follow-up actions on unsettled sales trades outside T+2. Heavy penalties including termination of membership for repeated offenders will be imposed on brokers in breach of SEHK rules. SFC will also take prosecution against clients and brokers conducting illegal short selling. 2. SEHK and the SFC will take joint actions to require all broker members and registered dealers to make submissions on short selling trades performed in the past two weeks. 3. SEHK has set up a task force to amend its rules to increase disciplinary actions on breaches of its short sales rules and default brokers, including penalty charges, temporary suspension of trading and even termination of membership. 4. SEHK have also reminded its members to discharge their responsibility seriously, including ascertaining that their clients do have the covering stocks for sales order and in the case of short sales do have appropriate arrangements in hand, report them to the Exchange and strictly adhere to the relevant Exchange Rules on short selling. They have also been reminded of possible heavy penalties in case of violation of the rules. 5. SEHK has reinstated the "uptick" rule to reduce the selling pressure of short selling on market prices. The rule has been approved by the SFC and come into effect today (7 September). 6. SEHK will review the current list of Designated Securities eligible for short selling to ensure that only stocks with sufficient liquidity will be accepted for short selling. Other areas 7. SEHK will remind its members to ascertain the identity of their beneficiary clients and disclose the information to the SFC upon request. 8. SEHK will review the rules on covered warrants, such as requiring physical settlement and prohibiting issuers from re-issuing the warrants bought back from the market. Hong Kong Clearing 1. HKSCC will immediately revise its settlement rules for the strict enforcement of the T+2. Its Board of Directors will discuss the details of implementation within this week, including compulsory buy-in on T+3 for outstanding positions. 2. And to impose effective penalties on default brokers, including buy-in price penalty charges, default fees and suspension of trades for repeated offenders. 3. HKSCC will also consider compulsory stock lending and borrowing arrangements for outstanding positions after close of market on T+2 to fulfil the settlement obligations vis-a-vis the buyers, and then to close the position through buy-in on T+3. Hong Kong Futures Exchange 1. HKFE rules on capping trade limits in relation to brokers' capital be strictly enforced and the rules limiting the "buffer" to no more than 20% of the capital be strictly observed, with a view to avoiding brokers maintaining a trading position inconsistent with its capital level. 2. HKFE discloses real-time information of holders of large open interests to SFC on a daily basis. 3. At the same time, HKFE also discloses large open interests at a broker level to the market. 4. The threshold for super margin be reduced to open interests of 5,000 contracts or below. 5. HKFE must specify the timetable for advanced migration of HSF trading from open outcry to Automatic Trading System in order to minimise confusion on order execution and possibilities of improper conduct at the trading floor. 6. HKFE in conjunction with the SFC must establish as soon as possible a cross-market early warning system which will provide warning signals to the market and its participants whenever the futures market activity exceeds a predetermined level of the cash market. A response system will also be put in place to trigger appropriate actions such as increasing margin in order to regulate market activities and facilitate market adjustment back to its prudent level. Securities and Futures Commission 1. Strengthen enforcement and prosecution against illegal short selling. 2. Co-ordinate and supervise the progress and implementation of the above measures, and provide support as may be necessary. 3. Study criminalising unreported short selling. 4. Increase the penalties on illegal short selling. The preliminary proposal by SFC is to increase the maximum penalty of $10,000 and 6-month imprisonment to $100,000 and 2-year imprisonment, so as to enhance its deterrent effect. 5. Prepare legislative proposal to make false reporting to SFC and exchanges a criminal offence. 6. Examine the means to achieve the objective that all investors must open account with CCASS. 7. Examine the feasibility of scripless market to solve the problems arising from physical custody and settlement. Financial Services Bureau 1. Closely monitor the implementation of the above measures. 2. Co-ordinate on the study on regulation over stock lending and borrowing (SLB) including regulation over custodians and other stock lenders, so as to enhance transparency on SLB and protection for interests of beneficiary owners of stocks. 3. Co-ordinate on the study on regulation over share registrars. 4. Submit the following legislation to the LegCo a.s.a.p. - criminalisation of unreported short selling - increase in penalties on illegal short selling - criminalisation of false reporting to SFC and exchanges. 5. Study the need to amend current legislation to enable the government to react to market situations promptly. Although existing rules already empowers the Chief Executive to give direction to the SFC, legal advice suggests that such power does not apply to exchanges and clearing houses and that it is subject to certain limitations. Therefore, it might be necessary to strengthen the power of the Chief Executive to give direction to the exchanges and clearing houses to ensure that the government can react quickly whenever public interests are under threat. 6. Co-ordinate a cross-market supervision committee to exchange market information among HKMA, SFC, SEHK, HKFE and HKSCC on a regular basis, and to take prompt and appropriate actions in response to anticipated market manipulation. ------------ Attachment B : Strengthening of Currency Board Arrangements in Hong Kong (already issued on Saturday, September 5, 1998) 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 liberalisation and the advancement of information and telecommunications technology, have been characterised by very high volatility in international capital flows. This can be very destabilising 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 realised. 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 destabilising 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 destabilising 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 destabilise 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. ----------------------------- *(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/Monday, September 7, 1998 NNNN