LegCo Paper No. CB(1) 964/96-97
(These minutes have been seen
by the Administration)
Ref : CB1/PL/FA/1

LegCo Panel on Financial Affairs

Minutes of Meeting held on Monday, 6 January 1997, at 8:30 a.m. in Conference Room A of the Legislative Council Building

I Confirmation of minutes

II Information papers issued since last meeting

III Date of next meeting and items for discussion

IV Consultation paper on investor participation in Hong Kong Securities Clearing Co. Ltd.'s Central Clearing and Settlement System

V Rolling forex and future development of Hong Kong's foreign exchange market

VI Memorandum & Articles of Association of the Mortgage Corporation

VII Any other business

Continued existence of the Mandatory Provident Fund Office

Members present:

Members absent:

Public officers attending:

Items IV to VII
Mr Rafael S Y HUI, JP: Secretary for Financial Services
Items V and VI
Mr Norman CHAN, JP: Deputy Chief Executive Hong Kong Monetary Authority
Mr Peter PANG, JP: Executive Director (Monetary Policy and Markets) Hong Kong Monetary Authority

Attendance by invitation :

Items IV and V
Mr Anthony NEOH, QC, JP: Chairman
Securities and Futures Commission
Item IV
Mr John CHAN, CBE, LVO, JP: Chairman
Hong Kong Securities Clearing Company Limited
Mr Stewart SHING: Chief Executive and Director Hong Kong Securities Clearing Company Limited
Item V
Mr David J White: Executive Director (Supervision of Markets) Securities and Futures Commission
Mr Ivers Riley: Chief Executive Officer Hong Kong Futures Exchange Limited
Mr Francis KWAN: Head, Electronic Trading Department
Hong Kong Futures Exchange Limited

Clerk in attendance:

Ms Estella CHAN: Chief Assistant Secretary (1)4

Staff in attendance:

Miss Anita SIT: Senior Assistant Secretary (1)6

I.Confirmation of minutes

(LegCo Paper No. CB(1) 562/96-97)

1. The minutes of the meeting held on 4 November 1996 were confirmed.

II.Information papers issued since last meeting

2. Members noted that the following papers had been issued since last meeting-

(a) LegCo Paper No. CB(1)584/96-97 - "Listing Chinese companies in Hong Kong" issued by the Stock Exchange of Hong Kong;

(b) LegCo Paper No. CB(1)559/96-97 - Press release by the Stock Exchange of Hong Kong regarding the system error of the Exchange's trading system on 12 December 1996;

(c) LegCo Paper No. CB(1)521/96-97 - Speech by the Chief Executive of the Hong Kong Monetary Authority on "Monetary Affairs in Hong Kong: Recent Developments and Outlook"; and

(d) LegCo Paper No. CB(1)496/96-97 - Submission from the Hong Kong Society of Accountants regarding the Securities and Futures Commission (Amendment) (No. 3) Bill 1996.

III.Date of next meeting and items for discussion

3. Members agreed that the next regular meeting would be held on Monday, 27 January 1997, at 8:30 am. The Chairman requested members to notify the Panel Clerk of items they wished to discuss at the next meeting.

IV.Consultation paper on investor participation in Hong Kong Securities Clearing Co. Ltd.'s Central Clearing and Settlement System

[Paper No. CB(1) 603/96-97(01) and LegCo Paper No. CB(1) 608/96-97]

4. Mr John CHAN introduced the consultation paper. He said that a working model for investor participation in the Central Clearing and Settlement System (CCASS) was proposed in response to calls from the market and this Panel for extension of the system to serve both corporate and individual investors. The proposed model would enable individual investors to have full control, legally and physically, over their shares kept in CCASS's Depository. By opening an Investor Account in CCASS, an investor would enjoy the benefits as set out in paragraph 2.1 of the consultation paper. Mr Stewart SHING added that at present, legal protection for shareholding in the CCASS Depository was only available to intermediaries who were direct participants in CCASS but not to investors. Under the proposed model, legal protection would be extended to shareholdings in Investors' Accounts.

5. On the timing for implementation, Mr John CHAN and Mr SHING advised that there would be a three-month consultation period during which views would be solicited from existing CCASS participants and an independent market survey would be conducted among investors. The proposed model could start operating by mid-1998, subject to a decision on its implementation. In reply to a member's enquiry on whether the implementation date could be advanced, Mr SHING explained that after the consultation period, the Hong Kong Securities Clearing Company Limited (HKSCC) would proceed with the system design and setup processes. As the proposed model would require substantial updating of the hardware and software of the existing settlement system and the ancillary facilities, it would take some time to conduct reliability tests on the new system before it could be put into operation.

6. On the cost implications of the proposed model, Mr John CHAN advised that the system development costs would be borne by HKSCC and the operational costs would be recovered from users of the service through a monthly subscription fee and a tariff on individual transactions. These charges would be set on a cost-recovery basis; HKSCC would not derive profits from these charges. Mr SHING advised that the monthly subscription fee level would depend on the number of users of the Investor Account service, and was estimated to be as follows-

Number of accounts	Monthly subscription fee
1,000	$300
10,000	$135
40,000	$50

7. As to whether the Investor Account service would be more expensive than the existing custody service provided by brokers or custodians, Mr SHING advised that such a comparison could not be readily made as brokers charged their clients in different modes and often the custody service was not charged separately from other services provided to their clients. Mr John CHAN remarked that the Investor Account service would not be compulsory but would provide for investors an additional alternative means for safekeeping of shares.

8. On the frequency of future reviews on the charges for the Investor Account service, Mr SHING advised that while the tariff on individual transactions would probably be reviewed annually, the monthly subscription fee would be reviewed as and when needed, depending on how the demand level would change. He added that over the past four years, the tariff on individual transactions levied on CCASS participants had been continually adjusted downward, with the present charge being 50% lower than that of four years ago.

9. As to how the estimated charges under the proposed working model compared with the charges under the securities clearing systems in overseas markets, Mr SHING agreed to provide relevant information but remarked that there were structural differences between the proposed working model and those of the overseas markets and thus their charges were not directly comparable. He also advised that a delegation of HKSCC had visited the exchanges in Singapore and Taiwan in March / April 1993 to study their clearing and settlement systems. The proposed working model had incorporated the advantages of those systems.

HKSCC

(Post-meeting note: Information on the comparison between the tariff and fee structure under the proposed model and the charges of overseas markets was circulated under LegCo Paper No. CB(1) 758/96-97 dated 23 January 1997.)

10. Regarding the implications of the proposed model on brokers, Mr SHING advised that brokers' additional work of inputting settlement instructions in CCASS for transfer of shares to or from the Investor Accounts under the proposed model would be offset by the reduced manual work currently undertaken like depositing or withdrawing share certificates for clients. HKSCC would organise seminars for market intermediaries to explain how they would also benefit from the security and convenience offered by the proposal model, and to relieve their worry that the Investor Account service would adversely affect their business. He added that HKSCC would study with the Stock Exchange of Hong Kong ways to streamline the clearing and settlement processes. A proposal was that the Exchange's Automatic Order Matching and Execution System be modified to enable brokers to enter the concerned Investor Account holders' identification numbers as part of the trade data, which was directly transmitted to CCASS by the Exchange. This would save the need for broker participants' back office to input settlement instructions to CCASS.

11. On the settlement efficiency of CCASS under the proposed model, Mr John CHAN advised that in the initial implementation period, the settlement process might take a bit longer as an additional step of affirmation of settlement instructions by Investor Account holders would be required. However, this should not cause significant delay; settlement should still be able to be carried out within the same day as at present for the majority of the transactions.

12. As regards whether the model would pose additional risks to HKSCC, Mr SHING advised that the present risk management system of CCASS was sound and it was not envisaged that the proposed model would entail any significant risk management problem for CCASS. He further informed members that the Guarantee Fund of CCASS had accumulated a reserve of $250 million, with $100 million being contributions by CCASS's broker participants, $100 million being insurance coverage and $50 million being surplus generated from HKSCC's operation and set aside. The Fund, which had not been utilized over the past four years, would be increased to $350 million shortly due to an increase in the insurance coverage of $100 million made possible by a 33% discount in the premium.

13. Some members were concerned that a number of banks which were shareholders of HKSCC had not been supportive of the development of CCASS. Mr CHIM Pui-chung was concerned that this might hinder the development of CCASS and urged the Administration to monitor the situation. In response, Mr John CHAN said that in his two-year experience as Chairman of HKSCC, the Board of Directors had been working co-operatively. The Board as whole had decided to conduct the present public consultation exercise and to use the proposals in the consultation paper as the basis for this. The Secretary for Financial Services (SFS) advised that the Administration was not aware of any shareholders of HKSCC opposing the development of CCASS.

V.Rolling forex and future development of Hong Kong's foreign exchange market

[Paper No. CB(1) 603/96-97(02)]

14. On the view that Rolling Forex was introduced to serve as a close substitute for the suppressed leveraged forex market, SFS advised that the legislation to regulate the leveraged forex market was introduced in response to the wide public concern about malpractices of leveraged forex companies and brokers at that time, and bore no relationship with the introduction of Rolling Forex. Mr Anthony NEOH further advised that as the approving authority, SFC would consider the application of the Hong Kong Futures Exchange (HKFE) for introducing the financial product on the basis of a set of criteria which were applicable to all financial products, such as the features of the product, the corresponding risk management system etc. Whether the product would serve as a close substitute for leveraged forex was not a material consideration for SFC.

15. On whether the launching of Rolling Forex was regarded successful, Mr Ivers Riley said that it was considered modestly successful. Over the past few years, Rolling Forex had been introduced in several other exchanges in the Asia Pacific region, and Hong Kong's Rolling Forex market could be considered the most successful in terms of the number of future contracts traded. However, HKFE had far greater ambition concerning the product than the present performance. During the past year, a number of improvements had been made to improve the liquidity and transparency of the Rolling Forex market, and the market had been developing incrementally. HKFE believed that with continued improvements and modifications in response to market demands, the market could be highly successful.

16. In reply to the Chairman's query on the respective proportion of Rolling Forex trading handled by banks and other institutions, Mr David White informed that at present, trading on Rolling Forex accounted for less than 0.5% of the total trading volume in forex in Hong Kong, while banks' wholesale transactions accounted for 80% to 90%. Mr Riley advised that the present trading volume of Rolling Forex was close to US$50 million per trading day and this was considered a good basis for the market to develop. He also remarked that Rolling Forex would always be a fraction of banks' forex trading as the former was essentially a retail outlet for the wholesale forex market.

17. On the future development of the forex market in Hong Kong, Mr Norman CHAN advised that Hong Kong's forex market witnessed the fastest growth rate (49%) during the period 1992 to 1995 among the three main Asian financial centres. While there would continue to be keen competition among these financial centres, Hong Kong should still be able to maintain its competitive edge with its highly qualified and professional market participants. SFS added that in line with the overall economic policy, the Government would not exert direct intervention in the market. However, it would continue to promote and facilitate the enhancement of the infrastructure for the industry.

VI Memorandum & Articles of Association of the Mortgage Corporation

[Paper No. CB(1) 612/96-97(01)]

18. Mr Norman CHAN briefed members on the preparatory work for the setting up of the Hong Kong Mortgage Corporation Limited (HKMC) as contained in the information paper. He advised that the Board of Directors would be constituted in the coming three to four months. It was anticipated that HKMC would commence operation in the second half of 1997, i.e., start negotiations with banks on mortgage purchase agreements and issue debt securities to the market to solicit funds.

19. As regards the volume of business of HKMC in the startup period, Mr Norman CHAN advised that the total asset value of HKMC would be subject to a maximum of 20 times the company's capital. As the initial capital of HKMC would be HK$1 billion, the total assets would not exceed HK$20 billion. Expansion of the business volume would thus necessitate an increase in capital, which could be achieved by reinvesting the company's profits, additional injection of equity by the Government and public listing of the company. Public listing would be a long-term strategic issue.

20. On the mechanisms to ensure accountability and transparency of the operation of HKMC, Mr Norman CHAN advised that as a "public" company, it would be obliged to publish its annual accounts. Furthermore, as HKMC would be a debt securities issuer, it would be required to disclose its financial position to its investors on a regular basis. These mechanisms would ensure high transparency of its future operation.

21. Members noticed that the draft Memorandum and Articles of Association (Memarts) of HKMC did not specify how the Board of Directors would be constituted by profession or by economic and social sectors. They enquired about the criteria for appointment of members to the Board and the mechanisms to ensure that public interests would be adequately protected and conflicts of interests could be avoided. SFS advised that the Administration had no concrete proposal for the constitution of the Board at present. He assured that concerns about public interests and potential conflicts of interests and the general principles of representativeness, possession of relevant professional knowledge and experience etc. would be taken into account in the appointments.

22. Mr SIN Chung-kai said that while he appreciated that persons having relevant professional knowledge and experience would be more suitable for appointment, such persons were usually associated with businesses having interests in the property and financial markets. He enquired if there would be mechanisms to ensure that there would not be undue influence of these interests in the Board. He opined that with the constitution of the Board specified in the Memarts of HKMC, the public could assess if a check-and-balance mechanism was built into the Board to prevent undue influence by sectoral interests. In response, SFS said that while sectoral interests would be an important consideration, it should be reckoned that one's professional background or business associations did not necessarily give rise to conflicts of interests in the course of exercising the directorship functions of HKMC. The Administration considered that the most important way to ensure protection of public interests was to specify in the Memarts of HKMC on what could and could not be done, rather than specifying the sector or profession which members of the Board should come from.

23. The Chairman noted that clause 2 of the draft Memorandum of Association provided that HKMC might enter into any financial derivative dealings and there were restrictive provisions in this regard. He considered it necessary to stipulate that the company's activities in financial derivatives must be for the purpose of protecting the value of its assets. Mr Norman CHAN agreed that HKMC should not be involved in speculative dealings in derivatives. He pointed out that clause 5 already provided that all kinds of transactions and arrangements entered into by HKMC should be desirable for the prudent management of the company's financial affairs. The object clauses were drawn up in a broad and inclusive manner so as to avoid unnecessary disputes over the company's future dealings as to whether they were ultra vires. At the Chairman's request, he agreed to consider revising clause 2 with a view to defining the purpose of the company's financial derivative dealings.

24. On the owner-occupancy criterion for mortgages to be purchased by HKMC, Mr Norman CHAN explained that the criterion was intended to avoid HKMC's exposure to the risks associated with rented residential properties. The bank selling the mortgages would be responsible for the owner-occupancy status at the time of mortgage sale. Banks would not be responsible for the changes to the occupancy status after the mortgage sale. If certain mortgages were subsequently found not fulfilling the occupancy status criterion at the time of mortgage sale, the bank concerned would be required to replace those unqualified mortgages with qualified ones. This should not be too onerous for banks as it would not be difficult for them to find replacements of similar value and characteristics in their pool of mortgages. He further explained that after entering into the Master Agreements with banks, HKMC would signed up an annex to the Agreements with the bank concerned in each event of mortgage purchase and the annex would set out in detail the features of the mortgages purchased. Any subsequent swap of the mortgages would only necessitate signing up a new annex with revised terms to supersede the previous one. This would not be a complicated procedure.

25. Regarding the provisions in the Memorandum of Association for the setting up of special purpose vehicles (SPVs) under HKMC, Mr Norman CHAN explained that these provisions were to facilitate the securitization of mortgages purchased by HKMC. The purpose of setting up SPVs would be confined to the acquiring by purchase or otherwise a portfolio or portfolios of mortgage or other loans secured on residential properties situated in Hong Kong as stipulated in clause 3 of the Memorandum. Such SPVs would be separate legal entities from HKMC to legally own a mortgage portfolio and issue debt securities secured on the portfolio. Through securitization, the risks associated with mortgages underlying the debt securities would be transferred to securities holders. If the borrowers of the underlying mortgage loans defaulted, the SPVs would serve as a servicing agent to recover mortgage debts on behalf of securities holders.

26. In response to the Chairman's enquiry on how investors would be able to assess the risks of the debt securities issued by the SPVs set up by HKMC, Mr Norman CHAN advised that investors might assess the quality of the underlying mortgage portfolios themselves, but this was not a popular approach among investors. A more popular way was to refer to credit ratings made by credit rating agencies. Furthermore, some securities companies might guarantee against losses caused by defaults in return for a guarantee fee. HKMC might incorporate this kind of guarantee service into its business in future. He also advised that the Government had clearly indicated it would not guarantee HKMC's debt securities. As regards credit rating arrangements, credit rating agencies had not been approached since HKMC was not yet officially set up. He remarked that the debt securities to be issued by HKMC would not be different from other financial instruments in that investors had to make their own investment decisions by assessing the risks involved. The level of risks as assessed by investors would be reflected in the prices of the instruments in the market.

VII.Any other business

Continued existence of the Mandatory Provident Fund Office

27. SFS informed members that the approval given by the Finance Committee in February 1996 was for the Mandatory Provident Fund (MPF) Office to operate up to end of March 1997. The Administration would submit a funding proposal to the Establishment Subcommittee in the coming few weeks and subsequently to the Finance Committee for the MPF Office to continue to operate up to the end of March 1998. It was expected that by that time, all the preparatory work for the MPF System would have been completed and the System should then be ready for implementation. The proposal would only cover existing civil service posts in the office as there would be no need to retain the consultancy posts.

28. The meeting ended at 11:15 am.

Legislative Council Secretariat
26 February 1997

Last Updated on 18 August 1998