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Futures Market: Hong Kong Experience Prof. Stephen Yan-Leung Cheung City University of Hong Kong Content Asian Financial Crisis (1997-1998) What happened Consequences Aftermath Lessons What Happened? Inflated asset price – Fell by 60% Potential recession – 1998 Q3 GDP ↓6.9% Other Asian currencies have sharply depreciated Market perceived that HK dollar was undervalued Hong Kong dollar is linked with US dollar with US$1 vs HK$7.8 What Happened? Pressures began in October 1997 on the forward rates for the HK dollar and regulated in a sharp full in equity market Pressures continued periodically through the first half of 1998 Weakness in domestic economy – Yen had fallen to an 8-year low of 147 per US$ – Renewed concerns an possible depreciation of RMB – In 1998. equity prices had fallen over 55% from their peak a year earlier, 12-month forward rate on the HK dollar was depreciated by 8% compared to 7.8 which is the official rate of HKD Double Play Taking short position in the equity market – – – Short-selling stock Short HSI futures contract Put option on HSI Putting upward pressure on the forward rates for the Hong Kong dollar → sharp fall in equity market Chart 1 HSIF Open Interest and 3-month Hong Kong Dollar Forward 175 8.2 155 . 8.1 115 7.9 95 7.8 75 7.7 55 HSIF Open Interest 3-month HK$ forward 9812 9811 9810 9809 9808 9807 9806 9805 9804 9803 9802 9801 9712 9711 9710 9709 9708 9707 9706 9705 9704 9703 7.6 9702 35 HK$/US$ 8.0 9701 Open Interest ('000) 135 9701 9702 9703 9704 9705 9706 9707 9708 9709 9710 9711 9712 9801 9802 9803 9804 9805 9806 9807 9808 9809 9810 9811 9812 Volatility 16% 55 14% 45 12% 10% 25 8% 6% 15 4% 5 2% -5 0% -15 HSIF Volatility 1m HIBOR HIBOR (%) . Chart 2 HSIF Volatility and 1-month HIBOR 35 Currency market Short position in the HK dollar may have established to over US$ 10 billion (6% of GDP) by institutions – SWAP-driven issuance of HK dollar dominated securities by international financial institutions in the first eight months of 1998 – Concentrated selling intended to move the exchange rate beyond the official exchange rate – Market rumors on devaluations of the HK dollar Derivatives market Activity on HSI futures contract rose from April to August 1998 4 hedge funds whose futures and options positions accounted for 40% in early August 1998 Their positions accounted for 49% of the total; one fund accounted for one-third Source: Report of the Work Group on Highly Leveraged Institutions (Financial Stability Forum 2001, BIS) Consequences HKSAR government’s intervention in the market during 14-28 August, US$ 15 billion in equities, led to the creation of HK tracker fund Subsequent improvement in the global outlook, the large hedge fund HSI futures positions were mostly unwound in October Risks Futures market – Concentration risk, a big concern? – Definitely yes for the economy, because of systematic risk Aftermath Open position limit Margin requirement Super-margin requirement Lessons (1) Communication channels between HKFE and SFC Coordination between regulators – Cross-market surveillance Committee Market Intelligent System Lessons (2) Education on products Investors Regulators Intermediaries ‘Big elephant jumped into a small pond.’ ~ END~