ENG-2006 — Page 128

100 | Financial and Monetary Affairs

Exchange Fund

The Exchange Fund was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance). Since its establishment, the fund has been responsible for backing Hong Kong dollar note issues. The role of the fund was expanded in 1976 to include the backing for coins issues. The Coinage Security Fund was merged with the Exchange Fund on December 31, 1978.

The Government transferred the fiscal reserves of its General Revenue Account (apart from the working balances) to the fund to centralise the investment management of its financial assets. Through this transfer, the bulk of the Government's financial assets are placed with the fund. Since April 1, 1998, the return on the fiscal reserves placed with the Exchange Fund was linked to its overall

return.

When the Hong Kong Special Administrative Region (HKSAR) was established on July 1, 1997, the Chief Executive appointed the Financial Secretary as the public officer to receive, hold and manage the Land Fund, as part of the HKSAR Government reserves, which were merged into the Exchange Fund and managed as part of the Investment Portfolio of the Exchange Fund since November 1, 1998.

A resolution was passed by the Legislative Council under the Public Finance Ordinance to authorise the transfer of $120 billion from the Land Fund to the General Revenue Account to meet the Government's expenditure requirement. A further transfer of $40 billion was made under a similar resolution passed by the Legislative Council in June 2004.

The Exchange Fund's primary statutory role, as defined in the Exchange Fund Ordinance, is to affect the exchange value of the Hong Kong dollar. Its functions were extended to maintaining the stability and integrity of the monetary and financial systems, with a view to maintaining Hong Kong as an international financial centre, when the Exchange Fund (Amendment) Ordinance 1992 came into force.

The HKMA manages the Exchange Fund. Apart from ensuring that the fund meets its statutory responsibilities, the HKMA's principal activity is the day-to-day management of the fund's assets. These are invested mainly in Organisation for Economic Cooperation and Development (OECD) bonds and equities.

To meet the objectives of preserving capital, providing liquidity to maintain financial and currency stability and generating an adequate long-term return, the Exchange Fund is managed as two distinct portfolios. The first is a Backing Portfolio, which holds highly liquid US-dollar-denominated debt securities to fully back the monetary base. The second is an Investment Portfolio, which aims to preserve the fund's long-term purchasing power. The asset allocation strategy of the Exchange Fund is guided by the investment benchmark, which defines the bonds and equities mix as well as the overall currency composition of the fund. The details of the management of the fund and the investment style adopted are set out and explained in the HKMA's annual report.