HONG KONG 2004 - Financial and Monetary Affairs

The Government is committed to strengthening Hong Kong's competitiveness as an international financial centre and the premier capital formation centre for the Mainland through enhancing its regulatory regime, promoting corporate governance, upgrading financial infrastructure and fostering the development of the bond market.

Enhancement of Hong Kong's regulatory framework will continue in the light of international experience and standards. The objective is an effective regulatory framework that will ensure sound business standards and confidence of the market but without unnecessary impediments. Some other major initiatives to enhance Hong Kong's competitiveness as an international financial centre are outlined in the following paragraphs.

The SFO came into force on April 1, 2003 and has been implemented successfully since then. The SFC continued to review the SFO after 21 months of implementation.

The Government has taken the lead in drawing up measures to improve the regulation of listing to enhance market quality, following public consultation on Proposals to Enhance the Regulation of Listing in October 2003. The consultation conclusions published in March 2004 recommended, among others, codifying in the statute the more important listing requirements, i.e. financial reporting and other periodic disclosure, disclosure of price sensitive information and shareholders' approval for notifiable transactions. Breaches of these statutory listing requirements would constitute a new type of market misconduct which could be subject to civil or criminal sanctions. The Government is working in collaboration with the SFC and HKEx with a view to introducing legislative amendments in the 2004-05 legislative year.

In December, the SFC consulted the public on an automatic levy triggering mechanism, under which the investor compensation levy provided under the SFO would be suspended if the net asset value of the Investor Compensation Fund reached $1.4 billion and would be reinstated if the net asset value fell below $1 billion.

The Standing Committee on Company Law Reform (SCCLR), established in 1984, meets regularly to consider amendments to the Companies Ordinance to ensure that it meets the changing needs of the business community. The Companies Registry provides secretariat support for the SCCLR.

The Overall Review of the Companies Ordinance by the SCCLR resulted in 62 recommendations for reform, including a mix of amendments to specific sections of the Companies Ordinance, topics which require further research and study, and major structural proposals such as rewriting and restructuring the Companies Ordinance. Virtually all the proposals regarding amendments to specific sections of the Ordinance have been included in the Companies (Amendment) Ordinance 2003, which was implemented in February 2004. Work on topics requiring further research and study has been undertaken either independently by the SCCLR or in the context of the SCCLR Corporate Governance Review which started in mid-2000 and ended in early 2004 following the issue of the Final Recommendations in January 2004. The aim of the Corporate Governance Review was to identify and bridge any gaps in Hong Kong's corporate governance regime, making it a benchmark in the region.

Major recommendations to enhance shareholders' remedies, including the introduction of a statutory derivative action, in the Review and a complete reform of Part XI of the Companies Ordinance regarding overseas companies have been included in the Companies (Amendment) Ordinance 2004, which was enacted in July 2004. The relevant amendments of the Ordinance were to be brought into operation in phases starting from December 2004.

The remaining corporate governance related recommendations of the SCCLR which require legislative amendments and the recommendations made by the Joint Government/ HKICPA Working Group (JWG), which is reviewing the accounting and auditing provisions of the Companies Ordinance, will be considered in future legislative amendment exercises. Consideration is also being given as to how the recommendation to rewrite and restructure the Companies Ordinance can best be taken forward. Corporate governance related recommendations which do not require legislative amendments have been or are being followed up by the relevant parties, such as HKEx and the HKICPA.

The HKEx issued the Consultation Conclusions on Proposed Amendments to the Listing Rules Relating to Initial Listing Criteria and Continuing Listing Obligations in January 2004. Key changes to the Listing Rules included introduction of alternative financial standards to profit requirement, waiver of the three-financial year trading record requirement for certain listing applicants, and increase of the minimum expected market capitalisation and the minimum number of shareholders at the time of listing. The Rules amendments came into effect on March 31, 2004.

Following publication of the Consultation Conclusions on Proposed Amendments to the Listing Rules relating to Corporate Governance Issues in January 2003, the HKEx promulgated the Rules amendments which came into effect on March 31, 2004. It also promulgated the Code on Corporate Governance Practices after a two-month public consultation in the first quarter of 2004. The Code set out standards and principles of good governance covering areas such as remuneration of directors and senior management, accountability and audit, delegation by the Board and communication with shareholders. The Code provisions were on a par with the best current international market practices, having regard to Hong Kong's own particular circumstances. The Code represented a significant move towards adoption of international benchmarks of corporate governance.

In October, the SFC and HKEx released a joint conclusion report on the Consultation Paper on the Regulation of Sponsors and Independent Financial Advisers (IFAs). The HKEx has amended the Listing Rules concerning the conduct of sponsors and IFAs, in particular the sponsors' role in advising listed companies and listing applicants and in conducting due diligence. The amendments become effective in January 2005. To further enhance the regulatory framework for sponsors and IFAs, SFC will conduct a public consultation on specific eligibility criteria requirements created specifically for sponsors and IFAs in 2005. In preparation for the consultation, SFC conducted an investor survey seeking views from retail and institutional investors on the standards of sponsors in Hong Kong and on possible measures to enhance the standards.

Quality and reliable financial reporting is of paramount importance for upholding Hong Kong's corporate governance regime and maintaining investors' confidence. In this regard, the Government is acutely aware of the need to maintain and enhance an effective, transparent and accountable regulatory regime for the accountancy profession that is on a par with international standards. Building on the public support during the consultation exercise in September 2003, the Government is working with the HKICPA, SFC and HKEx on legislative proposals to enhance the oversight of auditors and quality of financial reporting of listed corporations.

The key initiative is the proposal to establish a new statutory body to be named the Financial Reporting Council (FRC). This is a follow-up to the public consultation conducted by the Administration in late 2003 on the 'Proposals to (a): Enhance the Oversight of the Public Interest Activities of Auditors; and (b) Establish a Financial Reporting Review Panel', which received strong support from most of the respondents.

The FRC will oversee both an Audit Investigation Board and the Financial Reporting Review Committee. The former will be tasked to carry out investigations into suspected irregularities concerning auditors of corporations/collective investment schemes listed in Hong Kong, while the latter will be tasked to enquire into suspected non-compliance of the accounts and financial statements of such corporations/schemes with the relevant legal and accounting requirements.

The Administration has been actively pursuing relevant issues together with HKEx, the HKICPA and the SFC. These include the composition, mode of operation, powers, financial arrangements and accountability measures relating to the proposed FRC. To take the proposals forward, another consultation on the detailed proposals will be conducted in early 2005 before introducing a bill into the Legislative Council in mid-2005.

As part of the three-pronged strategy announced in the Budget Speech in March 1999 for reforming the securities and futures markets in Hong Kong, the Financial Secretary appointed a Steering Committee on the Enhancement of the Financial Infrastructure in Hong Kong (SCEFI) to study and recommend the necessary improvements to the local financial infrastructure. The objective is to enhance the competitiveness of Hong Kong as an international financial centre in terms of risk mitigation, efficiency enhancement and cost reduction. The SCEFI recommended the development of a single clearing arrangement for securities, stock options, futures and other exchange-traded transactions; straight-through processing and a scripless securities market. The Government, together with the SFC, the HKMA and HKEx, is pressing ahead with the implementation of various SCEFI recommendations.

In May 2004, HKEx issued its Consultation Conclusions on a Proposed Operational Model for a Scripless Securities Market. HKEx plans to implement the dematerialisation in two phases. Initially, subject to legislative amendments and finalisation of the technical model, HKEx plans to cancel the physical share certificates held by HKSCC nominees so that a percentage of shares will be uncertificated. Some physical certificates will remain in the CCASS vault for withdrawal if desired. The subsequent development, including offering general investors the option of holding uncertificated shares in the register of members, will depend on market readiness and finalisation of the working model with the agreement of all market participants. The Government is working towards the introduction of a Companies (Amendment) Bill into the Legislative Council in 2005 to facilitate the implementation of a scripless market.

Hong Kong possesses many fundamental advantages to develop a deep and liquid bond market, such as a sound legal system, world-class financial market infrastructure, efficient, effective and transparent regulatory regime, free flow of capital, simple tax regime with low tax rates, and abundant supply of financial professionals and intermediaries. The Government has been dedicated to facilitating the development of the bond market in recent years, including providing the necessary financial infrastructure, simplifying the issuance process, removing regulatory impediments, offering tax incentives and encouraging public corporations to issue bonds. Investor education on bond investment has also been strengthened.

The Hong Kong dollar debt market grew further in 2004, with the total outstanding amount rising to $608 billion at year-end, a 9 per cent increase from a year earlier. In 2004, the Government issued Hong Kong dollar debt for the first time since 1984. Other issuers included the Exchange Fund, statutory bodies or government-owned corporations, AIs, multilateral development banks (MDBs), non-MDB overseas borrowers and local corporations.

New issuance of Exchange Fund Bills and Notes (EFBNs) was stable at $206 billion and accounted for more than a half of the total new debt issuance in 2004. Demand for EFBNs was strong, with an average over-subscription rate of three times in 2004. The ample liquidity in the banking system due to capital inflows also helped keep yields on EFBNs down. The Aggregate Balance, a measure of interbank liquidity, rose sharply to a daily average of $30 billion in 2004, up from $3 billion a year earlier. The yield on 10-year Exchange Fund Notes decreased by 74 basis points to 3.63 per cent at year-end, which was 58 basis points lower than the yield of comparable US Treasury bonds.

Excluding the Exchange Fund paper, new issuance of Hong Kong dollar debt totalled $171 billion in 2004, little changed from the previous year. Of this total, non-MDB overseas borrowers remained the most active, accounting for 45 per cent of the new issues. That was followed by AIs and statutory bodies or government-owned corporations, with shares of 31 per cent and 10 per cent, respectively.

With interest rates remaining at historical lows in Hong Kong, fixed-rate debt still dominated the market. Excluding EFBNs⁷, fixed rate debt constituted about 78 per cent of total new issues in 2004, down from 89 per cent in 2003. Around half of these new issues were medium-term debts with maturity of three to five years.

In 2004, the Government launched two bond issues to provide funding for capital works projects and greater flexibility in the management of Government liquidity. These issuance activities have also helped to promote the development of the local bond market. In July, the Government completed a $20 billion global bond offering, which included Hong Kong dollar and US dollar tranches of different maturities and involved both institutional and retail investors. The tranches denominated in Hong Kong dollars were split between retail and institutional investors, while the international tranche, a US$1.25 billion 10-year note, was allocated to over 100 institutional investors around the world. Earlier, in May 2004, the Government completed the securitisation of toll revenues from selected Government-owned tunnels and bridges by issuing bonds of $6 billion. All the Government issues were met with strong demand and oversubscribed. The success of these two bond offerings and the overwhelming response from both retail and institutional investors have demonstrated that Hong Kong possesses the expertise and infrastructure for large scale bond issuance, and also indicated the enormous potential demand in Hong Kong for high quality bonds.

To foster debt securities settlement between the Mainland and Hong Kong, the HKMA signed an agreement in April 2004 with the China Government Securities Depository Trust & Clearing Co Ltd (CDC) to establish a direct link between the HKMA's CMU and CDC's Government Securities Book-entry System (GSBS). This is a one-way link from the GSBS to the CMU so that CDC members (including banks, trust companies and other financial institutions in the Mainland) that are authorised to invest in foreign debt securities may settle and hold Hong Kong and foreign debt securities through the CDC's account with the CMU.

The Government is implementing measures to review the existing regulatory framework for offers of shares and debentures under a three-phased approach. Measures under the first phase involved the issuance of various facilitative guidelines by the SFC in February 2003, permitting awareness advertisements and putting in place a 'dual prospectus' structure. They also included two class exemptions by the SFC in relation to prospectuses for offers of debentures, which came into operation in May 2003. As for the second phase, the prospectus-related provisions in the Companies (Amendment) Ordinance 2004 came into operation in December 2004. Major improvement measures contained in the ordinance included exempting 12 types of offers from the prospectus regime, such as offers to 'professional investors' and offers to not more than 50 persons.

In the third phase, the SFC will conduct a comprehensive review of laws and procedures governing public offers of securities as well as regulatory reforms introduced in other leading jurisdictions, with a view to putting in place a framework that provides the most efficient, competitive and fair environment for issuers and investors alike. The SFC has started the review and aims to put forward proposals for public consultation in mid-2005.

The Government continues its efforts to develop the domestic and regional bond markets through active participation in ongoing international and regional initiatives. The HKMA, which has spearheaded the Asian Bond Fund Initiative under EMEAP since 2002, played a pivotal role in the launch of the US-dollar denominated Asian Bond Fund (ABF1) in June 2003.

In December 2004, the HKMA, together with 10 other member central banks and monetary authorities of the EMEAP Group, announced the launch of the domestic currency-denominated Asian Bond Fund (ABF2). All 11 members of the EMEAP Group will invest in the ABF2. The ABF2, which will have an initial size of US$2 billion, will invest in domestic currency bonds issued by all EMEAP economies except Australia, Japan and New Zealand. It will consist of a Pan-Asian Bond Index Fund (PAIF) and eight single-market funds. The PAIF will invest in domestic currency bonds issued by sovereign and quasi-sovereign issuers in the eight EMEAP economies, whereas the eight single-market funds will invest in the same type of bonds issued in the respective markets. Implementation of the ABF2 is divided into two phases. In Phase 1, investment will be confined to EMEAP central banks, whereas in Phase 2 the PAIF and the eight single-market funds will be open to investment by other public and private sector investors. EMEAP has decided that the PAIF and the Hong Kong fund will be listed on the Stock Exchange of Hong Kong. Hong Kong was chosen as the place of listing for the PAIF in view of the liquidity of financial markets and robust market infrastructure framework.

The long-term development of the bond market is promising. There is abundant liquidity to fuel the growth of Hong Kong's bond market. Hong Kong's free and open financial markets, with free flow of capital, help create a large international investor base. Other positive factors contributing to higher demand for bond investments include the vast amount of Hong Kong dollar time deposits, the growing retirement funds in Hong Kong for the aging population, and capital from the Mainland as a result of gradual liberalisation of the capital account.

A well-developed secondary mortgage market plays a useful role in channelling long-term funds, such as insurance and pension funds, to meet the rising demand for long-term home financing. The Hong Kong Mortgage Corporation (HKMC), wholly owned by the Government through the Exchange Fund, was incorporated in March 1997 with a mission to develop this market.

The HKMC commenced business in October 1997 with its Mortgage Purchase Programme, which has developed in two phases. The first phase involves the purchase of mortgage loans for its own portfolio and the funding of the purchases largely through the issuance of unsecured debt securities. Under the second phase, the HKMC securitises the mortgages into Mortgage Backed Securities (MBS) and offers them for sale to investors. Through effective marketing and the introduction of innovative products, the outstanding principal balance of the HKMC's retained mortgage portfolio reached $35 billion as at end-2004.

In March 1999, the HKMC introduced the Mortgage Insurance Programme (MIP), enabling banks to lend home mortgage loans above the 70 per cent loan-to-value ceiling set by the HKMA up to an 85 per cent loan-to-value on completed properties without incurring additional risk. In August 2000, the MIP was expanded to cover mortgage loans with a loan-to-value ratio from 85 per cent to 90 per cent. In July 2001, the MIP was further expanded to cover equitable mortgage loans on residential properties under construction with loan-to-value ratio of up to 90 per cent. The product range of the MIP was made even more comprehensive with the introduction in July 2004 of the 95 per cent loan-to-value ratio product for both completed residential properties and properties under construction. To supplement the efforts of the Urban Renewal Authority in the rehabilitation of old properties and to assist homebuyers interested in purchasing such properties, the HKMC increased the limit on the combined age of property and loan tenor under the MIP to 60 years (with the market norm being 50 years).

Since its inception, the MIP has steadily gained acceptance by homebuyers and increased market penetration through product diversification and improving servicing standards. The total number of applications received since launch has exceeded 49 000, with a total value of $91 billion. The penetration ratio of the programme reached 16 per cent for 2004. About 81 per cent of MIP oans are in respect of properties in the secondary market, demonstrating that the MIP is particularly instrumental in promoting the liquidity of the secondary market.

Apart from contributing to banking stability and promoting home ownership, the HKMC also aims to promote the development of the MBS and bond market in Hong Kong. The HKMC launched a back-to-back MBS Programme in October 1999. The back-to-back structure allows banks to effectively repackage their mortgage portfolios into more liquid portfolios and to maintain the majority of the cash flow if they hold the MBS in their own investment portfolio. The HKMC's guarantee on the timely payment of interest and repayment of principal serves to make the MBS a safe and attractive investment for investors. A total of $2.8 billion of MBS has been issued since the inception of the back-to-back MBS Programme.

The HKMC also established a multi-currency MBS programme in the conventional bond style (the 'Bauhinia MBS Programme') in December 2001. Under the Bauhinia MBS Programme, the HKMC has securitised mortgage loans from its retained mortgage portfolio for an aggregate amount of $7.4 billion. Out of this total, $2.4 billion were done in 2004, which included a portion of $900 million set aside in a $2 billion issue in November 2004 for retail investors. This MBS issue was the first ever offered to retail investors in Asia.

Debt issuance is the mainstay of the HKMC's funding sources. Through debt issuing activities, the HKMC is able to achieve the mission of promoting the development of the Hong Kong dollar debt market. In 2004, the HKMC successfully launched 43 debt issues for a total amount of $11.4 billion under its Debt Issuance Programme and through retail bond issuance, making it the most active corporate issuer of debt securities in Hong Kong. As at end-2004, the HKMC had 120 issues of debt securities with a total amount of $35.5 billion outstanding. The HKMC debt securities were well received by financial institutions, as well as institutional and retail investors.

To help develop the retail bond market, the HKMC pioneered the issue of retail bonds through banks as placing agents in October 2001. Since then the HKMC has issued 22 retail bonds for a total amount of over $10.3 billion. In view of the solid development of the retail bond market, the HKMC established a Retail Bond Issuance Programme in May 2004 and initiated a plain language approach to the drafting of prospectuses to facilitate investors' understanding of the prospectus contents. Under the Retail Bond Issuance Programme, the HKMC has issued three retail bonds for an aggregate amount of $1.7 billion.

The bulk of the world's savings is generated within Asia. This is expected to be a long-term trend. Located in the heart of Asia, Hong Kong is well positioned to further develop as an international wealth management centre. According to a survey conducted by the SFC, fund management business, which comprises asset management, advisory business and other private banking activities, amounted to $2,947 billion in 2003. About $1,194 billion worth of assets were managed in Hong Kong. The survey also confirmed Hong Kong's attractiveness to overseas investors, with funds sourced from overseas investors amounting to $1,860 billion.

Hong Kong has a number of strengths to develop into a leading wealth management centre in the region, including the rule of law, a free economy, low and simple tax regime, no exchange controls, a highly efficient and competitive financial industry, a large pool of talented professionals and a high concentration of reputable fund management companies. These together helped ensure a quality market that is attractive to international funds looking for management.

The Government adopts a multi-pronged approach in developing Hong Kong as an international wealth management centre. Its objective is to provide a conducive environment. In 2004, it conducted a consultation on legislative amendments to the Companies Ordinance for exempting offshore funds from profits tax. Comments received were generally in favour of the proposal. The Government will introduce legislative amendments into the Legislative Council in 2005 to implement this initiative. During the year, the SFC also continued to facilitate the launch of new investment products and the access of international funds to the local market.

The Government, through organising and participating in forums, seminars and conferences relating to financial services in Hong Kong and overseas, continues to promote Hong Kong's position as an international financial centre and to publicise the excellent investment opportunities and sophisticated services provided by the financial market in Hong Kong. Opportunities have also been taken to explain the policy initiatives and measures undertaken by the Government and regulatory bodies to enhance the regulatory regime, financial infrastructure and corporate governance.

The Government organised a Forum on Management of Insurance Funds in Beijing in November 2004 for some 270 participants from the Mainland and Hong Kong. The forum successfully fostered experience sharing on management of insurance funds between the Mainland and Hong Kong participants. It also helped to improve the Mainland insurance sector's understanding of Hong Kong's strengths as a platform for global investment in the Mainland.

In December 2004, the Government also organised, in conjunction with the Advisory Committee on Human Resources Development in the Financial Services Sector, a forum on 'Hong Kong as an International Asset Management Centre: Challenges and Opportunities', in Hong Kong. The forum provided an excellent opportunity for all concerned parties to explore ways to further enhance financial services human resources to support Hong Kong's continued development as an international asset management centre. It was well attended by over 300 participants, including market practitioners from all fields in the financial services sector, market analysts, and academics.