According to an old Chinese saying, a small hole not mended in time will become a big hole that is much more difficult to mend. 

The country’s ruling Communist Party doesn’t appear to be heeding it.

Its increasingly nationalistic, authoritarian and intimidatory approach to Hong Kong’s almost three-month series of protests risks doing longlasting damage to China’s economic ambitions and international reputation.

The latest incident to concern investors and Hong Kong citizens alike was the departure of Rupert Hogg, the chief executive officer of Cathay Pacific Airways, effective Monday (August 19), less than two weeks after reporting a strong half-year annual earnings result. Speculation quickly circulated he had left because China was furious that Cathay Pacific employees had participated in the protests and its chairman refused to condemn them. Paul Loo also stepped down as chief customer and commercial officer.

International companies have always had to guard what they say and how their staff act in the mainland, knowing how sensitive Party officials are to views that are even obliquely criticise their authority. But it would mark a worrying escalation were China’s rulers to extend such arm-twisting to Hong Kong-based businesses.

As we have discussed, the more China seeks to impose itself on Hong Kong, the more it risks undermining the territory’s key advantage: the One Country, Two Systems agreement that supports Hong Kong’s independent rule of law, free media and commitment to international standards of business.

Beijing’s seeming willingness to punish companies for the actions of  their Hong Kong-based employees tears at the very fabric of the framework. It leaves companies facing the choice of censuring or firing employees for expressing views unpalatable to China – or facing the consequences of upsetting Beijing’s apparatchiks.

That would likely feed foreign investors’ existing apprehensions about the Party’s pernicious influence on companies operating inside its borders – and how much it dictates the plans of Chinese companies abroad.

CONTRITION AND GENUFLECTION

The step down of Cathay Pacific’s former CEO underlines just how prickly China is over the protests taking place in its boisterous southern territory.

On August 7 Cathay Pacific chairman John Slosar refused to condemn the cabin crew union's support of the protests during Cathay Pacific’s first-half results presentation. But the airline quickly changed tack, attempting to express support to the Hong Kong government, condemned protests at the city’s airport and complied with the mainland regulator demands to scrutinise crew in the name of safety. 

It ended by firing staff who supported the protests on August 14, and then parting ways with its CEO and chief customer officer.

The Swire group company isn’t alone. On Friday (August 16), Hong Kong’s top four accounting firms or the ‘Big Four’ put out separate statements distancing themselves from an advertisement in support of the protests, which was purportedly arranged by employees, according to the South China Morning PostThey did so following demands by The Global Times, the English language arm of the state-backed People’s Dailythat they investigate and sack the staff behind the advertisement.

These are just the latest examples of Beijing punishing companies that it believes caused it to lose face – or that it sees as being convenient scapegoats.

On June 13, Swiss bank UBS apologised for a senior economist’s quip about swine flu, which some Chinese readers interpreted as racist. It led the bank to lose its prime position arranging a $1 billion US dollar bond deal for state-backed China Railway Construction, according to ReutersDolce & Gabbana and Burger King also have had to face the ire of liberties taken by them with cultural stereotypes. 

Earlier this year, China banned Korean soap operas and music and then air purifiers and toilet seats made by Samsung and LG after tensions flared up between China and South Korea over the latter’s plan to install US anti-missile batteries.

LONG-TERM PAIN

To date, this bully-boy behaviour hasn’t resulted in any serious international censure from investors. 

On February 3 The Wall Street Journal reported that US index provider MSCI decided to start including Chinese equities into some of its benchmarks last year despite some investors raising concerns over the robustness and transparency of the country’s stock markets. And yield-hungry fund houses have also been happy to buy into bonds from Chinese real-estate firms, despite clear signs that the country’s property bubble is deflating.

That appears to have only emboldened China. It’s also forcing analysts and credit rating agencies to consider how judgemental they can dare to be about Chinese bonds and equities.

But its behaviour could, and should, have long-term consequences. For a start, risk-management is rising to the forefront of investment management. Investors in Chinese assets would be sensible to  start demanding premiums to account for the risk of holding the country’s assets – especially if they feel research houses can’t say what they truly think.

In addition, considerable numbers of asset owners and fund houses now claim to believe in environmental, social and governance (ESG) behaviour. If they are genuinely taking the importance of governance in particular into account then they should be prepared to negatively grade the assets of Chinese companies acting as vessels of government policy and international companies willing to sacrifice their own workers' happiness and rights for the whims of an authoritarian government.  

China's antics should also limit the ability of firms in the mainland get access to cheap funding. There are signs this may be happening. A senior executive told AsianInvestor in late July that the lower-than-expected uptake of Chinese bonds by foreigners was due to the lack of onshore research capabilities and the difficulty in hiring independent analysts to do that for them. 

It's worth bearing in mind that the country isn’t flavour of the day with foreign fund houses right now. Concerns over the health of its economy led investors to yank $2.9 billion from funds that invest in Chinese stocks in the month leading to August 14, according to data from EPFR.

Beijing might be successfully intimidating companies to toe the line it wants in both Hong Kong and the mainland in the short-term. But if investors are serious about assessing geopolitical and governance risks, these efforts should come at a sizeable cost over the longer term. 

Investors interested in the strategies of China’s asset owners can learn more at AsianInvestor's sixth Institutional Investment Forum China on September 18 in Beijing. Please click here for more details. 

Richard Morrow contributed to this article.