LC Paper No. CB(1) 534/98-99
(These minutes have been
seen by the Administration)

Ref : CB1/PL/FA/1

Members present :

Hon Ambrose LAU Hon-chuen, JP (Chairman)
Hon Kenneth TING Woo-shou, JP
Hon James TIEN Pei-chun, JP
Hon David CHU Yu-lin
Hon Cyd HO Sau-lan
Hon Albert HO Chun-yan
Hon NG Leung-sing
Hon Margaret NG
Hon Ronald ARCULLI, JP
Hon James TO Kun-sun
Hon CHEUNG Man-kwong
Hon Ambrose CHEUNG Wing-sum, JP
Hon HUI Cheung-ching
Hon Bernard CHAN
Dr Hon Philip WONG Yu-hong
Hon Jasper TSANG Yok-sing, JP
Hon Timothy FOK Tsun-ting, JP

Members attending :

Hon HO Sai-chu, JP
Dr Hon Raymond HO Chung-tai, JP
Hon LEE Wing-tat
Hon LEE Cheuk-yan
Hon Martin LEE Chu-ming, SC, JP
Hon LEE Kai-ming, JP
Hon Fred LI Wah-ming
Prof Hon NG Ching-fai
Hon Christine LOH
Hon CHAN Yuen-han
Hon CHAN Kam-lam
Hon Mrs Sophie LEUNG LAU Yau-fun, JP
Hon WONG Yung-kan
Hon LAU Kong-wah
Hon Emily LAU Wai-hing, JP
Hon CHOY So-yuk

Members absent :

Hon Eric LI Ka-cheung, JP (Deputy Chairman)
Dr Hon David LI Kwok-po, JP
Hon SIN Chung-kai
Hon CHIM Pui-chung

Public officers attending :

Items IV and V

Mrs Rebecca LAI, JP

Secretary for Financial Services (Acting)

Item V

Mr Donald TSANG, JP

Financial Secretary

Mr Norman CHAN, JP

Deputy Chief Executive,

Hong Kong Monetary Authority

Clerk in attendance :

Ms Estella CHAN,

Chief Assistant Secretary (1)4

Staff in attendance :

Ms Pauline NG,

Assistant Secretary General 1

Mr KAU Kin-wah,

Assistant Legal Adviser 6

Mr Daniel HUI,

Senior Assistant Secretary (1) 5

Mr Andy LAU,

Senior Assistant Secretary (1) 6

I Confirmation of minutes and matters arising

(LC Paper No. CB(1) 90/98-99 - Minutes of meeting on 14 July 1998)

The minutes of the meeting held on 14 July 1998 were confirmed.

II Information papers issued since last meeting

(LC Paper No. CB(1) 42/98-99 - Regional Monitor, Issue No. 14: July 1998 provided by the Stock Exchange of Hong Kong

LC Paper No. CB(1) 126/98-99 - Press release issued by the Insurance Claims Complaints Bureau

LC Paper No. CB(1) 153/98-99 - Press release issued by the Hong Kong Federation of Insurers)

2. Members noted the information papers issued since the last meeting.

III Items for discussion at the next meeting scheduled for 5 October 1998

(LC Paper No. CB(1) 156/98-99(01) - List of outstanding items for discussion)

3. Members agreed to determine at a later stage items to be discussed at the next meeting scheduled for 5 October 1998. They also agreed that the Chairman should convene special meetings as and when required so as to address members' concerns about the latest developments in the financial market in the light of the dynamic market situation.

IV Securities (Insider Dealing) (Amendment) Bill 1998

(Ref: C2/2/2C(97)XVI - LegCo Brief issued by the Financial Services Bureau)

4. The Secretary for Financial Services (Acting) (SFS(Ag)) briefed members on the legislative proposal of the Securities (Insider Dealing) (Amendment) Bill 1998, the details of which were contained in the relevant LegCo Brief issued by the Financial Services Bureau.

5. Whilst supporting the Bill in principle, some members expressed concern about the possible conflict of interests if senior counsel in private practice were to be appointed as chairmen of the Insider Dealing Tribunal. A member therefore suggested that a proper safeguard mechanism should be established to address the potential problem. In the long run, he suggested that judges of the Court of First Instance should be appointed as permanent chairmen of the Tribunal.

6. SFS(Ag) advised that it was the Administration's intention to appoint judges of the Court of First Instance as chairmen of the Tribunal as far as possible. However, due to the increasing workload of the Tribunal, there was a need to enlarge the pool of eligible candidates for appointment as Tribunal chairmen. The Judiciary considered that since deputy judges were deemed capable of doing the work of the Court of First Instance, they must also be capable of doing the Tribunal's work. The Administration would review the need to appoint a "permanent" judge to be the Chairman of the Tribunal in the context of the overall review of the Securities (Insider Dealing) Ordinance, which was presently in progress. As to the concern about possible conflict of interests, SFS(Ag) said that the Chief Justice would carefully consider and advise on the suitability of the candidates before appointment was made by the Chief Executive. At the request of a member, she undertook to request the Judiciary to provide further information on any guidelines for preventing possible conflict of interest in the appointment of deputy judges of the Court of First Instance.

(Post-meeting note: The response from the Administration had been circulated under LC Paper No. CB(1) 248/98-99 dated 25 September 1998.)

7. Referring to the scope of review of the principal Ordinance, a member opined that the review should also include whether there should be expressed provisions in the Ordinance to bind the State. Furthermore, she also considered it necessary to review the mode of operation of the Insider Dealing Tribunal. SFS (Ag) undertook to consider the suggestions made.

V Government's intervention in the foreign exchange, stock and futures markets

(LC Paper No. CB(1) 172/98-99 - Strengthening of currency board arrangements in Hong Kong

LC Paper No. CB(1) 175/98-99 - Measures to strengthen the order and transparency of securities and futures markets in Hong Kong)

Briefing by the Administration

8. At the invitation of the Chairman, the Financial Secretary (FS) briefed members on the recent actions taken by the Government in the currency, stock and futures markets. FS referred to the announcement made by the Hong Kong Monetary Authority (HKMA) on 5 September 1998 about the technical measures to strengthen the currency board arrangements in Hong Kong, and reiterated the Government's commitment to the maintenance of the linked exchange rate system. He also dispelled speculation of any foreign exchange control to be applied in Hong Kong.

9. FS acknowledged that there were concerns among the public, in particular the financial industry, on whether the Government would maintain its free market and non-interventionist policy despite his repeated assurances that there would not be any further operations in the securities market once the manipulators had left the markets. He stressed that the Basic Law ensured the status of Hong Kong as an international financial centre (Article 109); safeguarded the free operation of the financial business and financial markets (Article 110); stipulated the Hong Kong dollar as the legal tender in the Region (Article 111); prohibited the application of foreign exchange control in the SAR (Article 112); and allowed the Exchange Fund to be managed and controlled by the government primarily for regulating the exchange value of the Hong Kong dollar (Article 113). The Government's recent operations in the markets were therefore fully in compliance with the Basic Law.

Reasons for the Government's actions in the stock and futures markets

10. FS pointed out that the purpose of HKMA's operations in the stock and futures markets was not to penalize anybody or to support the stock prices at any particular levels. Rather, the operations were intended to restore the order of the stock and futures markets by combating those currency speculators who aimed to reap profits from cross-market manipulation. The game plan of these market manipulators was to sell short Hong Kong dollars heavily and at the same time spread the rumours that the dollar peg would be removed, creating pressures which led to interest rate hike and the anticipated downfall of the stock and futures markets in order to reap profits from the substantial short positions which they had accumulated. The Government's operations aimed to frustrate their plans. The HKMA had bascially not been involved in the market since 28 August 1998. As soon as there were clear signs that the cross-market manipulation activities ceased, the Government would retreat from the stock and futures markets in an orderly fashion.

11. In explaining the need for Government to take actions in August, FS pointed out that the speculators had borrowed a substantial amount of Hong Kong dollars through the debt market at a low interest rate since the beginning of 1998. The weakening of the Japanese Yen and the fall of the US Dow Jones Index to 8,500 points in late July, coupled with the poor mid-year reports of some listed companies in Hong Kong, the low turnover of the stock market at only HK$3 billion to 4 billion a day and the downward adjustments of the local trade as well as the retail and labour markets had together created a very favourable environment for manipulators to launch attacks on the Hong Kong dollar. Since the end of July, the Hong Kong dollar had come under severe speculative attacks and selling had been effected in New York, Sydney, Hong Kong and London continuously around the clock. The aggregate amounts of the purchase of Hong Kong dollars in the first two weeks of August by HKMA totalled over US$ 6 billion, as compared to only US$ 3 billion in late October 1997.

12. FS further told the Panel that from late July to mid-August, there had also been unusual developments in the futures market. The open interest of HSI futures had stayed persistently at an exceptionally high level. Between late July and early August, the gross open interest of HSI futures increased sharply by ten thousand contracts in three trading days, reaching a total of 92,000 contracts for the contract month of August, as compared to around 70,000 contracts in late October 1997 and early January 1998. During the period of late July to 13 August 1998, the gross open interest of HSI futures had stayed over 100,000 contracts for most of the days while the turnover of the stock market had been low at around HK$3 to 4 billion as compared to the average daily turnover of over $30 billion in October 1997. Coupled with the rumours about the unpeg of Hong Kong dollar from US dollar, devaluation of Renminbi, and the forecast of poor economic outlook of Hong Kong by overseas financial institutions, our internal assessment suggested that if no action were to be taken, the interest rates might surge to 50 percent in the third week of August and might stay high at the levels of 20 to 30 percent for quite a long period of time. HSI might drop further by 2,000 to 3,000 points and a further slump in the property market might be resulted. These market developments would inevitably impose enormous pressure on the banking system. With the second quarter economic indicators to be announced in late August, if the confidence in the financial system deteriorated further, the devastating effect would be fathomless.

13. FS said that before deciding on whether to launch operations in the markets the Administration had monitored the situation very closely, keeping the Chief Executive abreast of the developments. Careful assessment was also made on the reactions of the international and local markets to such operations and on their consistency with the Basic Law and the Exchange Fund Ordinance. Finally, on 14 August 1998, with the support of the Exchange Fund Advisory Committee and the consent of the Chief Executive, the Government launched operations in the local stock and futures markets. The Central Government was informed of the decision.

14. FS stressed that HKMA was fully in charge of the market operations, following certain guidelines set out by the FS himself and reporting to him on a daily basis. The procurement of shares was basically in accordance with the weightings of respective stocks in the HSI. Only a designated team of HKMA staff who were not engaged in banking supervision were involved in the operations to avoid any potential conflict of interests. The Government undertook to make public the details of the stocks purchased when it was clear that the manipulators had left the markets, and to retreat from the markets in an orderly manner. The Government would also examine the possibility of setting up a separate company under the Exchange Fund to manage the stock portfolio.

15. FS reiterated that Government would not tolerate any attempts of cross-market manipulation. In the coming months, senior Government officials would take every opportunity to explain to overseas' investors the reasons behind the Government's decision on market operations, and to reassure them of the Government's determination to maintain an open and free market and to maintain the linked exchange rate system.

Measures to strengthen the order and transparency of securities and futures markets

16. FS advised the Panel that apart from the seven technical measures to strengthen the currency board arrangements, the Administration also proposed a total of 30 measures to strengthen the order and transparency of the securities and futures markets. He asked members to refer to the list of measures tabled at the meeting and invited SFS(Ag) to explain the measures.

17. SFS(Ag) pointed out that the recent incidents in the financial markets had prompted the Administration to put forward a series of measures to make the stock and futures market less susceptible to manipulative practices. These measures in fact were an extension of the recommendations arising from the Financial Market Review concluded in April 1998. She stressed that the proposals were not intended to restrict market operations. Rather, it was hoped that they could help strengthen the robustness of the financial markets and enhance investors' confidence.

18. SFS(Ag) took members through the proposed measures. She pointed out that the proposals were mainly aimed at providing ways and means to tighten up discipline in the areas of short selling and stock lending and borrowing activities to enforce the T+2 settlement rule and to enhance the transparency of the futures market. Apart from the respective measures to be taken up by the Securities and Futures Commission (SFC), the Stock Exchange of Hong Kong (SEHK), the Hong Kong Futures Exchange (HKFE) and the Hong Kong Securities and Clearing Company Limited (HKSCC), the Administration would also put forward legislative proposals to increase the penalties on illegal short selling, and to make false reporting to SFC and the exchanges as well as unreported short selling a criminal offence. The Administration and SFC would closely monitor the implementation of these measures and step up necessary enforcement actions against any misconduct. The Administration would also examine the need to amend current legislation to enable the Chief Executive to give direction directly to the exchanges and clearing houses to ensure that the government could react quickly whenever public interests were under threat. They would also coordinate a cross-market supervision committee to exchange market information among HKMA, SFC, SEHK, HKFE, and HKSCC on a regular basis, and to take prompt and appropriate actions in response to anticipated market manipulation.

Members' reactions to Government's actions in the stock and futures markets and proposed measures

19. Regarding the Government's pledge to defend the linked exchange rate system, members present, including Mr Martin LEE Chu-ming on behalf of the Democratic Party, Mr Ronald ARCULLI on behalf of the Liberal Party, Ms CHOY So-yuk on behalf of the Hong Kong Progressive Alliance, Mr CHAN Kam-lam on behalf of Democratic Alliance for Betterment of Hong Kong, Ms Emily LAU Wai-hing of the Frontier, expressed their support for the linked exchange rate system. However, members questioned the Administration for failing to respond to the earlier appeals of respective parties for prompt actions to strengthen the currency board arrangements and the order and transparency of the stock and futures markets since the Asian financial turmoil last year.

20. FS thanked members for their categorical support for the linked exchange rate system. He advised members that the Administration had in fact had measures to cope with different contingent situations. The Administration was also aware of the price to be paid for each and every one of these measures, including the possible damages of introducing more stringent regulations on the dynamics of the market. The Administration therefore had to consider the measures carefully. Extensive consultation with local and international market practitioners, professionals, finance ministers and governors of central banks had been carried out to solicit their support to the proposed measures. It was also strategically important to choose a timing which would be conducive for implementation, i.e. when the market was relatively stable.

21. FS remarked that the problems faced by Hong Kong were unprecedented and the financial turmoil had led to the collapse of a number of governments and market systems elsewhere in the region. The contagion was still threatening other parts of the world. Hong Kong, being an open and free market, was prone to abuse. As such, the Government had to formulate strategies in response to different circumstances that might arise from time to time. While admitting that some of the very complicated problems faced were beyond the resolve of any individual governments, he stressed that every effort would be made to strengthen the confidence of Hong Kong people.

Conflict of interests

22. Mr Martin LEE Chu-ming indicated that the Democratic Party was prepared to work hand in hand with the Administration to resolve the difficulties encountered. He and some other Members of the Democratic Party considered that if the Administration had put in place the various measures earlier, the operations in the stock and futures markets would not have been necessary. They also questioned if it was appropriate for the Government to become a market player when it was already the rule-maker and regulator of the securities and futures markets.

23. FS stressed that the Government's operations in the stock and futures markets were part of its overall strategy to defend the linked exchange rate and the integrity of the financial markets, as explained in his earlier statements. He advised that there was clear division of labour amongst the different tiers of the regulatory framework, viz Government, SFC, the exchanges and the clearing houses, and there was no institutional conflict amongst the roles of these bodies. The circumstances in August were so critical that the Government had to take immediate actions to maintain the stability and intergrity of the economy. The Government undertook to set up an independent company under the Exchange Fund for the management of the stock portfolio to avoid any conflict of interests, and to retreat from the market in an orderly manner.

24. Miss Cyd HO Sau-lan opined that senior Government officials did not seem well conversant with the operations of the stock and futures markets. She questioned whether the Administration had consulted market practitioners before launching the operations, and whether there was any safeguard against persons involved in the course of the consultation or the operations making use of the sensitive information to obtain benefits in the markets.

25. FS responded that given the relevancy of their working experience in the financial aspects, HKMA staff and officials in the financial arm of the Government had the requisite knowledge of the market operations. To ensure confidentiality, all information related to the market operations was treated on an absolutely need-to-know basis. Civil servants were given clear guidelines on declaration of interests and avoidence of conflicts; their integrity was always highly respected. The Deputy Chief Executive of Hong Kong Monetary Authority added that HKMA staff did have relevant experience in the securities market as they also managed the investment portfolio under the Land Fund. HKMA had ensured that the staff involved in the operations were not engaged in matters relating to banking supervision to avoid any potential conflict of interests.

Transparency of operations

26. Miss Emily LAU Wai-hing, while stating that the justification for Government's intervention in the markets were yet to be substantiated by examining the relevant data, expressed dissatisfaction that the Govenment's unprecedented move to utilise the Exchange Fund to invest in the stock and futures markets had never been discussed in the Legislative Council, hence making it difficult for the Legislative Council to perform its role in monitoring the Government and controlling public expenditure. FS explained that given the urgency of the matter and having regard to the sensitivity of the operations, it was considered not feasible to consult the Legislative Council in advance. This was consistent with the practice in other major financial centres where the legislature would not be consulted on matters of this kind in advance. Miss LAU pointed out that her concern was more on the role of the legislature in overseeing public expenditure, and the relationship between the executive and the legislature over the manner in which public funds were managed. She requested the Secretariat to gather some information about the practices in other jurisdictions in this respect.

27. Responding to some Members' request for information on the amount of money spent for the operations and the securities in government's possession, and the question of whether the objectives of the operations had been achieved, FS said that as disclosure of the information at this stage would not be conducive to the objective of the counter-manipulation operation, detailed information on the stock portfolio acquired by the Government could only be disclosed when the manipulators had left the markets. He stressed that it was always the Government's commitment to be open and accountable. For this reason, the Government had made public its operation on the first day of the operation.

28. Regarding the identity of the manipulators, FS said that it was difficult to establish their identities as they used different channels and were possibly under different covers to launch their attacks. It was however visible that the double-play in the currency market and the stock and futures markets had been carefully planned, professionally engineered and closely concerted.

29. As to whether any local banks or institutions were involved in the manipulative activities, FS said that the trading of Hong Kong dollar was part of the normal business operations of these financial institutions. It was not the objective of the Government to penalize any local or foreign companies for conducting businesses legally in Hong Kong. That being the case, increased market transparency would be helpful in detecting possible manipulation in the market and in this regard, it was hoped that the measures recently introduced by HKMA would be useful.

Short-selling and settlement rules

30. Mr CHAN Kam-lam said that it was reported that one of the most serious flaws in Government's operations was HKSCC's failure to enforce the T+2 settlement rule in respect of the tradings on 27 and 28 August. While he was in support of Government's actions to protect the markets, he enquired if the settlement rules could be further tightened up to T+1.

31. FS said that given the volume of the turnover in late August, some degree of late delivery of stocks was understandable. However, the extent to which this had happened in end August caused concern to the Government. The SFC had been asked to look into those failures of delivery to see if there had been any illegal short-selling activities involved. The Administration would follow up with SFC and SEHK to see whether there were any illegal activities and, where substantiated, legal actions would be taken. SFS (Ag) added that compared with the settlement requirement of other major financial markets such as the USA, the UK and Australia where the settlement period ranged from T+3 to T+5, the settlement system in Hong Kong was probably the most efficient. Given the difference in time zones and taking into account the need to allow sufficient time for overseas investors to transfer their shares to Hong Kong or to seek the authorization of trustees, the T+2 settlement rule was considered appropriate. Before the implementation of a fully automated trading system where scripless and real time transactions could be made possible, it was not viable to further shorten the settlement period to T+1.

32. Some Members however pointed out that the problem lay in the arrangements for trades remained unsettled after T+2. It was noted that HKSCC could only execute compulsory buy-in for incomplete trades in the morning of T+5 despite the general understanding among local market participants that settlement should be done by T+2. They requested that follow-up investigation and remedial measures should be taken to ensure a level playing field in the market.

Automatic trading systems

33. A Member enquired whether it was feasible to designate a separate board for short selling where buyers would have a choice to take the short sale order or not, rather than having all transactions done through the Automatic Order Matching and Execution System (AMS). SFS(Ag) replied that presently all securities trading including short selling were executed by automatic matching through the AMS. Under the present system, the Central Clearing and Settlement System acted as the universal counterparty to both sides of the trade. To segregate short-selling from other transactions in AMS might not necessarily be beneficial for the market as such trades might turn to the over-the-counter market. However, she would relay the suggestion to the parties concerned for further examination. She further said that to enhance the fairness and transparency of the market, the Government would study the feasibility of regulating stock lending and borrowing activities.

34. On the progress of the migration of HSI futures trading from open outcry to the Automatic Trading System, SFS(Ag) said that it took time for HKFE to design, install and test the hardware and the system. They also had to provide the necessary training to its staff to ensure a smooth migration. The system was originally expected to be completed by end 1999. In the light of the present situation, the Administration would discuss with HKFE to see if the completion date could be advanced.

Other measures to protect the financial markets

35. Mr James TIEN Pei-chun expressed his support to the proposal of strengthening the power of the Chief Executive to give direction to the exchanges and clearing houses and the suggestion to form a cross-market supervision committee, and enquired about the timetable for implementation. SFS(Ag) advised that on the first issue, the Administration was still examing the proposal and consulting the parties concerned. Secondly, preparatory work for the first meeting of the cross-market supervision committee was being arranged.

36. As to the concern about the effectiveness of the proposed measures to curb market manipulation and whether further measures would be necessary, FS said that improvement measures would need to be launched in response to changes in circumstances. The market would be unduly disturbed if too many restrictions were imposed at one time. The Administration would continuously monitor the market situation and bring in further measures as and when necessary.

37. A Member considered that the penalty on illegal short-selling, even if increased to $100,000 and 2-year imprisonment, was still too lenient, FS responded that when the legislative proposal was put to the LegCo for consideration, Members and the Administration could further deliberate on the matter.

38. Mr Ronald ARCULLI said that the Liberal Party was in support of Government's actions in the markets. Turning to the 35% threshold for general offer, he enquired about the progress of the Administration's deliberation on the proposal to relax the takeovers threshold during a market downturn. Under the proposal, the controlling shareholders of listed companies should be allowed to increase their shareholding without having to make a general offer even if such acquisition increased their shareholding above the 35% threshold. Furthermore, under existing company law, shares bought back by listed companies represented a reduction in capital and had to be cancelled. Companies would be more prepared to buy back their shares in the market if such shares could be treated as treasury stock, and need not be cancelled. He therefore also enquired about the proposal to introduce treasury shares. In reply, SFS(Ag) said that the issue had been covered in the Report on Financial Market Review published in April 1998 and the relevant proposals were being actively pursued by SFC.

Need for further operations in the market

39. Some members urged the Government to refrain from launching any further operations in the markets. FS responded that whilst Government had formulated a series of measures to strengthen the currency board arrangements and the order and transparency of securities and futures markets, it would stand ready to take action in the markets again should clear signs of cross-market manipulation re-emerged. As noted earlier, the problem was an international one and could not be solved by any single government. The SAR Government would continue its pursuit of international co-operation in the regulation of capital flow, but meanwhile, it would take action as and when necessary in order to protect the interests of the people in Hong Kong and to ensure the order of the markets for the long term interest of investors.

Next meeting

40. In view of the time constraint, members agreed to continue the discussion with FS and his senior financial officials on Tuesday, 8 September 1998 at 4:30 pm. Representatives of the SFC, SEHK, HKFE and HKSCC would also be invited to the meeting to discuss the proposed measures to strengthen the order and transparency of the securities and futures markets.

VI Any other business

41. There being no other business, the meeting ended at 12:55 pm.


Legislative Council Secretariat
25 November 1998