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The Exchange Fund was established by the Currency Ordinance of 1935 (later
renamed as the Exchange Fund Ordinance). Since its establishment, the
Fund has assumed the role to back the bank note issuance of Hong Kong.
In 1976, the Fund's role was expanded. The backing for coins issued and
the majority of the foreign currency assets held in the Government's General
Revenue Account, were transferred to the Exchange Fund. Meanwhile, the
Government began to transfer the fiscal reserves of its General Revenue
Account (apart from the working balances) to the Fund to centralise the
investment management of its financial assets. Through this transfer,
the bulk of the Government's financial assets are placed with the Fund.
The Coinage Security Fund was merged with the Exchange Fund on December
31, 1978.
Prior to April 1, 1998, fiscal reserves were placed
with the Exchange Fund as deposits on which market interest rates were
paid by the Fund to the General Revenue. As the official reserves have
grown significantly over the years, it was decided that the fiscal reserves
placed with the Exchange Fund should seek to achieve a higher long-term
real rate of return. With effect from April 1, 1998, the return on the
fiscal reserves placed with the Exchange Fund is linked to its overall
return.
Upon the establishment of the Hong Kong Special Administrative
Region on July 1, 1997, the assets of the Land Fund Trust were vested
in the Hong Kong SAR Government. The Chief Executive of the Hong Kong
SAR appointed the Financial Secretary as the public officer to receive,
hold and manage the Land Fund, as part of the Hong Kong SAR Government
reserves. Subsequently, the Land Fund was established by resolution made
and passed by the Provisional Legislative Council under section 29 of
the Public Finance Ordinance. Between July 1, 1997 and October 31, 1998,
under the direction of the Financial Secretary, the Land Fund was managed
by the HKMA as a portfolio separated from the Exchange Fund. Effective
from November 1, 1998, the assets of the Land Fund, which itself has still
remained as a separate government fund, were merged into the Exchange
Fund and managed as part of the Investment Portfolio of the Exchange Fund.
The Land Fund will continue to be administered in
accordance with the Resolution of the Provisional Legislative Council
of July 1997. Following an investment decision taken by the Financial
Secretary under the terms of the Resolution, the placement of the entire
Land Fund, along with the fiscal reserves, with the Exchange Fund, yields
a return that is the same as that of the Exchange Fund. In 2003, a Resolution
was made and passed by the Legislative Council under the Public Finance
Ordinance to authorise the transfer of $120 billion from the Land Fund
to the General Revenue Account to meet the Government's expenditure requirement.
The Exchange Fund's primary statutory role, as defined in the Exchange
Fund Ordinance, is to affect the exchange value of the Hong Kong dollar.
Its functions were extended on the enactment of the Exchange Fund (Amendment)
Ordinance 1992 by introducing a secondary role of maintaining the stability
and integrity of the monetary and financial systems, with a view to maintaining
Hong Kong as an international financial centre.
The HKMA manages the Exchange Fund. Apart from ensuring
that the Fund meets its statutory roles, the HKMA's principal activity
is the day-to-day management of the Fund's assets. These are invested
mainly in OECD bonds and equities. To meet the Government's operational
needs, part of the Exchange Fund is also held in Hong Kong dollar denominated
assets.
To meet the objectives of preserving capital, providing
liquidity to maintain financial and currency stability and generating
an adequate long-term return, the Exchange Fund is managed as two distinct
portfolios. The first is a Backing Portfolio which ensures that the monetary
base related to the currency board operations is fully backed by highly
liquid, primarily short-term, US dollar denominated debt securities. The
second is an Investment Portfolio which preserves the Fund's value for
future generations of Hong Kong. The long term asset allocation strategy
of the Exchange Fund is guided by the investment benchmark, which defines
the bonds and equities mix as well as the overall currency composition
of the Fund. The management of the Fund and the investment style adopted
are set out and explained in the HKMA's annual report.
On December 31, 2003, the Exchange Fund's total assets
stood at $1,011.6 billion, of which foreign currency assets amounted to
$929.6 billion (or US$119.7 billion). The accumulated surplus of the Exchange
Fund amounted to $384.9 billion. The Fund's financial position from 1998
to 2003 inclusive is shown in the Appendices. With a view to demonstrating
the Government's continued commitment to greater openness and transparency,
foreign currency asset figures have been published monthly since January
1997. In addition, an abridged balance sheet of the Exchange Fund and
a set of Currency Board accounts are published monthly.
Another function related to the Exchange Fund is currency
issuance. Bank notes in denominations of $20, $50, $100, $500 and $1,000
are issued by the three note-issuing banks: the Standard Chartered Bank,
the Hongkong and Shanghai Banking Corporation Limited and the Bank of
China (Hong Kong) Limited. The note-issuing banks may issue currency notes
only by surrendering non-interest-bearing US dollar backing at a fixed
exchange rate of 7.80. Thus the Fund enjoys the seigniorage from the notes.
Through the HKMA, the Government issues the new $10
currency note and coins of $10, $5, $2, $1, 50 cents, 20 cents and 10
cents denominations. Sufficient quantities of the $10 note and all denominations
of coins have been maintained for injection into the market when required.
The total of notes and coins in circulation at year-end was $140.3 billion.
The new $100 and $500 banknotes issued by the three note-issuing banks
began to circulate in December (the new $20, $50 and $1,000 banknotes
will be available by the second half of 2004). This is the first comprehensive
redesign of banknotes for almost 10 years. The security features used
in the new banknotes and the colour schemes of each denomination are standardised.
On top of the security features used in the existing banknotes, the new
banknotes contain a number of new features to enhance the security of
the Hong Kong currency.
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