different forms of connectedness and creating different and new transmission channels, the models face significant difficulty in accurately estimating risk. furthermore, even if one could find better models, any models must inevitably assume market behaviour remains constant to some degree, yet we know too well that uncertainty and panic may and do engender irrational or herd - like behaviour which a model struggles to accommodate. so, if the model ’ s findings can be “ misguided ”, too great a reliance on them, or too limited an understanding of what the model actually tells us, may result in a significant misjudgement of risk. 8. all of this prompts the question of how far we should reflect on the efficacy of our methods for assessing, measuring and managing risks in the financial system. how can we avoid the temptation to see model output as the only crystal ball for the future? how can we equip management, board members and regulators and supervisors to overlay model output with informed expert judgement which can look to surrounding circumstances, be more forwardlooking and take into account possible behavioural responses to events? 9. tomorrow one of the panel sessions will be on stress - testing and the work in this area i think offers a significant opportunity, both at the bank and supervisory level, to examine risk and test the “ what if ” scenarios which the models cannot reach, and to “ think the unthinkable ”. adding complexity to the financial markets and regulation? 10. apart from the widespread use of models in risk management, the financial innovation of the past two decades and the globalisation of our markets have greatly increased the complexity of financial markets and their inter - linkages. the global financial crisis demonstrated all too clearly that certain types of financial innovation, resulting in the emergence of a vast variety of highly complex and opaque financial derivative instruments ( even if originally designed to repackage and diversify risk ), in fact led to greater, rather than less, financial instability that neither the firms nor their regulators fully foresaw or understood. 11. to address the risk arising from this increasing complexity in the financial system, the regulatory framework has also become more complex. for example, the basel i capital accord has about 80 pages in total. for basel ii, it runs to 333 pages plus another 76 pages for basel 2. 5. as for basel iii, insofar as it covers capital ( and not liquidity ), it is 562 pages ( including as it does basel ii and

reforms now in train, to the public discussions about consolidation of the banking sector, and also to the merger of the exchanges. third, it certainly requires a much higher degree of cooperation and coordination among different domestic regulators, and for each to take into account the wider cross - market issues that have a bearing on systemic stability. this means a greater regulatory burden for all and greater inconvenience to market participants, and possibly implications for the legal and institutional arrangements for regulation. fourth, this approach may involve tighter rules for the markets. the critics may again say that this will further erode market freedom. but should we be so dogmatic? in any case, it is all a matter of degree. in the end, it is the public interest that counts. is there, for example, anything wrong in restrictions against the holding of large dominating positions in any particular market, or against the taking of market moving activities? the purpose of a market is price discovery. there is no objection for buying low and selling high, and i would wish anybody who is attempting that the best of luck. but there is no legitimate reason for anybody to be operating in a market in a manner that has the sole aim of moving the price in order to make a profit. tighter rules aside, it is interesting, and indeed slightly worrying, to note that stronger forms of restrictions and controls have been gaining currency among some monetary authorities or regulators in the past two years. these range from restrictions on domestic credit to some forms of exchange controls. this response is quite understandable and may be a reflection of the failure of the international financial architecture to accommodate the needs of small markets. but it is also regrettable, given the enormous benefit that international capital has brought to the region. for the immediate future, self - fortification, in one form or another, will probably continue to be a prominent policy feature in the management of the monetary and financial systems of small open markets. this is one reason why we in hong kong have been pressing ahead with many domestic reform initiatives to strengthen our monetary and financial systems. there are many proposals still on the table. we need to make quick progress, for the current reprieve as the highly leveraged institutions lick their wounds may not last for long. in my opinion they have not met their nemesis yet. we should not assume that they have, nor should we necessarily wish that they should, remembering that free and open financial markets have been generally beneficial to economic growth and development. our objective is to harness