Market Views: Does China still need Hong Kong?
It's also a city in turmoil. Regular, almost daily protests have been taking place for 19 weeks now, and a solution is still nowhere in sight due to the increasingly hardline stances adopted by both the government and protestors.
Growing numbers of demonstrators appear to believe it's only a matter of time until they are quashed by a vengeful Beijing. Yet they seem dedicated to make such a step as painful as possible in a strategy they call “if we burn, you burn with us”.
Meanwhile, Chinese troops and tanks started to assemble in bordering Shenzhen in August, sending a signal that the the People's Liberation Army might be deployed to quell the protests.
The ongoing protests have already had a big impact on Hong Kong's economy, but it's also damaged its reputation for ease of doing business and finance. Some observers believe Shanghai and Shenzhen will be fastracked as replacements for Hong Kong, as both possess relatively advanced financial infrastructure.
According to China's “2020 Vision” plan, first unveiled in 2009, the central and city governments intend to make Shanghai an international financial hub that can meet the funding needs of the country's economy by next year. More recently in mid-August the State Council rolled out a plan to enhance Shenzhen’s social and economic power.
The eventual aim is to make Shenzhen's economic strength rank among the top cities in the world by 2025 and an exemplary city for the country by 2035 – adding to speculation that Beijing wants to replace the unruly and recalcitrant Hong Kong with its neighbouring city.
But are Shanghai and Shenzhen ready to take over Hong Kong's mantle as an international financial centre? And in what ways does China still need Hong Kong? We asked seven market experts for their opinions.
The following extracts have been edited for brevity and clarity.
Brock Silvers, managing director
For the moment, China still needs Hong Kong. While Shanghai and Shenzhen are solid substitutes in some regards, neither can replace Hong Kong as a finance or capital markets centre.
One major difference is simply the city’s legal system. Hong Kong’s rule of law provides a security to foreign corporates and investors that Chinese cities cannot match. The rapid development and increased attractiveness of those cities, while undeniable, still can’t overcome this distinction.
In fact, today’s environment of worsening trade relations and global Chinese enforcement of domestic political concerns only increases the value of an independent legal system in Hong Kong. In the long run, Chinese reforms could be a significant threat to Hong Kong. If Shanghai shared Hong Kong’s legal system, it would immediately become a top-tier global financial centre, and Hong Kong would lose much of its value to Beijing. This would surely please parts of China’s bureaucracy.
But such reforms remain unrealistic for the foreseeable future, and if Hong Kong can maintain the integrity of “one country, two systems” it may continue to thrive once social stability resumes.
George Magnus, economist and associate
Oxford University’s China Centre
As Asia’s premier financial centre and China’s window on the world, Hong Kong plays a very important role for the Chinese economy, for Chinese companies and investors.
Around 8,000 international companies have their principal regional headquarters in Hong Kong, and there are more than 60 consulates there. The city is a huge magnet for talent and for the provision of financial services, which are important for people running businesses in China.
The question, in extremis, is: if for some reason Hong Kong were to lose its status overnight or even over five or six years, will that make a difference to China? The answer is yes.
Yes, some of those business and financial services could be relocated to Shenzhen or Shanghai.
But anecdotally, I have spoken to some local businesses in Hong Kong, and they question whether there would be any point in them staying in Hong Kong if China’s organisational influence were to increase more quickly because of the consequences of trying to pacify the city.
That would likely prove a deterrent for some of the talent that’s assembled there. Hong Kong is a rule-of-law territory, which makes it stand out against potential rivals.
In extreme circumstances, if troops were sent in, that’s a worst-case scenario that would accelerate the demise of Hong Kong. Net-net, that would be a loss to China and I don’t think it can be replicated in a [mainland] Chinese city.
Lorraine Tan, director of research for Asia
Our view is the Hong Kong stock market remains the preferred access point for China equities and this status is unlikely to change over the next few decades. While both the Shanghai and Shenzhen stock exchanges have been growing and the Chinese government recently removed limits on QFII and RQFII quotas, there are still impediments to these mainland markets gaining the full confidence of global investors.
China’s legal system, capital controls and the full convertibility of the Chinese yuan renminbi, as well as transparency and consistency of enforcement are commonly cited as key considerations by global investors. While Shanghai is ranked fifth in the Global Financial Centres Index, and it is expected to make progress on the above, we have not seen enough enhancement in the legal system, and policy consistency to protect minority shareholders to pinpoint a timeframe.
In addition, a shift in the mission of the central bank is needed. The objective of China’s monetary policy is to maintain stability in the value of the currency and thereby promote economic growth. This contrasts with most global central banks where monetary policies are often independent of fiscal policy.
We have not seen a very big disruption in Hong Kong, but we expect to see a general slowdown in terms of retail, tourists and hotel businesses. Needless to say, we have not seen the detrimental effects in full scale yet such as devaluation, plummeting sales figures and declining profit growth from companies. We also believe there will be some economic policies coming from the government to promote growth in the near future.
Could Shanghai and Shenzhen replace Hong Kong and carry some of the the core values that Hong Kong currently has? I don't believe so. My reasons are as follows:
- The judiciary of Hong Kong is sound, with a sound legislative system inherited from the former British colony. Its common law is widely recognised in the financial world all over the world. This gives an assurance from an investors point of view to invest here.
- In order to be an international financial hub/centre, the free exchange of Hong Kong dollars against other currencies is crucial. This also signifies the importance of the Hong Kong dollar's peg, which gives a economic stability and limits the foreign exchange volatility. Other cities cannot offer investors such assurance until we see the full internationalisation of the renminbi.
- It has a free port trade area and is also renowned for its unique independent tariff status, while it also benefits from a low tax environment. Even now, amid the US-China trade conflict, Chinese tariffs on goods imported from the US don't have any effect here.
- Hong Kong has an open and trustworthy internet and media exchange, which is important for all corporates and foreign companies. This is a very important pre-requisite for foreign investors to obtain news, which gives them important context to make investment decisions.
Under “one country, two systems”, we believe Hong Kong will continue to serve as an IPO hub for local and foreign investors. Bear in mind that it is more difficult to list shares in China and it possibly takes longer. Until we see the full internationalisation of the renminbi and a completely open market from China Hong Kong will play a key role in its economic development and economic reform.
Stewart Aldcroft, senior fund industry adviser
For more than 150 years, Hong Kong has been the gateway into and out of China for trade, finance and a multitude of other activities and services. As a result, there is an enviable wealth of knowledge accumulated on how to do business with and for China.
Global as well as Chinese businesses value the system of common law applicable in Hong Kong, the presence of all major banks that are able to provide financing solutions, trade finance, investment management and custody, legal advisers to provide legal advice and guidance on doing business throughout the region, auditors who can ensure accounts are correctly prepared in accordance with international standards, and others to help ease the flows.
Hong Kong acts as the software that drives Chinese hardware. This is why China needs Hong Kong.
When doing business, especially in the financial services area, the importance of trust can never be underestimated. Trust works for both sides, i.e. China and the rest of the world, and that too is what Hong Kong provides.
Alicia Garcia Herrero, chief economist for Asia Pacific
Gary Ng, economist for Asia Pacific
The share of Hong Kong’s GDP to the rest of China has shrunk over years, but it does not mean that Hong Kong is less important. One could argue Hong Kong is more vital strategically. The most obvious aspect is finance, and in particular the increasingly relevant role as China’s most widely used offshore centre. For example, Hong Kong was home to 73% of China’s initial public offerings overseas and 60% of bond issuance offshore.
The importance of Hong Kong can be summarised in four key points:
- Although the onshore market is growing rapidly, Hong Kong remains a key magnet for Chinese firms to get USD funding. This will continue to be important as long as China keeps capital controls in place.
- Hong Kong has a widely diversified investor pool that enables Chinese firms to access liquidity from international investors.
- Hong Kong plays a critical role in RMB internationalisation and financial opening.
- Some 60-70% of China’s inward and outward foreign direct investment goes through Hong Kong.
In sum, as long as China keeps capital control in the onshore market, Hong Kong will continue to play a vital role as a financial firewall. Shifting offshore funding onshore to Shenzhen or Shanghai is not feasible today, nor is it easy to move it to Singapore, London or New York, as Hong Kong’ investor base is complimentary for Chinese financial institutions, which dominate many segments of the market. This is not true in any other existing offshore centre.
The story has been updated to include Natixis's views on this topic.