CONFIDENTIAL
MDLIA
044725
0802
1
GIVEN THE PRESENT STATE OF OUR CAPITAL MARKETS, IT WOULD NOT BE FEASIBLE TO BORROW LONG TERM FIXED RATE MONEY IN THE AMOUNTS REQUIRED THROUGH BANK LENDING OR THE ISSUE OF DEBT SECURITIES. THERE IS, OF COURSE, A MORE ACTIVE AND LIQUID MARKET FOR FLOATING RATE PAPER. BUT IN BORROWING MONEY ON SUCH A BASIS, THE SCHEME WOULD BE SUBJECT TO INTEREST RATE RISKS IN ADDITION TO THE EXCHANGE RATE RISKS. IF THE VALUE OF HONG KONG DOLLAR WERE UNDER STRONG DOWNWARD PRESSURE, LOCAL INTEREST RATES WOULD RISE SHARPLY TO STEM THE OUTFLOW OF FUNDS. THE SOLUTION OFFERED BY MARGOLIS IS THAT HKG SHOULD PROVIDE A FORM OF GUARANTEE THROUGH AN INTEREST RATE CAP FOR THE HONG KONG DOLLAR, BUT THIS WOULD MEAN AN UNKNOWN CONTINGENT LIABILITY FOR US. ON THE OTHER HAND IF, AS MARGOLIS GOES ON TO SUGGEST, THERE WERE TRIGGER POINTS TO LIMIT OUR LIABILITY TO SOME EXTENT, THE SCHEME WOULD BE VULNERABLE TO BEING WOUND UP IN THE VERY CIRCUMSTANCES IT WAS DESIGNED TO MEET.
5. ON YOUR PARA 6, NEITHER OF THE TWO ALTERNATIVES FLOATED BY MARGOLIS SEEMS TO BE WORKABLE. UNTIL HONG KONG'S LONG TERM DEBT MARKET DEVELOPS, THERE IS NO RELIABLE BENCHMARK FOR SETTING THE DISCOUNT RATE FOR THE FLOW OF PENSION RECEIVABLES OVER THE TIME SCALE REQUIRED TO PROVIDE SOME MEANINGFUL PROTECTION TO SERVING OFFICERS, MOST OF WHOM ARE NOT DUE TO RETIRE WITHIN THE NEXT FEW YEARS. MOREOVER, SUCH A SCHEME WOULD BE VERY TIME SENSITIVE. THE DISCOUNT FACTOR FOR, SAY, 20 YEARS IS 0.14864 BASED ON A CONSERVATIVE DISCOUNT RATE OF 10 PERCENT. BUT THE PRESENT VALUE WOULD BE MUCH SMALLER (0.0611) IF THE DISCOUNT RATE RISES TO 15 PERCENT. MARGOLIS SUGGESTS THAT HKG SHOULD TOP UP ANY SHORTFALL BETWEEN THE VALUE OF THE RECEIVABLE SOLD AND THE VALUE OF THE INVESTMENT. BUT AGAIN THIS COULD INVOLVE HEAVY GOVERNMENT
SUBSIDY.
6. THE SUGGESTION TO INTRODUCE A CURRENCY HEDGING SCHEME THROUGH A SERIES OF FORWARD EXCHANGE RATE CONTRACTS IS ALSO UNWORKABLE. THE MARKET FOR SUCH LONG TERM HKD FORWARD CONTRACTS DOES NOT PRESENTLY EXIST. FORWARD CONTRACTS QUOTED AND TRADE IN THE MARKET RARELY GO BEYOND ONE YEAR AND, EVEN WHEN THEY DO, THE SUMS INVOLVED ARE SMALL. MORE IMPORTANTLY, HKG'S INVOLVEMENT IN SUCH A CURRENCY HEDGING SCHEME MIGHT IN INTERPRETED AS LACK OF CONFIDENCE IN THE LOCAL CURRENCY AND THE LINKED EXCHANGE RATE SYSTEM. THIS WOULD HAVE UNDESIRABLE POLITICAL AND MONETARY
IMPLICATIONS.
7. YOU MAY LIKE TO KNOW THAT WE SUBMITTED A PROGRESS REPORT TO THE EXECUTIVE COUNCIL ON THE ISSUE OF PENSION SAFEGUARDS LAST
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