LegCo Paper No. CB(1) 2075/95-96
(These notes have been seen by the Adminsitration)
Ref : CB1/BC/44/95

Bills Committee on
Banking (Amendment) Bill 1996

Minutes of Meeting
held on Thursday, 18 July 1996 at 8:30 am
in Conference Room B of the Legislative Council Building

Members Present :

    Dr Hon HUANG Chen-ya, MBE (Chairman)
    Hon Ronald ARCULLI, OBE, JP
    Dr Hon LAW Cheung-kwok

Members Absent :

    Dr Hon David LI Kwok-po, OBE, LLD, JP
    Hon Paul CHENG Ming-fun
    Hon Ambrose LAU Hon-chuen, JP
    Hon SIN Chung-kai
    Hon Mrs Elizabeth WONG CHIEN Chi-lien, CBE, ISO, JP

Public Officers Attending :

Mr Albert K C LAM
Principal Assistant Secretary for Financial Services
(Banking & Monetary)
Mr G A FOX
Senior Assistant Law Draftsman

Attendance by Invitation :

Mr David CARSE
Deputy Chief Executive (Banking),
Hong Kong Monetary Authority
Mr Raymond LI
Executive Director (Banking Policy),
Hong Kong Monetary Authority

Legal Adviser in Attendance :

Ms Kitty CHENG
Assistant Legal Adviser 2

Staff in Attendance :

Mrs Constance LI
Chief Assistant Secretary (Finance Committee)
Mr Andy LAU
Senior Assistant Secretary (Finance Committee)

Internal discussion

The Committee had an internal discussion prior to the meeting with the Administration. The Committee reviewed the information obtained from the Administration so far, and discussed whether interested parties should be invited to give submissions on the proposed legislation. Since the proposed bill was to protect consumers subscribing to the multi-purpose stored value card (MP) schemes, and to ensure that the new vehicle would not affect the stability of the existing payment system, members considered that the views of the Consumer Council and finance experts/economists would assist the Committee in its deliberations. After discussion, members agreed that, at the initial stage of deliberations, the Committee should invite submissions from the Consumer Council and economic experts at the local tertiary institutions.

2. As regards further information required on the operation of the MP systems to be introduced in Hong Kong, the Committee would decide at a later stage whether the potential issuers of MPs should be invited to provide information to the Committee.

Committee

Meeting with the Administration

Issue of Stored Value Cards (SVCs) by Special Purpose Vehicles (SPVs)

3. Following up on the point raised at the last meeting concerning the extension of the existing authorization criteria and regulatory mechanism for authorized institutions to SPVs, Mr CARSE advised that, to avoid any possible confusion as to whether a financial institution registered as a restricted licence bank (RLB) or a deposit-taking company (DTC) was authorized to issue MP or for the traditional banking business, the following arrangements could be introduced:-

  1. for SPVs whose principal business consisted of issuing/facilitating the issue of MPs should be allowed to apply for authorization as a DTC only, but not as RLB as previously proposed; and
  2. the applicants would be clearly advised of the scope of the authorized business. It would also be possible to specify the nature of their authorized status (i.e. as issuers of MPs) in public sources such as the register of authorized institutions.

4. The Chairman suggested the Administration provide an information paper on DTCs and the existing regulatory Adminframework.

Authorization and exemption criteria

5. On the authorization criteria, Mr CARSE advised that the details were yet to be worked out, and these would likely include the financial standing of the issuer, the core purpose of the card to be issued, and the value to be stored on the card. The general principle was to ascertain the financial soundness of the issuer and to reduce the credit risks of the card-holders. There was no intention to regulate the issue of single-purpose stored value cards (SPs), but consideration was being given to imposing a maximum limit, say, $1,000, on the value that could be stored on a SP card.

6. As regards the discretion of the Hong Kong Monetary Authority (HKMA) to exempt some SPCs from authorization (paragraph 6 (d) of the Legislative Council Brief dated 22 May 1996 (ref. G4/16/18CII), Mr CARSE explained that the exempt cards would normally be allowed to pay for a limited range of low value goods and services, such as that used under the initial phase of Creative Star Scheme for payment of public transport services and the ancillary services. The exemption could also apply to high value SPs issued for a designated purpose such as that used for placing bets with the Hong Kong Jockey Club. Moreover, a declaration to exempt such cards would be subsidiary legislation and hence would be subject to the vetting and possible amendment of the Legislative Council.

Stability of the payment system

7. In reply to the Chairman, Mr CARSE advised that the proposed legal framework was to ensure the stability of the existing payment system rather than to protect the interests of the licensed banks. The Administration would have to strike the right balance between the public interests of preserving the stability of the payment system, and providing for product innovation and consumer convenience which could be served by the new technology. Since MPs represented a new payment system, allowing non-bank entities to issue MP would mean opening up a parallel payment system, the unrestricted use of which could lead to serious consequences.

8. A member argued that such risks could be significantly reduced if a statutory ceiling was to be imposed on each card and if these issuers were required to make regular reports to HKMA. In reply, Mr CARSE said that a ceiling could be considered as one of the criteria for exemption. He warned however that there were risks in granting automatic exemptions, and sensible guidelines in this respect would be necessary.

Regulatory framework in other jurisdictions

9. As regards the regulatory framework in other jurisdictions, Mr CARSE advised that while some developed countries such as the United States and Australia were still at a "wait-and-see" stage, their proposed regulatory framework was in line with most European countries where the issue of MP was restricted to regulated credit institutions. He said these countries including Germany recognized the potential risks of MP such as forgery and money laundering, and were in the process of drawing up the regulatory mechanism.

10. Mr CARSE further advised that, unlike banknotes, electronic value was invisible , and forgeries of electronic value could be difficult to detect and would cause substantial losses to the issuers who would be required to re-deem a greater value that had no backing. It was therefore necessary to design detailed regulatory requirements for MP schemes to provide for control against forgeries and money laundering.

Backing of value on MP cards

11. Concerning the backing of value on Mondex cards, Mr CARSE advised that the present thinking was that the originator of Mondex value should be subject to the same capital adequacy rule currently imposed on DTCs. The main concern should be to ensure that its liability (the electronic value created) would be less than its assets ( backing for the value created), and that the backing should be in the form of high quality liquid asset. While some degree of market risks was allowed, the backing should be invested in credit risk free instruments such as the Exchange Fund Bills.

12. As for the VISA/Master Card system, Mr CARSE explained that each member bank would issue its own card while VISA/Mastercard provided the clearing network. Since the issuing bank was already holding liquidity to meet its liability (the value stored on the card), Mr CARSE advised that holders of the cards were subject to the same risks as other depositors with the bank. In case the issuer went bankrupt, the value that could be re-deemed by a card-holder would depend on the capital and liquidity of the issuing bank, and the arrangements would be similar to that for other depositors.

13. A member noted that as the value of a Mondex card would be guaranteed by the originator of the Mondex value, it appeared that the Mondex scheme would provide better consumer protection. In this respect, Mr CARSE said that the security of that scheme would depend largely on the soundness of the originator and that the Administration would aim to ensure that the backing for the scheme would be sufficient and secure. The meeting noted that, while Mondex cards were similar to banknotes, the profits accrued from the interests of deposits placed by the card-holders would go to the originator of the Mondex value.

14. On exemption and SPV authorization, Mr CARSE explained that HKMA would have to consider each case on its merits, based on the criteria to be established in paragraph 5 above. The present proposal of requiring a SPV to register as DTC would enable HKMA to impose licence conditions as to float management by potential issuers of MP.

Possible monopoly by licensed banks

15. Noting that the Mondex system was akin to note-issuing and the likely popularity of a cashless and checkless payment system, members expressed concern that the potential market might be monopolized by the issuer. They enquired if there would be any statutory requirements for the issuer of Mondex to accept new share-holders. Mr CARSE advised that, as far as he was aware, there would be other shareholders in the Mondex company apart from the Hong Kong Bank, but the ultimate composition would depend on the decision of the franchised holder of the Mondex scheme in Hong Kong (i.e. the Hong Kong Bank).

Money laundering

16. Given that there were other easier means for money laundering, a member questioned in what ways MPs could be used for money laundering and how the proposed legislation could prevent such abuses. In response, Mr CARSE quoted the Mondex scheme as an example. As the Mondex scheme was an off-line system without audit trails, and in the absence of any limit for the value stored on a card, it would be possible to transfer Mondex value from card to card and to other jurisdictions. As such, it could become a convenient tool for money laundering. At present, the franchised holder of the Mondex scheme in Hong Kong, the Hong Kong Bank, was considering imposing a ceiling on the value to be stored on different types of cards, so that the retailer and the customer could have different value limits. A limit could also be set for the number of daily transactions on the part of the customer. There would also be other security measures to prevent abuses and forgeries such as the use of a PIN and the linking of cards to specific accounts, etc. To ensure that these regulatory measures would be adopted by other member banks or other issuers, the Administration considered that a statutory framework would be necessary.

Authorization system for money brokers

17. Members questioned the need for a formal authorization system for money brokers as proposed in the bill. Since there were only ten existing money brokers and the Administration was unaware of any new prospective applicants at the moment, members were concerned that the proposal might result in over-regulation and inhibition of the capital market. In response, Mr CARSE explained that the proposed regulation was made in response to the concerns raised by the industry itself. While money brokers were subject to a Code of Conduct, the Hong Kong Foreign Exchange and Deposit Brokers Association (HKFEDBA) found self-regulation difficult because of the absence of statutory protection for the Association in exercising disciplinary actions against its members.

18. Mr CARSE said that both HKFEDBA and the Hong Kong Association of Banks suggested that HKMA should assume the role of the authorization authority under a formal regulatory regime for money brokers. The authorization criteria would include fitness and propriety of the management, financial soundness, prudent conduct and adequacy of accounting and control systems. This would help to ensure that the highest standards of integrity and fair dealing would be observed by the brokers.

19. On the proposed Committee Stage Amendments to the definition of ‘money-brokers’, Mr CARSE explained that comments received from the trade suggested that the current definition of ‘money-broker’ in the Bill might not cover electronic brokers. He explained that the role of traditional voice brokers was that of a matchmaker bringing together two independent counterparties to a transaction, and the deals arranged through voice brokers were directly settled between the principals. An electronic broker, on the other hand, operated a computerized interactive data system to facilitate, among others, forex transactions and interbank deposits between its subscribers. Dealing quotes could be entered into its worldwide computer network which would automatically match all bids and offers subject to some credit checks. To remove any uncertainty that electronic brokers who operated from overseas might not be covered by the definition of ‘money-broker’, it was proposed that the definition should be expanded to include persons who provided services to persons in Hong Kong. The amendment would also capture voice brokers who operated from overseas but provide money broking services to persons in Hong Kong. This was considered justified as the overseas voice and electronic brokers were providing a service similar to money brokers in Hong Kong, albeit from different locations.

20. On the enforcement of the provision, Mr CARSE advised that HKMA could include this as one of the licence conditions of banks, so that the banks could only deal with brokers approved or vetted by HKMA. At present, the two electronic brokers which accounted for perhaps as much as 50% of the spot market in Hong Kong were under the direct supervision of the Bank of England, and HKMA could report to their home regulator any irregularities found.

21. Noting that the role of a money-broker was basically that of a match-maker who did not deal with the physical money, the Chairman enquired whether it was absolutely necessary to include the fitness and propriety of the management and the accounting system of the money-broker in the authorization criteria. In reply, Mr CARSE advised that HKMA had a responsibility to ensure the integrity and competence of an institution authorized by HKMA. Mr CARSE stressed that the proposed regulation was not new rule, but a formalization of the existing market practice.

22. After discussion, members considered that there was insufficient information at the meeting to justify the introduction of the proposed legislation on money brokers. At the request of the Chairman, Mr CARSE undertook to provide further information on the following:

Admin
  1. the justifications and the effects of regulating money-brokers, and the reasons why the regulatory requirements were to be set out in authorization conditions and not as subsidiary legislation; and
  2. whether the proposed regulation for money-brokers would have implications for their tax status in Hong Kong.

Date of Next Meeting

23. Members agreed that three further meetings would be tentatively scheduled for 11, 18 and 24 September 1996 at 8:30 a.m. in Conference Room B of the Legislative Council Building.

24. The meeting ended at 10:30 a.m.

LegCo Secretariat
26 September 1996

Last Updated on 15 December 1998