Hong Kong’s not so special status as China’s financial centre
Over time, Beijing will be perfectly happy to see it replaced by Shenzhen and Shanghai
Financial Times . September 27, 2019
Andrew Collier
Does China need Hong Kong as a financial centre? The People’s Daily certainly thinks so. In an editorial on September 16, the paper argued that Hong Kong was irreplaceable for China because of its importance as an offshore renminbi trading hub, its rule of law, its role as a risk and wealth management centre and its place as one of the freest economies in the world.
But is this true? Unfortunately, due to the globalisation of finance, along with rising mainland control of Hong Kong’s banks and corporate life, Hong Kong’s role in China’s financial system is likely to diminish.
The chief executive of the London Stock Exchange dismissed Hong Kong’s significance as a financial centre when the LSE rejected a takeover offer from the Hong Kong Exchange. “We view Shanghai as the financial centre of China,” David Schwimmer, the LSE’s chief executive, told the South China Morning Post.
In commercial banking, Hong Kong has outstanding loans (including non-formal “shadow loans”) of $725bn to the mainland. This is a hefty chunk of outstanding loans — 35 per cent of the total. But for the mainland, it is only 3.7 per cent of outstanding domestic loans of $19.7tn. Almost 40 per cent of the Hong Kong loans go to state-owned firms, which already have relatively easy access to capital within the mainland.
Hong Kong has an important and global stock exchange but volumes are far smaller than up north. Average daily volume is about $8bn, compared with $48bn in Shanghai and Shenzhen
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combined.
One of the big arguments for Hong Kong’s role is that it is a centre for the initial public offerings (IPOs) of Chinese firms, attracting crucial global capital. Hong Kong was the home of 73 per cent of mainland companies’ IPOs overseas between 2010 and 2018. In the same vein, Hong Kong accounted for 60 per cent of overseas bond issuance of mainland companies and 26 per cent of their syndicated loans, according to data from the Hong Kong Monetary Authority and investment bank Natixis.
However, although the Hong Kong market has been an important source of capital for mainland companies, offshore listings have grown significantly. By February 2019, there were 156 Chinese companies listed on US exchanges, with a total market capitalisation of $1.2tn, including at least 11 Chinese state-owned companies, according to the US-China Economic and Security Review Commission. Although the trade war has clouded the growth path, offshore listings in other countries could eventually replace Hong Kong for corporate listings.
Hong Kong also has an important bond market for China, with $177bn of bonds traded there. Once again, the offshore bond market is growing and could replace Hong Kong as a source of capital. Currently, there are $308bn of outstanding US dollar offshore bonds issued by Chinese companies.
Most sales of bonds and IPOs involve a global “roadshow” where the bank takes the company to visit investors across the world, usually including New York, San Francisco, London, Frankfurt and other cities. This makes any one location less important than it used to be.
There are a few other international programmes where Hong Kong plays a role for China. This includes the stock connect, under which foreign investors get preferential treatment when buying domestic Chinese shares via Hong Kong. Over the past year, this has attracted between $50bn and $90bn. This may be illusory. Interviews with traders (there are no available data) suggest a large percentage of this consists of Chinese state firms bringing capital back into the country, rather than true inflows of foreign capital.
Trade finance is also cited as an important link for the mainland. But that only accounts for HK$260bn ($33bn), or just 6.2 per cent of mainland loans at the end of 2018. This would be time-consuming but not impossible to replace in other jurisdictions. Similarly for wealth management; Singapore, Zurich and many other regions would be able — and happy — to pick up the slack.
The other area of focus for China is the internationalisation of its currency, an area where Hong Kong plays a key role as middleman between China and the global economy. Unfortunately, due to China’s closed economy, this has not been terribly successful, and as of April 2019 constituted just 4.3 per cent of global foreign exchange trading. Much of this is restricted to trading partners of China forced to trade in renminbi. The convertibility of the Hong Kong dollar is important to China but the eventual, more widespread use of the renminbi will erode this advantage.
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So if Hong Kong is not that important to China as a financial centre, what is its role? In a word: control. Much of Beijing’s interest in upholding the independence of Hong Kong has less to do with access to global capital than it does with controlling that access. As one Beijing finance official told me this month: “If you sell bonds in New York you have to give information to New York. In Hong Kong we have more control.” It is true, for example, that shifting to other exchanges for stock listings may be problematic if the US follows through on threats to remove Chinese firms from domestic markets.
This is confirmed by the gradual “mainlandisation” of the Hong Kong economy. Mainland commercial Chinese banks have expanded 3.2 times since 2010, reaching $1.2tn in assets, at a higher growth rate than the rest of the banking sector. Their share of Hong Kong bank assets has increased from 22 per cent in 2010 to 37 per cent in 2018. Ten years ago, only two Chinese investment banks were in the top 10 for IPOs. Now, there are five. Unfortunately, their access to favoured clients and ways of doing business don’t always square with Hong Kong’s vaunted independence.
This interference in corporate and financial activity was made clear during the recent protests, when Cathay Pacific fired two pilots due to their participation in the demonstrations. There was further confirmation from a report by Reuters that mainland state firms were ordered to invest more in key Hong Kong businesses such as real estate and tourism. Oddly enough, this appeared to be a valiant attempt to boost the Hong Kong economy, but the end result could be greater state ownership of Hong Kong corporate assets.
There are also unconfirmed rumours that local accounting firms have been asked to confirm that their employees are not demonstrating on the streets, or these firms won’t get mainland business. This slippage in Hong Kong’s independence is in direct conflict with the desire by Beijing to take advantage of the “regulatory arbitrage” provided by Hong Kong’s system, which could be lost over time.
As the independence of professional services — accounting, banking, corporate life — in Hong Kong is eroded, many Chinese firms will ask why they should pay the high fees for labour and rent when it is much cheaper across the border.
Practically, Beijing would not want Hong Kong’s financial advantages to disappear overnight. It takes time to develop new channels, which Beijing is busy doing. Eventually, though, China would be perfectly happy to see Shenzhen or Shanghai replace Hong Kong.
Andrew Collier is managing director of Orient Capital Research in Hong Kong