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SCMP Reporter

THE government's issue of Exchange Fund bills has provided the backbone of the Hong Kong dollar debt market since 1990.

  Beginning with two-year notes issued in November 1991, the programme was extended to three-year notes in October last year.

  There is a possibility that five-year notes will be issued later this year.

  The Hong Kong Monetary Authority has said work was underway on the extended maturity notes but the launch date is unknown.

  In 1992, the government issued four two-year bonds, raising $2.4 billion. Last year, there were five issues, raising $2.5 billion, and, as of this month, there were two issues this year, raising $1 billion.

   One of the main contributions of the Exchange Fund bill programme is the flexibility it has given the swap market through the ability to short bonds or bills.

  Andrew Fung, the manager of swaps and trading at HSBC Markets, said the Exchange Fund bill programme had been the major contributor to the construction of ''a realistic and liquid yield curve''.

  He said that before the bill programme, the interest rate swap market, a dominating factor for issuers of fixed income with up to three-year maturities, ''was basically a very small market, swap transactions were occasional, and dealing size was only $50 million or, at the most, $100 million''.

  ''It was corporate or commercial-driven. But, after the establishment of the programme, banks could provide swaps through arbitrage, so the swap market's liquidity has progressed by leaps and bounds,'' he said.

   ''Now if you receive a three-year swap and you cannot find a counter-party to square off your position, you just sell the government bond to match the position and you are only running a basis risk between the swap and government bond - this is basically the tax exemption risk; the tax factor dominates the basis risk.''   Although swap figures were only approximate, Mr Fung estimated that about $500 million to $700 million per week was swapped through brokers last year.

  The amount swapped through brokers for the last week of April and the first week of May was ''no less than a billion per week,'' Mr Fung estimated.

  Swap transactions through brokers account for only about 60 per cent of the total, with the remainder done through the corporate or direct markets.

  Mr Fung said the ability to hedge provided by Exchange Fund bills had, to a large extent, protected the market in the interest rate shock sparked by US interest rate hikes.

   In 1987, after a two-year bull run, it collapsed and became largely a private placement.

  ''It is a more orderly market now than during the crisis in 1987.

  ''Investors can still liquidate at a reasonable price to sell bonds; they can still get a reasonable quotation because market makers and arrangers can hedge their positions by shorting government bonds,'' Mr Fung said.



Fund gives flexibility to Hong Kong swaps