HKMA Money Market Operations Under the Linked Exchange Rate System: The Role of Financial Institutions

The Hong Kong Monetary Authority (HKMA) issued a series of updated operational guidelines in late 2024 and early 2025 concerning the conduct of money market operations under the Linked Exchange Rate System (LERS). These updates, detailed in HKMA circulars from October 2024 and January 2025, introduced stricter compliance requirements for licensed banks acting as market makers and placed new emphasis on the real-time monitoring of Hong Kong dollar (HKD) liquidity flows. For financial institutions—particularly those holding or applying for a Money Broker Licence or a Restricted Banking Licence—understanding these revised operational parameters is no longer optional. The HKMA’s stated objective is to enhance the resilience of the HKD money market against volatility stemming from global interest rate differentials and cross-border capital movements. This article provides a structured overview of the current money market operations under LERS, the specific responsibilities of financial institutions, and the procedural steps required for regulatory compliance. It does not constitute legal advice.

The Legal and Operational Framework of LERS

The Linked Exchange Rate System is established under the Exchange Fund Ordinance (Cap. 66). The HKMA operates the system by maintaining the HKD exchange rate within a defined band against the US dollar. The operational mechanics involve the Convertibility Undertaking, which allows banks to convert HKD into USD at the weak-side Convertibility Rate. The HKMA’s money market operations are the primary tool for managing liquidity and ensuring the system’s stability.

The Convertibility Zone and the Role of the HKMA

The HKMA sets the Convertibility Zone, which is the band within which the HKD exchange rate may fluctuate. The weak-side Convertibility Rate is fixed at 7.85 HKD per USD. The strong-side Convertibility Rate is 7.75 HKD per USD. When the exchange rate approaches the weak-side limit, the HKMA purchases HKD from banks. When it approaches the strong-side limit, the HKMA sells HKD. This mechanism is not discretionary; it is an automatic undertaking.

The HKMA’s money market operations include the issuance of Exchange Fund Bills and Notes (EFBNs), which are the primary instruments for absorbing or injecting liquidity. The HKMA also conducts daily liquidity operations, including overnight and term repurchase agreements (repos), to manage the aggregate balance of the banking system. The aggregate balance is the sum of banks’ clearing accounts held with the HKMA. It is the key indicator of HKD liquidity.

The Role of the Discount Window

The Discount Window is a standing facility that provides overnight liquidity to licensed banks against eligible collateral. The HKMA sets the base rate for the Discount Window. The base rate is determined by the higher of the US Federal Funds Target Rate or the Hong Kong Interbank Offered Rate (HIBOR) for the relevant tenor, plus a fixed spread. As of the HKMA’s January 2025 circular, the base rate is reviewed daily.

Banks may borrow from the Discount Window for a maximum of one business day. The collateral must be EFBNs or other securities that the HKMA deems eligible. The HKMA’s circular of October 2024 clarified that banks must pre-position eligible collateral at the Central Moneymarkets Unit (CMU) before accessing the Discount Window. Failure to do so results in a penalty rate of the base rate plus 5 percentage points.

Responsibilities of Licensed Banks Under LERS

Licensed banks are the primary participants in the HKMA’s money market operations. Their responsibilities extend beyond simple compliance. They must act as market makers and maintain adequate liquidity buffers.

Market Making Obligations

A licensed bank that operates as a market maker in the interbank HKD market must quote two-way prices for HKD against USD for standard tenors. The HKMA’s 2024 Supervisory Policy Manual (SPM) module on market conduct requires that these quotes be firm and executable for a minimum notional amount of HKD 50 million. The bank must maintain these quotes during the HKMA’s designated trading hours, which are 8:00 a.m. to 5:00 p.m. Hong Kong time.

The HKMA monitors compliance through its Money Market Statistical Data Reporting system. Banks must report all HKD spot and forward transactions above HKD 10 million to the HKMA by 9:00 a.m. the following business day. The reporting deadline is strict. Late submissions attract a warning letter, and repeated non-compliance may lead to a suspension of market-making privileges.

Liquidity Coverage Ratio (LCR) and the Aggregate Balance

The Banking (Capital) Rules (Cap. 155L) require licensed banks to maintain a Liquidity Coverage Ratio (LCR) of at least 100%. The LCR is calculated as the ratio of High-Quality Liquid Assets (HQLA) to total net cash outflows over a 30-day stress period. Under the LERS framework, HKD-denominated HQLA are primarily EFBNs and cash held at the HKMA.

The HKMA’s January 2025 circular introduced a new requirement: banks must maintain a minimum aggregate balance of HKD 500 million for every HKD 10 billion in HKD-denominated deposits. This is a prudential measure to ensure that banks can meet their Convertibility Undertaking obligations. Banks that fall below this threshold must submit a liquidity restoration plan to the HKMA within 5 business days.

Reporting and Disclosure Requirements

Banks must submit a daily report to the HKMA detailing their aggregate balance, holdings of EFBNs, and any Discount Window borrowings. The report is due by 10:00 a.m. each business day. The HKMA also requires quarterly submissions of the bank’s stress test results under a scenario where the HKD weakens to 7.85 per USD for 5 consecutive business days.

The HKMA publishes aggregate data on its website, but individual bank data is confidential. However, the HKMA may disclose a bank’s non-compliance to the public if it determines that the non-compliance poses a systemic risk. This is a significant reputational risk for any institution.

The Role of Non-Bank Financial Institutions

Non-bank financial institutions, including money brokers and finance companies, have a more limited but still important role in the LERS money market. Their operations are governed by the Money Brokers Ordinance (Cap. 90) and the HKMA’s supervisory guidelines.

Money Brokers and Interbank Dealing

Money brokers act as intermediaries between licensed banks in the interbank HKD market. They are not permitted to trade on their own account. The HKMA’s 2023 guidelines require money brokers to maintain a record of all transactions for at least 7 years. They must also report all HKD transactions above HKD 5 million to the HKMA within 30 minutes of execution.

Money brokers must not provide any form of credit to their clients. Their role is strictly that of a facilitator. The HKMA may suspend or revoke a money broker’s licence if it finds evidence of market manipulation or failure to report transactions.

Finance Companies and the HKMA’s Money Market

Finance companies that hold a Restricted Banking Licence may participate in the HKD money market, but only through a licensed bank as their settlement agent. They cannot directly access the Discount Window or the Convertibility Undertaking. Their HKD liquidity is managed by their settlement bank.

The HKMA’s January 2025 circular clarified that finance companies must maintain a minimum of 10% of their HKD liabilities in EFBNs or cash at their settlement bank. This is a new requirement. Finance companies that fail to meet this threshold must submit a compliance plan to the HKMA within 10 business days.

Enforcement and Penalties for Non-Compliance

The HKMA has a range of enforcement powers under the Exchange Fund Ordinance and the Banking Ordinance (Cap. 155). Non-compliance with money market operational requirements can lead to administrative penalties, licence conditions, or criminal prosecution.

Administrative Penalties

The HKMA may impose a financial penalty of up to HKD 10 million for each instance of non-compliance with reporting requirements. For failure to maintain the minimum aggregate balance, the penalty is HKD 1 million for each day the shortfall persists. These penalties are set out in the HKMA’s 2024 Enforcement Policy Statement.

The HKMA may also issue a reprimand or require the bank to publish a corrective statement. The decision to impose a penalty is made by the HKMA’s Deputy Chief Executive after a formal hearing. The bank has the right to appeal to the Chief Executive of the HKMA.

Licence Conditions and Revocation

For serious or repeated non-compliance, the HKMA may impose additional licence conditions. Examples include requiring the bank to hold a higher minimum aggregate balance or to submit weekly liquidity reports. In the most severe cases, the HKMA may revoke the bank’s licence.

The HKMA’s power to revoke a licence is found in Section 22 of the Banking Ordinance. The HKMA must give the bank 14 days’ notice of its intention to revoke the licence. The bank may make written representations to the HKMA during this period. The HKMA’s decision is final, subject to judicial review by the Court of First Instance.

Criminal Liability

Failure to report transactions or providing false information to the HKMA is a criminal offence under Section 80 of the Banking Ordinance. The maximum penalty is a fine of HKD 5 million and imprisonment for 7 years. The HKMA typically refers such cases to the Department of Justice for prosecution.

Actionable Takeaways

1. Licensed banks must pre-position eligible collateral at the CMU before accessing the Discount Window to avoid the penalty rate of base rate plus 5 percentage points.
2. Banks must maintain a minimum aggregate balance of HKD 500 million for every HKD 10 billion in HKD deposits, as per the HKMA’s January 2025 circular.
3. All HKD spot and forward transactions above HKD 10 million must be reported to the HKMA by 9:00 a.m. the following business day.
4. Money brokers must report HKD transactions above HKD 5 million within 30 minutes of execution and retain records for 7 years.
5. Finance companies holding a Restricted Banking Licence must hold 10% of HKD liabilities in EFBNs or cash at their settlement bank, with a compliance plan due in 10 business days if the threshold is not met.

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