ENG-1997 — Page 127

FINANCIAL AND MONETARY AFFAIRS

marked an important milestone in the development of the Hong Kong debt market. Government debt paper provides a benchmark yield against which private debt issues can be priced. From a weekly issue of 91-day bills, the programme was gradually expanded to include 182-day and 364-day bills and two-, three-, five-, seven- and 10- year Exchange Fund Notes. Three tap issues of 28-day Exchange Fund Bills were launched in 1996 to facilitate the liquidity management of banks under the RTGS system. They continued to be rolled over in 1997 in view of the continuing market demand.

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 10 multilateral financial organisations, such as the World Bank and the Asian Development Bank. To facilitate further the development of the local debt market, in May 1996 the government introduced 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 1997, 52 private debt issues totalling $99.5 billion qualified as LAF-eligible securities.

Development of a Secondary Mortgage Market

There are fertile grounds for the development of a secondary mortgage market in Hong Kong as evidenced by the strong increase in outstanding residential mortgage loans from 8 per cent of GDP in 1980 to 32 per cent in 1997. A properly developed secondary mortgage market can play a useful role in channelling long-term funds, such as insurance and pension funds, to meet the rising demand for long-term home financing.

Since 1994, there have been several issues of residential mortgage-backed securities (MBS) in Hong Kong. However, the market has been slow to evolve because of technical issues such as the heterogeneity and complexity of the MBS product, the prepayment risk and the mismatch between the floating rate issues, limited liquidity in the secondary market and the preference of institutional investors for fixed rate paper.

In April 1996, the HKMA conducted a two-month public consultation on the proposal to set up a mortgage corporation in Hong Kong. A wide spectrum of the community including the banking sector, capital market participants and academics have expressed support for the proposal. There is general agreement that the successful operation of a Mortgage Corporation will entail significant benefits to Hong Kong in terms of promoting banking and monetary stability, debt market development and home ownership. There is also broad support for initial government ownership of the corporation in securing its acceptance by the market.

Having received the approval from the Exchange Fund Advisory Committee in July 1996, the Hong Kong Mortgage Corporation (HKMC) was incorporated in March 1997. The HKMC is a public limited company incorporated under the Companies Ordinance. It is 100 per cent owned by the government through the Exchange Fund with a capital base of $1 billion and is recognised as a 'public sector entity' under the

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