1. Futures Market: Hong Kong Experience Prof. Stephen Yan-Leung Cheung City University of Hong Kong

2. Content Asian Financial Crisis (1997-1998) What happened Consequences Aftermath Lessons

3. What Happened? Inflated asset price –Fell by 60% Potential recession –1998 Q3 GDP ↓6.9% Other Asian currencies have sharply depreciated Market perceived that HK dollar was undervalued Hong Kong dollar is linked with US dollar with US$1 vs HK$7.8

4. What Happened? Pressures began in October 1997 on the forward rates for the HK dollar and regulated in a sharp full in equity market Pressures continued periodically through the first half of 1998 – Weakness in domestic economy –Yen had fallen to an 8-year low of 147 per US$ –Renewed concerns an possible depreciation of RMB In 1998. equity prices had fallen over 55% from their peak a year earlier, 12-month forward rate on the HK dollar was depreciated by 8% compared to 7.8 which is the official rate of HKD

5. Double Play Taking short position in the equity market –Short-selling stock –Short HSI futures contract –Put option on HSI Putting upward pressure on the forward rates for the Hong Kong dollar → sharp fall in equity market

8. Currency market Short position in the HK dollar may have established to over US$ 10 billion (6% of GDP) by institutions –SWAP-driven issuance of HK dollar dominated securities by international financial institutions in the first eight months of 1998 –Concentrated selling intended to move the exchange rate beyond the official exchange rate –Market rumors on devaluations of the HK dollar

9. Derivatives market Activity on HSI futures contract rose from April to August 1998 4 hedge funds whose futures and options positions accounted for 40% in early August 1998 Their positions accounted for 49% of the total; one fund accounted for one-third Source: Report of the Work Group on Highly Leveraged Institutions (Financial Stability Forum 2001, BIS)

10. Consequences HKSAR government’s intervention in the market during 14-28 August, US$ 15 billion in equities, led to the creation of HK tracker fund Subsequent improvement in the global outlook, the large hedge fund HSI futures positions were mostly unwound in October

11. Risks Futures market –Concentration risk, a big concern? –Definitely yes for the economy, because of systematic risk

12. Aftermath Open position limit Margin requirement Super-margin requirement

13. Lessons (1) Communication channels between HKFE and SFC Coordination between regulators –Cross-market surveillance Committee Market Intelligent System

14. Lessons (2) Education on products Investors Regulators Intermediaries

15. ‘Big elephant jumped into a small pond.’

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