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. * * * 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 1984 1. 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 ( [UNK] 人 治 [UNK] ) and that there is to be a high degree of autonomy in the governance of hong kong ( 高 [UNK] [UNK] 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

reserve requirements, banks in hong kong do not need to maintain large balances in their clearing accounts held with the hkma. this means that the crucial part of the monetary base, in the form of the aggregate balance in the clearing accounts that all the licensed banks maintain with the hong kong monetary authority, is very small. this in turn makes interbank interest rates in hong kong very sensitive to capital flows into and out of the currency board. the sale of a small amount of hong kong dollars by a bank to the hkma, which has to take it and provide us dollars at the fixed exchange rate in accordance with the discipline of currency board arrangements, could send interbank interest rates sharply higher. fact number two : the hedge funds had been borrowing and sitting on large amounts of hong kong dollars. from the beginning of this year to the middle of august, over hk $ 30 billion of one and two - year money were raised through the issue of debt paper in hong kong. the issuers were the multilateral institutions such as the world bank, the asian development bank, the nordic investment bank, the european investment bank, the european bank for reconstruction and development, the council of europe, etc. we welcomed these multilateral issuers making use of, and therefore helping to develop, the debt market in hong kong. but the real borrowers behind these hong kong dollar debt issues were predominantly the hedge funds, providing, through swaps arranged by intermediaries, attractive us dollar funding at below libor to the multilateral institutions. to use less jargon, as i said the hedge funds have been borrowing and sitting on large amounts of hong kong dollars. they of course do so for a purpose. but since i am talking about facts i do not wish to venture a guess here. all i would like to point out is that the cost of running a hk $ 30 billion position, with an interest rate premium over the us dollar that had been driven up to about 5 percentage points, is over hk $ 4 million a day. and i would only add that the hedge funds are not exactly in the habit of throwing money away for nothing and that they do not seem to have been using the money to buy up hong kong stocks. fact number three : on the securities side, the potential for serious market dislocation had been building up. while the turnover in our stock market fell quite substantially as financial turmoil in the region intensified, activity in our stock index futures market grew sharply and disproport