Ladies and gentlemen,

Let me start by thanking the Institute for organising this briefing. Hong Kong returned to the People's Republic of China just eight weeks ago. It has since embarked upon a new era, an era guided by the "one country, two systems" concept, conceived by our late patriarch Mr Deng Xiaoping and enshrined in the Basic Law, the mini constitution of the Hong Kong Special Administrative Region.

At the ceremony to mark the establishment of the Hong Kong Special Administrative Region, or Hong Kong SAR for short, the President of our country Mr Jiang Zemin emphasised the importance of maintaining Hong Kong's capitalist way of life separate from the socialist system practised in the Mainland. This encapsulates the "two systems" principle. Indeed, I cannot emphasise more the importance of keeping the two systems separate and independent for the long term prosperity of Hong Kong. This said, I think it is equally important to understand how the two systems, being so different in nature, interact within "one country", bearing in mind the very strong linkages already established between them. Being a practitioner in the securities market, you will no doubt be especially interested to know how the "one country, two systems" principle translates into practical arrangements in the financial and monetary areas. Let me first of all give you an overview of the "one country, two systems" principle.

Why "one country, two systems"?

This principle, enshrined in the Sino-British Joint Declaration and the Basic Law, guarantees that Hong Kong will maintain its previous social, economic and financial systems after 30 June 1997. The Hong Kong SAR and the Mainland of China are operating under fundamentally different economic systems and are undergoing different speed and stages of development. The "one country, two systems" concept recognises this difference and allows both systems to evolve along different paths to the benefit of both.

Hong Kong is a market economy operating under a capitalist system. A number of ingredients can explain its past success, in particular its miraculous growth in recent years into an international financial centre. These are a high savings rate, a dedicated and flexible labour force with good education and professional training, a well-established and properly supervised banking sector, advanced infrastructure for the financial markets, fiscal and monetary prudence, a government supporting the private sector but not imposing government leadership on economic development, and last but not the least, the rule of law.

As regards the Mainland of China, it has come a long way since 1979 in moving away from a command economy to a more market-oriented economy. Our Central Government has made important and significant progress in reforming its public finances, liberalising its exchange control which led to partial convertibility for the Renminbi, commercialising and upgrading its banking sector, as well as modernising its financial market infrastructure. However, the Mainland economy continues to operate within a socialist system, rooted to a large extent in central administrative control.

What exactly is "one country, two systems"?

Building on the "one country, two systems" principle, the Basic Law stipulates that the Hong Kong SAR will enjoy a high degree of autonomy other than in foreign affairs and national defence. The SAR will formulate its own monetary and financial policies. The Hong Kong dollar shall remain the only legal tender in the SAR. In other words, even if the Renminbi becomes fully convertible before 2047, it will not and cannot take the place of the Hong Kong dollar in accordance with the constitutional arrangements promulgated in the Basic Law. Furthermore, no exchange control policy shall apply in Hong Kong. And the SAR shall safeguard the free flow of capital. At the moment, Hong Kong has something like $95 billion US dollars in the bank, of which $82 billion is held in foreign currency. This amount of money shall be managed by the SAR Government on its own. The SAR shall have independent finances and the Central People's Government shall not levy taxes in the SAR.

The above arrangements, in monetary terms, mean that there shall be one country, two currencies, two monetary systems and two monetary authorities after 30 June 1997, and that they shall be mutually independent. Senior Mainland officials have on various occasions reiterated this policy. Let me now elaborate briefly on each aspect of this formula.

The "two currencies" principle means that Renminbi will continue to be regarded as a foreign currency in Hong Kong. The Hong Kong dollar will also be regarded as a foreign currency in the Mainland of China. As far as the Hong Kong dollar is concerned, it will continue to be linked to the US dollar, a system which has served Hong Kong well since October 1983. The current exchange rate regime has lasted for almost 14 years. During the period the link with the US dollar has remained stable while confidence in the local currency has grown. This has been clearly demonstrated again during the recent volatility in the currency markets in Asia, in which the Hong Kong dollar has remained remarkably stable throughout.

Corresponding to the two mutually independent currencies are two mutually independent monetary systems. To ensure that the two mutually independent monetary systems are properly managed, it is essential that the two monetary authorities, the People's Bank of China in the Mainland and the Hong Kong Monetary Authority in the HKSAR, would remain separate and independent of each other.

In the securities markets, the separate configuration is equally visible. We have in Hong Kong a three-tiered regulatory framework which is distinct and separate from the regulatory regime in the Mainland. The frontline self-regulated entities are the two exchanges and their related clearing companies, which are required under the law to provide an orderly and fair market place for securities and futures trading. They are subject to the supervision of the Securities and Futures Commission (SFC), which is established by law outside the Government as the second tier market regulator.

As non-government regulators in the market in their own right, the SFC is a full and active member of the International Organisation of Securities Commissions and, likewise, our Stock Exchange is a member of FIBV (Federation Internationale des Bourses de Valeurs). These entities are separate and independent from but yet maintain close cooperation with their Mainland counterparts.

At the government level, the Financial Services Bureau is responsible for ensuring that the SAR has in place an adequate and efficient policy and legislative framework conducive to a favourable and fair environment for the securities industry and to proper protection for investors. In our three-tier regulatory system, government intervention with the operation of the market are consciously controlled to the minimum and the market forces are free to prevail within the limits of the law. This market-oriented philosophy is obviously distinct from that of the Mainland market where direct state involvement is still the norm.

How the Two systems Will Interact Within One country?

I have so far put to you the importance of maintaining a mutually independent relationship between the Hong Kong SAR and the Mainland of China. One should not, nevertheless, assume that Hong Kong's continued prosperity emanates entirely from its own economic strength. Indeed, its geography, being at the heart of a high growth region and its proximity to, and as a part of, China, will continue to be the source of Hong Kong's vitality. This underlines the importance of the "one country" dimension of "one country, two systems" formula.

Over the years, close links have been developed between the economies and financial markets of Hong Kong and Mainland China. There are plenty of examples to demonstrate this rapidly evolving synergy.

First, in banking, the number of branches established by Hong Kong banks in the Mainland has more than doubled in the past five years to about 30. Meanwhile, 35 Mainland-owned banking institutions are operating in Hong Kong. In 1996, they accounted for 23 per cent of customer deposits and nine per cent of loans extended by the Hong Kong banking sector. Mainland banks in Hong Kong are treated as foreign banks and are required to meet the licensing criteria applicable to all other foreign banking institutions seeking to enter the Hong Kong market. In the Mainland of China, Hong Kong banks are also regarded as foreign institutions and are treated the same as banks from other countries. There is close supervisory cooperation between the Hong Kong Monetary Authority and the People's Bank of China in the banking area.

Second, with China's support the Hong Kong Monetary Authority has been admitted into a number of important international central banking forums, including the Bank for International Settlements, Executive Meeting of East Asia and Pacific Central Banks (or "EMEAP") and SEANZA, a forum comprising 18 members from the Asia Pacific Region. In these forums, the Hong Kong Monetary Authority attends in its own right and along with the People's Bank of China. The People's Bank of China has also entered into a bilateral repurchase agreement with the Hong Kong Monetary Authority which enhances the liquidity of foreign currency reserves in a manner helpful to the maintenance of currency stability.

Third, since December last year, Hong Kong has introduced a Real Time Gross Settlement System for its interbank payment system, thereby reducing substantially the settlement risks in the financial markets. This is one of the most advanced systems of the kind in the world. In view of the growing economic and financial links between Hong Kong and Mainland, the Hong Kong Monetary Authority and the People's Bank of China have agreed to link up the HK dollar payment system and the RMB payment system to provide a Payment versus Payment, or PvP, facility for foreign exchange transactions involving the two currencies. We expect to be able to start the PvP link as soon as the People's Bank of China introduces real time gross settlement for its payment system in 1999. A PvP link will substantially reduce settlement risk in foreign exchange transactions. The link will be of strategic importance in view of the steady increase in transactions involving these two currencies.

Fourth, over the past four years Hong Kong has become the major funding centre for China. Thirty-two Chinese state-owned enterprises have made their initial public offerings in Hong Kong in the form of the issue of "H" shares. Through their initial public offerings in Hong Kong, US$1.67 billion has been raised locally while another US$4.62 billion has been raised through global placements. In raising funds in Hong Kong, Mainland enterprises are required to abide by all the listing and other relevant laws and regulations in Hong Kong. No favouritism or preferential treatment has been, or ever will be, granted to Mainland companies. They will be subject to the same standards applied across the board in Hong Kong. The listing of Mainland companies in Hong Kong not only enables them to raise the much needed capital in foreign exchange but also facilitates the upgrading of the corporate governance of these listed companies in line with international standards. This process is of great importance to the reform of state-owned enterprises in the Mainland, and Hong Kong is proud to be playing a strategic role in the process. Through this process, the capitalization of the Hong Kong securities market received a significant boost in terms of strength and variety of products. Hong Kong will continue to be the centre for placement of 'H' shares in the future - the centre of a rapidly enlarging and outward going Chinese economy.

In order to have effective regulation on Mainland companies listed in Hong Kong, the Securities and Futures Commission of Hong Kong entered into a Memorandum of Regulatory Cooperation with the China Securities Regulatory Commission in 1993. This was followed by another Memorandum signed in 1995 for the regulation of futures trading activities. The two Memoranda are similar to 22 others signed by the Securities & Futures Commission with regulatory authorities in the other markets.

Market Confidence in the Future of Hong Kong

I can go on to quote many examples to illustrate how much effort we have devoted to enhance the interface between the two systems in Hong Kong and the Mainland. But perhaps the best indicator of Hong Kong's viability in the future should come from the market.

First, the Hong Kong dollar remains stable under the linked exchange rate system, notwithstanding the recent turmoil of the Asian currencies markets. The stock market remains buoyant and prosperous after the handover, with Hang Seng Index reaching record highs.

You may also be aware that Hong Kong is the only place in Asia, outside Japan, which has developed a highly liquid debt market through the Exchange Fund Bills and Notes programme administered by the Hong Kong Monetary Authority. The programme now provides benchmarks for a maturity of up to 10 years. And the yield of 10-year Exchange Fund Notes is only about 60 basis points above the yield of 10-year US Treasuries at present. This is a very narrow spread indeed. It means that the market is confident in the future of Hong Kong and is not demanding any significant risk premium for debt securities issued by the Hong Kong SAR Government which are not due until the year 2007.

Furthermore, a number of credit rating agencies have accepted the view that Hong Kong should receive a separate, and higher, rating from that of China under the "one country, two systems" arrangements in view of the stronger economic fundamentals of Hong Kong. This is a further demonstration of the financial market's confidence on the "one country, two systems" arrangements.

The picture is rosy but we can never afford to be complacent. Indeed everyone of us in Hong Kong works very hard to maintain the dynamism and versatility of our economy. The financial sector is of course no exception. Indeed, our securities market is also developing quickly. In keeping with our position as the leading Asian centre for derivatives outside Japan, new products such as regional derivative warrants and convertible bonds have recently been introduced by the Stock Exchange of Hong Kong and more are under consideration. The Hong Kong Futures Exchange has also linked up with the Philadelphia Stock Exchange and the New York Mercantile Exchange (NYMEX) to enable overseas currency options and futures contracts of petroleum and other commodities to be traded in Hong Kong during Asian business hours.

Given our advance financial market and close relationship with the Mainland, Hong Kong has naturally become the most important capital-raising centre for Mainland Chinese enterprises. Apart from over 30 Chinese state-owned enterprises which have been listed in Hong Kong, Mainland enterprises also raise capital on our securities market through companies domiciled and listed in Hong Kong, commonly known as the "red-chips". We expect our role in this respect to become more important as the Mainland economy continues to develop and prosper.

Separately, with the Mandatory Provident Fund scheme soon to be introduced in Hong Kong, the size of retirement funds assets in our market is expected to grow from US$15 billion to over $70 billion. This will generate strong demand for debt instruments of even larger issue sizes and longer term maturities and create abundant opportunities for the development of the primary and secondary debt markets in Hong Kong. These are but a few examples of the financial market development in Hong Kong in the foreseeable future. We are committed to ensure that the software and hardware of our financial infrastructure are enhanced and sustained at the world-class level to meet challenges in the coming century.

Conclusion

What we have now in Hong Kong, ladies and gentlemen, is an innovation. The concept of "one country, two currencies, two monetary systems, two monetary authorities, two securities systems, and two securities market supervisory authorities" is being put into practice. The political uncertainties surrounding 1997 are behind us. Our economy is important to China as a whole. With the rapid and steady growth in the economy of Mainland China, Hong Kong as her premier international financial centre is likely to do much better in the years ahead in meeting the huge funding requirements of our motherland and in contributing to the modernization of her financial systems.

Perhaps the best way to appreciate how this concept works in practice is to come to Hong Kong to see it for yourselves. So, it is with great pleasure that I extend an open invitation for you all to come to visit Hong Kong as soon as you can spare the time. You will find that Hong Kong remains as interesting, vibrant, dynamic, profitable as ever. Go into Mainland China as well and witness for yourselves the momentous market changes that are taking place. Also let us show you the way.

Thank you.