Bond market development: The case of Hong Kong Alfred Wong Hong Kong Monetary Authority

Outline I. Motivation to develop bond market Authorities’ efforts Lessons and impediments

Part I What motivates the authorities to develop the local currency bond market?

An overview of the financial system Financial Markets Money market Bond market Equity market Lenders Households Firms Central bank Borrowers Households Firms Government Banks and other financial institutions Insurance companies and pension funds Other financial intermediaries Financial Intermediaries

Financing structure in Asia – 1996

Motivation of the authorities Lessons from the Asia financial crisis Currency and maturity mismatches Prone to sudden capital flow reversal To foster financial stability As back-up facilities Diversity in financial intermediation

The role of the State A multifaceted role: Investor protection Innovation Provision of market infrastructure Positive non-interventionism Facilitating, not forcing!

Part II What have the authorities done to develop the local currency bond market?

Major initiatives taken since the Asian financial crisis Product development Market infrastructure Tax and regulation Regional cooperation

1. Product development Government issues Securitised debts Bond funds Retail bonds

Government issues Exchange Fund Bills and Notes (EFBNs) HK$ debt instruments issued by the HKMA Benchmark yield curve Good liquidity in the secondary market Banks collectively hold about 85% of the outstanding EFBNs for favourable risk weighting and can be used as collateral to borrow from the HKMA Government bonds The Government successfully launched its first global bond offering in July 2004 Total HK$20 billion of which US$1.25 (around 50%) in a 10-year US$ denominated bond

Securitised debts The Hong Kong Mortgage Corporation Established by the Hong Kong SAR Government in March 1997 To promote development of a secondary mortgage market mortgage purchase debt issuance securitisation of mortgage loans mortgage insurance In May 2004, the Government sold HK$6 billion (US$770 million) of securitisation bonds, backed by toll revenues from 5 tunnels and 1 bridge to finance infrastructure projects

Bond funds An EMEAP initiative ABF1 (2003) ABF2 (2005) Closed-end: Confined to investment of the central banks only USD-denominated sovereign and quasi-sovereign bonds in the region ABF2 (2005) Open to any interested investors Domestic currency-denominated bonds in the region

Retail bonds The Hong Kong Mortgage Corporation first offered bonds to retail investors in October 2001 The HKMA operated a pilot scheme to stimulate retail investment in Exchange Fund Notes in 2003 The programme was refined in 2005 under which the fee structure was simplified and retail distributors were appointed

2. Market infrastructure Benchmark yield curve Hong Kong bond settlement system On-line access to market information for retail investors

Benchmark yield curve A domestic yield curve gradually took shape when the HKMA began issuing Exchange Fund papers in 1990s Considerable effort has been directed at maintaining a smooth and continuous yield curve in designing the EFBN issuance programme

Hong Kong dollar bond settlement system Central Moneymarkets Unit (CMU) Established in 1990 to provide computerised clearing and settlement facilities to debt securities Linked with other major international securities settlement systems To foster cross-border bond trading and investment

Clearing and settlement system CDC - China USD RTGS (2000) Clearstream 2003 2004 Euroclear DvP 1994 PvP 2002 PvP 1994 CMU DvP HKD RTGS (1996) 1997 AustraClear - Australia PvP 1998 DvP 1999 AustraClear - New Zealand KSD - South Korea EURO RTGS (2003)

On-line access to bond prices CMU Bond Price Bulletin website Launched in 2006 Provides convenient access to indicative bond prices quoted by major banks in Hong Kong

CMU Bond Price Bulletin

3. Tax and regulation Demand side: Supply side: tax concessions to bond buyers Trading profits from bonds with a maturity period of 7 years or more (issued after 5 March 2003) were exempted totally from profits tax (previously 50% tax concession) Minimum maturity requirement for the 50% tax concession was relaxed from 5 to 3 years Supply side: simplified issuance process for fund raisers The Government and the Securities and Futures Commission have together streamlined regulations and procedures for issuing and listing debt securities Enabled issuers to market their offers with greater flexibility and effectiveness to the public Lowered issuance costs

4. Regional cooperation APEC Initiative on the Development of Securitisation and Credit Guarantee Markets Asian Bond Market Initiative (ABMI) Asian Bond Fund (ABF)

After all these…

Hong Kong dollar bond market Steadily growth over the past decade Outstanding Hong Kong dollar bond reached US$85 billion at end-2005 Almost 50% of GDP

Local currency bond outstanding US$ billion % of GDP Sources: HKMA and HK Census and Statistics Department.

Market growth by issuer US$, bn US$, bn Source: HKMA.

Financing structure in 2005* *As at end-September 2005

Part III Lessons and impediments: any more we can do?

More work to do? Macroeconomic policies Government bonds Banking sector soundness Corporate governance Regulatory framework Tax treatment / incentives Investor base

Impediments to the Hong Kong dollar bond market Supply Issuance of Exchange Fund papers is limited Government issuance is politically sensitive Lack of corporate issuers Business size Credit bureaux Demand Mutual funds invest mainly in equities Currency board system

Retail demand for bonds Transaction cost is high for individuals Increased competition between banks made deposits fiercely competitive Attraction is mainly on medium term papers There is more interest in holding bonds via other investment vehicles (e.g. mutual funds) Any more room for ABF2-typed initiatives?

Looking ahead Market making system Length of the yield curve League table Tender arrangements Uniform-price auction Length of the yield curve Number of EFN issues EFN futures market Electronic trading platform

Conclusion The Hong Kong bond market has grown steadily since crisis Structure of financing still tilted towards loans and equities Scope for improvements