Y K Choi Deputy Chief Executive Hong Kong Monetary Authority Beijing‧Shanghai 6 - 7 June 2006

1. How Hong Kong’s multi-currency financial infrastructure platform helps meet the needs of Mainland banks in managing foreign exchange settlement risk Y K Choi Deputy Chief Executive Hong Kong Monetary Authority Beijing‧Shanghai 6 - 7 June 2006

2. Agenda (1) Financial reforms in Mainland China (2) Foreign exchange settlement risk on the Mainland (3) How to leverage on Hong Kong’s settlement platform (4) Hong Kong’s financial infrastructure (5) Co-operation for development between Hong Kong and the Mainland 2

3. Highlights of 11.5 Roadmap Chapter 33 Stepping up financial reforms Clause 2 – expedite the development for direct fund raising activities • Actively develop equities, debt and futures markets • Perfect financial market structure and functions • Introduce channels through which funds can enter the market, increase the share of direct fund raising activities 3

4. Highlights of 11.5 Roadmap Clause 3 – perfect monetary fine-tuning mechanism • Pursue steady development of currency markets, rationalise monetary policy transmission mechanism, promote interest rate liberalisation reforms • Perfect managed floating exchange rate regime, moving gradually towards convertibility for the Renminbi’s (RMB) capital account items 4

5. Reforms in Mainland’s foreign exchange market FX reform measures introduced since mid-2005 • Perfect renminbi exchange rate formation mechanism • Greater access to foreign exchange (FX) market：allowing qualified financial institutions and corporations to take part in the FX market • Enrich the mode of FX transactions：introduce market-driven over-the-counter (OTC) FX trading mode • Expand the variety of FX products：allowing interbank forward FX transactions and swap transactions between RMB and other foreign currencies Qualified Domestic Institutional Investor (QDII) scheme introduced in mid-2006 • Allowing offshore investments by Mainland entities and individuals Mainland’s FX market • Of the average daily FX turnover of around US$1bn+，the majority are associated with the USD, and remaining with HKD, euro and yen • The USD and euro funds are predominantly settled in the US and Europe 5

6. Foreign exchange settlement risk • FX transactions for RMB against foreign currencies are respectively settled in different time zones • Having the FX transactions settled overseas and impacted by the time zone difference, financial institutions involved are exposed to over 20 hours of “non-synchronised” settlement risk involving the entire settlement amount this is referred to as the Herstatt Risk • With OTC FX transactions gaining increasing popularity and the restrictions on offshore investments by Mainland entities and individuals lifted gradually, the amount of FX transactions that needs to be settled will increase substantially – the bigger the amount, the higher the risk 6

7. Settlement risk for USD/RMB FX transactions Mainland China New York, USA Mainland receives credit confirmation at 9am on the next day Bank A’s US correspondent bank Bank A Over 20 hrs of time zone difference Involving the entire principal amount: Herstatt Risk Receive USD in New York on the same day (evening in the Mainland) Pay RMB funds during the day in the Mainland Wire payment instruction Bank B Bank B’s US correspondent bank 7

8. Ensuring financial stability and integrity Stepping up financial reforms and development Financial and economic activities take off Tremendous Increase in FX turnover Safe and efficient foreign currency settlement system Reduce settlement risk Increase funding efficiency  Meeting the objective for ensuring financial stability and integrity 8

9. Hong Kong’s five major financial development strategies Strategies that facilitate financial markets development on the Mainland: • Hong Kong financial institutions to go into the Mainland to provide services • Hong Kong to serve as a gateway for Mainland funds to come out • Financial instruments issued in Hong Kong, particularly those issued by Mainland enterprises, to be made available on the Mainland • To enhance the capability of Hong Kong’s financial system to handle renminbi-denominated transactions • To strengthen financial infrastructure linkages between Hong Kong and the Mainland 9

10. Strategies that facilitate financial markets development To further strengthen financial infrastructure linkages between Hong Kong and the Mainland, Hong Kong has been actively developing cross-border settlement arrangements with the Mainland to provide convenient, safe and efficient settlement for cross-border financial intermediation activities: • To channel overseas savings into Mainland investments • To channel Mainland savings into overseas investments • To help expand the scope of business for Hong Kong’s financial sector • To provide the Mainland with a greater diversity of financial services and instruments • To bring convenience to Mainland funds investing in Mainland-related stocks and bonds issued in Hong Kong • To expand the RMB business as a pilot for moving towards full convertibility for the RMB 10

11. Hong Kong’s role for financial intermediation Mainland Overseas Mainland savings Overseas investments Hong Kong Multi-currency payment platform Multi-instrument settlement platform Cross-border payment and settlement platform Payment linkages with Mainland HKD Debt USD Equity CMU’s linkage with CDC, Mainland EUR Banking Service CMU’s linkage with Euroclear / Clearstream RMB Overseas savings Mainland investments CMU = Central Moneymarkets Unit CDC = China Government Securities Depository Trust & Clearing Co. Ltd. 11

12. Hong Kong as a fund raising centre Hong Kong has been pursuing new funds transfer and settlement arrangements to strengthen Hong Kong’s capability as a fund raising centre: At the end of 2005, • Hong Kong has surpassed Japan to become Asia’s most prominent centre for initial public offerings (IPO) with the largest amount of IPO funds raised in Asia • Stock market capitalisation reached HK$8 trillion equivalent, ranking 8th in the world (In May 2006, Hong Kong’ stock market capitalisation reached HK$10 trillion equivalent) • A total of 209 Mainland-related (H shares & red chips) companies were listed in Hong Kong’s stock exchange, representing 1/3 of the total market capitalisation • H shares & red chips raised as much as HK$180 billion, accounting for 60% of total funds raised and represented 40% of the total trading volume The Bank of China has completed listing in Hong Kong’s stock exchange on 1 June. Its IPO attracted HK$270 billion funds for subscription representative to over 70 times of over-subscription. Together with other interbank payments, Hong Kong’s HKD payment system handled over HK$1 trillion funds that day. • The FX market registering an average daily turnover of over USD100 billion (about HKD800 billion) ranked 6th in the world 12

13. Cross-border payment systems – facilitate cross-border financial intermediation To provide highly efficient and low risk settlement service for commercial payments, remittances and FX transactions between Hong Kong and the Mainland: • RTGSsystem：cross-border RTGS system linkages have been established with the Guangdong Province and Shenzhen city to provide cross-border HKD & USD RTGS payment service to banks in Hong Kong and the Mainland, thereby improving the efficiency for cross-border flow of funds and settlement efficiency • Joint cheque clearing：cross-border joint cheque clearing facilities (for HKD, USD & RMB cheques) have been established with the Guangdong Province and Shenzhen city that promote the effectiveness and safety of cross-border cheque settlement • Debt clearing system：the central debt clearing, settlement and custodian systems (ie the CMU in Hong Kong and the CDC in the Mainland) have established cross-border system linkages to facilitate cross-border debt securities settlement • Hong Kong’s RMB business that provides specialised cross-border RMB payment and settlement service 13

14. Mainland’s FX transactions - Utilising Hong Kong’s foreign currency settlement platform 14

15. Hong Kong’s financial infrastructure • Multi-currency and multi-dimensional payment, settlement and custodian system that meets the world’s most advanced standards • Provide a safe and robust, comprehensive and efficient financial infrastructure platform for the smooth settlement of all types of financial transactions • Cater not only for market participants in Hong Kong, the multi-currency, same time zone settlement platform also serves the Mainland and Asia markets 15

16. Hong Kong’s multi-currency settlement functions Real-time interbank transfer and settlement for HKD, USD and euro funds in Hong Kong (The HKD RTGS system on average settles HK$600 bn interbank funds transfer daily. The USD & EUR RTGS systems register an average daily turnover of US$6.7 bn and EUR1.2 bn respectively) HKD, USD, EUR RTGS System PvP Payment-versus-Payment PvP settlement for multi-currency foreign exchange transactions (USD/HKD, EUR/USD, EUR/HKD, HKD/CNY) DvP Delivery-versus-Payment DvP settlement for securities transactions denominated in HKD, USD & EUR HKD & USD cheques HKD & USD funds will be available on the next day following the presentation of HKD or USD cheques to the bank 16

17. New measures in the light of Mainland’s FX reforms The Hong Kong Monetary Authority (HKMA) has enhanced the functionalities of Hong Kong’s settlement systems: Hong Kong’s multi-currency systems have incorporated new enhancements in April 2006 to specially provide cross-border settlement of the foreign currency legs of Mainland’s FX transactions in Hong Kong: Mainland’s FX transactions will be settled in the quickest manner with the highest liquidity management efficiency 17

18. Utilising Hong Kong’s multi-currency settlement platform The People’s Bank of China (PBOC) allows market participants engaging in OTC FX transactions to agree the settlement channel bilaterally: • Mainland market participants engaging in FX transactions (such as banks, financial institutions, FX market makers, rural cooperatives, etc) should make greater use of Hong Kong’s foreign currency settlement platform to settle the foreign currency legs of RMB-related FX transactions • Practice real timepayment and receipt of foreign currency (HKD, USD & EUR) funds in Hong Kong: to reduce settlement risk; raise efficiency of managing foreign currency funds; and enhance funding efficiency Achieving same time zone settlement of RMB and foreign currency funds on the Mainland and Hong Kong respectively to eliminate overnight risks 18

19. Benefits of same time zone settlement for Mainland’s FX transactions • Eliminate Herstatt risk for FX transactions arising from settlement in different time zones • Raises efficiency in managing foreign currency liquidity • Provide additional liquidity for intraday transactions, strengthen liquidity management • Reduce operational risk • Enjoy statutory protection for settlement finality under Hong Kong’s Clearing and Settlement Systems Ordinance 19

20. RMB-related FX transactions- same time zone settlement via HK Beijing / ShanghaiHong Kong Credit confirmation to be received on the same day Bank A’s HK correspondent bank Bank A Same time zone settlement Zero time zone difference HKD USD EUR Receive foreign currency funds on the same day Pay RMB funds during the day Settlement Systems Wire payment instruction Bank B Bank B’s HK correspondent bank 20

21. The choice ofBank Negara Malaysia • Malaysia’s central bank has, after careful consideration, decided to link their Ringgit RENTAS RTGS system with Hong Kong’s USD settlement system to achieve cross-border PvP settlementfor USD/Ringgit FX transactions, eliminating all FX settlement risk. This linkage will be launched by end-2006. • HKMA is discussing with other central banks in this region on a similar arrangement: to link their domesticcurrency settlement system with Hong Kong’s USD settlement system to provide cross-border PvP settlement and eliminate FX settlement risk 21

22. Development strategies for Mainland and Hong Kong’s settlement systems • Most ideal to provide cross-border PvP settlement between Mainland and Hong Kong • The model is to develop linkage between Mainland’s RMB settlement system (CNAPS) and Hong Kong’s foreign currency settlement systems to provide cross-border PvP settlement to eliminate FX settlement risk entirely 22

23. Overview of Hong Kong’s financial infrastructure Malaysia’s RENTAS RTGS system PvP (2006) Mainland China Guangdong Province Clearstream USD RTGS system (2000) Shenzhen city CCASS (Equities) DvP DvP DvP PvP Euroclear Central Moneymarkets Unit (CMU) (1990) PvP HKD RTGS system (1996) DvP AustraClear - Australia PvP DvP PvP Euro RTGS system (2003) Continuous Linked Settlement System (CLS) RMB Settlement system (2006) AustraClear - New Zealand South Korea DvP: Delivery-versus-Payment PvP: Payment-versus-PaymentCross-border payment and settlement system linkage Cross-border debt settlement system linkage 23

24. Summary • Since the introduction of OTC FX transactions in January 2006 by the PBoC, HKMA has conducted meetings with Mainland’s FX market makers and banks: the majority recognise the benefits of same time zone FX settlement in Hong Kong • Among them, HSBC (Shanghai), Standard Chartered Bank (Shanghai), ABN Amro (Shanghai) and Bank of Communications have been using Hong Kong’s platform for FX settlement • To fully reduce FX settlement risk, other banks, FX market makers and financial institutions are encouraged to direct their FX settlement to Hong Kong’s multi-currency platform • In the rapidly growing FX market on the Mainland, it is hoped that Mainland financial institutions can make greater use of Hong Kong’s foreign currency systems to reduce settlement risk for themselves as well as their customers • Let’s achieve same time zone settlement for RMB FX transactions to reduce FX settlement risk, and promote financial stability and integrity 24

25. HKMA Task Force on Same Time Zone Settlement Monetary Markets and Financial Infrastructure Department Monetary Markets and Financial Infrastructure Department Haster Tang Senior Manager (Payment Systems) Market Systems Development Division Esmond Lee Head (Market Systems Development Division) Tel: (852) 2878 8198 Fax: (852) 2509 3264 Email: Esmond_KY_Lee@hkma.gov.hk Tel: (852) 2878 8268 Fax: (852) 2878 8725 Email: Haster_YY_Tang@hkma.gov.hk Monetary Markets and Financial Infrastructure Department Monetary Markets and Financial Infrastructure Department Sylvia Yip Senior Manager (Market Systems) Market Systems Development Division Daniel Leong Manager (Payment Systems) Market Systems Development Division Tel: (852) 2878 1476 Fax: (852) 2878 8725 Email: Sylvia_SW_Yip@hkma.gov.hk Tel: (852) 2878 1309 Fax: (852) 2878 8725 Email: Daniel_LC_Leong@hkma.gov.hk 25

26. Thank you! 26