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Following is the keynote speech (English only) delivered by the Secretary for Financial Services, Mr Rafael Hui, at the Financial Conference on Asia organized by The Hong Kong Trade Development Council today (Thursday):
"What follows the Financial Turmoil"
Introduction
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The last time I had the honour and pleasure of addressing such a similar and equally distinguished gathering organized by the TDC was in 1996. My main theme on that occasion was that, despite the political wrangles, it would be business as usual after 1997. As we have seen, it is indeed business as usual, even despite the worst financial crises in the last thirty years. Hong Kong continues to be resilient; our economic fundamentals were shaken but still intact; our financial system and related infrastructure were put to unprecedented stress and have proven to be as robust as ever.
This brings me to the title of my speech - "What follows the Financial Turmoil?" The answer is 'recovery' of course. But after that, what? The next financial turmoil, I think, if we are not careful. The financial turmoil in 1997 and 1998 provided many lessons to be learnt. One of the main lessons that we in Hong Kong have learnt is that we urgently require international consensus and co-operation in constructing a better financial architecture.
In recent weeks, at APEC and elsewhere, our Financial Secretary and the Chief Executive of our Monetary Authority have been speaking on the same subject. What I am going to say this afternoon therefore should not come as a total surprise to you. We may have a different view on when the next financial turmoil will come. But one thing we do know is that, history will repeat itself without the joint effort of the international community in reforming the global financial architecture, and formulating new rules and strategies to cope with the massive and volatile capital flows in our globalized world economy.
The trend of globalization in recent years is phenomenal. Advance in information technology and increased openness of domestic financial markets allow capital to flow in and out of an economy in huge amounts and within a very short time. Rapid increase in the quantity and volatility of capital flows has led to new problems and challenges. According to the Bank for International Settlements, the global value of foreign exchange transactions taking place on an average day in April 1998 was US$ 1.5 trillion.
While there are no comprehensively accurate statistics, there are indications that the great majority of forex transactions are unrelated to genuine commercial trade or hedging. The lack of definitive data makes it difficult to fully understand the nature of capital flows, their movements and impact on financial markets and the real economy.
In light of the potential destabilizing effects of capital flows, especially on emerging markets, we consider it timely to review the existing regulatory framework. The ultimate objective should be to promote the free flow of soundly based capital and the smooth-functioning of financial markets.
We are not advocating capital control
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At this juncture, I must put it beyond doubt that we are not advocating capital control. In the first place, capital control will be illegal under the Basic Law, our mini-constitution. Moreover, we believe that this will not be effective in resolving the problem in the context of our globalized financial market. What we are advocating is to enhance the transparency and surveillance of volatile short term capital flows.
"Punishment is good for you"
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There is a school of thought which considers the attacks on Asian currencies were mainly attributed to over-valued currencies with structural flaws in domestic financial systems and relatively weak economic fundamentals. These in turn led to sudden collapse of investor confidence and massive flight of short-term capital.
It is true that, prior to the crisis, some Asian economies, including Hong Kong, did exhibit various degrees of overheating and macro-economic imbalances. But the over-shooting of the currencies and the resulting devastation seem to be out of proportion to the severity of their "policy mistakes". Moreover, the lack of transparency and data on some capital flows have made it very difficult to assess to what extent the overshooting and devastation were in fact exacerbated by the activities of the highly leveraged institutions (HLIs), including hedge funds.
Some people also cited the choice of exchange rate regimes as a source of the problem. But the Asian experience has confirmed that even economies with floating exchange rates, such as Australia, are not immune from massive speculative attacks.
It is all very well to say that any type of capital flows must be good. If your policies are 'bad', the market will punish you. But if you take this thesis to its logical conclusion, there can only be an endless series of 'punishments' because, in this day and age when dynamic changes, both domestic and international, can be so rapid and complex. No economy can remain "in balance", at least according to textbook yardsticks, indefinitely. Yesterday, it was Britain in 1992, Mexico in 1994. Today it is the Asian economies, Russia, Brasil, Argentina. And tomorrow? Who knows which economy is due for 'punishment'.
Risks of Small, Open Markets
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Open markets, in particular the smaller ones, can be overwhelmed by very large and highly leveraged institutions.
Most of the Asian markets are tiny in relation to the size of global capital flows and will remain so for many years to come. The liquidity of these markets is also much less than that in larger ones. For example, for the month of March 1999, the turnover of the stock exchange in New York is US$801 billion, while that in Hong Kong is only US$14 billion, and that in Thailand is less than US$2 billion. As at March 1999, the market value of shares of domestic listed companies is US$ 10,737 billion for New York, US$358 billion for Hong Kong, and US$36 billion for Thailand.
These smaller economies have in a way become victims of their relatively small size and openness. Experience shows that some highly leveraged institutions could generate panic in the market by acting in concert as a pool, sometimes even using means such as wash sales and rumour-mongering. Market integrity, which is fundamental to the health and efficiency of a free market, is compromised. The problem is often aggravated by the lack of transparency in the unregulated capital markets, in which many activities of these institutions are conducted.
Even more important, the stability of the financial system of the smaller markets will be put to risk. No matter how sound is a financial market, there is a limit as to how far and how quickly prices can fall. Once the threshold is broken, it would cause serious disruptions to the markets, the banking system, the currency and the real economy. It is not a question of allowing market overshooting to return to equilibrium in normal textbook conditions. It is a question of market panic leading to the collapse of the financial system.
Asymmetry of information
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For some time, the public sector and the international financial institutions have been endeavouring to enhance transparency. Greater transparency and disclosure permit better investment decisions. The Hong Kong Government fully supports the principle and practice of transparency. We have subscribed to the IMF's Special Data Dissemination Standards (SDDS). We are participating in the pilot exercise for an IMF Transparency Report. We also welcome IMF's deliberations on the Code of Good Practices on Fiscal Transparency and Code of Transparency Practices for Monetary and Financial Policies. Since the beginning of this year, the Hong Kong Monetary Authority has published data on foreign currency assets within one week of the end of each month, and data on the Exchange Fund balance sheet within two weeks of each month. In addition, since March, the Monetary Authority has released the abridged Exchange Fund Balance Sheet and the Currency Board Account on a monthly basis. With these disclosure measures, I am proud to say that Hong Kong has one of the most transparent central banks in the world.
But very regretfully, there is asymmetry of information disclosure between the private and public sectors. While much of the international efforts in the past 22 months have been on improving the transparency and accountability of the public sector, the private sector so far is lagging behind. The problem is especially highlighted by the lack of transparency in the over-the-counter market (OTC market), where geographically dispersed traders are linked to one another via telecommunication systems and computers. Nowadays, the trading activities of highly leveraged institutions are often conducted in the OTC market. However, in contrast to organized exchanges, that market is not subject to rules and regulations designed for protecting investors and preserving market integrity. This has made monitoring and surveillance difficult, thereby raising the risk of price-ramping, collusion and other misconduct by the larger players. This information gap may have serious implications on market integrity and stability of the financial system.
Is the international community addressing the core issues?
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Since the outbreak of the financial crisis, both national authorities and the international community have been working hard to boost economic recovery and development. In many instances, participation of the private sector is encouraged. On HLIs, multilateral organisations such as the IMF, the Basle Committee on Banking Supervision, and IOSCO etc. have done useful work to help prevent recurrence of the LTCM type of systematic crisis. Many proposals call for better risk management by financial institutions when extending credits to the HLIs. While this would certainly help reduce the credit risks caused to these institutions, it would not be sufficient to address the concerns of smaller markets in situations that I have explained earlier. This is because the sheer size of the highly leveraged institutions, even with more limited leverage, would still be able to overpower or corner the smaller markets.
We suggest that a better solution would entail the imposition of some suitable form of transparency requirements on the OTC markets and their large market participants. I fully appreciate that this is by no means an easy task. Given the technical and political complexity of the issues involved, international consensus building takes time, even if there is the will. But the next crisis will not wait forever. As long as this gap in our international financial architecture remains unplugged, our financial system, individually and collectively, will continue to be vulnerable to manipulative attacks of one kind or another.
Hong Kong's response
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We are not sitting back and relaxing while global efforts have yet to bear fruit in the form of real actions. Before any agreement on international cooperation is reached, the best we can do in the mean time is to further bolster our own system.
We have strengthened our currency board arrangements to make it less susceptible to manipulation. We did so through seven technical measures introduced in September 1998. The two major planks of these measures are the provision of a Convertibility Undertaking and modifications to the Discount Window Facility. These measures have effectively enlarged the monetary base of the banking system, and as a result, excessive and destabilizing volatility in interest rates have been dampened.
On the securities and futures side, a number of measures have been introduced to strengthen market discipline and transparency. These include measures relating to short-selling of stocks such as the reinstatment of the "uptick" rule and tightening of enforcement and penalty against breaches of short selling rules. Automatic trigger of stock lending and borrowing arrangements has also been put in place to cover default in delivery of short-selling trades. Measures are also taken to enhance the transparency and disclosure in the futures market, especially regarding large positions and some form of position limits is to be introduced in the near future. These are of course nothing new to the international market participants because similar or comparable rules and regulations have long been in place in major markets such as London, New York and Chicago.
In March 1999, our Financial Secretary reaffirmed the plan to consolidate our existing 12 pieces of securities-related legislation into one. The consolidated Bill is intended to provide a more transparent and coherent regulatory framework and more effective regulation in an increasingly sophisticated and fast changing financial market. Hitherto, banks and 'professional' dealers have enjoyed exemption from regulatory requirements of our SFC. While we are satisfied that dealing activities handled by banking institutions are well regulated by Hong Kong Monetary Authority using the same code of conduct and guidelines as the SFC, dealings by 'professional' non-bank institutions which are not supervised by the SFC should be brought back into the SFC remit. Information relating to dealings made by these 'professionals' on a principal-to-principal basis must be captured by the regulator because such information is essential to the management of systemic risks and the maintenance of a fair and orderly market.
There also have been suggestions that the predominance of our stock market by a few Hang Seng Index constituent stocks have made our market more prone to manipulation. It is of course a matter for the market to develop and diversify so as to change the situation. But we are also doing our part in facilitation. For example, we are in the process of partially privatizing our MTRC. We are also in the process of demutualizating and merging our stock and futures exchanges with a view to listing the new Exchange in Hong Kong next year.
The crisis affects all - Global solution required
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In the globalized financial market, large market players take global strategies. Any position in one market may be used to offset or complement their position in another. In such circumstances, the performance of the markets are highly interrelated and what is happening in one market will have knock-on effects on all the others. The near collapse of the LTCM in the most liquid and the most capitalized market in the world is a case in point.
Without a proper international framework, economies under severe stress will have little alternative but to do the best they can on their own. Governments and politicians are inevitably affected by domestic concerns. Will this be conducive to global well-being? Recall the currency depreciation pressure that regional economies exerted on one another when local competitiveness became the focus of concern. Recall, also, emerging markets' reduced imports of goods from industrialised countries as a result of rapid economic contraction and weakened currencies.
A global problem calls for a global solution. We call for global cooperation of the industrialised and emerging market economies to perfect international financial architecture as a matter of urgency. This is the key to sustaining long-term growth of the world's financial markets, and allowing all of us to enjoy the full benefits of market liberalization in a truly globalized world economy.
I am therefore heartened and encouraged to note some latest developments which have been taking place recently on the international front. The US President's Working Group Report has recommended measures to reduce excessive leverage of HLIs and more disclosure and reporting requirements by supervised institutions. Hedge funds would come under the expanded disclosure net of the Commodity and Futures Trade Commission. Germany has proposed the setting up of an international credit register as a means to improve transparency of the HLIs. At the APEC Finance Minister meeting held two weeks ago, Ministers agreed on the importance of looking into short-term capital flows in rebuilding the international financial architecture. In the process, they also agreed that the experience of the industrialized, developing and emerging markets should be fully taken into account. I look forward to early completion of the work of the G7 Financial Stability Forum on HLIs, offshore centres and short-term capital flows. And Hong Kong as always will continue to play an active part in all of these endeavours.
Conclusion
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Ladies and Gentlemen, no matter what you think regarding the actions taken by the Hong Kong Government in handling the financial crisis in the past 18 months, I hope you will at least grant us the fact that we do know one thing or two about liberalization and globalization - their benefits, as well as their pitfalls. Because of history, actual experience, geography and the nature of our economy, Hong Kong, before many, many others, has long embraced the doctrines of globalization. Our faith in and commitment to globalization remain as steadfast as ever. Even now, today, after the worst financial crisis in decades, I doubt there is any economy in this part of the world, other than Hong Kong, which is as completely open and where the domestic and international sectors of the financial and capital markets are indistinguishable.
Therefore, when we say that there is a serious threat to globalization, it is not because we no longer believe in free and open trade. On the contrary, it is because of our deep concern that, just at this time, finally, when the vast majority of economies of this world are converted to open competition and globalization, we may squander our hard-won success by brushing aside the role of short term capital flows in subverting the onward march of globalization into the new millennium.
End/Thursday, May 27, 1999
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