The Government has consistently worked towards providing a favourable environment in the financial sector, with adequate regulation to ensure sound business standards and confidence in the institutional framework, but without unnecessary impediments of a bureaucratic or fiscal nature.

The Hong Kong Monetary Authority (HKMA) was established in April 1993 by merging the Office of the Exchange Fund with the Office of the Commissioner of Banking. The Exchange Fund (Amendment) Ordinance 1992 provides for the establishment of the HKMA.

The HKMA's policy objectives are to maintain currency stability, within the framework of the Linked Exchange Rate System, through sound management of the Exchange Fund, monetary policy operations and other means deemed necessary; to ensure the safety and stability of the banking system through the regulation of banking business and the business of taking deposits, and the supervision of authorised institutions; and to promote the efficiency, integrity and development of the financial system, particularly payment and settlement arrangements.

The HKMA is an integral part of the Hong Kong Special Administrative Region (HKSAR) Government, but can employ staff on terms different from those of the Civil Service to attract personnel of the appropriate experience and expertise. Its staff and operating costs are charged directly to the Exchange Fund instead of the general revenue.

The HKMA is accountable to the Financial Secretary, who is advised by the Exchange Fund Advisory Committee (EFAC) on matters relating to the control of the Exchange Fund. The committee functions as a management board, meets monthly and advises the Financial Secretary on, among other things, the HKMA's annual budget.

The HKMA is organised into seven departments — namely the Banking Supervision Department, Banking Policy Department, External Department, Reserves Management Department, Monetary Policy and Markets Department, Research Department and Corporate Services Department — as well as the office of the General Counsel.

Under the Banking Ordinance, the HKMA is the licensing authority responsible for the authorisation, suspension and revocation of all authorised institutions, as well as the approval and revocation of money broker licences. The licensing criteria for authorised institutions seek to ensure that only fit and proper institutions are entrusted with public deposits. The HKMA conducts periodic reviews of the authorisation criteria and introduces amendments as appropriate to reflect the changing needs of the regulatory environment and to meet international standards. Checks and balances are provided in the ordinance with the requirement that the HKMA consult the Financial Secretary on important authorisation decisions, such as suspension and revocation. The Chief Executive in Council is the appellant body for hearing appeals against decisions made by the HKMA.

The HKMA seeks advice on policy matters routinely from the Banking Advisory Committee and Deposit-taking Companies Advisory Committee. Both committees are established under the Banking Ordinance. They are chaired by the Financial Secretary and comprise members from the banking industry and other relevant professions. Members of the committees are appointed by the Financial Secretary under the delegated authority conferred by the Chief Executive.

The Banking Ordinance provides the legal framework for banking supervision in Hong Kong. Among other things, authorised institutions are required to maintain adequate liquidity and capital adequacy ratios, submit periodic returns to the HKMA on required financial information, adhere to limitations on loans to any one customer or to connected parties (e.g. directors and employees), and seek approval for the appointment of chief executives and directors. The HKMA seeks to maintain a regulatory framework that is fully in line with international standards, primarily those recommended by the Basel Committee on Banking Supervision. The objective is to devise a prudential supervisory system to help preserve the general stability and effective working of the banking system while at the same time providing sufficient flexibility for authorised institutions to take commercial decisions. Since 1999, Hong Kong's framework of banking supervision has been fully in line with the Core Principles for Effective Banking Supervision promulgated by the Basel Committee. In addition, the Banking Ordinance regulates the issuance of multi-purpose stored value cards and money brokers operating in the wholesale foreign exchange and deposit markets.

A Banking (Amendment) Bill was introduced in November, putting forward amendments to the Banking Ordinance corresponding to the proposals of the Securities and Futures Bill. The bill aims at enhancing the HKMA's regulatory framework for the securities business conducted by authorised institutions that are exempt under the Securities Ordinance and bringing it in line with the regulatory standards set by the Securities and Futures Commission in the regulation of securities dealers and investment advisers.

The HKMA's supervisory approach is based on a policy of 'continuous supervision' through a combination of on-site examinations, off-site reviews, prudential meetings and co-operation with external auditors. Since the beginning of 2000, the HKMA has been implementing a more formalised risk-based supervisory framework. The approach puts emphasis on evaluation of the quality of risk management practices and internal controls of various types of risks faced by authorised institutions. The eight major types of inherent risk factors identified by the HKMA under the risk-based methodology are credit, interest rate, market, liquidity, operational, legal, reputation and strategic risks.

In July 1999, the HKMA announced a reform programme to further develop Hong Kong's banking sector. The objectives of this programme are to encourage market liberalisation and enhance competitiveness in the banking sector, and to strengthen banking infrastructure with the objective of enhancing the safety and soundness of the sector. A number of the policy initiatives have been implemented according to the programme schedule. In June 1999, the HKMA issued a policy statement to clarify its role as lender of last resort to the banking sector. In September 1999, the HKMA relaxed the 'one branch' policy to allow foreign banks previously subject to the restriction to carry out business in not more than three buildings. The HKMA will review the situation and consider further relaxation of this policy in 2001. Since May, restricted licence banks have been permitted to join the Real Time Gross Settlement system, Hong Kong's interbank payment system.

The Interest Rates Rules (IRRs) made by the Hong Kong Association of Banks, which govern retail deposit rates offered by licensed banks in Hong Kong, were first relaxed during 1994-95. As part of the current reform programme, the HKMA has undertaken to deregulate the remaining IRRs in two phases. The first phase of deregulation covering time deposits with a maturity of less than seven days and the prohibition on benefits for all deposits (except Hong Kong dollar savings and current accounts) took effect in July. Following this, all time deposit rates are now deregulated. The remaining IRRs, covering savings and current account deposits, are scheduled for removal in July 2001, provided that the economic and financial environment at that time is not unfavourable.

A public consultation on the establishment of a commercial credit reference agency (CCRA) in Hong Kong was concluded in September. The initiative seeks to address the need for authorised institutions to have better information about the creditworthiness and overall indebtedness of their corporate customers, thereby promoting banking sector stability. From the responses received, there appears to be general support from the banking and corporate sectors for the idea of establishing a CCRA. The HKMA has convened a working group with representatives from the banking and corporate sectors to study the implementation issues in greater detail before making any firm recommendations.

A consultation paper on enhancing deposit protection in Hong Kong was issued in October following completion of an independent consultancy study on this subject. The study aimed at making a fair and objective assessment of deposit protection in Hong Kong based on independent evaluation with due regard to international practices and local conditions. The study found that the best protection for small depositors would be achieved with an insurance-based system, with features of liquidity and credibility that are necessary to make deposit protection effective. The consultation would be concluded in January 2001.

Other major initiatives contained in the Banking Sector Reform Programme include a review of the existing market entry requirements for a local banking licence and a review of the three-tier licensing system. There are also ongoing efforts to improve financial disclosure standards and promote higher standards of corporate governance.

Electronic banking and the adoption of new technology in general is one of the key strategic challenges facing Hong Kong's banking sector. The year saw a number of electronic banking initiatives in Hong Kong. The majority of retail banks in Hong Kong have already introduced Internet banking services. Given the rapid pace of development in this area, the HKMA has stepped up its efforts to ensure that the regulatory framework continues to evolve and keep pace with technological developments. The HKMA has established a specialist electronic banking team and developed a risk-based framework for conducting more focused examinations of the electronic banking activities and general information technology controls of banks. Two guidance notes were issued to provide authorised institutions with recommendations on security aspects of electronic banking. A guideline was also issued on the authorisation of virtual banks that deliver banking services primarily through the Internet or other electronic delivery channels.

One of the functions of the HKMA is to promote and encourage high standards of conduct and sound and prudent business practices among authorised institutions. This is important to maintain public confidence and trust in the banking system. In October, the HKMA released a set of proposals aimed at enhancing the business practices of authorised institutions in the provision of credit card services. The proposals, which were formulated by an informal working group to review the Code of Banking Practice convened by the HKMA and comprising representatives from the banking industry, would be finalised and promulgated in January 2001. Further recommendations in relation to other business areas are being proposed as the review of the code continues, which is expected to be completed by the first quarter of 2001.

On the international front, the HKMA continues to promote co-operation among central banks in the region, principally through the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP), whose activities cover supervisory liaison and co-operation, development of financial markets and infrastructure, and various areas of central bank operations. The HKMA has chaired a Working Group on banking supervision since its establishment in August 1996 under the direction of the EMEAP. The group comprises experts in banking supervision from EMEAP members and meets half yearly to hold discussions in areas of common interest. The HKMA has also been playing an increasingly active role in international forums of banking supervision. These include participation in the Core Principles Liaison Group set up by the Basel Committee on Banking Supervision, the Offshore Group of Banking Supervisors, and the South East Asia, New Zealand and Australia (SEANZA) Forum of Banking Supervisors. In addition, Hong Kong is a member of the Financial Action Task Force (FATF), an inter-governmental body with the objective of developing and promoting legal, law enforcement and financial regulation policies to combat money laundering. The FATF membership is currently made up of 29 governments and two regional organisations. At the 12th Plenary Meeting of the FATF held in early October, Hong Kong was selected as President of the FATF for the period July 2001 to June 2002.

The Securities and Futures Commission (SFC) was established in May 1989 following enactment of the Securities and Futures Commission Ordinance (SFCO). This represented the first important phase in the overhaul of the regulation of the securities and futures market in Hong Kong and the implementation of one of the most important recommendations made by the Securities Review Committee in May 1988.

The SFCO transfers to the SFC the functions of the former Securities Commission, the Commodities Trading Commission and the Office of the Commissioner for Securities and Commodities Trading. It provides a general regulatory framework for the securities and futures industries, leaving certain elements to be covered by regulations, administrative procedures and guidelines developed by the commission.

Established as an autonomous statutory body outside the Civil Service, the SFC has 12 directors (half of them executive) appointed by the Chief Executive of the HKSAR. It must present the Financial Secretary with its annual report, budget and an audited statement of its accounts, which are also required to be laid before the legislature.

The SFC seeks advice on policy matters from its Advisory Committee, which comprises three executive directors of the SFC and nine independent members. They are appointed by the HKSAR Chief Executive and are broadly based and representative of market participants and relevant professions. Decisions relating to matters concerning the registration of persons and intervention in their business are subject to appeal to the Securities and Futures Appeals Panel, the members of which are also independently appointed by the HKSAR Chief Executive.

Over the years, the SFC has developed a framework of securities and futures regulation that is on par with internationally accepted standards.

The SFC is funded largely by the market and partly by the Government, although no funding has been sought from the latter in the past eight years. Its budget for 2000-01 was $475 million and it had an establishment of 334 at year-end.

The SFC exercises prudential supervision over the securities, financial investment and futures industries in Hong Kong. It is divided into four operating divisions. Each division is headed by an Executive Director.

The Supervision of Markets Division is responsible for market oversight, in particular oversight of the operations of the HKEx, and its subsidiaries, namely the SEHK, the HKFE and their Clearing Houses to ensure the sound functioning and development of their trading, settlement and operational systems. It also administers the two statutory investor compensation funds, namely the Unified Exchange Compensation Fund and the Commodity Exchange Compensation Fund, which were established respectively under the Securities Ordinance and the Commodities Trading Ordinance.

The Corporate Finance Division is responsible for regulating takeovers and mergers and share buy-backs of public companies, administering securities legislation relating to listed companies and the Codes on Takeovers and Mergers and Share Repurchases, and supervising the listing-related activities of the SEHK.

The Intermediaries and Investment Products Division administers the registration requirements for securities and commodities dealers, securities margin financiers, investment advisers and their representatives, as well as leveraged foreign exchange traders, including matters relating to the fitness and properness of registered persons. In addition, the division also supervises registered dealers and investment advisers to ensure that they are financially sound, adhere to good business practices and are in compliance with registration requirements. It is also responsible for regulating the marketing to the public of unit trusts, mutual funds and other collective investment schemes.

The criteria for registration are stipulated in the Securities Ordinance, the Commodities Trading Ordinance, the Leveraged Foreign Exchange Trading Ordinance, and the Securities and Futures Commission Ordinance. At the end of 2000, the SFC had registered 22 668 persons, of whom 361 were corporate securities dealers and 160 were corporate commodities dealers. As regards the regulation of leveraged foreign exchange trading, the SFC had issued 12 foreign exchange trade licences by the end of the year.

To ensure that the registered persons and applicants possess the necessary technical skills and knowledge to perform regulated activities, the SFC introduced new competence and continuous professional training requirements. Following this change, the SFC issued in December the revised Fit and Proper Criteria and the Guidance Note on Competence and the Guidance Note on Continuous Professional Training. The new requirements, that would affirm the professional standard of financial intermediaries in Hong Kong and further enhance Hong Kong's competitiveness position as an international financial centre, would come into effect from April 1, 2001.

Following the merger and demutualisation of the SEHK, the HKFE and their associated clearing houses and the establishment of the HKEx on March 6, 2000, the SFC assumed responsibility for front-line supervision of exchange participants and took over the disciplinary matters involving these intermediaries.

The Enforcement Division is responsible for undertaking inquiries into alleged breaches of relevant ordinances and codes, including possible insider dealing and market manipulation offences.

There are other supporting divisions and departments, including the Legal Services Division, to assist the commission in discharging its duties.

The SFC considers investor education the first important step to investor protection. In June, the SFC launched the web-based electronic investor resources centre (eIRC), which gives investors access to a round-the-clock, one-stop and multilingual reference centre with information on investment. The eIRC operates as a virtual library with links to web sites of regulators, market operators and Internet content providers.

During the year, the SFC also worked with Radio Television Hong Kong and Commercial Radio to produce two series of radio segments entitled 'Learning to Invest' and 'Basics of Smart Investing' respectively. Both series aimed to promote investors' understanding of their rights, obligations, and the risks that they are entered into when making an investment. A 'Question Corner' was also introduced on the SFC's web site to answer typical questions raised by retail investors on stock, derivative and fund investments.

During the year, the SFC continued to participate actively in external relations and international activities, including the commission's work with the International Organisation of Securities Commissions (IOSCO). The SFC chairs the IOSCO Committee responsible for developing implementation and assessment methodologies for the IOSCO Objectives and Principles, and offering assistance to the international financial institutions in their use of financial Objectives and Principles. The SFC is also a member of the IOSCO Task Force to consider the regulatory implications of the provision of financial services and the offering of investments over the Internet. The SFC further participates in five IOSCO's working parties which focus on multinational disclosure and accounting, regulation of secondary market, regulation of market intermediaries, enforcement and exchange of information and investment management, respectively.

In September, the SFC hosted a seminar for members of the IOSCO's Asia Pacific Region Committee (APRC) to discuss regulatory issues relating to on-line trading. The commission also continued to maintain close liaison with the China Securities Regulatory Commission and conducted a staff exchange programme with it for attachment purposes. The SFC also jointly runs an enforcement training programme in Shenzhen with trainers from the Securities and Exchanges Commission of the United States as part of its efforts to assist the Mainland in the training and development of market professionals.

The Insider Dealing Tribunal is an important feature of the regulatory framework for the securities market in Hong Kong. Established under the Securities (Insider Dealing) Ordinance, the tribunal looks into cases involving suspected insider dealing referred to it by the Financial Secretary. Since it commenced operation in 1994, the tribunal has successfully concluded 10 cases.

The Commissioner of Insurance, appointed as the Insurance Authority (IA), exercises prudential supervision over the insurance industry in Hong Kong under the Insurance Companies Ordinance (ICO).

The ICO, which prescribes a comprehensive regulatory framework for all classes of insurance business, has two main objectives as regards protection of policy holders. First, it aims at ensuring the financial stability of all insurers authorised in Hong Kong. Secondly, it aims at ensuring the fitness and propriety of the management of an insurer. These objectives are achieved through the prescription of, inter alia, the minimum share capital and the solvency margin requirements, and the requirement for directors and controllers of insurers to be fit and proper persons.

A general business insurer is also required to maintain assets in Hong Kong to meet the claims of Hong Kong policy holders, which is particularly important when the insurer is involved in cross-border insolvency proceedings. The solvency margin required of a life insurer, however, is calculated on the amount of the insurer's mathematical reserves and capital at risk.

As a member of the International Association of Insurance Supervisors, Hong Kong endeavours to comply with the principles and standards developed by the association to bring Hong Kong in tandem with the international regulatory standards. Prudential supervision is carried out mainly through examination of the annual financial statements, actuary's reports and other returns submitted by insurers and regular on-site visits. The IA may take interventionary action against an insurer, if considered appropriate, to safeguard the interests of policy holders. These measures include the limitation of premium income, placing of assets in the IA's custody, assumption of control by the IA or petitioning for the winding-up of the insurer.

Self-regulatory measures are in place to strengthen the market discipline in the insurance industry. These measures, which were formulated by the insurance industry in consultation with the IA, include the adoption by the industry of a Code of Conduct for Insurers governing the writing of insurance contracts of life and general insurance business, and the insurance benefit illustration standards for both linked and non-linked life insurance policies.

Insurance intermediaries, i.e. insurance agents and brokers, have been brought under the regulation of the ICO since 1995. No person may act as an insurance intermediary unless he is an appointed insurance agent or an authorised insurance broker. An insurance agent must be properly appointed by an insurer and an insurer is required to comply with the Code of Practice for the Administration of Insurance Agents in appointing and controlling its agents. An insurance broker must meet certain minimum requirements before he can be authorised. To enhance the professionalism and standard of service of insurance intermediaries, an Insurance Intermediaries Quality Assurance Scheme was implemented in January. Under the scheme, all insurance intermediaries, their chief executives and technical representatives, unless otherwise exempted, are required to pass a qualifying examination before they can be registered or authorised as appropriate. They are also required to attend continuing professional development programmes thereafter to ensure that the required standard of professionalism can be maintained.

The IA is committed to improving the transparency of the insurance industry. Starting from 1999, the IA has been releasing the provisional industry aggregate statistics to the public on a quarterly basis through the Internet home page of the Office of the Commissioner of Insurance. Additionally, individual insurers' annual statistics are released through the IA's annual reports. Commencing in May, the IA has issued I lens, a quarterly publication to enhance the public knowledge and awareness of insurance matters. A 24-hour telephone enquiry hotline (2867 2565) has been in operation since August.

In 2000, the ICO was amended to give the IA power to disclose financial and statistical information of individual insurers and Lloyds, thus enhancing market transparency. The IA is also empowered to accept actuarial standards comparable to the prescribed one, for compliance by the appointed actuaries of insurers.

The Mandatory Provident Fund Schemes Authority (MPFA), which was set up in September 1998 under the Mandatory Provident Fund Schemes Ordinance (MPFSO), is tasked with the responsibility of the prudential regulation and supervision of the Mandatory Provident Fund (MPF) System and ensuring compliance with the MPFSO. Two statutory committees, the Mandatory Provident Fund Schemes Advisory Committee and the MPF Industry Schemes Committee, have been established to advise the MPFA on the overall operation of the MPFSO and the Industry Schemes, respectively. A Mandatory Provident Fund Schemes Appeal Board has also been set up under the MPFSO to hear appeals against the decisions of the MPFA.

On December 1, 2000, the MPF System was fully implemented to assist members of the workforce to accumulate financial resources for their retirement protection. The MPF System, which was formulated after extensive consultation, is a privately managed, employment-related mandatory system of provident fund schemes. Except those exempt in the MPF legislation, employees aged between 18 and 65 and self-employed persons are required to participate as members of MPF schemes.

The MPF System provides for joint contributions by the employer and employee, each contributing 5 per cent of the employee's relevant income to a registered MPF trust scheme, subject to the maximum and minimum levels of income for contribution purposes. The accrued benefits will be fully vested in the scheme members and can be transferred from scheme to scheme when employees change or cease employment. A self-employed person has to contribute 5 per cent of his or her relevant income. In normal circumstances, benefits must be preserved until the scheme member attains the retirement age of 65.

During the year, MPFA has proceeded zealously with the preparatory work essential for launching the MPF System in December. The main areas of preparatory work include the development and installation of an information management system, approval and close monitoring of MPF trustees, approval of products and registration of schemes, as well as exempting certain occupational retirement schemes from MPF requirements. The MPFA has also launched an intensive public education and publicity campaign since January to instil public awareness and understanding of the MPF System, and to remind the employers and self-employed persons of their legal responsibilities under the MPFSO. The campaign has been included in the Government's major publicity campaign for 2000-01.

As the MPF System is a new system for Hong Kong, apart from the efforts made by the Government and MPFA, the success of the system will depend on the support from the employers, employees and the self-employed. Strenuous efforts will be made in 2001 to ensure the compliance with the MPFSO by the relevant employers, employees and self-employed persons, to monitor and regulate the operation of the MPF System, to monitor MPF service providers and to ensure that the interests of MPF scheme members will be fully protected.

Apart from supervising and regulating the MPF System, the MPFA is also appointed the Registrar of Occupational Retirement Schemes to administer the Occupational Retirement Schemes Ordinance (ORSO) which regulates private voluntary occupational retirement schemes operating in or from Hong Kong.

The occupational retirement schemes (ORSO schemes) registered under the ORSO are voluntary schemes established by employers for their employees. The objective of the ORSO is to regulate all voluntarily established occupational retirement schemes through a registration system which requires that these schemes are properly administered and funded, so as to provide greater certainty that retirement scheme benefits promised to employees will be paid when they fall due. There is an appeal board established under the ORSO to consider appeals against the MPFA's decisions, on matters such as registration and cancellation of ORSO schemes.

All registered schemes must meet certain basic requirements, including asset separation, independent trusteeship, restricted investments, funding, independent audit, actuarial reviews and the submission of annual returns and audited financial statements to the Registrar. There are also requirements for disclosure of information to the scheme members regarding the operation of the scheme. As for exempted schemes, annual submission of compliance certificates or membership statements, as appropriate, are required. Changes of certain scheme particulars in respect of both registered and exempted schemes are also required to be notified on prescribed forms and within statutory time limits.

To tie in with the implementation of the MPF System, registered and exempted ORSO schemes could apply for MPF exemption, subject to the conditions as set out in the MPF legislation. The MPFA has completed the processing of all applications for exemption as scheduled. Members of the MPF-exempted ORSO schemes are exempted from the requirement of the MPFSO. They may choose to remain in the existing scheme which is granted exemption, or join new MPF schemes. During the year, the Registrar has made rules on the recovery of arrears for MPF-exempted ORSO schemes, to facilitate the Registrar in recovering the arrears in contributions payable by the relevant employers of an MPF-exempted ORSO scheme.