Two decades on from the handover of sovereignty from the United Kingdom to China, Hong Kong currently ranks first in the world according to the Heritage Foundation’s 2019 Index of Economic Freedom, ahead of Singapore, New Zealand, Switzerland and Australia (the United Kingdom ranks 7th). Hong Kong’s economic freedom score is currently 90.2, supported by trade freedom, monetary freedom, and government integrity backed by a high-quality legal framework that “provides effective protection of property rights and strongly supports the rule of law” according to Heritage Foundation data. The key is Hong Kong practises the separation of legislative, executive and judiciary powers, so checks and balances are baked into the system.
There was also a time when Hong Kong was seen as a genuine competitor to London and New York as the pre-eminent global financial centre. Its position as a gateway to China, high growth emerging markets and Greater Asia, cementing that view. The tax system is simple and efficient, with a Standard Income Tax of 15 per cent and a Corporate Tax rate of 16.5 per cent. Hong Kong has the highest concentration of banking institutions in the world, playing host to more than 71 international banks out of the largest 100, supported by a very strong presence of fund management companies. In addition, Hong Kong’s domestic economy is mature, but it does depend on the Chinese mainland to support its role as a financial centre. Currently, Chinese companies makeup 42 per cent of the total capitalisation of the Hong Kong stock market and in recent years up to 80 per cent of funds raised through initial public offerings (IPO) in Hong Kong were by companies from the mainland. Its own stock market is capitalised at 12 times the gross domestic product of Hong Kong (the US Equity market is capitalised at 1.5 times the US gross domestic product). Of course, it is also important to recognise that Hong Kong generates just three per cent of China’s GDP today, whereas back in 1997, it generated 18 per cent of China’s GDP. Its economic value to China is on the wane.
Recent events around the well documented, 24-hour global social media footage of the protests, that erupted over a subsequently withdrawn extradition bill, have led to a wealth of detractors emerging, arguing that political turmoil will undermine the city as a credible financial centre and certainly question its economic freedom. China’s possible intervention will make it more difficult for financial firms to operate, its argued, and China itself could turn its attention to promote Shenzhen as its priority as a global financial centre. Any international response to further unrest could lead to sanctions or other forms of financial punishment that would likely have a hugely detrimental effect on Hong Kong being the gateway to China. It is important to recognise that Hong Kong is a global business centre and not a nation. This implies that ongoing protests targeting, for example, retail sales, with the knock-on effect of dampening tourism, will undermine Hong Kong’s total economic output. It does, however, remain unclear as to whether this in itself, will impact Hong Kong’s status as China’s “window to global capital”. What is clear is that alternative are not naturally forthcoming, although Singapore is a potential beneficiary as the leading financial centre in the region, if Hong Kong continues to suffer from protests, although Singapore is itself more recognised as having a financial reach more to Southeast Asia, and not Asia-Pacific as a whole. China could endorse London as a beneficiary in the longer term. Something we shall explore further.
In the meantime, Hong Kong gross domestic product will shrink by 1.5 per cent this year, and many economic analysts are expecting a further 3 per cent fall in 2020, in the absence of a significant fiscal stimulus. Visitors through the airport are down by 13 per cent, and retail sales figures are falling by more than 15 per cent according to monthly data. Economic outflows are still limited, but the word is that many of the wealthier clients of the likes of HSBC or Standard Chartered are opening international accounts in countries like Singapore. Alarm bells are ringing and not necessarily on mainland China.
Of course, the economic pulling power of China should not be underestimated. Any international financial firm thinking about shifting away from Hong Kong, or even denouncing the response to the protests, would find itself shut out of business development that is supportive of China’s ongoing economic growth. That is presently a big risk for Banking, Insurance and Asset Management CEO’s to consider. There is no doubt that Hong Kong’s destiny remains in China’s hands. China in the meantime is unlikely to grant Hong Kong liberal democracy, just because of a few riots, whilst firmly backing its own model of universal suffrage. Nor will it let Hong Kong break free from mainland Chinese control. Since September this year, Chinese state-owned enterprises have been asked to play a larger role in Hong Kong, with the clear underlying message that only state-owned companies can be fully trusted. In order to retain a say in Hong Kong’s political future, the finance sector will have to follow the ‘Chinese dream’. That is the entire business sector, both domestic and international, in order to have a seat at the table in Hong Kong.
When considering what might happen if Hong Kong did lose its status as a key Asian, even global, financial centre, the alternatives are many but not necessarily ideal. We have already highlighted Singapore as a candidate, but so is Tokyo, Shenzhen or Shanghai. China itself would likely want to build up Shenzhen as a potential replacement. The advantage Hong Kong has over other Chinese cities, of course, is the “one country, two systems” policy. Hong Kong’s legal system is very similar to the international standard, which gives investors a degree of comfort. Cities within China could not replicate that option. China is unlikely to sanction Tokyo as its ‘gateway to capital’ although it could lean more on London as a recognised global financial hub. This option being recently highlighted by a failed bid for the London Stock Exchange by Hong Kong Exchanges and Clearing Limited (HKEX). In early October this year, HKEX refrained from sweetening its £29.6 billion bid but did say, in a regulatory statement that “ the board of HKEX continues to believe that a combination of the London Stock Exchange Group and HKEX is strategically compelling and would create a world-leading infrastructure group.” Under UK Take-over rules, HKEX will not now be able to pursue a bid for the London Stock Exchange for a minimum of six months to beyond April 2020. However, a clear pathway to maintaining unfettered access to the global capital markets may have been revealed by the actions of HKEX. Only London could meet China’s growing demand for a deep and wide offshore financial centre, as China continues to increase its economic influence on the world. In this instance, the United Kingdom breaking away from the European Union would be seen positively, as a further indication of their independence as an offshore financial hub for the likes of China.
Does China need Hong Kong as a financial centre? In commercial banking terms, Hong Kong has outstanding loans of USD725 billion to the mainland, which is 35 per cent of total outstanding loans, but to the mainland is only 3.7 per cent of outstanding Chinese domestic loans. In fact, nearly 40 per cent of Hong Kong loans go to state-owned firms, who could very easily be replaced and sourced by direct funding from mainland China. The Hong Kong stock exchange used to be a leading trading market for the larger Chinese companies but now has a daily volume closer to USD8 billion, compared to USD48 billion for Shanghai and Shenzhen combined. Of course, Hong Kong is known as the place to go for mainland company IPOs. The Financial Times highlighted that between 2010 and 2018, 73 per cent of Chinese IPOs were handled there. Hong Kong also accounted for 26 per cent of syndicated loans and 60 per cent of overseas bond issuance for mainland companies, according to the Hong Kong Monetary Authority. However, things are changing as more Chinese companies are taking part in offshore listings. Earlier this year, it was noted that there were 156 Chinese companies now listed on US exchanges, including eleven Chinese state-owned companies. They had a combined market capitalisation of USD1.2 trillion. So despite ongoing trade war concerns, it would be easy to paint a picture of Chinese companies diversifying away from Hong Kong as a place to list, in search of arguably richer valuations in a more financially stable environment. The same trend is occurring in the Bond market, with USD177 billion of Chinese backed bonds trading in Hong Kong being dwarfed by a growing offshore market for China, that has over USD300b billion of outstanding bonds, denominated in US Dollars.
The internationalisation of the Renminbi is another potential element to Hong Kong’s importance to China. It is attempting to play the middle man between China and the global economy with regard to foreign exchange trading. However, this has not been a growing or successful role for Hong Kong. As of April 2019, according to the Financial Times, just 4.3 per cent of global foreign exchange trading was handled in Hong Kong. Much of this, in itself, was down to ‘ in-house’ trading between the Hong Kong dollar and the Renminbi. In essence, Hong Kong has not forced itself onto the global foreign exchange markets as the go-to trader in the key Chinese currency, despite taking into account the closed economy aspect that China offers. With outstanding loans, stocks, bonds and currency, Hong Kong is proving itself not to be as important to China as it may have been two decades ago.
Of course, where Hong Kong does have value to mainland China as a financial centre is in the area of China controlling its access and being able to introduce a domestic financial company offering. That is something China cannot do when dealing with the hubs of New York, London or Tokyo. China can impact its currency and to a certain extent, international investment interest into the mainland via Hong Kong. This should be considered when looking at the slow but deliberate ‘mainlandisation’ of the Hong Kong economy. Commercial Chinese Banks are playing an increasing role in Hong Kong. Their share of Hong Kong bank assets has increased from 22 per cent in 2010 to nearly 40 per cent this year. They feature in many more IPOs today than ten years ago. China will take comfort from the domestic banking system asserting itself within Hong Kong. Unfortunately, this development could bring into question Hong Kong’s much-admired independence as an environment to do business in. This development applies across many professional services on offer in Hong Kong – like accounting and law – and Chinese firms are increasingly successfully competing by offering their services at cheaper rates on the other side of the border in mainland China.
Hong Kong has been rewarded for many years as a place that enjoys better economic freedom than any other place in the world. Its role as an important financial hub on a global stage has strengthened considerably this century, supported by being a key gateway into China. However, the recent protests and reaction, are giving a signal that things are changing. Mainland China has no desire or need to compromise its universal suffrage and its own long term ‘Chinese Dream’ to accommodate Hong Kong. It is evolving the Hong Kong model to allow for domestic companies, some state-owned, to take greater control in its economy and offer a competitive solution. It will want to do this in a methodical way, so as not to impact on the domestic Chinese economic agenda. In doing so, Hong Kong will, undoubtedly, have a continued role to play on a global financial stage, albeit with less influence than it has enjoyed in recent years.
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