FINANCIAL AND MONETARY AFFAIRS
Exchange Fund
The Hong Kong Government's Exchange Fund was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance). Since its inception, the fund has held the backing to the note issue. In 1976, its role was expanded, with the assets of the Coinage Security Fund (which held the backing for coins issued by the government) as well as the bulk of foreign currency assets held in the government's General Revenue Account, being transferred to the fund. On December 31, 1978, the Coinage Security Fund was merged with the Exchange Fund.
In 1976, the government began to transfer the fiscal reserves of its General Revenue Account (apart from the working balances) to the fund. This arrangement was introduced to avoid fiscal reserves having to bear exchange risks arising from investments in foreign currency assets and to centralise the management of the government's financial assets. The fiscal reserves are not permanently appropriated for the use of the Exchange Fund, but are repaid to the General Revenue Account when they are required to meet the obligations of the general revenue. Through this transfer of the fiscal reserves, the bulk of the government's financial assets are, therefore, with the fund.
The statutory role of the Exchange Fund, as defined in the Exchange Fund Ordinance, is to influence the exchange value of the Hong Kong dollar and it is used to intervene, when necessary, in the local money market or foreign currency markets to maintain stability. The functions of the fund were extended on the enactment of the Exchange Fund (Amendment) Ordinance 1992 by introducing a secondary and subsidiary role of maintaining the stability and integrity of the monetary and financial systems, with a view to maintaining Hong Kong as an international financial centre.
The management of the fund is undertaken by the HKMA. Apart from ensuring that the fund meets its statutory roles, the principal activity of the HKMA on a day-to-day basis is the active management of the fund's assets. These are held mainly in the form of bank deposits and marketable interest-bearing instruments in certain foreign currencies and in Hong Kong dollars.
In the past, the management of the fund was largely passive, characterised by a conservative approach with a preference for a high degree of liquidity and for short-term investments. Both the overall size of the fund, and the greater emphasis on the long-term stability and strength of Hong Kong's financial system, now enable the HKMA to have a longer-term outlook. The HKMA has an ongoing programme of upgrading and modernising its management of the Exchange Fund, which is now comparable to other central bank reserves management operations. Strategies appropriate to a long-term fund, such as a benchmark approach and a greater use of the long-term capital markets, have been adopted, and the range of currencies and instruments used has also been increased. The HKMA places great emphasis on establishing links with other market participants; the management style is one of openness and co-operation with the market, with a view to encouraging close working relationships to enable the markets to play their part in assisting in the HKMA's management of the fund. The returns from the management of the fund, and the investment style adopted, are set out and explained in the HKMA's annual report each year.
Another function related to the Exchange Fund is the supply of notes and coins to the banking system. Bank notes in the denominations of $20, $50, $100, $500 and $1,000 are issued by the Hongkong and Shanghai Banking Corporation Limited, the Standard
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