LC Paper No. CB(1)1428/98-99
(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 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
Hon SIN Chung-kai
Dr Hon Philip WONG Yu-hong
Hon Jasper TSANG Yok-sing, JP
Hon FUNG Chi-kin

Members attending :

Dr Hon Raymond HO Chung-tai, JP
Hon Martin LEE Chu-ming, SC, JP
Hon LEE Kai-ming, JP
Hon CHAN Kam-lam

Members absent :


Hon Eric LI Ka-cheung, JP (Deputy Chairman)
Hon David CHU Yu-lin
Dr Hon David LI Kwok-po, JP
Hon Timothy FOK Tsun-ting, JP

Public officers attending :

Agenda items IV and V

Mrs Rebecca LAI, JP

Deputy Secretary for Financial Services

Agenda item IV

Miss Vivian LAU

Principal Assistant Secretary for Financial Services

Mr Edmond LAU

Division Head of Banking Development Division,

Banking Policy Department

Hong Kong Monetary Authority

Mr Keith LUI

Director of Supervision of Markets Division

Securities and Futures Commission

Mr H Y MOK

Assistant Commissioner of Insurance

Office of the Commissioner of Insurance

Agenda item V

Miss Hinny LAM

Assistant Secretary for Financial Services

Clerk in attendance :

Ms Estella CHAN

Chief Assistant Secretary (1)4

Staff in attendance :

Ms Pauline NG

Assistant Secretary General 1

Ms Connie SZETO

Senior Assistant Secretary (1)1

I Confirmation of minutes and matters arising

The minutes of the meetings held on 7 and 8 September 1998 were confirmed.

II Information papers issued since last meeting
(LC Paper No. CB(1)465/98-99 - A Modern Day Currency Board System (English version only))

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

III Date of the next meeting

3. Members agreed to re-schedule the next regular meeting of the Panel for Thursday, 7 January 1999 at 10:45 am. The agenda for the meeting would be discussed under "Any other business".

4. The Chairman reminded members that a special meeting had been scheduled for Thursday, 17 December 1998 at 10:45 to discuss the Hong Kong Monetary Authority (HKMA)'s response to views of market practitioners and academics on mechanism for defending the linked exchange rate system, and alignment of investment policies of Land Fund and Exchange Fund.

IV Year 2000 readiness of the financial services sector in Hong Kong
(LC Paper No. CB(1)565/98-99(02))

5. The Principal Assistant Secretary for Financial Services (PAS/FS) gave a visual presentation on the progress which the financial services sector in Hong Kong had made to tackle the year 2000 (Y2K) problem. The presentation outline tabled at the meeting is attached (available in Chinese only ).

6. Messrs CHEUNG Man-kwong and SIN Chung-kai expressed concern about the slow progress of the securities and futures industry in tackling the Y2K problem. Pointing out that HKMA and the Office of the Commission of Insurance (OCI) already started to address the Y2K issue as early as August 1996 and June 1997 respectively, Mr CHEUNG Man-kwong queried the Securities and Futures Commission (SFC) for having only started its work in June 1998 and whether the progress of related institutions in solving the Y2K problem had been adequately monitored. Quoting that testing of shared financial systems involving the securities and futures firms in the New York Stock Exchange had started towards the end of 1998, Mr SIN Chung-kai questioned the late commencement of testing activities in Hong Kong in early 1999 and asked about measures to expedite progress.

7. Whilst admitting that progress in the securities and futures industry in this respect was relatively slower than the banking and insurance sectors, the Deputy Secretary for Financial Services (DS/FS) explained that the situation might be attributed to the large number of firms involved, variation in their sizes and levels of sophistication in the application of information technology. She said that the Steering Committee on Year 2000 Compliance in the Financial Services Sector (Y2K Steering Committee) was equally concerned about the matter and would endeavor to ensure timely Y2K compliance of core financial infrastructural systems and individual systems of all financial institutions.

8. In explaining SFC's work on the Y2K issue, the Director of Supervision of Market Division, SFC (DSMD/SFC) said that efforts had been focused on ensuring that the key providers of shared financial systems of the securities and futures industry, all registered intermediaries under SFC's purview, as well as all other market participants had taken adequate actions and necessary steps to rectify their systems affected by the Y2K problem. In this regard, SFC had started work as early as in September 1997 to issue questionnaires to the two exchanges and the clearing houses in order to assess their Y2K readiness and to prepare for the follow-up visits. Before the commencement of on-site inspection since June 1998 to assess intermediaries' Y2K readiness, surveys were also conducted in February 1998 to enquire about their progress and to remind them to take steps to rectify their systems. There were about 1,300 registered intermediaries in the securities and futures industry engaging in various types of business activities and most of these intermediaries were small and medium sized companies. Given the relatively large number of intermediaries and the diversity of their backgrounds, SFC envisaged that some would lag behind others in meeting the targeted compliance deadline. To this end, SFC and the two exchanges had set up monitoring procedures to identify registered intermediaries which fell into this category. In September 1998, SFC sent out a Y2K information package to all registered intermediaries. Apart from reminding intermediaries about the urgency and importance of the Y2K problem and the need to complete rectification work in time, the package also provided useful references for tackling the problem. In addition to seeking information from institutions about the state of their compliance with Y2K, SFC also required quarterly progress reports from institutions.

9. As regards the late commencement of industry-wide testing for shared financial systems, DSMD/SFC said that complicated large scale external testing activities involving systems providers and securities and futures firms took time to prepare and should be conducted after the firms concerned had rectified their own internal systems. He advised that the first test had been scheduled for 16 January 1999 and two more rounds would be held in mid-March and mid-June 1999. A pilot test would be conducted in mid-December 1998 to lay the ground work for the industry-wide testing. DSMD/SFC also clarified that tests conducted during summer 1998 by the New York Stock Exchange were only rehearsals to the major industry-wide testing scheduled for second quarter of 1999.

10. Mr FUNG Chi-kin pointed out the concerns of the securities and futures industry about the lack of co-ordination among SFC and the two exchanges on solving the Y2K issues and inadequate assistance offered to individual firms, especially the smaller ones. The industry was also dissatisfied with the decision of SFC and the exchanges to revoke registration or membership of registered intermediaries or broker firms which failed to achieve Y2K compliance by the specified deadline without offering adequate assistance for resolving the problem.

11. In response, DSMD/SFC said that SFC recognized the difficulties faced by small broker firms, as many of them relied heavily on small scale and unregulated service and utilities providers for tackling the Y2K problem. In order to assist small firms in complying with Y2K requirements, SFC had stepped up on-site inspection to intermediaries identifying their key deficiency areas and providing assistance and guidance for development appropriate strategies and plans. Moreover, SFC had encouraged the two exchanges to set up technical working groups comprising computer experts for making site visits to system providers with a view to providing assistance whenever necessary and keeping in view their progress.

12. DS/FS re-iterated that the Y2K Steering Committee was tasked with, inter alia, co-ordinating the efforts of various financial services regulators in enhancing Y2K readiness of the institutions under their respective supervision. Taking note of the securities and futures industry's concern, the Steering Committee would step up support for the industry including considering the provision of comprehensive technical guidelines on Y2K compliance for intermediaries.

FSB

13. Responding to Mr Philip WONG Yu-hong's enquiry on the methodologies used to correct the computer interpretation problem for dates from and including Y2K, PAS/FS advised that two commonly used methods were expansion of number of data fields and windowing of existing data fields of the computer system. She took note of Mr Wong's suggestion of using the first three digits of a six-digit data field to represent the day number of a 365-day or 366-day year and the last three digits to represent the year and the century, and undertook to reflect it to technical experts for consideration.

14. Mr CHAN Kam-lam was concerned that since individual financial institutions might use different methodologies to rectify their own systems, the systems so modified might not be compatible with each other and there might be problems when internal systems were interfaced with the shared financial systems. He enquired about the policy on rectification methodologies for Y2K compliance and possible ways to ensure reliability and stability of systems tested to be Y2K compliant.

15. Concerning the policy on Y2K rectification methodologies, PAS/FS advised that the different technologies available in the market for tackling the Y2K problem should conform with the definitions on Y2K compliance which were developed by international organizations. The most basic and essential definitions, such as those developed by the British Standards Institution, included successful transition from the last day of year 1999 to the first day of year 2000 without any interruption or error in system operation and recognition of year 2000 as a leap year by the system.

16. DS/FS stressed that whilst financial intermediaries should determine the best strategies and plans for themselves, taking into account the respective sizes and levels of complexity of their operations and the levels of their own business risk exposure to Y2K, stringent standards were set to ensure that their modified internal systems would properly interface with the rectified shared financial systems which they had access to. She also emphasized the importance of conducting external testing activities to identify possible problems or gaps in the modified systems, as well as to ensure their reliability.

17. On the progress of external testing activities in the banking industry, Head, Banking Development Division, HKMA advised that by HKMA's Y2K compliant deadline on 31 December 1998, all Authorized Institutions under its purview were expected to have completed the modification and testing of individual systems, and have tested the interaction of modified systems with the institution's other systems with which they interfaced directly. The first round of end-to-end testing of the interbank clearing and payment system was conducted in summer 1998 and two further rounds of tests were being planned in 1999 for banks wishing to re-test their systems, including those which had been enhanced since the last testing. Repeated testing would ensure the reliability of the rectified systems.

18. DSMD/SFC supplemented that besides conducting tests on various scales for modified systems, financial regulators also attached much importance to formulate contingency plans to address unforeseen problems that might arise due to the Y2K problem with a view to enhancing protection for clients and minimizing system risks. DS/FS added that apart from requiring individual institutions to draw up their own contingency plans, detailed contingency plans for the financial services sector as a whole would be developed to address potential problems.

19. On the need to legislate for tackling the Y2K problem, DS/FS said that the Administration did not consider a legislative approach necessary for the moment. Nevertheless, she remarked that such an option would be regularly reviewed taking into account regulators' supervisory powers for enforcing Y2K compliance on institutions under their respective purview and the best way to protect the investing public against system risks arising from the Y2K problem.

20. In this connection, members noted that statutory powers were provided for HKMA, SFC and OCI to enforce Y2K compliance on their respective institutions. DSMD/SFC added that SFC had reminded registered intermediaries on a number of occasions that a registered person who failed to take appropriate action to address the Y2K issue might impugn the registrants' fitness and properness to remain registered with SFC. Action against non-compliant registered intermediaries included appointment of external consultants, restriction of business and suspension or revocation of registration.

21. Mr Jasper TSANG Yok-sing expressed concern about protection for clients or investors and enquired about regulators' legal responsibility in the event of claims by clients for damages resulting from system faults of certified Y2K compliant institutions.

22. In response to Mr Martin LEE Chu-ming's enquiry on relevant legislation in other jurisdictions, PAS/FS advised that legislation was passed in October 1998 in the USA with the spirit of encouraging more Y2K information disclosure. However, the legislation did not, as far as she was aware, deal with legal issues relating to system risks arising from the Y2K problem.

23. The Chairman concluded that members had expressed concern about the slow progress in the securities and futures industry in tackling the Y2K problem and urged SFC and the Y2K Steering Committee to step up efforts in this area with a view to ensuring institutions' compliance in time. He suggested that the Administration should undertake more studies on legal issues relating to the Y2K problem as members' concern in this respect had not been adequately addressed.

V The Administration's response to views of market practitioners and academics on the mechanism for defending the linked exchange rate system (Part I)
(LC Paper No. CB(1)565/98-99(05), CB(1)570 and CB(1)571/98-99)

24. Mr Albert HO Chun-yan enquired about the results of consideration of the Board of the Exchange Fund Investment Limited (EFIL) on the suggestions made by market practitioners and academics for the disposal of shares acquired during the August market operation. He also sought clarification on the role and mode of operation of EFIL.

25. As a member of the Board of EFIL, DS/FS advised that the duty of EFIL was to advise the Financial Secretary (FS), as the Controller of the Exchange Fund on the management and investment strategies of the Hong Kong equity portfolio acquired in the August market operation. The Board of EFIL, comprising representatives from different sectors of the community and assisted by professional investment advisers, would consider possible approaches for disposal of the acquired equity, including suggestions made by market practitioners and academics, and conducting appropriate consultation as and when necessary. She added that given the sheer size of the portfolio, the disposal programme could not be completed over a short period of time. Whilst it would be unrealistic to devise a rigid timetable for the disposal programme, EFIL's primary objective was to dispose of the shares in an orderly manner without disrupting the stability of the market.

26. On the mode of operation of EFIL, DS/FS emphasized that the Board was committed to enhancing its transparency and accountability. Apart from the full disclosure of the details of the portfolio made in October 1998, the Board also announced that EFIL would be subject to securities-related legislation and rules as for other market players and the application for the necessary registration with SFC was also underway. It would comply with the statutory obligation to disclose any incremental changes in shareholdings of 0.1% or more of the issued shares in respect of those shareholdings exceeding the 10% threshold. Moreover, the Board would also consider, having regard to the need of safeguarding public interest and avoiding disruption to the market, regular disclosure of details of the equity portfolio. She also undertook to provide the terms of reference of EFIL after the meeting.

27. Mr Fung Chi-kin shared some market practitioners' suggestion of establishing a separate supervisory committee to supervise the work of SFC. He opined that the independent committee should be responsible for co-ordinating and monitoring the overall regulation and future development of the financial industry. He cited SFC's recent approval for the Hong Kong Futures Exchange (HKFE) to extend its trading hours beyond those of the Stock Exchange of Hong Kong in facing the threat of competition from overseas markets as an example of poor co-ordination of the work of market bodies. He pointed out that the initial reason for synchronizing the closing times of the cash and futures markets by the two exchanges was to avoid any possible market manipulation. Mr Philip WONG Yu-hong also expressed concern about possible market manipulation which might occur due to the different in closing times of the cash and futures markets.

28. On the need of establishing a separate supervisory committee over SFC, DS/FS explained that the Administration considered this unnecessary as adequate checks and balances were in place to monitor the work of SFC and there was no role conflict amongst the three tiers of regulatory bodies, viz Government, SFC, the exchanges and the clearing houses. She advised that the three-tier regulatory structure of the financial market was recommended in the Davison's report back in 1988 and had been working well since its establishment. She however agreed that further improvement could be made to enhance communication and co-operation amongst different market bodies. The Administration would follow this up as part of the 30-point programme to strengthen the transparency and discipline of the securities and futures markets.

29. As regard the concerns about the difference in trading hours of the two exchanges, DS/FS said that the extension of the trading hours of HKFE was its commercial decision. It was noted that in some major markets, the trading hours of the futures markets were also longer than the cash markets. Indeed, the international trend of the financial services industry was moving towards greater globalization and increased application of information technology, necessitating "24-hours trading" and the use of fully automated stock trading systems. As such, the physical opening hours of exchange houses would become less important. She supplemented that the Administration was committed to enhancing the financial infrastructure of Hong Kong in meeting the requirements for a first class international financial centre.

30. As far as market manipulative activities were concerned, DS/FS stressed that whilst recognizing the need for market bodies to devise appropriate strategies in response to rapid development and keen competition from other markets, the regulator would ensure that sufficient measures were in place to ensure the fair operation of the markets. To this end, HKFE had been asked to consider and to report to SFC additional surveillance measures for any malpractices during the extended trading hours. Moreover, SFC had been making regular reports to FS on market situations and there was so far no evidence of market manipulation during the extended hours.

31. On details of the trading hours of the two exchanges, DS/FS undertook to provide further information on the closing times of the cash and futures markets on the last trading day of the spot contract month for Hang Seng Index futures.

(Post-meeting note: The information was circulated to members vide LC Paper No. CB(1)596/98-99 on 8 December 1998.)

32. Responding to Mr James TIEN Pei-chun's enquiry about the progress of the Administration's recommendation of empowering the Chief Executive (CE) to give directions to the exchanges and clearing houses, hence enabling the Government to react promptly when public interests were under threat, DS/FS advised that the recommendation was still under careful consideration. Issues needed to be examined included whether sufficient power was already provided under the Securities and Futures Commission Ordinance (Cap. 24) for the CE to give directives, as he saw fit, to the above bodies to act, and if necessary, in what ways such residual power could be incorporated in the current legislation.

VI Any other business

Items for discussion at the next regular meeting scheduled for 7 January 1999

33. Members went through the list of outstanding items for discussion (LC Paper No. CB(1)565/98-99(01)) and decided to discuss the following items at the next regular meeting:

1. Proposed Regulation on Share Margin Financing; and
   
   
2. Financial monitoring of public works projects.

Tentative agendas for future Panel meetings

34. Members agreed on the tentative agenda for the February 1999 regular meeting as follows:

1. Progress of development of a Venture Board; and
   
   
2. Cost of the Mandatory Provident Fund to businesses.

35. In order to follow up the discussion on "Year 2000 readiness of the financial services sector in Hong Kong", members further agreed to invite representatives of the exchanges and Hong Kong Securities Clearing Company to discuss the results of Y2K external testing activities in the April 1999 Panel meeting.

36. Members also agreed to include the item "Privatization of government services" proposed by Mr Ambrose CHEUNG Wing-sum in the list of outstanding items for discussion.

Overall economic development of Hong Kong

37. The Chairman invited members' view on arrangements to follow up the House Committee's decision that the Financial Affairs Panel should be tasked with the responsibility to invite the Financial Secretary for holding regular briefings on macro economic issues for all LegCo Members.

38. After deliberation, members agreed that briefings should be held quarterly upon issue of the Economic Report, except for the first quarter of each year as the overall economic development will be discussed in the context of the annual Budget announced at this time of the year.

39. The meeting ended at 12:45 pm.


Legislative Council Secretariat
3 June 1999