1. Bond market development: The case of Hong Kong
Alfred Wong
Hong Kong Monetary Authority

2. Outline I. Motivation to develop bond market Authorities’ efforts
Lessons and impediments

3. Part I What motivates the authorities to develop the local currency bond market?

4. An overview of the financial system
Financial Markets
Money market
Bond market
Equity market
Lenders
Households
Firms
Central bank
Borrowers
Households
Firms
Government
Banks and other financial institutions
Insurance companies and pension funds
Other financial intermediaries
Financial Intermediaries

5. Financing structure in Asia – 1996

6. Motivation of the authorities
Lessons from the Asia financial crisis
Currency and maturity mismatches
Prone to sudden capital flow reversal
To foster financial stability
As back-up facilities
Diversity in financial intermediation

7. The role of the State A multifaceted role:
Investor protection
Innovation
Provision of market infrastructure
Positive non-interventionism
Facilitating, not forcing!

8. Part II What have the authorities done to develop the local currency bond market?

9. Major initiatives taken since the Asian financial crisis
Product development
Market infrastructure
Tax and regulation
Regional cooperation

10. 1. Product development Government issues Securitised debts Bond funds
Retail bonds

11. Government issues Exchange Fund Bills and Notes (EFBNs)
HK$ debt instruments issued by the HKMA
Benchmark yield curve
Good liquidity in the secondary market
Banks collectively hold about 85% of the outstanding EFBNs for
favourable risk weighting and
can be used as collateral to borrow from the HKMA
Government bonds
The Government successfully launched its first global bond offering in July 2004
Total HK$20 billion of which US$1.25 (around 50%) in a 10-year US$ denominated bond

12. Securitised debts The Hong Kong Mortgage Corporation
Established by the Hong Kong SAR Government in March 1997
To promote development of a secondary mortgage market
mortgage purchase
debt issuance
securitisation of mortgage loans
mortgage insurance
In May 2004, the Government sold HK$6 billion (US$770 million) of securitisation bonds, backed by toll revenues from 5 tunnels and 1 bridge to finance infrastructure projects

13. Bond funds An EMEAP initiative ABF1 (2003) ABF2 (2005)
Closed-end: Confined to investment of the central banks only
USD-denominated sovereign and quasi-sovereign bonds in the region
ABF2 (2005)
Open to any interested investors
Domestic currency-denominated bonds in the region

14. Retail bonds
The Hong Kong Mortgage Corporation first offered bonds to retail investors in October 2001
The HKMA operated a pilot scheme to stimulate retail investment in Exchange Fund Notes in 2003
The programme was refined in 2005 under which the fee structure was simplified and retail distributors were appointed

15. 2. Market infrastructure
Benchmark yield curve
Hong Kong bond settlement system
On-line access to market information for retail investors

16. Benchmark yield curve
A domestic yield curve gradually took shape when the HKMA began issuing Exchange Fund papers in 1990s
Considerable effort has been directed at maintaining a smooth and continuous yield curve in designing the EFBN issuance programme

17. Hong Kong dollar bond settlement system
Central Moneymarkets Unit (CMU)
Established in 1990 to provide computerised clearing and settlement facilities to debt securities
Linked with other major international securities settlement systems
To foster cross-border bond trading and investment

18. Clearing and settlement system
CDC
- China
USD
RTGS
(2000)
Clearstream
2003
2004
Euroclear
DvP
1994
PvP
2002
PvP
1994
CMU
DvP
HKD
RTGS (1996)
1997
AustraClear
- Australia
PvP
1998
DvP
1999
AustraClear
- New Zealand
KSD
- South Korea
EURO
RTGS
(2003)

19. On-line access to bond prices
CMU Bond Price Bulletin website
Launched in 2006
Provides convenient access to indicative bond prices quoted by major banks in Hong Kong

20. CMU Bond Price Bulletin

21. 3. Tax and regulation Demand side: Supply side:
tax concessions to bond buyers
Trading profits from bonds with a maturity period of 7 years or more (issued after 5 March 2003) were exempted totally from profits tax (previously 50% tax concession)
Minimum maturity requirement for the 50% tax concession was relaxed from 5 to 3 years
Supply side:
simplified issuance process for fund raisers
The Government and the Securities and Futures Commission have together streamlined regulations and procedures for issuing and listing debt securities
Enabled issuers to market their offers with greater flexibility and effectiveness to the public
Lowered issuance costs

22. 4. Regional cooperation
APEC Initiative on the Development of Securitisation and Credit Guarantee Markets
Asian Bond Market Initiative (ABMI)
Asian Bond Fund (ABF)

23. After all these…

24. Hong Kong dollar bond market
Steadily growth over the past decade
Outstanding Hong Kong dollar bond reached US$85 billion at end-2005
Almost 50% of GDP

25. Local currency bond outstanding
US$ billion
% of GDP
Sources: HKMA and HK Census and Statistics Department.

26. Market growth by issuer
US$, bn
US$, bn
Source: HKMA.

27. Financing structure in 2005*
*As at end-September 2005

28. Part III Lessons and impediments: any more we can do?

29. More work to do? Macroeconomic policies Government bonds
Banking sector soundness
Corporate governance
Regulatory framework
Tax treatment / incentives
Investor base

30. Impediments to the Hong Kong dollar bond market
Supply
Issuance of Exchange Fund papers is limited
Government issuance is politically sensitive
Lack of corporate issuers
Business size
Credit bureaux
Demand
Mutual funds invest mainly in equities
Currency board system

31. Retail demand for bonds
Transaction cost is high for individuals
Increased competition between banks made deposits fiercely competitive
Attraction is mainly on medium term papers
There is more interest in holding bonds via other investment vehicles (e.g. mutual funds)
Any more room for ABF2-typed initiatives?

32. Looking ahead Market making system Length of the yield curve
League table
Tender arrangements
Uniform-price auction
Length of the yield curve
Number of EFN issues
EFN futures market
Electronic trading platform

33. Conclusion The Hong Kong bond market has grown steadily since crisis
Structure of financing still tilted towards loans and equities
Scope for improvements