Anyone who knows a bit about the financial markets in Hong Kong could tell you that fund management in Hong Kong is expanding, with a potential that has yet to see limits.

In 2002, the total assets under management by licensed fund managers of the Securities & Futures Commission amounted to US$191 billion, two-thirds of which came from outside Hong Kong.

But this figure does not include funds of, for example, high net worth individuals and institutional investors. I know some financial houses have estimated that the total assets under management in Hong Kong, including those funds which are not required to seek authorisation from the SFC, could reach as high as US$400 billion.

Despite the relatively sluggish market conditions, the total assets actually managed in Hong Kong continued to rise steadily in the last few years, and last year by almost 11%.

The number of companies that provide fund management or advisory services has also increased by 12% from 2001 to 2002, 19% of which have made Hong Kong their regional headquarters or office. All these suggest that Hong Kong is becoming more and more important as a fund management centre.

Retail investment funds expand

In recent years, there has also been a steady expansion in retail investment funds offered in Hong Kong, in terms of both product types and complexity. In 2002, for example, the SFC-authorised retail funds and funds of the Mandatory Provident Fund accounted for about 29% of the total of funds managed in Hong Kong, a significant increase from the 22% in 2001.

As of the end of October this year, among the 1,911 SFC authorised unit trusts and mutual funds, alternative investment products such as structured products and hedge funds accounted for close to 14% of the total.

The success of the fund-management sector in Hong Kong is built on the excellent market infrastructure which is friendly to the fund-management business, and attracts talent and capital to the territory.

These include a sound legal system, simple and low tax regime, good communications network and supporting infrastructure, the presence of a critical mass of financial professionals, availability of supporting financial services such as brokerage and custodian services, legal and accounting services. And last but not least, efficient and transparent regulation of the markets in accordance with the "Big Market, Small Government" philosophy.

Hong Kong is a services-oriented economy with 87% of its GDP coming from services. The financial services, which employ only 5% of our workforce, add the highest value by contributing 12% of our GDP. The Government therefore attaches high priority to developing this sector, of which fund management is a crucial part.

Government plays role of facilitator

The role of the Government and the regulators has been one of facilitation through providing the necessary market infrastructure friendly to asset management and reviewing Government policies constantly to meet the ever-changing market needs.

In view of the growing importance of the sector, the Government has taken a number of initiatives to promote market liquidity and the development of asset management in Hong Kong.

In recent years, the SFC has made steady progress to broaden the choices of investment products for the retail public in Hong Kong, responding to the needs of market development. Since January 2002, the SFC has published codes and guidelines concerning the regulation of index funds, guaranteed funds, retail hedge funds, real estate investment trusts ("REITs") and index tracking exchange-related funds ("ETFs"). These sets of regulations lay the foundation for the development of the so-called specialised investment funds in Hong Kong.

We do recognise the various benefits that the hedge fund industry as a whole can bring to an economy. While seeking to achieve positive investment returns with vigorous risk-management control, hedge funds have been instrumental in providing the investing public with an asset class and an alternative investment that could provide opportunities even in times of difficult market conditions and sentiments.

Hedge funds can help diversify investment risks

As the hedge-fund industry engages in directional trades and makes investments in special situations and in distressed securities, it has contributed towards market efficiency and liquidity.

In following strict investment discipline and performing extensive research on the "intrinsic" value of an investment, hedge funds could in fact help to minimise mispricing of assets prices and counteract short-term speculative sentiments in the market.

If properly used as an investment tool, a hedge fund could help to diversify investment risks.

As an international financial centre, we welcome the introduction and development of new investment products, hedge funds included. But, from the perspective of the Government and the regulators, we are concerned about the need to protect investors' interests, given that hedge fund products are now increasingly being marketed to retail investors.

By bringing hedge funds under a proper regulatory and disclosure framework for retail sales to the public, we hope that we would illustrate to the industry that hedge funds could be made more transparent without undermining the effectiveness of their investment strategies.

In the long run, we hope that the success of authorised hedge funds would encourage more hedge funds to seek authorisation.

Exemption of taxation on offshore funds

After extensive consultation and in-depth discussion with the fund-management industry, we announced in the 2003 Budget that the Government would grant profits-tax exemption to offshore funds, an initiative that would bring Hong Kong on par with practices in other international financial centres.

We believe that this policy will help to preserve and enhance Hong Kong's overall competitiveness as an international fund-management centre. The Government will soon consult the industry on proposed amendments to the Inland Revenue Ordinance which are necessary for implementing the exemption.

Relaxation of the short-selling rules

Last year, the SFC introduced rules that made possible naked short-selling exemptions for all types of market-making and related hedging transactions. The Hong Kong Exchanges and Clearing Ltd  has also granted tick-rule exemption for all types of market-making transactions and hedging transactions of market makers of single stock warrants.

Both of them are now considering whether to extend the tick-rule exemption to hedging transactions of other market-makers and to further relax the criteria for index arbitrage transactions.

On the stock lending side, the HKEx has introduced a trial exemption to compulsory buy-in on trade day + 3 under certain circumstances. This effectively provides the flexibility to deal with settlement failure arising from delay due to recalling stocks that were lent out.

This trial proposal will last six months, after which the HKEx will assess the need to extend the trial period or to make the exemption permanent. Looking forward, we believe that the industry will have a more efficient and effective operating platform for trade execution.

Of course, we are not blind to the potential systemic risk posed by the large and concentrated positions of hedge funds to small and open economies like Hong Kong. We are therefore supportive of further market reforms in the international financial architecture to strengthen our financial systems.

Enormous potential for further development

Now you may ask, the hardware and software is here, the Government is all-supportive, what about the potential for further growth? What are the opportunities? And what makes Hong Kong better than our competitors in the region? To answer these questions, I will point you to a few developments.

At the end of the day, it is up to you to make your commercial decision of course. But I am highly confident that Hong Kong will remain 'the choice'.

CEPA opens up opportunities in the Mainland

Developments in the Mainland of China have offered, and will continue to offer, enormous opportunities for Hong Kong business executives for the past decade. The geographical proximity of Hong Kong to the Mainland, the historical and cultural ties, language advantage, years of trading and investment experience in the Mainland, abundance of professionals who know the Mainland system, and 25 years of economic co-operation and integration with the Mainland, have, in many ways, made Hong Kong a natural choice of doing business in China.

In June this year, the Central Government and the Hong Kong Government signed a landmark free-trade agreement, known as the Closer Economic Partnership Arrangement, between the Mainland and Hong Kong, or CEPA for short.

CEPA provides for market liberalisation commitments towards Hong Kong ahead of and beyond the Mainland's WTO commitments. It provides for tariff free treatment for 273 products, and improves market access for 18 services sectors, including four financial services sectors, namely, banking, insurance, accounting and securities.

It is important to note that this is just the beginning. CEPA adopts a building-block approach, which means there would be continuous discussions for further liberalisation of trade in goods and services between the two sides.

Way paved for HK banks to offer renminbi services

You will have read in the news about the signing of a memorandum of understanding between the Hong Kong Monetary Authority and the People's Bank of China two weeks ago, which paves the way for Hong Kong's banks to offer renminbi services.

Banks in Hong Kong will be allowed to conduct four major areas of personal renminbi business, namely, deposit, exchange, remittance and credit-card services. This scheme marks an important milestone in the cooperation between Hong Kong and the Mainland in the financial field which has tremendous potential.

And China is moving forward at a fantastic speed. Its accelerating pace of economic and financial reforms, liberalisation of its capital markets, rising needs for sophisticated investment management and advisory services, as well as needs for international asset diversification, have offered, and will continue to offer, unprecedented opportunities for Hong Kong.

Today, with close to US$400 billion in foreign reserves, and savings deposits of US$1.18 trillion, China is potentially one of the largest investors in the region. Under WTO, China will allow foreign fund managers an initial one-third stake in its fund-management companies, which will increase to 49% over three years. Fund managers in Hong Kong are ideally positioned to capitalise on these opportunities.

MPF, Investment Entrant schemes contribute to growth

The launch of the Mandatory Provident Fund Scheme in 2000 contributes significantly to the sustained growth of our fund-management industry. As at the end of October, 319 MPF constituent funds were approved, with a net asset value of about US$10 billion. Contributions to MPF Schemes are accumulating at a rate of about US$250 million per month.

Another development which you may wish to note is the implementation of the Capital Investment Entrant Scheme on October 27. The scheme enables foreign nationals to apply for Hong Kong citizenship by investing not less than about HK$6.5 million in either real estate or specified financial instruments in Hong Kong.

In less than two months since inception, 67 applications have been received. So far, there are 10 approvals and approvals-in-principle, with total personal assets of the applicants amounting to over US$48 million. The response is encouraging. I am sure the fund-management industry would welcome this development in the long run.

Conclusion

There is enormous potential for Hong Kong's fund-management industry to grow much further. We have the best financial market infrastructure, an efficient and transparent regulatory regime, low taxes, a critical mass of multi-national financial institutions and talents with global exposure.

We believe in the market, and are doing all we can to facilitate its development and to remove impediments. To look to the future, China is our biggest advantage. The Mandatory Provident Fund Scheme and the Capital Investment Entrant Scheme will contribute significantly to the local demand for fund management.

We will continue to co-ordinate new initiatives to promote the development of Hong Kong's financial markets, including in the area of asset management. We have been in close touch with the industry to keep ourselves up-to-date with market developments, and will continue to review our policies to meet the needs of the investors and changing market environment.