THE investment scope of the Exchange Fund will be expanded to include the trading of derivatives for hedging purposes. The change is part of a larger proposal in the Exchange Fund (Amendment) Bill 1994 gazetted yesterday to improve the management of the Exchange Fund and to transfer certain powers now vested in Britain to the Hong Kong Government. The bill seeks to widen the scope of investment so that the Financial Secretary can enter into any financial arrangements for the prudent management of the fund, after consulting the Exchange Fund Advisory Committee. The existing investment instruments of the fund are confined to bonds and any change in investment securities has to be done in consultation with the British Government. 'We are constrained in the types of securities we can invest and there is a need to expand the categories which include derivatives,' said the chief executive of the Hong Kong Monetary Authority (HKMA), Joseph Yam. He cited this year as an example to show that an all-bond portfolio would face a no-win situation because the bond market worldwide has tumbled 20 per cent to 30 per cent in response to rising interest rates. However, he stressed that derivatives would only be used as hedging instruments to protect the underlying assets and would not be speculative tools to enhance returns. The amendment substitutes the Exchange Fund Advisory Committee for the secretary of state as the ultimate decision-maker. Meanwhile, to pave the way for the real-time gross settlement system (RTGS) to be implemented in 1996, the bill seeks to empower the Financial Secretary to require authorised institutions to open an account with HKMA for the account of the Exchange Fund. 'To minimise risk in the system, all banks will maintain a clearing account with the HKMA, not the Hongkong Bank any more, when RTGS is implemented,' Mr Yam said. The 'accounting arrangements' are contractual agreements between the Financial Secretary, as the controller of the Exchange Fund, and Hongkong Bank, as the management bank of the clearing house of the Hong Kong Association of Banks. Under the accounting arrangements, Hongkong Bank is required to maintain an account with the fund and to manage the net clearing balance of the rest of the banking system in such a way that it will not exceed the balance in its account with the exchange fund. The accounting arrangements allow the Government to influence the level of interbank liquidity and interbank interest rates, improving its capability of achieving exchange rate stability. The bill also contains provisions that would remove an impediment to the Exchange Fund raising funds at short notice when circumstances warrant. Under the existing provisions, the Financial Secretary may borrow for the account of the fund on the security of any asset held by the fund or on the general revenue. Such secured borrowings are subject to a limit of $50 billion. The bill will remove the ceiling on borrowings secured on the fund's assets. The limit will continue to apply to those secured on the general revenue. 'In crisis situations, we need flexibility in our borrowing,' a spokesman for HKMA said. The bill proposes a tightening of the mechanism for a transfer of 'excess assets' of the Exchange Fund to the general revenue and other funds of the Hong Kong Government. The bill imposes an additional requirement whereby the Financial Secretary must be satisfied that such a transfer would not adversely affect his ability to maintain the stability and integrity of the monetary and financial systems. The existing ordinance prescribes that such transfer can only be made when the fund maintains 105 per cent of its total outstanding obligations. The bill also transfers to the Hong Kong Government certain powers over the control of the fund now vested in the British Government. The amendments were consistent with the provisions in the Joint Declaration and the Basic Law, Mr Yam said.