Hong Kong 2006 - 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. There are also other major initiatives to enhance Hong Kong's competitiveness as an international financial centre.

Quality financial reporting is of paramount importance for upholding Hong Kong's corporate governance regime. The Hong Kong Financial Reporting Standards (HKFRS), which are issued by the HKICPA, have been fully convergent with the International Financial Reporting Standards (IFRS) since January 2005. This uniform accounting platform, well understood by global investors and financial analysts, enables the comparison of corporations and their results in different jurisdictions and leads to greater confidence in the transparency and quality of Hong Kong's financial markets.

In addition, the Government is acutely aware of the need to maintain an effective, transparent and accountable regulatory regime for the accountancy profession that is on a par with international standards. The Legislative Council enacted the Financial Reporting Council Ordinance on July 13, 2006, providing the statutory basis for establishing the Financial Reporting Council (FRC), which is a new statutory body to investigate audit irregularities and accounting non-compliances of listed companies in Hong Kong.

The Government announced the appointment of Ms Sophia Kao as the inaugural Chairman of the FRC on December 1, 2006. Together with nine other FRC members (including two ex-officio members, namely the Registrar of Companies and the Chief Executive Officer of the FRC), the FRC is expected to be fully operational as soon as practicable in 2007, to discharge its statutory functions in an impartial, efficient and transparent manner.

The saving rates in Asia are high compared to other regions and this is expected to be a long-term trend. Located at the heart of Asia, Hong Kong is well positioned to further develop as an international asset management centre. According to the Fund Management Activities Survey 2005 released by the SFC in July 2006, which covered licensed corporations and registered institutions, the combined fund management business had grown by 25 per cent from $3,618 billion in 2004 to $4,526 billion in 2005. Since the establishment of the SFC in 1989, the number of retail funds in Hong Kong had more than doubled from 781 to 1 964 in 2005, with the value jumping 18 times from $283 billion to $5,210 billion. The introduction of the QDII Scheme by the Mainland authorities in April is expected to provide further impetus to the development of the asset management industry in Hong Kong (see 'Capital Formation Centre and Global Investment Platform for the Mainland' under Financial Links between Hong Kong and the Mainland).

In addition, according to a hedge fund survey conducted by the SFC, the hedge fund industry has shown significant growth in recent years with aggregate assets managed from Hong Kong by the SFC licensed hedge fund managers and advisors of US$33.5 billion as at March 31, 2006, representing a remarkable increase of 268 per cent from March 2004. These findings again confirmed Hong Kong's position as Asia's major asset management hub for investors worldwide.

To provide a conducive environment for the further development of Hong Kong as Asia's asset management centre, the Government abolished estate duty, with retrospective effect from July 15, 2005. In addition, the legislation exempting offshore funds from profits tax was enacted on March 1, 2006. The exemption, which applies with retrospective effect from the year of assessment 1996-97, will put Hong Kong's tax treatment of offshore funds on a par with other international financial centres such as the United States and the United Kingdom. The SFC also continued to review relevant codes and guidelines and facilitate the launch of new investment products and international funds' access to local market.

The SFO came into force on April 1, 2003 and has been implemented successfully since then. During the year, the SFC continued to maintain and update the SFO in light of market developments.

In 2006, the Government continued to work closely with the SFC and HKEx to refine, taking into account market comments, proposed legislative amendments to the SFO for giving statutory backing to major listing requirements covering financial reporting and other periodic disclosure by listed companies, disclosure of price-sensitive information by listed companies and shareholders' approval for certain notifiable transactions. The Government aimed to introduce the bill into the Legislative Council in 2007.

In the Budget Speech of the Financial Secretary for the year of 2006, he announced a 20 per cent reduction of the SFC Levy, pursuant to a recommendation from the SFC. The Securities and Futures (Reduction of Levy) Order 2006 was made to give effect to the new levy rates (0.004 per cent per purchase or sale of securities and $0.80 per purchase or sale of a futures contract) which came into operation on December 1, 2006.

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

The Overall Review of the CO and the Corporate Governance Review by the SCCLR in recent years resulted in a number of recommendations for reform. Some of the recommendations such as those relating to shareholders' remedies have been implemented through amendments to the CO. There are, however, many remaining recommendations such as reform of the capital maintenance provisions and modernisation of statutory language that are best taken forward through a comprehensive rewrite of the CO. The rewrite exercise will also provide Hong Kong with an up-to-date legal infrastructure attuned to its needs as a major international business and financial centre.

To take forward the rewrite, a dedicated Companies Bill Team (CBT) comprising officers from the Financial Services and the Treasury Bureau and the Companies Registry was set up in mid-2006. In addition to the SCCLR and a joint Government-Hong Kong Institute of Certified Public Accountants working group set up in March 2002 to review the accounting and auditing provisions of the CO, the CBT also consults relevant professionals, market practitioners, academics and other stakeholders through four advisory groups established in late 2006. It also leverages on recent company law developments in other common law jurisdictions such as the United Kingdom, Australia and Singapore.

Certain complex subjects, including accounting and auditing provisions, share capital, distribution of profits and assets, and company charges, will be put forward for public consultation in 2007 and 2008. The new Companies Bill will be issued for public consultation in the form of a white bill in mid-2009.

HKSCC launched the Stock Segregated Account (SSA) service in 1994 to facilitate brokers/custodians to segregate an investor's stockholdings (which are under their custody) from their own and that of other investors. Investors receive statements (daily movement statement and monthly balance statement) directly from HKSCC, which serve as an additional way for investors to track their stockholdings. In January 2007, HKSCC announced the introduction of new features to the SSA service to provide users with an enhanced customer interface and more timely information.

Separately, the SFC worked closely with the Government, various regulatory authorities, and industry and professional associations during the year to promote XBRL (eXtensible Business Reporting Language) for financial reporting in Hong Kong. XBRL is an evolving global standard for faster and more accurate electronic communication of business and financial data.

The HKMA has taken steps to implement the recommendations arising from a comprehensive review of Hong Kong's financial infrastructure conducted in 2005. The objective is to build a safe and efficient financial infrastructure based on a multi-currency, multi-dimensional platform, and to develop Hong Kong into a payment and settlement centre in the region.

Major projects completed in 2006 include:

The HKMA has established a comprehensive marketing programme to explore opportunities to link the various RTGS systems and the CMU with similar systems in the region, and to promote the use of the clearing and settlement systems in Hong Kong.

The Government has boosted the development of the bond market in recent years by 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 HKMA completed a review of the EFBN programme in 2006 and will gradually implement the recommendations of the review. These include refining the market-making system for EFBNs by providing incentives to encourage market makers to trade EFBNs more actively; extending the benchmark Exchange Fund Note (EFN) yield curve to beyond 10 years; streamlining the issuance programme by making greater use of re-opening existing EFN issues; and introducing an electronic trading platform. The first set of league tables, ranking market makers according to their turnover in Exchange Fund Bills (EFBs) and EFNs, was released in December. This will help provide recognition for top-performing market makers.

The review also recommended the removal of the 'three-year rule' to help develop the domestic bond market. The 'three-year rule', which was imposed in 1998, requested nine Multilateral Development Banks (MDBs) to confine their issuance of Hong Kong dollar-denominated bonds to tenors of three years or longer. The request was withdrawn on October 9.

In 2006, the Hong Kong dollar debt market grew further, with the total outstanding amount rising to $748 billion at year-end, a 13 per cent increase from a year earlier. Issuers included the Exchange Fund, statutory bodies or government-owned corporations, AIs, MDBs, non-MDB overseas borrowers and local corporations.

New issues of EFBNs increased by 3 per cent to $220 billion and accounted for almost a half of the total new debt issuance in 2006. The Exchange Fund papers were broadly welcomed by the market, with subscription averaging over four times the issue size of Exchange Fund Bills, and over three times the Exchange Fund Notes.

Excluding the Exchange Fund paper, new issuance of Hong Kong dollar debt totalled $234 billion in 2006, representing a 24 per cent increase from the previous year. Of this total, non-MDB overseas borrowers remained the most active, accounting for 63 per cent of the new issues. That was followed by AIs and local corporations, with shares of 19 per cent and 9 per cent, respectively.

While the US Federal Reserve kept its policy interest rate on hold in the second half of the year, following 17 consecutive increases since mid-2003, issuance of fixed-rate debt accounted for a smaller share of the market in 2006. Excluding EFBNs⁶, fixed rate debt constituted about 51 per cent of total new issues in 2006, down from 74 per cent in 2005. The average maturity was broadly stable at around three years.

During the year, there was a growing interest in bond offerings at the retail level. The HKMA offered four issues of retail Exchange Fund Notes, totalling $800 million.⁷ The Hong Kong Mortgage Corporation (HKMC) also issued four series of retail bonds to the public, comprising two series of Hong Kong dollar bonds amounting to $100 million and two series of US dollar bonds totalling US$10 million. All these HKMA and HKMC issues were well received and oversubscribed.

The Government participates actively in ongoing international and regional initiatives to develop the domestic and regional bond market. The HKMA, through its chairmanship of the EMEAP Working Group on Financial Markets, continues its effort on the implementation of Asian Bond Fund 2 (ABF2) in 2006.

All 11 members of the EMEAP Group have invested a total of US$2 billion in ABF2, which invests in domestic currency bonds issued by all EMEAP economies except Australia, Japan and New Zealand. ABF2 consists of an ABF Pan-Asian Bond Index Fund (PAIF) and eight single-market funds. The PAIF is a single bond fund investing in domestic currency bonds issued by sovereign and quasi-sovereign issuers in the eight EMEAP economies, whereas the eight single-market funds will each invest in the same type of bonds issued in the respective markets. After the successful listing of the PAIF and three single-market funds of Hong Kong, Malaysia and Singapore in 2005, three other single-market funds of Korea, the Philippines and Thailand were listed or offered to the public as unlisted open-ended funds during 2006. The remaining two single-market funds are scheduled for public offering in 2007.

The long-term development of the bond market is promising. Hong Kong's free and open financial markets, with free flow of capital, help create a large international investor base and will continue to fuel the growth of Hong Kong's bond market. 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.

Through its debt-issuing activities, the HKMC is able to promote the development of the Hong Kong dollar debt market. In 2006, the HKMC successfully launched 49 debt issues totalling $12.1 billion under its Debt Issuance Programme, making it the most active corporate issuer of Hong Kong dollar debt securities in Hong Kong for the sixth consecutive year. By the end of 2006, the HKMC had $28.7 billion of debt securities outstanding.

The HKMC has pioneered the development of retail bond market in Hong Kong since 2001. The HKMC has issued retail bonds totalling over $12 billion, with $1.3 billion issued in 2006, including issuing the 10-year retail zero-coupon bond for the first time.

With an upgrade of the HKMC's local currency issuer rating to triple-A by Moody's in October 2006, the HKMC became the first triple-A institution in Hong Kong, enhancing its ability to promote the development of the debt and securitisation markets in Hong Kong.

A well-developed secondary mortgage market plays a useful role in channelling long-term funds, such as insurance and pension funds, to meet demand for long-term home financing. To develop this market, the Government established the HKMC in October 1997:

Under the Mortgage Purchase Programme, the HKMC purchases mortgage loans from banks to facilitate their risk and balance sheet management. The HKMC is a key player in the secondary mortgage market. Its current mortgage portfolio consists of 73 652 loans with a total outstanding principal balance of $26.8 billion at the end of November 2006.

The Mortgage Insurance Programme (MIP) was launched in 1999 to provide mortgage insurance cover to banks so that they can extend residential mortgage loans to homebuyers and above the 70 per cent loan-to-value ceiling set by the HKMA. The maximum insurance cover is up to 25 per cent of the value of the mortgaged property.

The MIP has gained wide acceptance and promoted home ownership through product diversification and improvements to servicing standards. As at the end of 2006, over 80 000 applications have been received involving an aggregate mortgage loan amount of $154 billion, out of which a total of $119 billion in mortgage loans were approved. The market penetration rate of approved loans was 13.5 per cent in 2006. About 86 per cent of MIP loans drawn down in 2006 are for secondary market properties, demonstrating that the MIP is particularly instrumental in promoting the liquidity of the secondary market.

The HKMC established a back-to-back mortgage-backed securities (MBS) programme in October 1999, which provides a platform for banks to effectively repackage their mortgage portfolios into more liquid MBS. The HKMC guarantees the timely payment of interest and repayment of principal for the securitised mortgage loans. Since the inception of the back-to-back MBS programme, $2.8 billion of MBS have been issued.

In December 2001, to further develop the range of products available in Hong Kong's MBS market, the HKMC established the multi-currency Bauhinia MBS Programme with MBS collateralised by mortgage loans from the HKMC's retained mortgage portfolio. A total of $10.4 billion of MBS have been issued under the Bauhinia MBS Programme by the end of the year, including the first un-guaranteed AAA-rated MBS in Hong Kong in November 2006.