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Following is the full text of remarks (English only) made by the Financial Secretary, Mr Donald Tsang, on "Beyond The Crisis: Strengthening the International Financial Architecture" at the Sixth APEC Finance Ministers Meeting in Langkawi, Malaysia today (Sunday):
Mr Chairman, after two years of extreme turbulence and human drama since the Asian financial crisis broke out in July 1997, we are naturally pleased to see that stability is returning to the financial markets in the crisis-hit economies. We all hope that the worst is behind us, but there is no room for complacency. The road to full recovery for many is still bumpy and return to rapid growth is by no means guaranteed.
One cannot overstate how important it is for all of us to learn from the bitter lessons of the crisis. This crisis is the latest in a series of currency crises that have occurred with increasing intensity and ominous regularity. We have not completely forgotten the ERM crisis in 1992. The Mexican peso crisis in 1994-1995 remains fresh in our mind. But it was from the Asian crisis that we learnt dearly how volatile capital flows can devastate our markets and economies, and can threaten to demolish social and political order. We have learnt how quickly and fiercely contagion can spread from one economy to another in an increasingly open and integrated environment. The main lesson is clear: we must strive to strengthen our own financial markets, banking system, corporate sector in order to withstand the volatile capital flows. We also believe now that the strengthening of the domestic financial system alone is not enough to prevent the recurrence of another major financial eruption in the medium term. Let me explain why.
The changing nature of capital flows generated by Highly Leveraged Institutions (HLIs) can pose very difficult challenges to regulators and policy makers. In this context, I should make it absolutely clear that we do not in principle or in practice object to speculative activities conducted by any market participants, including the hedge funds. Nor do we have any difficulties with the hedge funds undertaking risky trading or investments in accordance with their own views of any particular market. What we are concerned about is the potential risk that the HLIs may pose to market integrity and, in some extreme cases, to the stability of the global financial system. It is perhaps useful to illustrate the issue at stake by depicting two different scenarios.
The first scenario is fairly easy to understand. The near collapse of the LTCM has provided a powerful demonstration of the type of systemic risks that may arise when one single HLI, having taken up very large positions in mature and deep markets, is suddenly overwhelmed by market forces. Of course, the global financial system did not melt down, but it appeared at some stage to be close to this.
The second scenario is somewhat less straightforward. It refers to a situation in which a smaller open market is run over by one or more HLIs taking very large positions against it. This scenario threatens many emerging market economies, simply because they are relatively small, open and are vulnerable to manipulation by the HLIs. The HLIs pose what I would call the "Elephant in the Pond" problem. If vicious, the large and aggressive HLIs could squash the minor players and destroy small or emerging markets. Even if benign, the theatre and fright of an elephant coming could panic the small players to flee the pond, beckoning an imminent market fall. Unfortunately, this scenario has so far not received sufficient attention in any of the international fora.
Several international bodies under the leadership of the industrial economies have started to pursue new initiatives designed to prevent the recurrence of LTCM-type crisis. For example, the Basle Committee on Banking Supervision, the two working groups of the Committee on Global Financial System, the IOSCO are active in this regard. The main emphasis of these initiatives revolves around the promotion of better risk management practices by the banks and counterparties in dealing with the HLIs and the reduction of excessive leverage by the HLIs. These initiatives can go a long way in addressing the concerns of the first scenario I have described, it is not clear that they are adequate in dealing with second scenario. Simply put, some predatory HLIs are so large that, even with more limited leverage, can readily corner many smaller markets of today and indeed overwhelm them.
I am under no illusion on the technical, economic and political complexities in devising workable measures to address the destabilizing impact of the hedge funds. There is a range of possible approaches, with direct regulation at the one end of the spectrum to enhanced transparency of the OTC markets and of the large players at the other. None of these approaches is straightforward or easy, and one can easily conclude that they are all too difficult to adopt. But if we ever concede defeat, it will be defeat at our peril. Not only for emerging markets, but more pertinently for the global economy. Particularly, we must not always blame the ready scapegoat of intrinsic market weaknesses or policy mistakes. There is simply no perfectly balanced economy as long as it remains open and dynamic. We must take a considered view on whether the international financial system will become more stable or less stable if we once again brush aside the concerns of the smaller economies over the aggressive trading activities of the HLIs.
In considering counter-measures, we recognize that the trend of globalisation and liberalisation should and will continue. We have already seen how quickly and violently contagion can spread from one troubled spot to another, and then from one region to another. Given the increasingly integrated financial markets, when the next crisis hit, the contagion would be more virulent and move much faster. Rather than attempting to reverse the course of globalisation, we should use our best efforts to make the international financial system more robust and resilient to crisis regardless of whether or not it plagues Asia, Latin America or the industrialised economies. We must , most of all, be objective and humble enough to understand the mixed ingredients of global financial crisis.
I welcome G7's leadership in setting up the Financial Stability Forum. I have no doubt that the Forum and its working groups will take a further look at the HLIs and what we might do in monitoring or harnessing them and to those who bankroll them. I sincerely hope that the Forum will involve the emerging market economies and take into account their experiences and their views in its work. After all the emerging market economies comprise the bulk of the victims of the current crisis. This echoes Mr Summers' observation yesterday that those devastated economies should help shape the new architecture in dealing with HLIs.
Finally, one observation of Mr Birch of New Zealand just now struck me deeply. We should be all grateful to him in reminding us of our priority for trade. Perhaps our discussion over the past two days are equally relevant. Simply, we have on this occasion focussed on the life-blood of trade. And that life blood is the architecture for capital flows which drive international trade. Indeed I look to New Zealand as the incoming APEC Chair to take up this urgent challenge and champion our common cause in the coming year. 1999 is critical. It may define the spirit and health of APEC economies in facing the new millennium.
Thank you.
End/Sunday, May 16, 1999
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