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Derivative transactions of banks

Following is a question by Dr the Hon Huang Chen-ya and a written reply by the Secretary for Financial Services, Mr Michael Cartland, in the Legislative Council today (Wednesday):

Question:

Following the progressive abolition of the Interest Rate Agreement, some banks have, one after another, offered various kinds of derivatives in order to secure more retail customers. In this connection, will the Government inform this Council:

(a)

(b)

(c)

whether government approval has to be sought before the banks offer such derivatives to their clients; if so, which department is responsible and what the procedures are for granting the approval;

whether the advertisements put out by the banks for such derivatives are subject to the regulation of the Securities and Futures Commission or the Monetary Authority; if so, what the regulating procedures are; and

what legislation is in place to safeguard the customers' investment in these derivatives?

Reply:

We do not see a direct link between the deregulation of the interest rate cap on time deposits governed by the Interest Rate Rules and the introduction of derivative products by banks. Such products are more likely the result of product innovation by banks aided by the development, and more common use, of derivatives.

Regarding (a), the Monetary Authority, as the regulator of banks, expects that all the activities of banks should be conducted in a responsible, honest and business- like manner. Banks are therefore required to be financially sound, to be prudently managed by fit and proper persons and to have adequate systems of internal control for the various aspects of their business, including derivatives related business. Within this overall framework, it is not generally the practice of the Monetary Authority to require banks to obtain its prior approval for each and every new business product. However, where certain products raise risk-related issues (such as deposit-linked derivatives), banks are expected to consult with the Monetary Authority in advance. In such cases, the primary focus is to ensure that banks fully understand the nature of the risks involved and have systems and controls to manage those risks.

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