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FS'speech at 12th APEC Finance Ministers' Meeting (English

Following is the speech by the Financial Secretary, Mr Henry Tang, at the Policy Dialogue Session on Free and Stable Movement of Capital of the 12th APEC Finance Ministers' Meeting on "Maintaining Financial and Monetary Stability" in Jeju Island, Korea today (September 8):

Chairman and fellow Finance Ministers,

It gives me great pleasure to be here today for the 12th APEC Finance Ministers' Meeting.  I thank our Korean host for your excellent hospitality.  On behalf of the people and government of the Hong Kong Special Administrative Region, I also convey our deepest sympathy and condolences to the victims of Hurricane Katrina and their families.

Coming back to the policy themes of this meeting, I would express our appreciation for Korea's leadership in setting out the two themes, which are crucial to the sustainable growth of the APEC region.  The need to maintain free and stable capital flows is ever larger, but the task is perhaps getting more complex and increasingly difficult in a globalised environment.

As we look back at the Asian financial turmoil, we have learnt a few lessons: first, the risks posed by highly leveraged offshore institutions, particularly hedge funds; second, the importance of having a deep, mature domestic bond market to better recycle domestic savings into domestic investment; and thirdly, the need to implement sound policies, which include, among other things, an appropriate monetary framework.  Let me address these issues in turn.  

Risks posed by highly leveraged offshore institutions

Soon after the Asian turmoil in 1998, APEC economic leaders in their Declaration drew attention to the concerns posed to the financial markets by highly leveraged institutions and called for increased transparency and disclosure standards.  Since then, substantive work has been done on reducing banks'overexposure to hedge funds through better counterparty risk management, but direct regulation of hedge funds was ruled out.

Over the years, some of the macro hedge funds such as Tiger Fund that had generated big waves in financial markets have become extinct, but the hedge fund industry has expanded phenomenally through a proliferation of smaller hedge funds.  

While we recognise the contribution to market liquidity and risk diversification by hedge funds, concerns remain that hedge funds, as a group with significant and concentrated exposures, have accelerated market volatility especially in markets of thin liquidity.  It is time we revive the discussion on whether some form of oversight is necessary.

Many hedge funds are not based in Hong Kong or the Asian region, their activities are off-shore.  Against this background, I do hope that individual economies could review your oversight policies over hedge fund activities.  In this regard, I am glad to see a growing trend of increased regulatory engagement over hedge funds, such as the rule of the US Securities and Exchange Commission on hedge fund managers.  The UK's Financial Services Authority is also considering some form of regulatory approach towards hedge fund managers.

In addition, with increasing popularity of hedge funds to retail investors, we should consider the regulation of hedge funds from the angle of investor protection.  For hedge funds offered to public, our securities regulator in Hong Kong has issued guidelines requiring registration and reporting requirements, as well as imposing minimum criteria for assessing hedge fund managers.

Importance of having a deep, mature domestic bond market

The second lesson we can draw from the Asian turmoil is that a mature bond market would serve as an important source of capital to the corporate sector when other financial intermediaries, such as banks and equity markets, falter or fail.  Not least to say, the domestic bond markets should help reduce any potential currency or maturity mismatch associated with the corporate sector's foreign borrowing.  

An effective and efficient regional bond market would also help reduce the destabilising movements of capital.  Since the Asian financial crisis, two developments have augured well for the development of the regional bond market.  The first one is the accumulation of savings by Asian economies.  On the back of strong current account performances, the foreign-exchange reserves of the major Asian economies rose phenomenally, from US$790 billion in 1998 to nearly US$2,450 billion in 2004.  These figures of course only refer to the foreign currency portion of the official reserves.  The savings held in the private sector and in domestic currencies are also significant.  

The second factor is the ageing population in this region.  According to the World Bank, 7.2% of our population was over the age of 60 in 2000, and the percentage is expected to double by 2030.  Concomitant to an ageing population is the appreciable increase in pension funds looking for low-risk investment instruments with stable returns, for which the bond market provides the ideal vehicle.

Over the years, there have been a number of initiatives in promoting the development of a regional bond market.  I would like to draw your attention to a recent overture íV and a successful one íV namely the Asian Bond Fund Initiative (ABF) as launched by the Executives' Meeting of East Asia-Pacific Central Banks.  Hong Kong is honoured to chair the working group responsible for launching this initiative, which saw the recent listings of the ABF Pan-Asia Bond Index Fund and three Single-Market Funds, with the remaining five Single-Market Funds to be offered in the next few months.

Through investing in Asian bonds, the ABF initiative helps channel regional savings into regional investment.  More importantly, it has helped raise investor interest in the domestic bond markets by providing a low-cost and efficient instrument to invest in Asian bonds.  From the perspective of market development, the ABF initiative has accelerated regulatory and tax reforms in some of the Asian markets, which are conducive to further bond market development.

Implementation of sound monetary policies

The third lesson we learnt is that we should implement appropriate policies to reduce our economies' vulnerabilities to capital flows. One key element is a sound and robust monetary framework.  In this regard, let me share with you how Hong Kong has contributed to regional monetary stability through strengthening its own monetary framework in coping with strong inflows of funds in anticipation of the appreciation of the renminbi.  Such capital flows have persisted since late 2003, leading to very easy monetary conditions in Hong Kong.  While easy monetary conditions would be helpful to the economy, the persistently low interest rates could generate concerns about the formation of asset price bubbles.  

In May 2005, we introduced three refinements to the Linked Exchange Rate System, with a view to remove the uncertainty over the extent to which the Hong Kong dollar may appreciate.  Shortly after the implementation of these measures, expectations about any Hong Kong dollar appreciation have subsided.  We noticed that some of the hot money which had made use of Hong Kong dollar as proxy for speculation had flowed out, and monetary conditions have largely returned to normal.

Our refined monetary system was put on trial on 21 July 2005 when the People's Bank of China announced the move to a managed floating exchange rate.  I am pleased to note that the Hong Kong dollar has not experienced any significant pressure.  

I also take the opportunity to congratulate the Mainland authorities for implementing the exchange rate reform smoothly.  There are in fact very few recent examples of self-initiated monetary reforms which run so orderly.  Given the size of China's economy and its importance in the world, any overshooting in the reform can trigger financial pressure elsewhere in the region.  

Deliberations such as this APEC Finance Ministers' Meeting can help ensure that future monetary and financial reforms in the region are similarly implemented in a way that will preserve financial stability.  

Thank you.

Ends/Thursday, September 8, 2005
Issued at HKT 13:15


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