Joseph Yam: One country, two financial systems
Speech by Mr Joseph Yam, Chief Executive of the Hong Kong Monetary Authority, at the luncheon of
the British Chamber of Commerce, Hong Kong, 20 October 2006.
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Ladies and Gentlemen,
Thank you for inviting me to speak to you today on the subject of "One Country, Two Financial
Systems". The continuing strong British presence in Hong Kong since 1997 - in all areas of business
and society - has been one of the many positive features of the "one country, two systems" policy: it is
also a measure of the success of this policy. The British Chamber of Commerce in Hong Kong has
played a leading role not only in representing the interests of British companies in Hong Kong, but also
in promoting Hong Kong to the world. The British commercial presence in Hong Kong is a rich and
diverse one, covering a vast range of economic activities. These include, of course, the
everexpanding financial services sector, which benefits both from Hong Kong's dense economic
connections with the Mainland of China, as well as from the "one country, two systems" policy. It is this
subject that I now wish to explore with you.
I believe it was Deng Xiaoping who first coined the phrase "one country, two systems". A study of his
speeches suggested that the concept germinated at the beginning of the eighties, before Margaret
Thatcher paid him a visit in 1982 at the Great Hall of the People and raised with him the question of
the political future of Hong Kong. The phrase was then used, for the first time in public, by Deng
Xiaoping when he received industry and business leaders from Hong Kong in June 19841. Since that
occasion, it has become by far the most common formula for summarising the governance
arrangements for Hong Kong after the resumption of the exercise of sovereignty. It has, indeed, turned
out to be a most effective political expression, capturing succinctly China's policy towards Hong Kong,
emphasising that Hong Kong is to be ruled by Hong Kong people (港人治港) and that there is to be a
high degree of autonomy in the governance of Hong Kong (高度自治). The policy has also been most
successfully implemented, contributing further to the credibility of the formula and the unique political
concept that it encapsulates.
Indeed, whenever one hears the phrase "one country, two systems", the immediate context will almost
invariably be the political arrangements for the governance for Hong Kong. But I think there is much
more to be said for "one country, two systems" beyond politics and governance, for the simple reason
that there are many differences between the two systems within our country, on whatever dimension
one chooses to examine the situation, and differences present opportunities for relative strengths to
be exploited and relative weaknesses to be addressed, and synergies maximised to the benefit of all
concerned. The economic system on the Mainland, described as a socialist market economy, is very
different from the economic system of Hong Kong, a capitalist free market economy. The medical
system on the Mainland is different from that in Hong Kong, in terms of the manner in which medical
services are delivered and funded, and in terms of the types of medicine used. The tax systems are
also very different, so are the labour systems, the educational systems and the transport systems (we
drive on different sides of the road); and, of primary interest to me as Monetary Authority, so are the
monetary and financial systems.
China is therefore probably unique in having two different systems, including two different financial
systems, in one country. I believe that, beyond politics and governance - the arrangements for which
have been quite well bedded down - there is perhaps a need for all concerned to pay greater attention
to the opportunities presented by the differences between the two financial systems and to developing
a beneficial working relationship between them. Put in another way, the relationship between the two
systems within the country is a multi-dimensional one. While the governance relationship at the
political level is of crucial importance, the relationships on other dimensions also require close
attention. One important question that needs to be answered is whether, on any one of these other
dimensions, the two systems have a working relationship that maximises the mutual benefits of the
two jurisdictions and therefore is in the best interests of the country.
As Monetary Authority, I have certain responsibilities for the financial system of Hong Kong. These
derive from the laws of Hong Kong and are clearly set out in a formal and transparent exchange of
letters between the Financial Secretary and the Monetary Authority of June 20032. I believe therefore
that it would not be inappropriate for me to contribute to answering that important question, insofar as
the working relationship between the two financial systems in the country is concerned.
Let me do so first by making a brief comparison between the two financial systems in the country. As
the fundamental role of the financial system is financial intermediation, or the channelling of funds from
those who have a surplus of it to those in need of it, the comparison should usefully be made in
respect of the three channels of financial intermediation, namely, that of banking, equity and debt.
The total assets of the banking system of Hong Kong are equivalent to 21% of those of the Mainland.
You may think that this is not high; but if you put this along with similar comparisons for population,
which is only 0.5%, or gross domestic product, which is 8%, you can appreciate the significance of the
banking system of Hong Kong in the context of the country as a whole. What is more, the quality of
assets in the banking system of Hong Kong is superior and the efficiency in financial intermediation, in
mobilising savings in the form of deposits into the hands of borrowers who are credit-worthy, is also a
lot higher.
Capitalisation of the equity market of Hong Kong is 2.6 times that of the Mainland. The amount of
funds raised in the past ten years in Hong Kong, through Initial Public Offerings (IPO) and other
fundraising activities, is nine times that on the Mainland. The turnover value in 2005 was about 1.5 times
that on the Mainland, and Hong Kong also has an active derivatives market, which traded 25 million
contracts in stock futures and options last year. The high liquidity helps price discovery, and attracts
fund raisers and investors to our market. This is shown by the listing of the large state-owned banks
this year, including what is expected to be the largest IPO ever in the world - the listing of the Industrial
and Commercial Bank of China. The efficiency of our equity market is underpinned by a combination
of fundamental strengths, including a sound legal and regulatory framework and an advanced financial
infrastructure. In particular, the high standard of disclosure required in Hong Kong promotes market
transparency and good corporate governance.
The size of Hong Kong's debt market is equal to 24% of that of the Mainland, and liquidity is a lot
higher. Despite the significant progress made in recent years, the development of the Mainland bond
market has been constrained by over-regulation (partly reflecting concerns about corporate
governance and credit culture), a narrow investor base, and lack of instruments for pricing and risk
management. Hong Kong has built up an efficient financial infrastructure for debt market development
over the years. The Exchange Fund Bills and Notes (EFBN) programme has created a yield curve for
the Hong Kong dollar of up to 10 years, providing a benchmark for debt issuance by other entities. A
multi-currency and multi-product payment and settlement platform serves local and overseas investors
to facilitate their fund transfers and delivery versus payments when they buy and sell debt instruments.
More broadly, the developed financial markets, including derivatives for managing interest-rate and
exchange-rate risks, a critical mass of financial institutions and a large investor base, support the
growth of the debt market.
This brief comparison will, I hope, bring out quite clearly the size, sophistication and efficiency of Hong
Kong's financial system in the context of the country as a whole. It should also give some indication of
the actual and potential utility of the financial system of Hong Kong to the country, in contributing to
sustainable economic growth and development on the Mainland. It was also Deng Xiaoping who
coined another memorable phrase. He said that: "finance is very important; it is the nucleus of a
modern economy"3. Indeed, the future path of the economy of China depends crucially on how
matters concerning money and finance, currency and exchange are organised. To sustain the current
rapid pace of economic growth and development, what China needs now is an effective mechanism
for financial intermediation for the Mainland - a mechanism to mobilise the huge amount of savings
(now equivalent to over 40% of GDP) into the hands of those who need funding to finance
consumption, investment and other economic activities.
Currently, domestic savings on the Mainland are mostly trapped in the banking system earning fairly
low rates of interest and as a result sustaining or even increasing a savings rate that is already far too
high. There is a serious lack of diversity in investment opportunities. The ability of the banking system
to allocate funds in accordance with the credit-worthiness of the borrower, although improving, is still
not quite efficient in view of the relatively low degree of market orientation in credit allocation. Thus,
the overall effectiveness of the financial system on the Mainland in the important task of financial
intermediation is not high. There is, of course, room - and there are concrete plans - for improvement.
But meanwhile the financial intermediation needs are there and have to be satisfied. This is where,
quite clearly, the other financial system of the country can come in.
As reform and liberalisation of the financial system on the Mainland continue, allowing the greater play
of market forces, there is a need to conduct experiments in specific areas of activity in finance,
including currency convertibility. The free market environment of Hong Kong provides the ideal
laboratory for conducting such experiments.
So, what about the question I raised earlier on about whether the two financial systems of the country
have a working relationship that maximises the mutual benefits of the two jurisdictions and therefore is
in the best interests of the country? If you want an honest answer from me, it would I am afraid not be
one in the affirmative. There seems to me considerable scope for a co-operative, complementary and
interactive working relationship between the two financial systems, in which, as I said earlier, relative
strengths are exploited and relative weaknesses addressed, and synergies maximised. The further
question then is how such a working relationship should best, and realistically, be developed.
It is quite natural to think that developing such a relationship between the two financial systems could
be left to the market. While this is theoretically possible, it assumes that market forces are allowed to
work freely across the two financial systems, which is not always the case. In merchandise trade, this
is by and large true, and as a result the two economic systems specialise in areas in which they have
respectively comparative advantage in producing. But in the provision of different services, as in the
case of financial services, there are restrictions limiting the working of market forces, for example,
restrictions on access of service providers to the other system and restrictions on the mobility of the
user of services across the two systems. On top of these, there are the restrictions in the mobility of
factors of production, notably labour and capital, with the asymmetry in capital mobility between the
Mainland and Hong Kong presenting the most obvious obstacle. These restrictions may well be there
for good reasons, but they do not mean that the development of a working relationship that is
beneficial to both financial systems and to the country as a whole can just be left to market forces.
There is a clear case for the involvement of the authorities responsible for these policy areas.
To be sure, there have been notable co-operative efforts between the two financial systems, both
between the authorities and between the private sectors of the two financial systems, and these have
been quite obvious since the resumption of the exercise of sovereignty. These efforts have arisen
simply out of need, particularly where the free play of market forces has been possible, and through
the initiatives of the authorities concerned, where a common understanding can be arrived at
concerning the common benefits that could flow from the removal of restrictions. But I think it is fair to
say that the process has not always been a smooth one. Neither has the outcome been as productive
as it could be, at least when assessed, narrowly some say, against the fundamental objective of
making the two financial systems work together for their mutual benefits and in the best interests of the
one country.
It is not hard to understand the obstacles to developing a mutually beneficial relationship between the
two financial systems. Naturally, with financial restrictions much more prevalent on the Mainland than
in Hong Kong, relationship-building between the two financial systems, to the extent that it involves
relaxation of financial restrictions, invariably requires policy decisions on the Mainland. In making such
decisions, the Mainland authorities have to weigh carefully the benefits of financial liberalisation with
the over-riding need to avoid doing anything that will destabilize such a large and complex economy.
This need for balance and careful sequencing of the reforms that are introduced is, I believe, well
understood by the Mainland authorities. It is something that we in Hong Kong, in our desire for rapid
change, need to approach with understanding and patience.
One thing remains clear: the utility of the financial system of Hong Kong to the country as a whole. The
mutual benefits of financial co-operation are also clear - on the one hand greater efficiency of financial
intermediation and therefore greater sustainability of economic growth and development on the
Mainland and on the other hand the successful maintenance of Hong Kong as an international
financial centre in accordance with the requirement laid down in Article 109 of the Basic Law. Both are
very desirable objectives that are clearly in the national interest. The financial conditions on the
Mainland also present, in my opinion, a golden opportunity for the liberalisation of restrictions to
facilitate the greater use of Hong Kong's financial system and for the associated risks to be prudently
managed. With nearly US$1 trillion, the Mainland is now the largest foreign reserve holder in the
world: it is running a fairly large balance of payments surplus and its savings rate is probably the
highest in the world.
There may not be many precedents of any great significance, in the history of economic development
in other countries, of having access to two financial systems in one country, and so we need to be
cautious, as always, as we venture into something new. Deng Xiaoping, when giving guidance to the
drafting of the Basic Law on 16 April 1987, also recognised that "one country, two systems" is "a new
thing" and that "there are many matters we cannot predict"4.
The important thing is to be clear about the principles behind what we are trying to do. The basic
principle, as far as the financial system is concerned, has always been very clear, regardless of the
characteristics of the political, economic and social systems, and this is the effective mobilisation of
savings into the hands of those in need of funds to finance consumption, investment and other
economic activities5. In any jurisdiction, this is a matter of national interest and its importance
surpasses that of the vested, private interests of whoever is involved in the financial system, and in
whatever capacity. This basic principle of the financial system has recently been articulated in the form
of policy statements in the eleventh five-year plan of China, notably in Chapter 33 and in a most
encouraging paragraph towards the end on Hong Kong, reiterating, among other things, the
determination to maintain the status of Hong Kong as an international financial centre.
These policy statements, read together, suggest to me that there is, at the policy making level on the
Mainland, recognition of the utility of the financial system of Hong Kong to the country's development. I
also believe that this is an open invitation to us to build a working relationship between the financial
systems in Hong Kong and on Mainland for achieving the objectives underlying those policy
statements. Indeed, our Chief Executive has seized the opportunity presented by the eleventh
fiveyear plan to launch an extensive and intensive work programme, starting with the Economic Summit
held on 11 September and following through with the continuing work of four Focus Groups that will,
by the turn of the year, result in a response to be put to the Central People's Government. One of the
four Focus Groups, chaired by my knowledgeable friend Dr the Hon. David Li, deals exclusively with
financial services. As a member of that Focus Group, I am happy to be in a position to contribute to
this important and promising cause.
I have already outlined elsewhere and in a different context a five-prong strategy developed in the
Hong Kong Monetary Authority to further co-operation between the two financial systems, which will
have the desirable dual effect of enhancing the effectiveness of financial intermediation on the
Mainland and maintaining the status of Hong Kong as an international financial centre6. The strategy
comprises:
First, opening doors through CEPA and other forums so that Hong Kong financial institutions can
provide the much needed financial services (and competition) on location in the Mainland;
Secondly, sustaining the flow of fund raising activities from the Mainland to Hong Kong, not just in the
IPO of H-shares but also in bank syndication and debt issuance, and creating channels, for example
through QDII schemes, to facilitate the flow of investment funds from the Mainland;
Thirdly, creating a mechanism for the marketing of suitable financial instruments (for example CDR of
H-shares) on the Mainland to satisfy the enormous investor demand there;
Fourthly, enhancing the capability of the financial system of Hong Kong to handle financial
transactions denominated in the RMB, with a view to facilitating in Hong Kong financial intermediation
of the Mainland, the conduct of experiments in financial liberalisation and the management of the
associated risks; and
Fifthly, connecting the financial infrastructures (the payment, clearing, settlement and custodial
systems) of the Mainland and Hong Kong, to facilitate the orderly flow of money and financial
instruments across the two financial systems.
We are now working hard on the specific proposals under each of these five strategic headings.
These, together with other proposals from a market-specific perspective, will form quite a rich menu on
what we, the financial system of Hong Kong, can do for the country and on the benefits the country
can derive from the arrangement of "one country, two financial systems".