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.
Hong Kong Monetary Authority
5 September 1998
Strengthening of Currency
Board Arrangements in Hong Kong
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
Fund paper
held by a licensed bank |
Applicable Discount Rate
|
| 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 , 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:
- 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;
- to report to the Financial Secretary through the Exchange
Fund Advisory Committee on the operation of the Currency
Board arrangements in Hong Kong;
- 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;
- 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
- to promote a better understanding of the Currency Board
arrangements in Hong Kong.
Hong Kong Monetary Authority
5 September 1998
