Wednesday, March 26, 2014

Speech on the Second Reading of the Loans (Amendment) Bill 2014

Mr President, I speak in place of the Hon Kenneth Leung, chairperson of the Bills Committee on Loans (Amendment) Bill 2014, who is on sick leave today.

The purpose of the Bill is to amend the Loans Ordinance to accommodate the issuance of Islamic bonds, i.e. sukuk, under the Government Bond Programme. The Bills Committee, of which I am also a member, has held one meeting with the Administration to discuss the Bill. It has also invited written views from the public but received no submissions.

The Bills Committee notes that allowing sukuk issuance s under the Government Bond Programme will help diversify the financial products and services for the Hong Kong financial markets, further promote Islamic finance in Hong Kong through encouraging issuers to raise funds by issuing sukuk, and reinforce Hong Kong’s status as a major international financial center and an asset management center. The Bills Committee supports the Bill in principle. I shall now turn to the major issues deliberated by the Bills Committee.

The Bills Committee has examined the need to amend the Loans Ordinance and studied how the proposed amendments operate in achieving the purpose of the Bill.

The Administration explains that as asset transactions involved in sukuk may not be regarded as “borrowing” in the prevailing context of the Loans Ordinance, it is necessary to amend the Ordinance to encompass the situation in which the Government shall be regarded as “borrowing” moneys from the Special Purpose Vehicle set up to effect sukuk issuance. This will enable the funds so raised to be credited to the Bond Fund. It is also necessary to amend the Bond Fund Resolution to allow payments to be made out of the Bond Fund Resolution to allow payments to be made out of the Bond Fund for meeting the coupon and redemption payments to holders of sukuk issued under he Government Bond Programme, as well as the expenses incurred in relation to the issuance of sukuk. Furthermore, the Bill also amends the Inland Revenue Ordinance to exempt coupon payments and disposal gains derived from the sukuk issued in connection with the Government Bond Programme to enjoy the same profits tax exemption as that currently applicable to those in relation to conventional bonds.

As issuance of sukuk under the Government Bond Programme may have implications on other types of bonds issued under the programme and the local bond market, the Bills Committee has sought information on the Administration’s considerations in launching sukuk under the Programme, the target investors and offering mechanism involved, as well as management of sukuk proceeds.

Members of the Bills Committee note that the Administration will determine the timing and actual issuance size of sukuk under the Government Bond Programme with regard to the prevailing market conditions and needs. The preliminary thinking for the inaugural sukuk issuance may be in the size equivalent to around US$500 million or more. The Administration envisages that the investors as they are major players in the global sukuk market. The Bills Committee further notes that depending on market interest and developments, the Administration may consider extending sukuk issuance under the Government Bond Programme to retail investors in future.

As far as the offering mechanism is concerned, the Administration may engage financial institutions and legal advisers in arranging the deal through a Special Purpose Vehicle.

On the management of sukuk proceeds, the Administration advises that investment return for the Bond Fund is calculated based on the average annual rate of return of the Exchange Fund’s investment portfolio oer the past six years or the average annual yield of three-year Exchange Fund Notes for the previous year, whichever is the higher.

The Bills Committee has expressed concern about the competitiveness of Hong Kong’s sukuk platform vis-à-vis those of other jurisdictions in attracting international sukuk issuers and investors given that major Islamic financial centers, such as Malaysia, have well-developed sukuk markets, and that Hong Kong lacks ties with Islamic communities.

In response, the Administration advises that the Inland Revenue and Stamp Duty Legislation (Alternative Bond Schemes) (Amendment) Ordinance 2013 passed by the Council in July last year has enhanced Hong Kong’s competitiveness in the development of a sukuk market by providing a comparable taxation framework for some common types of sukuk vis-à-vis conventional bonds. Coupled with the core strengths of Hong Kong financial market, Hong Kong is now on a better footing to promote Islamic finance through encouraging issuers to raise funds by issuing sukuk. The Administration considers that sukuk issuance under the Government Bond Programme will signal to the markets that Hong Kong’s legal, regulatory and taxation frameworks are well established to accommodate sukuk issuances. This will give further impetus to other potential sukuk issuers to raise funds in Hong Kong. An inaugural sukuk issuance originated by the Hong Kong Government, with an excellent credit rating of AAA, will draw attention and interest in the global market and attract a new group of investors from the Middle East and other parts of the world to Hong Kong’s financial platform.

In view of increasing competition from other financial centers in developing the sukuk market and Islamic finance, the Bills Committee has stressed the need for the Administration to make concerted efforts with relevant parties to promote Hong Kong’s sukuk platform, including increasing exchanges with other financial centers to foster cooperation and to keep abreast of latest developments in the global sukuk market. Moreover, members of the Bills Committee have urged the Administration to ensure a sufficient supply of professionals and market practitioners with expertise in sukuk issuance and Islamic finance which is vital to the development of sukuk market and Islamic finance in Hong Kong.

The Administration has stressed that the strengths of Hong Kong’s bond market, including sukuk market and the listing platform, are among the key features in the promotional work targeting international investors in recent years. The Administration has been collaborating with relevant parties, such as Hong Kong Economic and Trade Offices and the market, in promoting Hong Kong’s sukuk platform overseas, and keeping a close contact with the industry to encourage them to issue sukuk in Hong Kong. The Administration assures the Bills Committee that it will continue to seize every possible opportunity to promote Hong Kong’s bond market and its sukuk platform when meeting with institutional investors, issues and asset managers.

On the promotion of market awareness of Islamic finance, the Administration has pointed out that the Hong Kong Monetary Authority has been in close collaboration with overseas central banks, international organizations and local industry bodies to offer training for market practitioners. Over the past few years, the Hong Kong Monetary Authority has organized a series of Islamic finance seminars and workshops covering a wide range of topics. The Bills Committee notes that these activities have received enthusiastic market response and provided opportunities for Hong Kong market practitioners to interact with their overseas counterparts and exchange views on issues relating to Islamic finance and sukuk issuance.

Regarding cooperation with major Islamic financial markets, the Administration advises that the Hong Kong Monetary Authority has been maintaining a close partnership with key Islamic financial markets, such as Malaysia and Dubai. Moreover, the Securities and Futures Commission has been working closely with its counterparts from major Islamic markets, including signing a Memorandum of Understanding with the Dubai Financial Services Authority in 2008 for mutual cooperation on capacity building and human capital development in Islamic finance, as well as the promotion and development of the Islamic capital market.

Given that sukuk have more complex structures than conventional bonds, the Bills Committee considers it important for the Administration to ensure a robust regulatory regime over sukuk issuers ith a view to providing adequate protection for sukuk investors.

The Administration has assured the Bills Committee that, similar to other financial products, sukuk are subject to the prevailing regulatory regime in respect of product offering, marketing, disclosure, and intermediaries requirements in accordance with the relevant provisions of the Securities and Futures Ordinances and the Companies Ordinance. These include the requirement on sukuk issuers to seek authorization from the Securities and Futures Commission on the issuance of any advertisement, invitation or document, which is or contains an invitation to the public to enter into or offer to enter into an agreement to acquire the relevant sukuk products, unless an exemption applies. The Bills Committee notes that as institutional investors will be the target investors of sukuk issued under the Government Bond Programme, certain exemptions under the Securities and Futures Ordinance will apply.

Neither the Bills Committee nor the Administration will propose Committee Stage amendments to the Bills. The Bills Committee supports redemption of the Second Reading debate on the Bill.

Mr President, the following is the view on the matter related to the Loans (Amendment) Bill 2014 of the Hon Kenneth Leung and that I share, on the opportunities and the pressing need for promoting the Hong Kong Dollar Bond Market.

Hong Kong is a leading international financial centre with a stock exchange which ranked the top globally for funds raised from initial public offering from 2009 through 2011.

However, in order to stay competitive, Hong Kong needs to capitalize on other key successful factors and take a holistic approach in promoting our financial platform.  Developing the local bond market not only enriches the diversity of the financial products but is also a key component which meets the intrinsic needs of institutional and retail investors.

The majority of local investors have very limited choices if they are looking for a long-term investment instrument with stable return.  It is therefore not surprising to see the soaring property prices in recent years under a low-interest rate environment.

For those who cannot afford to buy properties, they probably have to invest in more risky and turbulent markets such as the equity market, foreign exchange and commodity  – or others, such as the victims of the Lehman Brothers incident,  they would have tempted to invest in complicated structured products to earn a slightly higher yield than normal time deposits.

I also believe that a mature and liquid Hong Kong dollar bond market is crucial for stabilizing and sustaining investment returns for Hong Kong’s retirement population.

A sizable Hong Kong dollar-denominated debt securities market can offer more options for MPF funds.  Bonds issued by local reputable institutions, in particular, help provide employers and employees with relatively low-fee alternatives, and  earn reasonably stable returns while enjoying the compound interest benefits. Of course, those with more aggressive risk appetite may always choose MPF funds with higher risks, higher returns and higher management fees, like stocks fund. The Government should encourage and facilitate the provision of a more risk-balanced choice of funds, and the rest will be market-driven.    

Indeed, Mr. President, Hong Kong does not lack competitive advantages required for deepening and broadening the local fixed income market.

We have a sophisticated business infrastructure and transparent regulatory environment. A triple A credit rating status (S&P long-term credit rating) which can minimize the cost of the Government, statutory bodies and government-owned corporations for fund raising through issuance of securities papers.

Unfortunately, the Government fails to perform its role in promoting Hong Kong dollar debt issuance.  Based on FSTB’s statistics, the Government, Statutory bodies and Government-owned corporations made in total 654 issuance, with a total amount of around HK$264.2 billion Hong Kong dollar debt securities* between 2003 and 2012 or 13.2% of the total HKD debt securities issued in the same period, excluding Exchange Fund Bills and Notes (“EFBNs”) issued by the HKMA.

Compared with other international financial centres, Hong Kong is lagging behind in terms of scale of issuance.

Perhaps one may say that our huge reserves justify the conservative position of the Government. But I am afraid this is somewhat myopic.

As Hong Kong Government is going to invest as much as HK$340 billion in mega projects including a new airport runway, new development areas and reclamations in the coming years (Budget 2014-15), it is high time for the Government to leverage this golden opportunity to speed up the development of Hong Kong dollar bond market as an alternative financing channel rather than to be over reliant on public revenues alone.

This is particularly true when the Government is subject to a financial commitment to address the needs of the poor and our aging population.

To achieve this, we need a number of positive actions:

1. The active participation of the Government, statutory bodies and government-owned corporations in using the Hong Kong dollar bond instrument to raise funds for these mega projects where possible;

2. Expedite necessary enhancements on regulatory and infrastructural supports to improve market liquidity (e.g. enforcement of underwriters’ market making responsibilities, setting up of an electronic platform for online retail trading, provision of a central depository system for HKD bonds); and

3. Promote investor awareness and demand through education programs.

Development of the sukuk market or RMB bond market should not be hindering the growth of the Hong Kong dollar bond market. Instead, we should head for diversity which will make the bond market as a whole fly in Hong Kong.

Together, the different types of bonds will attract a critical mass of fixed income traders, buyers and issuers which will support the healthy growth of the instrument.

I would urge the Government to take up its pivotal role in accelerating the development of HKD debt market with a view to achieving a more diversified and  resilient financial sector in Hong Kong.  Thank you.

*Note:  HKD debt securities include bonds, shorter-term papers such as bills, and other types of fixed income instruments. 


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