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Following is the speech by the Chief Executive, Mr Donald Tsang, at the Foreign Correspondents' Club of Japan on "The Role of Hong Kong in International Financial Cooperation and China's Financial Development" in Tokyo today (November 12):
Ladies and Gentlemen,
It is a great pleasure to have this opportunity to speak at the FCC of Japan today.
I am sure that this has been a very busy week for all you members, with the G20 Summit in Seoul, and the APEC Economic Leaders' Meeting here in Yokohama. And as we have seen over the past two years, issues relating to the global economy and financial systems have topped the agenda of these very important meetings. And again, it must be one of the key subjects where the journalists have been focusing on.
As an international financial centre well integrated into the global and regional financial systems, Hong Kong has been taking very keen interest in these and other forums as they work hard to make the financial systems safer and more stable.
While Hong Kong is part of China, we participate in many international forums in our own rights given our special status under the "One Country, Two Systems" principle. For example, we are one of the 21 Member Economies of APEC, and we sit on the Basel Committee on Banking Supervision as a full member. We are also a member of the Financial Stability Board.
Despite our small geographical size, Hong Kong has a unique position in the global financial world. Last week the World Economic Forum ranked Hong Kong third in their Financial Development Index, after the US and the UK. That's because of our robust institutional and business environments, and a high degree of stability in our financial system.
So, we are most happy to contribute to discussions on global financial regulatory reform. We want to understand the implications on our own financial institutions and systems of such reform, and we also want to help ensure that the reforms remain pertinent and appropriate to this part of the world, and of course to Hong Kong.
This is important because the global financial crisis has brought very different sets of issues to different countries. For example, while bank capital and liquidity have been major problems in the US and Europe, they are much less of a concern in most Asian economies.
Indeed, banks in Hong Kong have weathered the financial crisis relatively well. In June this year, the capital adequacy ratio of the Hong Kong banking sector stood at 15.2%, and the Tier 1 capital ratio was 12.6%. About 85% of the Tier 1 capital was common equity.
Banks in Hong Kong are also highly liquid, with retail banks' liquidity ratio standing at over 40% in the second quarter of this year. So, we see no major difficulty for Hong Kong banks meeting the tighter minimum capital and liquidity requirements under Basel III.
Of course, global regulatory reforms go beyond bank capital and liquidity standards. Proposals on the table include reducing moral hazard risk of systemically important financial institutions, increasing supervisory intensity and effectiveness, improving transparency and regulation of over-the-counter derivatives markets, reducing reliance on credit rating agencies, as well as enhancing regulation of hedge funds, and many other measures as well.
Many of these initiatives are new and will require much effort to put in place. But, Hong Kong is firmly committed to working with the international community to achieve consistent implementation of standards across jurisdictions so that we avoid regulatory arbitrage and ensure a level playing field in today's highly integrated global financial markets.
The strength of Hong Kong's banking system is no accident.
Thanks to a fair share of financial and economic shocks in recent years, our regulator has developed an armoury of regulatory tools to mitigate the risks of our banks through boom and bust.
For example, we have been using prudential tools such as loan-to-value ratio and debt-service ratio to ensure prudent mortgage lending by banks. These measures used to be seen by some as market intervention but are now receiving growing recognition by advanced economies. We are also taking measures in the securities market as well.
Effective as these measures may be in mitigating the risks, they are under renewed pressure as the global market is awash with excess liquidity. Since the outbreak of the financial crisis, major central banks around the world have been pursuing quantitative easing with a view to revitalising their economies.
So far, quantitative easing does not seem to have achieved the desired effect in the advanced economies. But the side effects on the Asian region and other emerging market economies are already very apparent.
Given their better growth prospects compared to the US and Europe, Asian economies are attracting huge amounts of excess liquidity in pursuit of higher yields. These money flows are creating upward pressure on exchange rates, on consumer price inflation and on asset prices in the region.
In the one-year period to September this year, property prices in the Mainland of China had increased by 28%, in Taiwan increased by 18%, in Singapore by 23% and in Hong Kong by 19%. As an export-oriented economy, Japan also suffers from a substantial appreciation of Yen as a result of the quantitative easing policy.
The US Federal Reserve announced early this month that it would pursue a second round of balance sheet expansion. We all call it the QE2. As a result, it is widely expected that more funds will flow into the emerging economies. There is inadequate absorption capability in the US economy to deal with that quantity, with a corresponding increase in the risk of an asset bubble in the Asian region.
In Hong Kong, we have been tackling the overheated property market with targeted policy tools. Specifically, we have taken measures to increase land supply and restrain speculative activities. We have also tightened the underwriting standards of residential mortgage loans to mitigate the increasing risks associated with soaring property prices. These measures have had some dampening effects, but we need to watch the market carefully, particularly following the announcement of QE2. We will not hesitate to take further measures if necessary.
Because of ample liquidity around the world, most Asian and emerging economies are also confronted with the difficult tasks of managing capital inflows and asset price inflation.
Without a certain degree of capital controls, exchange rate appreciation and interest rate hikes will attract, rather than deter, further pro-cyclical hot money flows. They are essentially ineffective. But, of course, capital control is abnormal. We don¡¯t normally do this. In fact, in Hong Kong we will not do this. So these fund flows will try to profit from currency speculation and carry trades, and they will offset the cooling effect of interest rate and exchange rate policies on consumer price inflation and on asset markets.
If your economy is receiving all these, the natural tendency is to try to revalue your currency. As I said, it is generally not effective in a medium and a longer term. For instance, in the case of Hong Kong, some people have suggested that with the emergence and strength of Renminbi, the Hong Kong Dollar should no longer be linked to the US Dollar and should be linked to Renminbi. But this is impossible because the Renminbi is not fully convertible yet. The financial and asset markets in the Mainland must also become more liquid and deep enough for us to hold a substantial amount of Renminbi to support the Hong Kong Dollar in the currency market -in an open market system, just as we do today with the US Dollar. So that option is closed for us.
On the other hand, Renminbi is presenting some very exciting business opportunities in the Hong Kong financial markets. Here, I would like to put into perspective the role of Hong Kong in the economic development of China.
Thirty years ago China embarked on a policy of opening up and reform, initially focusing on the industrial sector. In the early days, Hong Kong entrepreneurs were the first to set up factories in the Mainland, and they provided the capital and know-how much needed at the time.
We then saw exponential growth in the Mainland's manufacturing capabilities, and Hong Kong's economy benefited tremendously as a result. Indeed, almost entirely the manufacturing sector of Hong Kong has migrated into the southern part of China. As a result, Hong Kong owners are now managing roughly about 8,000 factories in the Pearl River Delta alone, and they are employing 11 million workers there.
Today, everyone knows that China is the biggest manufacturer in the world. But you may not know that Hong Kong has remained the largest source of external direct investments in the Mainland throughout all these years. We are the number one investor in China. And we are also the number one investor in each and every province in China. We are the number one investor in Shanghai, and we are the number one investor in Beijing. Last year, Hong Kong accounted for US$46 billion, or about half, of total external direct investment flows into the Mainland of China.
More recently, as China modernises its financial systems, Hong Kong has also been playing a key role. The reorganisation of state-owned banks into commercial shareholding banks, and their subsequent listings on the Hong Kong stock market, is a sign of the success of China's banking reform.
Four major banks raised some US$39 billion through their IPOs in Hong Kong between 2003 and 2006. A few months ago, the Agricultural Bank of China, completed its dual-listing in Hong Kong and Shanghai, raising a record of US$22 billion.
Going forward, further financial reform in the Mainland will involve liberalisation of the capital account to gradually achieve full convertibility of the Renminbi and link the domestic capital markets with the rest of the world. But, there are significant risks in the process. It is necessary to proceed in a gradual and cautious manner ¡ª as we Chinese say, "feeling the stones when crossing the river". In this regard, Hong Kong is once again playing a pivotal role with our well-established financial markets and unique status under "One Country, Two Systems".
First, Hong Kong is an ideal platform for the expanding cross-border investment activities of the Mainland. We are familiar with the investment and trading environment globally and we are also familiar with the trading and investment in the Mainland of China and our global commercial connectivity is second to none. Most of all, Hong Kong is a fair trader. As a result, Hong Kong will continue to be the main bridge for further financial integration between the Mainland and the rest of the world. In 2009, the Mainland's outward direct investment reached something like US$57 billion. Of this amount 60% was invested in Hong Kong, or through Hong Kong to other places. Hence we see the importance and growing status of Hong Kong as a bridge as the Mainland's financial market grows and when Renminbi becomes convertible.
Along with this trend, there is an increasing need for Mainland financial institutions, especially banks, to develop their business overseas. Hong Kong is the preferred platform for Mainland banks to launch into the international scene.
Indeed, many Mainland banks have set up operations in Hong Kong. In 1996, the total assets of Mainland banks in Hong Kong amounted to HK$870 billion, or 11% of Hong Kong's banking sector. In 2009, this figure already reached HK$2,000 billion, and accounted for 19% of Hong Kong's banking sector.
Secondly, Hong Kong is playing an important role in the wider use of the Renminbi outside of the Mainland. Hong Kong has the "first-mover" advantage of conducting personal RMB business since 2004, while our Renminbi bond market started in 2007. We have since established an efficient Renminbi clearing platform and payment systems in Hong Kong.
There were more exciting developments in July 2009, when a Renminbi trade settlement scheme was introduced. The scheme has been successively expanded since then to cover more Mainland cities and to include trade in services. The clearing and supervisory controls for Renminbi funds in Hong Kong have also been progressively relaxed, which has allowed the development of a range of offshore Renminbi wealth management products, including the certificates of deposits, insurance products and investment funds in Hong Kong.
These developments have led to a notable increase in Renminbi deposits in Hong Kong ¡ª from 63 billion yuan in late 2009, to 150 billion yuan in September this year.
Renminbi bond issues are also set to be a record this year, amounting to at least 20 billion yuan. The range of issuers has expanded from largely Mainland financial institutions in the past, to Hong Kong and multinational corporations. For instance, even the McDonald's has successfully raised Renminbi through a bond issue in Hong Kong. The Asian Development Bank and the International Finance Corporation of the World Bank Group just launched Renminbi bonds in Hong Kong last month.
In the years to come, the Renminbi is set to gain increasing importance as an international currency, and Hong Kong is privileged to be able to contribute to this process.
Ladies and gentlemen, Hong Kong is a dynamic city, and we always thrive on challenges. We have a track record of emerging from crises stronger and more resilient. Indeed, when every crisis comes, I'll think of ways in which we can leverage that crisis to ensure Hong Kong's financial and general market will grow. And that has been the right strategy so far. We did it in 1997 and we did it again this time round.
While we are pleased with our economic recovery after the global financial crisis, and excited about the opportunities in the region, we remain acutely aware of the risks of an asset bubble and the very uncertain outlook of the global economy and financial markets.
There are still daunting tasks ahead to accomplish for governments, for regulators and for business before our financial systems are safer and more resilient throughout the world. The key to success will be a spirit of collaboration and partnership in various international forums, such as APEC and G20. It is not a forum to do the blame game. It must be a forum to talk about collaboration and accommodation. And it is not a forum that we should look for change at the rate at which the crisis developed. For instance, the financial crisis, over a period of one year had set the whole world back, and you cannot ask a certain economy to adjust to this system within one year, to regain the original position. It will take a much longer time.
I am looking forward to some fruitful discussions in Yokohama and at the APEC Leaders' Meeting. And I am sure I will see some of you again there when you cover that scene. And I hope to come back again sometimes in the future.
Thank you very much.
Ends/Friday, November 12, 2010
Issued at HKT 19:25
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