ENG-1996 — Page 123

FINANCIAL AND MONETARY AFFAIRS

of Exchange Fund paper has further been extended with the subsequent introduction. of the two-, three-, five- and seven-year Exchange Fund Notes in the past three years. A major development in the Exchange Fund Bills and Notes market in 1996 was the introduction of 10-year Exchange Fund Notes in October.

The tender results were very encouraging with an oversubscription rate of 13.52 times. The average accepted yield was 7.57 per cent, or about 92 basis points above that of the 10-year US Treasury Notes. In another development, four tap issues of 28- day Exchange Fund Bills were launched towards the end of 1996 to facilitate the liquidity management of banks in the initial stage of implementing the RTGS system. The total amount of outstanding Exchange Fund Bills and Notes increased to $92 billion at the end of 1996, compared with $59 billion at end-1995.

Exchange Fund Bills and Notes are one of the world's most actively traded government securities. The daily turnover in 1996 was $16 billion, representing 25 per cent of the entire amount outstanding. Contributing to the liquid secondary market is a market-making system under which 33 market makers are obliged to quote two-way prices.

To encourage the supply of high-quality debt issues in Hong Kong, profits tax exemption has been granted to the Hong Kong dollar debt securities issued by nine multilateral financial organisations such as the World Bank and the Asian Development Bank. To facilitate further the development of the local debt market, the government introduced in May 1996 a scheme under which the interest income and trading profits derived from eligible debt securities issued in Hong Kong enjoy a concessionary profits tax rate equal to 50 per cent of the profits tax rate.

Since 1994, the HKMA has broadened the scope of repo securities eligible for discounting under the Liquidity Adjustment Facility (LAF) to cover high quality Hong Kong dollar private debt issues (in addition to Exchange Fund Bills and Notes). At the end of 1996, 33 private debt issues totalling $60.1 billion qualified as LAF-eligible repo securities.

Development of a Secondary Mortgage Market

The secondary mortgage market in Hong Kong started to develop in 1994 when four issues of mortgage-backed securities (MBS) were launched. However, the market has been slow to evolve because of the heterogeneity and complexity of the MBS products, the prepayment risk and the lack of secondary market liquidity in the MBS issues.

At the suggestion of some private sector market participants, the HKMA conducted a study on the mortgage corporation proposal which concluded that the setting up of a mortgage corporation in Hong Kong was both feasible and beneficial in terms of promoting banking and monetary stability, the development of the local debt market and home ownership. It was also considered to be an effective way to kick-start the development of a secondary mortgage market.

In April 1996, the HKMA undertook a two-month public consultation on the mortgage corporation proposal. A wide spectrum of the community, including the banking sector, capital market participants and academics, indicated broad support for the mortgage corporation proposal. In July, the Exchange Fund Advisory Committee approved the setting up of the mortgage corporation, which would

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