Recent Turmoil in Asian Financial Markets -
Implications for Hong Kong

by Edgar W. K. Cheng

近 期 金 融 風 暴 席 捲 亞 洲 ， 市 場 人 士 和 經 濟 學 者 對 怎 樣 應 付 眼 前 戲 劇 性 的 逆 轉 議 論 紛 紛 。 本 文 嘗 試 針 對 一 些 相 關 的 政 策 性 問 題 進 行 討 論 ， 包 括 應 否 控 制 外 匯 或 組 合 投 資 的 買 外 活 動 、 限 制 某 些 衍 生 工 具 買 賣 和 股 票 拋 空 和 借 貸 ， 以 及 就 政 府 應 否 干 預 市 場 等 問 題 提 出 意 見 。 這 篇 文 章 是 鄭 維 健 博 士 1997 年 11 月 27 日 香 港 政 策 研 究 所 講 座 中 的 演 辭 。

The first and most obvious issue of the Asian financial turmoil is whether it is desirable or practical to introduce controls over either foreign exchange movements or inward and outward portfolio investment to counter market volatility caused by the activities of big international funds. After recent events, it is difficult not to feel a twinge of sympathy with Dr. Mahatir, Prime Minister of Malaysia. The fact that Mainland China has been largely insulated from the turmoil sweeping Asian markets (at least so far) is partly due to the fact that the RMB is not yet convertible on capital account. But there is a world of difference between maintaining controls in an economy which is still only very partially exposed to global competition, and reintroducing controls in an economy which is already open. Nowhere is this more true than in Hong Kong. Hong Kong lives off being an entrepot and a financial centre. The main reason for our phenomenal growth in these areas over the past 20 years is our openness. Any attempt to introduce controls on capital movement would be totally counter- productive. Nothing caused international investors to run for the exit more assuredly than the fear that they may be locked in. Such action would also pull the rug from under Hong Kong's position as a regional and global financial market place, with devastating long term consequences.

The same applies even in countries such as Thailand, Malaysia, Indonesia and the Philippines, which may not depend on international trade and investment to the same extent as Hong Kong. The long term benefits brought to such economies by foreign investment (including portfolio investment) and access to international markets are too great to put at risk in order to try to solve a short-term problem, however acute.

If controls on capital movement as such cannot realistically be contemplated, what about controls over dealing activity which tends to accentuate volatility, such as certain derivative-trading or short-selling and its related stock-borrowing? The answer here is not quite so obvious, but is still basically the same. The example of Malaysia is instructive. A ban on short selling on the Kuala Lumpur stock exchange was introduced last August. The effect was to sharply accelerate the fall in the stock market, with the result that the short selling ban was quickly lifted again. Short selling, index futures, traded options, covered warrants - all these (and other derivative products) are part and parcel of being an international financial centre. Sophisticated investors look for means of hedging their exposures and following more complex investment strategies. The suggestion that such instruments may be withdrawn from them causes them to abandon the relevant market. In the case of Hong Kong, it would also do untold damage to our credibility as a first division international financial centre. The fact remains that hedging and speculation are opposite sides of the same coin. It is not possible to stop one without hitting the other.

There is a point, however, where speculation and market manipulation become difficult to disentangle. That point may have been reached where some of the big international hedge funds are concerned. I think this realization is beginning to take hold even in the USA, the bastion of free markets. But it is extremely difficult for even the US authorities to do anything to curb such activities. Any attempt to control the hedge fund operators would probably cause them to move their operations to some Caribbean island and just carry on. The only possible antidote I can conceive of is stricter disclosure requirements. There is something unfair about the ability of such funds to build up huge positions without the rest of the market knowing what they are doing. This is the field which I believe deserves serious examination by international authorities, though it will require a high level of international co-operation to make enforcement of any new disclosure rules effective.

If capital market controls are generally not practical or desirable as a means of curtailing volatility, what then of intervention in markets by government or its agencies? Here, there is an important distinction, I believe, between foreign exchange markets and stock markets. Intervention in spot and forward forex markets by central banks (whether it is effective or not) is an accepted part of macro-economic management which has a direct bearing on interest rates and money aggregates. Intervention by governments in stock or equity futures markets is a more questionable proposition. This has been attempted a number of times (either directly or indirectly) in countries where government intervention in the economy is part of the national culture - e.g. Japan, Korea and Malaysia. Rarely, if ever, has such intervention worked on more than a short-term basis. And the people who fund such support operations involuntarily are effectively taxpayers, pensioners, bank shareholders and others, whose patience cannot necessarily be taken for granted. In the case of Hong Kong, where non-intervention rather than intervention is built into our economic culture, I find it particularly difficult to contemplate action by government of this nature. What we do have available as a mechanism which helps the market to self-correct is share buy-backs by listed companies and purchases by controlling shareholders for their own account when they consider the shares in their companies under-valued by the market. Recently, suggestions have been made by market participants for temporarily waiving the provisions of the Hong Kong Takeover Code which restrict the amount of such purchases which can be made in a given period of time. Devising a formula which ensures that a temporary relaxation of this rule does not lead to abuse of minority shareholders would represent a challenge for the regulators but may be worth studying.

Another policy area which obviously needs examination at times such as this is the ability of our financial market infrastructure to withstand sharp fluctuations in asset values. As far as the banking system is concerned, we are in a very much more favourable position than any of our Asian neighbours, and also than many larger developed economies. The capital adequacy ratios of Hong Kong banks are very high by international standards. Mortgage lending is admittedly also high as a proportion of domestic bank advances - a natural product of our high property values. But the average security cushion is also larger than in most other markets. I believe our banks could absorb a very substantial fall in property prices without serious damage.

As far as the stock and futures markets are concerned, recent events have served to demonstrate how far we have come since 1987 in strengthening our market infrastructure. Our trading, clearing and settlement systems have worked like clockwork, despite large volumes and sharp price fluctuations. There has not been a single broker failure - which is fairly remarkable in the circumstances. There have even been relatively few unmet margin calls. Liquidity has not dried up. Hong Kong has felt no need to introduce circuit-breakers of the type practiced by New York, with questionable results. In short, it is quite difficult to find fault with our market infrastructure as such.

That does not mean we can afford to sit back and relax. There are still important ways in which the institutional framework of our securities and futures markets needs to be improved. I have outlined the main improvements I see as desirable in recent speeches when I was chairing the Stock Exchange of Hong Kong. One of the suggestions was to have a much more integrated approach to developing Hong Kong's cash and derivative markets together. One key aspect of such integration (in the context of the recent market turmoil) is between clearing systems. This will improve both market efficiency (through cross-margining) and risk management (through consolidated control of the positions of market players).

It would in my view be a great mistake to react to recent events by curtailing the development of our derivatives market. In fact the market turmoil has highlighted the strength of the Hong Kong market's foundations, and thereby enhanced Hong Kong's capability to act as a regional centre for developing the sophisticated hedging and other products which investors are calling for more loudly as a result of recent events. We should build on this competitive advantage. But we should do so in a better co-ordinated way than we have sometimes done in the past. There is no shortage of international competition in the creation of new financial market products and facilities. I do not believe Hong Kong needs to compete against itself in this area. Nor is there room for institutional empire-building. What is needed is an objective assessment of the most appropriate way to develop our market in the interests of Hong Kong as a whole, followed by a co-ordinated effort by the stock and futures exchanges (and others where necessary) to implement the chosen plan, setting aside sectional interests.

The final question to try to answer is whether the turmoil which has now reached the Hong Kong market has impaired Hong Kong's future as an international financial centre. I believe it has not. The credibility and value of a financial centre is not measured by its stock price index. What matters is the soundness of the financial market infrastructure, the quality of regulation, the depth and liquidity of the market, the convenience and congeniality of the place for sophisticated international investors and intermediaries, the openness of the market, and the maintenance of a level playing field for all market participants. In all these areas, recent events have if anything shown up the strengths rather than the weaknesses of Hong Kong, relative to other Asian centres. And one of Hong Kong's weaknesses (namely our high cost base) has been materially corrected by recent events. I therefore believe we are likely to emerge from the present turmoil in a better competitive position than before, provided we stick to our open and internationally oriented market development policies. This is important, because our position as a leading international financial centre is probably the most valuable single aspect of Hong Kong from the point of view of the Mainland, and the one which it would take a great many years to replicate anywhere else.

Dr. Edgar W. K.Cheng is the Chairman of the World-Wide Investment Company Limited. The above is an extract from his speech at the Hong Kong Policy Research Institute monthly seminar on November 27, 1997.