- backed securities and retail products brought to the market by the hong kong mortgage corporation. all have been readily absorbed by the latent demand to which i also referred earlier. and with the recent introduction of the mandatory provident fund schemes, the demand for bonds has been building up quickly. in 1991, the bond market has a size of only about 4 per cent of gdp. this has grown to 35 per cent last year, and the share of private sector debt is now at around 77 per cent. we have come a long way but there is still a lot of room for expansion, as evidenced by comparisons with bond markets in the g - 3 economies. but our bond market has grown big enough and has been robust enough for it to provide some meaningful back - up in times of financial stress. in 1998 - 99 when, as property prices fell sharply and the financial turmoil led to deteriorating asset quality, the banks adopted a conservative stance in their lending, corporate bond issuance increased significantly. positioning for the future our present pre - occupation in the development of the hong kong bond market is to bring in the international dimension. as an international financial centre, we of course aspire to play a role in international financial intermediation. to achieve this, our efforts have been concentrating on two fronts. first is the establishment of bilateral linkages of the appropriate elements of our financial infrastructure with those of other jurisdictions wherever it is compatible to do so, and whenever the counterparts are willing. this basically is for the purpose of facilitating the cross border investments in debt securities. our cmu was linked up with euroclear and clearstream in 1994, with the central securities depositories in australia in 1997, new zealand in 1998 and korea in 1999. we also have a standing offer in the region to link up our hong kong dollar rtgs payment system with other currencies with rtgs capability so as to achieve payment versus payment in foreign exchange transactions, in other words, to eliminate herstatt risk. but i must confess that, for the former, there has not been a lot of traffic, and for the latter, there have been no takers, so far. i hope this is merely a reflection of the fact that the financial infrastructures of others are not yet ready for these types of linkages. but i really cannot see a more robust arrangement than what we have proposed for promoting and facilitating the international financial intermediation that is found so lacking in the region. but we shall be patient. the

##s are really mortgages extended to those who are, to put it bluntly and simply, not credit worthy. and as mortgages are assets on the books of the lenders, subprime mortgages are really sub - standard financial assets. second, when property prices were rising and there was a clear expectation that they would continue to rise, those who were responsible for lending took comfort from the possibility of second mortgages providing borrowers with funding for servicing the first, sub - prime mortgages, in the event that the borrowers encounter difficulties in their mortgage payments. indeed, when property prices were on a rising trend, the delinquency rate of sub - prime mortgages was quite low and sub - standard financial assets were considered as good quality assets. third, through securitisation the lender was able to off - load the sub - standard financial assets to third parties quickly. this eroded the incentive of the lender to carefully assess the ability of the borrower to service the sub - prime mortgage. instead, the lender was more interested in accelerating the production line in this “ originate and distribute ” model, earning a fee and providing other customer services. ironically, therefore, financial innovation in the form of securitisation and credit risk transfer to those in a better position to assume risks, while it should theoretically enhance financial efficiency and promote financial stability, has led to distortions in the incentives of financial intermediaries, eroded credit standards and undermined financial stability. fourth, the powers of financial innovation continued to work after the sub - standard financial assets got into the hands of the third parties. slicing, mixing and re - packaging came in and the sub - prime mortgages were buried in very complex financial arrangements to become what are nicely described as collateralised debt obligations ( cdo ), or generally as structured products. fifth, the complexity of many of these structured products and the risks involved were simply beyond the comprehension of the ordinary investors and perhaps even the professional investors who did not have the time to look into the fine details of the financial arrangements. and so the rating agencies were relied upon, for a fee, to provide an objective view, or rather a rating that was as objective as it could be under the circumstances. but we all noticed the instability of these ratings, some falling from aaa to junk within a short time span, which threw doubt not so much on the integrity of the rating agencies – they are respectable organisations essential to the functioning of the financial system