Government Stock Market Intervention
31 January 1999
On 14-Aug-98 the Hong Kong Government intervened in the stock market and the related futures market, which had fallen by over 50% in the preceding year following the bursting of a property and stock market bubble. The Hong Kong Monetary Authority drew its authority for such a move from its role as protector of the the currency and in particular the link between the Hong Kong dollar and US dollar. The HKMA alleged that "manipulators" were profiting from a "double play" involving shorting the currency to squeeze up interest rates, while holding large short futures positions, thereby profiting as the stock market fell in sympathy.
Of course, one man's "trading" is another man's "speculation" is another man's "manipulation". These trading strategies were only successful because the rest of the market was not willing to buy the stocks as they fell, correcting the fall. We have been vigorously opposed to the market intervention because it creates far more problems in the economy than it might have solved. Indeed, after the intervention was over, the government introduced some technical amendments to the peg mechanism which basically allowed them to damp down interest rate movements and make it much harder to squeeze up interbank rates. Had this amendment been made earlier, then the excuse for intervention would probably not have existed.
The logical extreme of intervention is when the government takes on a controlling or total interest in equities, that is, nationalisation. Experiments in communism since World War II, and to a lesser degree the nationalisation of industries in Western Europe, have all shown that such an economic system does not work. Even by buying 10% stakes in companies, the government has distorted the pricing mechanism for equity, which in turn affects the cost of funds for companies and lead to the inefficient allocation of capital in the economy. In addition, it creates conflicts of interest as the activities of almost all businesses are affected to some degree by the government of the territory in which they operate. For example, telecommunication licenses, the price of government land leases and transportation franchises all involve direct negotiation with the government. Now that a part of the reserves are invested in the equity of property developers, will the Government's land policy really be unaffected?
Read the following articles:
- The letter we wrote to the SCMP, (published on 20-Aug-98) regarding the question of whether the government, by seeking to artificially raise market prices, was creating a false market
- The SCMP article of the same date regarding my letter and including a response by Joseph Yam, Chief Executive of the HKMA
The HKMA claims it is above the law
On 3-Sep-98, a spokesman for the HKMA was quoted in the SCMP as stating that the Securities (Disclosure of Interests) Ordinance ("SDI") (requiring disclosure of interests in excess of 10% of the voting rights in a company) did not apply to the HKMA . The spokesman claimed that disclosing its holdings in Hong Kong firms would "assist speculators". SFC spokesman Bill Weeks was quoted as saying that he was aware the law allowed for exemptions to the disclosure rule but that "generally the commission's view is that the law applies to all".
- This prompted us to write a letter to the SCMP, (published on 4-Sep-98) regarding the effects of non-disclosure by governments on free markets, and estimating the extent of the intervention which later proved to be correct.
The law under which the HKMA sought exemption is known as the Interpretation and General Clauses Ordinance which in essence says that no law shall apply to the government "unless it is therein expressly provided or unless it appears by necessary implication that the Government is bound". Like most laws, the securities laws do not (in their text) explicitly apply to anyone, so the question boils down to whether it is a "necessary implication" that they should apply to the government.
We will probably never see this tested in court, but it seems to me to be common sense that if the laws on things like insider dealing, creating a false market, and disclosure of interests don't apply to everyone, then they don't achieve their objective of investor protection and market transparency. If only one investor (whoever that is) is allowed to keep his holdings secret, then other investors are disadvantaged (a) through not knowing and (b) through not being able to keep their own stakes secret. It has to be the case that when the government gets involved in the markets, it steps beyond the bounds of its exemption.
- In late October, the government finally came clean and disclosed that it had more than 10% of the voting rights in 2 companies. This meant that they had, in my opinion, breached Rule 33 of the Takeover Code, which requires notification of such holdings by 9.00 a.m. on the next business day after which they are acquired. The Code is voluntary and does not have the force of law, so my argument is that the government cannot claim exemption from it in law, but can choose not to comply with it, in which case the SFC, as market regulator, should take appropriate action. I raised this issue with the SFC, as well as the question of whether the SDI law should by "necessary implication" apply, and the SCMP ran an article regarding our correspondence with the SFC on 16-Nov-98. The article contains a response from the Chairman of the SFC.
This issue has not gone away. The government has transferred management of its portfolio to a wholly-owned company, Exchange Fund Investment Limited ("EFIL"). On 26-Oct-98, when releasing the first dislcosure of the HKMA holdings, Mr. T. L. Yang, the Chairman of EFIL, stated that "neither the Govenment nor EFIL is under any legal obligations to disclose" its holdings, while volunteering to disclose "incremental changes in shareholding of 1% or more". There was no reference to decremental holdings, so let us hope the voluntary undertaking includes those. However, the assertion of immunity from the SDI law means that EFIL considers itself to fall within the government's general exemption from some other laws, and we don't know what those are.
Paradoxically, Mr. Yang also stated that EFIL "will be subject to the full regulation by the Securities and Futures Commission". As we've already pointed out, the SFC regulates the Takeover Code, including Rule 33 regarding disclosure. EFIL's assertion of immunity is in stark contrast to the apparent views of the SFC Chairman Andrew Sheng, who was quoted in the SCMP on 14-Nov-98 as saying "[EFIL] is a private entity. It must follow all Hong Kong's laws and regulations". So that's clear then.
In Jan-99, EFIL invited selected investment banks, without a public tender, to present proposals for advisory services in relation to the portfolio. This may include the lucrative mandate to sell part or all of the portfolio. A shortlist was selected to give presentations on 4-6 Feb-99. Amazingly, legislator and EFIL board member and legislator Eric Li Ka Cheung was quoted in the SCMP as saying that factors for appointment include "where the banks are headquartered" (i.e. local favouritism), "their comments and predicitions on Hong Kong markets" (i.e. you've got to say you're bullish, even if you believe in 'random walk' market efficiency theory) and "their opinions on the Hong Kong dollar peg" (i.e. you've got to be a fan). Maybe the invitation should have advertised for "yes men" rather than advisers.
You can read our views on what EFIL should do in the article EFIL comes to LIFE.
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