under certain conditions …. however, … the theoretical benefits seemed to be outweighed by the disadvantages … [ including ] the complications that the writing of options would bring to the currency board system, and the possibility of negative perceptions that the hkma was engaging in risky activities or lacked the means to support the currency board system in the spot market. " the feasibility and advisability of using derivatives as a monetary instrument are subjects which have been debated over the years by academics and policymakers, and a few countries have relevant experiences to tell. a number of points seem worth making. first, in most instances, if you are confident in your monetary policy you should probably be up front in supporting it by your actions. if you don't possess sufficient resources for that support, you should certainly think twice before leveraging yourself in derivatives, even if it can be demonstrated that such a strategy might, if successful, be profitable - for the potential downside could be considerable. second, although central banks and governments are nowadays much more transparent about their operations than previously, use of derivatives may in some instances provide some temporary disguise, but disguise would seldom be a very healthy reason for selecting a strategy. third, as implied in the above quotation, the perception continues to exist that derivatives are a particularly risky activity, or one which might signal some degree of desperation. despite the fact that such views may be irrational, a central bank may need to acknowledge public sensitivities and err on the side of conservatism in its operations. fourth, in searching for the most cost - effective or reliable avenue for monetary operations, it should be borne in mind that the derivative markets may be more fickle and less liquid than the cash markets, perhaps the more so at the very moment when you might be most tempted to use them. in sum, i do not currently see a convincing case for using derivatives as a monetary policy tool. in the final analysis, however, a central bank is entitled to keep all its options open and to surprise the markets if it so wishes, provided that it is ultimately accountable for its actions. conclusion i have tried to briefly explain some of the angles from which central bankers generally, and the hkma in particular, view derivatives. this is perhaps a rather dry topic and i feel sure that there are many more interesting and challenging aspects of derivatives which will be discussed during these two days of seminars related to the derivatives expo. record of discussion of the exchange fund advisory committee sub

. supervision despite for the most part providing a beneficial service, derivatives trading also has the potential to bring disaster. mere mention of the word barings is no doubt sufficient to make the point. it is for this reason that the relevant authorities exercise supervision of derivatives activity. in the hong kong context, hkma supervises the banks and other deposit taking institutions to ensure suitably prudent behaviour, while the sfc regulates exchange trading and the other players. i should perhaps make the point here that supervision is not aimed at suppressing activity, but rather at ensuring that risks are properly identified and managed and that disasters which might threaten systemic stability are avoided. particular emphasis is placed on ensuring that management possesses sufficient understanding of the derivatives business and the associated risks, and has the appropriate internal mechanisms in place for monitoring and control. officialdom in general, and central banks more especially, are sometimes characterised as being opposed to speculation and, by extension, as being suspicious of derivatives, which are often regarded as a convenient vehicle for speculation. that characterisation is mistaken. we are not opposed to speculation. indeed, we recognise very clearly that financial markets cannot operate efficiently if the speculator is excluded. he plays a key role in the price formation process and is the essential counterparty to the hedger. the textbooks tell us that if the speculator stabilises prices he makes a profit, while if he doesn't he loses. the fact that speculators still exist is then taken as prima facie evidence that their activity is on balance stabilising, although i am also conscious of the counterargument, namely that they are destabilising and lose money, but the population of them is constantly being replenished by fools who think they can do better. however, although we acknowledge the generally positive role of speculation, we are very much opposed to manipulation. the key distinction is that, whereas the speculator takes a view based on the price which he observes in the market and acts upon it, the manipulator uses his resources and the advantage of a dominant market position to try to influence the price - in other words, he is a potential price setter rather than a price taker. particularly in small markets where relatively small deals may be able to move prices significantly, we need to be alert to this potential problem, which may, if unattended, seriously undermine one's vision of competitive, efficient markets. information the prices at which derivatives trade contain information which