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Financial Reforms for Hong Kong

2 May 2001

The Honourable Antony Leung, JP
Financial Secretary
Government Secretariat
Central Government Offices
Lower Albert Road
Central, Hong Kong


Dear Mr Leung,

We are a policy think tank established in Hong Kong since 1989. Over the years we have made many proposals for financial reform, and are pleased that your predecessor's last budget addressed one such suggestion: to adopt accrual accounting for Government. We now set out further reforms that we believe are needed to strengthen Hong Kong's fiscal, monetary and financial system and make it competitive to serve China and the region.

1. Reduction of excessive reserves

The fiscal reserves, currently in excess of HK$400 billion, are extremely high. Since the Government has the power to raise additional funds at any time, through the issuance of debt or increases in taxation, it is quite unnecessary for the Government to retain large fiscal reserves as well. The arguments put forward for retaining reserves on this scale are spurious. Further, the reserves are mainly invested, via the Exchange Fund, in low yielding instruments such as US Treasuries, hence the return earned for the people of Hong Kong is low. The existence of such large reserves encourages politicians to put forward schemes for spending them, some of which may be wasteful, and at the same time cushions Government officials from the need to seek value for money. From all points of view, the retention of extremely large reserves in the hands of the Government is economically inefficient. A large portion of the reserves should be returned to the people of Hong Kong via such means as a dividend, a tax rebate or a tax holiday.

2. Fundamental review of tax system

We understand that a review of the tax system is in progress. However we believe that a more fundamental review of the tax system is needed. This should include:

1. Large-scale revision of the Inland Revenue Ordinance which has its roots in nineteenth century British colonial legislation. Many concepts need clarification, including the source concept for profits tax, and modernisation is needed to accommodate, for example, the service sector and e-commerce.
2. Better distribution of the tax burden. We have argued strongly over the years against the removal of large sectors of the population from the scope of salaries tax. Today, less than half the workforce pay tax. We believe that this is socially divisive, especially since many of those who do not pay salaries tax enjoy substantial tax-funded benefits such as subsidised housing. We would prefer a lower rate of tax to be paid by a more substantial proportion of the working population.
3. Maintain simplicity. The simplicity of the Hong Kong tax system has been a major economic asset. Unfortunately in recent years there has been a tendency to grant tax concessions for special classes of activity – and introduce concomitant anti-evasion measures – and to enter into double tax treaties. Although some complexity may be difficult to avoid, every effort should be made to keep the system as simple as possible. Complexity increases costs, diverts energies from productive uses to exploitation of loopholes, and provides opportunity for corruption.
   
   
3. Reform of the land system

Traditionally, the Hong Kong Government has raised up to one-third of its income from land-related revenues. The sale of land was in fact almost the first and certainly the major revenue-raising mechanism of the British colonial government. However, pursuit of land related revenues has led the Government, whether deliberately or not, to restrict the supply of land and keep property prices higher than they would otherwise be – to the detriment of the people and businesses of Hong Kong. The land problem is a very major one, reaching beyond the tax system and damaging Hong Kong's competitiveness. We would like to see consideration of the privatisation of Hong Kong's land in its entirety, i.e. a transition to a freehold system.

4. Privatisation

Following Britain's early lead in privatisation, most countries around the world embarked on major privatisation programmes in the 1980s and 90s. Hong Kong, where Government holdings are quite extensive, has made a very late and hesitant start with the sale of part of its stake in the MTRC. We would urge that the Government state firmly its commitment to large-scale privatisation. A list of privatisation targets should be published, and this could include such items as the Airport Authority, the Post Office, the Hospital Authority, the Housing Authority, the Port Authority, many Government operations such as water supplies, electrical and mechanical services, and the KCRC. And, as stated above, the entire land supply of the territory should be privatised by conversion into freehold.

The benefits of privatisation in other economies are well-documented. These include lower cost, higher quality, improved safety standards in the sectors concerned, and greater flexibility in the economy as a whole as entities within the privatised sector can achieve synergies through combination with entities in related sectors. Further, if Hong Kong can set a successful example of privatisation and build up experience, it will help Mainland China in its much larger privatisation needs, thus opening substantial long term opportunities for the Hong Kong economy. We believe the case for privatisation is compelling, and action should be taken without delay.

5. Value for money

Notwithstanding the valuable work of the Audit Department, we believe that compared with other developed economies there is remarkably little awareness of value for money, and accountability for the use of money in the Hong Kong Government and the Government-linked corporations (GLCs). Reasons for this include the lack of a proper accounting system (about to be remedied by the introduction of accrual accounting), general low transparency, inadequate scrutiny by legislators, and over-abundant reserves.

We believe that performance measurement systems, such as activity-based costing, need to be introduced into Government and the GLCs, so that inputs of resources are firmly linked through the activity chain to valuable outputs. By various means transparency needs to be improved, e.g. through the introduction of Freedom of Information legislation, so that scrutiny of Government activities can be more effective. There should be a review of grandiose over funded schemes like the Central Library, the Asian Games bid.

6. Government fees and charges

Government fees and charges have been raised over the years without necessary linkage with the economic cost of providing the service, indeed without consideration of whether the service needs to be provided by Government at all. We note that many fees have been frozen in recent years, but a freeze is useless if once it is over fees are simply raised again to "catch up". There should be a fundamental review of charged-for Government services. Many such services need not in fact be provided by Government at all but should be contracted out to private sector suppliers, where necessary under Government supervision to ensure standards. Where the provision of a service is retained within Government, the basis of charging should be reviewed and placed on a true economic footing (accrual accounting should help here).

7. Reform of the Hong Kong Monetary Authority

We welcome the commitment in the recent Budget speech to review the HKMA. We believe that this is an overmighty institution that has outgrown its proper role. The HKMA operates the linked exchange rate mechanism, acts as fund manager and banker to the Government, regulates banks, issues and trades securities, establishes and operates financial market infrastructure, and through its affiliates, operates a Mortgage Corporation and Hong Kong's largest investment company (EFIL). Some of these roles conflict; most are defined loosely, if at all; accountability for any of them is low. Notwithstanding its achievements in some of these roles, the HKMA overall is becoming a drag on the further development of Hong Kong's financial systems and needs to be reviewed.

We recommend the appointment of independent consultants with a brief to conduct such fundamental review. Reference can be made to ample overseas experience, including that of the UK where the function of banking regulation was moved from the Bank of England to the Financial Services Authority, leaving the former free to concentrate on monetary matters.

8. Financial market regulators

Current debate over the Securities and Futures bill has highlighted the tensions between the various regulators in Hong Kong's financial markets and the differing standards applying to different sectors. A welcome step was taken last year with the merger of three regulatory bodies into Hong Kong Exchanges and Clearing (HKEx). However, we believe that Hong Kong still has too many financial regulators - the HKMA, HKEx, the Securities and Futures Commission, the Mandatory Provident Funds Authority and the Insurance Commission. This increases costs and complexity for market participants, inhibits development, raises risks of loopholes and inconsistencies between jurisdictions, and generally acts as a drag on Hong Kong's competitiveness. If a single financial regulator is sufficient for the vast financial markets of the UK, we believe that five is far too many for Hong Kong.

9. Corporate governance

We welcome the commitment in the recent budget speech to improve Hong Kong's corporate governance. However, we recall commitments being made in previous budget speeches, with little subsequent result. Reform is needed: Hong Kong is certainly not a "paragon" of corporate governance at present; it may be better than other Asian jurisdictions, but some of these are catching up, and in such areas as protection of minorities, insider dealing, manipulation, Hong Kong's record is not good. This will seriously impact Hong Kong's competitiveness if not addressed.

Corporate governance in Hong Kong will not improve unless regulations are introduced which bite. The regulations, mainly the Exchange listing rules and other non-statutory codes, are too weak for the purpose, and, unfortunately, are rarely enforced against well-connected parties. Consideration should be given to reinforcing the regulations, including a thorough revision of the Companies Ordinance, and the granting of effective powers to investors to sue companies themselves.

Yours sincerely,

Alan Lung
Chairman