By Donald Tsang, Hong Kong's Financial Secretary

Outdated financial architecture must be strengthened to maximize global financial integration. The destabilizing impact of volatile capital flows on markets must be minimized.

Pain is a transient feeling. It can cripple us at its most intense, but when it abates how quickly we forget. With signs of economic recovery emerging in Asia, are we beginning to forget the pain and suffering we have endured over the past two years? Moreover, as stock markets across the region revive, there is a danger of forgetting important lessons learned from the financial crisis. If that happens, we risk falling into a similar, if not worse, crisis in the new millennium.

The message is clear: The world's economies must not weaken their resolve to push through reforms to global financial structures. The Asian crisis - like its European and Mexican predecessors - revealed a common problem of excessive leverage in the global financial system. Banks and corporations over-stretched themselves in risky or unproductive investments using borrowed money at home and abroad. Some hedge funds were on very high gearing, clearly untenable at the swing of the market. When some investors became nervous and withdrew investments, others quickly followed. This unleashed a sequence of predictable but disastrous events: corporate default on payments, massive outflow of foreign exchange, currency devaluation, market collapse and fall of government. The rest of the world suffered, too, as their banks re-scheduled payments and took "hair cuts," and the IMF passed its hat around for more rescue money. Globalization of the world's financial institutions means that, irrespective of where a major financial problem began, it will spread almost immediately to the rest of the world. Indeed, we can no longer describe this effect as "contagion" spreading through wholly separate markets. The world's open markets are organs of the same body. If one organ goes down, the whole body falls ill. It is foolhardy to believe that any open market benefits from the demise of another. There was inadequate risk management by investors, creditors, debtors and regulators. A lack of transparency at individual firm and government levels made it difficult for investors to assess risks. Aside from pressing on with reforms in each country, the problem must be tackled on a global scale. Outdated financial architecture must be strengthened to maximize global financial integration. The destabilizing impact of volatile capital flows on markets must be minimized.

In our increasingly interdependent world, building a more robust international financial system is everybody's business. Policymakers should pursue consistent and sustainable economic and exchange rate policies, enhance transparency and disclosure, promote the adoption of best practices and international standards, and strengthen regulatory regimes. International financial institutions should respond more swiftly and effectively to crises, and participate in efforts to improve transparency. Creditors and financial intermediaries should adopt sound market practices, exercise prudent risk management, and collect and disseminate sufficient information to allow accurate risk management. And investors need to better grasp underlying risks involved in their decisions. The IMF is strengthening public sector transparency, and Hong Kong is involved by adhering to the Enhanced Special Data Dissemination Standard, which governs disclosure of international reserves and external debt. We have also taken part in the pilot study of the IMF's new Code of Good Practices on Transparency in Monetary and Financial Policies.

At the individual firm and market participant level, guidelines regulating entities are being reviewed by international working groups and regulatory bodies to ensure better risk measurement and management. Assigning appropriate capital structure to holders of risky assets is also being considered. Hong Kong welcomes the initiative of the Financial Stability Forum, formed earlier this year by the G7 economies, in broadening its participants to include Australia, Hong Kong, the Netherlands and Singapore. It will be useful in coordinating future efforts that address issues surrounding highly leveraged institutions, offshore financial centers and short-term capital flows.

The substantial effort devoted to reforming the global financial architecture is encouraging. But serious challenges lie ahead. So here I come back to my original point. With memories of the latest financial crisis fading, the momentum for change may lose steam. It is crucial that economies affected by the crisis continue reforms and pursue macroeconomic policies conducive to economic growth.

What's more, we need to establish a permanent mechanism for industrial and emerging market economies to discuss these problems, to build consensus and to take collective action. Only when these reforms are implemented will we have an effective global system to deal with future crises.