CONFIDENTIAL
Reference
THE HONG KONG GOVERNMENT'S GUARANTEE TO ITS BANKS
4.
Turning to the Hong Kong Government's guarantee to its banks, one has to consider the relation of Sterling to the Hong Kong dollar. Under the Exchange Fund Guarantee Scheme the Fund guarantees to the banks the Hong Kong dollar value of 100% of the Sterling covered under the scheme and a small charge is made. This guarantee is implemented in respect of any fall in the rate between the Hong Kong dollar and Sterling. Adjustment payments have to be made to the banks to restore the Hong Kong dollar value of the Sterling covered. but, unlike the Sterling Agreements, payments will be made in one amount on the balances left in the Fund (cf below) when Sterling ceases to float. If the fall in the fixed rate is due to Sterling falling by more than 1% below $2.40 for a continuous period of 30 days, then the British Government is obligated to pay the Hong Kong Government, for the account of the Exchange Fund, sufficient Sterling to restore the US dollar value of the guaranteed proportion of their official Sterling reserves. Thus, given that there was no signifi- cant fall in the total of bank owned Sterling assets between the date that Sterling was floated and the date the rate first fell below US $2.40 by 1%, and given that the Hong Kong dollar maintained its relationship with the US dollar, the burden of adjustment pay- ments from the Exchange Fund to the banks would be largely met - to the extent of 90% by compensation payments to the Fund by the Bank of England.
5. In June 1972 Hong Kong did not float down with Sterling but instead, on 6 July, established a direct link with the US dollar as an interim measure prior to setting a new fixed rate between Sterling and the Hong Kong dollar. In this way, the Hong Kong dollar was insulated from the effects of the floating of Sterling. However, as a consequence, the Hong Kong dollar value of the banks' Sterling declined but no compensation was received from the Bank of England for the decline between US$2.6057 (Sterling's Smithsonian rate) and US$2.40 ́. (the level at which the Sterling Agreement's guarantee came into operation) The Hong Kong authorities were left uncovered between these points and sustained the loss themselves (estimated at about £36 million). At the same time, the Hong Kong authorities told the banks that, whereas their 6 July position in the Fund would remain covered, further accruals would notbe accepted for cover.
Final compensation to the banks, when Sterling ceased to float, would therefore be based on those positions or on a smaller figure, if the banks had diversified out of Sterling in the meantime.
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6. The situation Hong Kong is facing now is somewhat different, but accounts for Hong Kong's complaint of losses as a result of "Sterling floating down for the second time from US$2.60". you say in your minute, Sterling has followed the US dollar part of the way down while the Hong Kong dollar has maintained its previous gold parity. The Hong Kong dollar value of the banks' Sterling has therefore certainly declined but this is due to the Hong Kong
it is not due to Government not following the US dollar down Sterling falling below US$2.40. The burden of adjustment is there- fore transferred to the Hong Kong Government again. Since, under the Exchange Fund Guarantee Scheme, the Fund has Hong Kong dollar liabilities and Sterling assets, the Hong Kong authorities stand to lose in Hong Kong dollar terms on the banks' Sterling held as part
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DD 897261 230443 500M 5/72 GM 3643/2
CONFIDENTIAL
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