A few years ago it was almost fashionable to think that Hong Kong’s days as a leading Asian financial center were numbered. The city’s reputation for lax regulation looked like a handicap in the competition with London and New York for new stock market listings. Other Asian cities were on the rise, with Singapore making inroads in private banking and asset management. And the growing dominance of the massive Chinese market, coupled with mainland authorities’ promotion of a domestic financial center in Shanghai, seemed destined to marginalize Hong Kong.
Today, however, Hong Kong is thriving to an extent that most rivals would envy. The Hang Seng index rose 52 percent in 2009, one of the strongest recoveries among major market indexes around the world. The stock market operator Hong Kong Exchanges and Clearing attracted $31 billion in initial public offerings, the most of any exchange and 39 percent more than runner-up Shanghai. And at a time when bankers in New York and London are grappling with new regulations and bonus taxes, financiers have flocked to Hong Kong to participate in the dramatic upturn in Asian markets, strengthening the city’s claim to be the region’s leading financial hub.
Now the authorities are looking to build on those strengths. In February the government announced new tax breaks designed to promote the growth of exchange-traded funds and bond trading, and to lure more hedge funds to the city. Regulators are considering a number of measures aimed at increasing market transparency and improving consumer protection. And perhaps most important for the long term, the local authorities are stepping up efforts to make Hong Kong the leading offshore center for trading the renminbi and renminbi-denominated bonds, anticipating that China will gradually liberalize the international use of its currency.
“We will build upon the strength of Hong Kong,” K.C. Chan, Hong Kong’s secretary for Financial Services and the Treasury, tells Institutional Investor in an interview. “As China’s economy grows and as enterprises there thrive, they will take advantage of Hong Kong’s offering in financial services.”
Many bankers share a similar sense of optimism. “A lot of the initiative will come from within the mainland financial entities that are expanding in Hong Kong,” says Erwin Sanft, head of China and Hong Kong equities research at BNP Paribas Securities (Asia). “Regulators will need to be responsive to allowing the creation of products and services demanded by these institutions and their clients.”
Hong Kong has taken advantage of the dynamism of Asian economies to win a big share of the global IPO business and to attract a new wave of bankers looking for a piece of the region’s fast-growing fee pool. The city has jumped ahead of Singapore to rank as the world’s third-most-competitive financial center, behind New York and London, in the latest Global Financial Centres index, compiled for the City of London by consultants Z/Yen Group.
“Hong Kong has an excellent financial talent pool and infrastructure and is a strong financial services center,” says Andrew Gordon, Hong Kong–based executive vice president and head of broker-dealer and alternative-investment services for Asia at Bank of New York Mellon Corp. The bank, which plans to boost employment at its Asian headquarters in Hong Kong this year by 50, to a total of 200, won regulatory approval from Chinese authorities in February to manage Chinese stock and bond funds on behalf of foreign investors.
Renminbi trading outside of China has been minimal so far, but Chan, 53, believes it’s vital to Hong Kong’s long-term prospects.
Beijing has taken modest steps to relax controls on the use of its currency, whose unit is the yuan. Hong Kong residents have been allowed to buy up to 20,000 yuan ($2,930) a day since 2007 and can move as much as 80,000 yuan a day into China. Mainland individuals, in turn, are allowed to send the equivalent of $50,000 a year abroad.
In the past two years, the Chinese government and some of its banks have taken tentative steps toward developing an offshore bond market in renminbi, or RMB, as the currency is often called. They have issued a total of 16 billion yuan in bonds in Hong Kong. The Chinese government has done three issues worth a total of 6 billion yuan — a fraction of the 6.7 trillion yuan in outstanding central government bonds, but a start all the same. The mainland banks that have tapped the Hong Kong market include Bank of China, Bank of Communications, China Construction Bank, China Development Bank and the Export-Import Bank of China. In the past year, meanwhile, HSBC Holdings and the Bank of East Asia have each issued 1 billion yuan in bonds in Hong Kong, the first non-Chinese institutions to do so.
“We hope to get more of these type of bonds issued in Hong Kong, particularly government bonds,” says Chan, who earned an MBA and Ph.D in finance from the University of Chicago’s Booth School of Business and was dean of Hong Kong University of Science and Technology’s business school before taking up his post in 2007. “We would like to see investment products other than bonds denominated in RMB. This whole process will help Hong Kong establish itself as an offshore center in the RMB business. This will attract all kinds of investors globally.”
To be sure, this strategy is very much a long-term play. Beijing allows foreign companies to issue renminbi bonds in Hong Kong only through Chinese subsidiaries, and it requires that the proceeds be used in China. “We hope to see more such offerings, but right now the rules surrounding the issuance of RMB bonds restrict the number of issuers,” says Gordon of BNY Mellon, which acted as a trustee for HSBC’s bond issue. “We don’t see a lot of activity in this area. It comes around to the convertibility issue.”
Most analysts see only gradual moves at best toward freer convertibility. After allowing the currency to rise under a managed float for a couple of years, Beijing ordered a halt in 2008 and pegged the renminbi at a rate of 6.83 to the dollar. The government has been vocal in recent months in resisting U.S. pressure for renewed appreciation. But many observers expect change before too long.
Yifan Hu, Hong Kong–based chief economist for Citic Securities Co., predicts that Beijing will first shift from a dollar peg to a currency basket, and later move to a managed float that allows the renminbi to appreciate against that basket by 3 to 5 percent a year.
Hong Kong needs to develop greater liquidity in renminbi to support an expansion of the market, says Michael Buchanan, Hong Kong–based chief economist at Goldman Sachs (Asia). According to the latest disclosure by the Hong Kong Monetary Authority, there were 56 billion yuan on deposit in Hong Kong as of September.
“The key next step would be to allow Hong Kong institutions that are licensed to extend credit to take on leverage in Chinese yuan,” says Buchanan. “This will provide a credit multiplier effect in expanding the Chinese yuan monetary base in Hong Kong.”
Recent steps by Beijing to accelerate the internationalization of the renminbi are likely to grow the deposit base in Hong Kong. China has signed $95 billion worth of swap agreements with six trading partners — Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea — that enable them to settle trade in renminbi rather than dollars. Beijing requires that all renminbi trade payments be cleared by banks in Hong Kong or in neighboring Macao.
In early March officials from the People’s Bank of China, the country’s central bank, embarked on a road show to major Asian capitals to promote the renminbi as a trade-settlement currency. Trade between China and its Southeast Asian neighbors made up roughly 9 percent of the country’s $2.56 trillion global trade in 2008.
“What we are trying to do is get our banks to provide more RMB services, to facilitate more companies in using RMB,” says Hong Kong’s Chan. “As we gain more experience, as Chinese regulators gain more experience, we hope to see more such services be provided in Hong Kong. We love to see investment products that are denominated in RMB.”
Hong Kong’s renminbi ambitions may be starting from a small base, but most bankers agree that the potential is enormous. Indeed, the offshore dollar market had similar modest origins in the early 1960s, they note. “Hong Kong is doing the right thing to develop as an RMB offshore center,” says Cheng Cheng-mount, chief economist at Citigroup Global Markets in Hong Kong. “It could bring significant financial opportunities, just as the eurodollar market has to London.”
Hong Kong is bound to face increased competition. China’s State Council aims to develop Shanghai into a global financial center by 2020. That could pose a major threat to Hong Kong, which has built much of its recent boom on the back of Chinese companies. As of September, 483 mainland enterprises were listed in Hong Kong, accounting for more than one third of the market’s 1,146 companies. Chinese concerns have raised a total of HK$2.3 trillion ($296 billion) since 1993 and account for Hong Kong’s ten largest IPOs.
Chan sees the development of Shanghai as more of an opportunity than a threat. He wants to increase cooperation between the two centers. In January he signed a memorandum of understanding with his counterpart in Shanghai, Fang Xinghai, director general of the city’s Financial Services Office, to work together to develop financial products.
“If foreign exchange controls are lifted in China, it doesn’t mean Hong Kong will not be a strong place for firms to raise international capital,” Chan says. “That’s because Hong Kong has a concentration of international issuers and fund managers. Hong Kong is very diversified. Hong Kong will be a very good place to raise capital to do all kinds of financial transactions. If Shanghai is doing well, it means China’s financial services industry will grow. That also will be beneficial to Hong Kong.”
Hong Kong isn’t putting all of its eggs in the China basket, though. Chan has traveled frequently in recent years to Dubai, Moscow, New York, Seoul, Sydney, Tokyo and other financial centers to try to entice companies to list shares in Hong Kong. So far he can claim at least one notable success: Russian aluminum producer United Co. Rusal raised HK$16.7 billion in a public listing in January, money that will help it pay down its $14.9 billion debt. It was the first Russian company to list in Hong Kong and reflected an effort by local authorities to diversify the market.
Meanwhile, Hong Kong authorities are taking other measures to enhance the city’s attractiveness. In presenting his 2010–’11 budget to the Hong Kong legislature in February, Financial Secretary John Tsang announced a number of changes designed to bolster the city’s status as a global financial center. The government is extending tax exemptions for exchange-traded funds, increasing tax benefits for bond trading and promoting hedge funds by allowing even funds domiciled outside Hong Kong but run by city residents to qualify for tax exemptions on their profits. The new measures enhance the attractiveness of a city that already boasts some of the lowest taxes anywhere in the world, including a flat 16.5 percent corporate profits tax, a personal income tax rate of 15 percent and no taxes on dividends, capital gains and inheritances. The changes also stand in stark contrast to rising tax pressures in many developed markets, which earlier this year resulted in new taxes on banker bonuses in the U.K. and Germany.
“We appreciate the government taking these steps, as tax competitiveness is critically important for the growth of the industry,” says Christophe Lee, chairman of the Hong Kong chapter of the Alternative Investment Management Association. Martin Lau, Hong Kong–based director of greater China equities at First State Investments, the asset management arm of Commonwealth Bank of Australia, echoes the point. “The U.S. and U.K. are talking about raising taxes,” he says. “Many firms are thinking of moving top staff to Hong Kong these days. Having low taxes would play an important role for driving the direction of talent in the next one or two years.”
Low taxes are a particularly strong selling point for Chinese executives and investors, and for the international bankers who court their business. Hong Kong “will likely retain our role as a Chinese private banking and asset management center because of our low tax regime,” says David Webb, an independent corporate governance activist. “This will make it attractive for mainland tycoons to establish their tax residency here and remove it from the mainland.”
Although low taxes have long been a strong selling point for Hong Kong, regulation has not. The local market has long had a reputation for loose oversight and tolerance of insider trading.
That reputation wasn’t helped by the fallout from the collapse of Lehman Brothers Holdings in September 2008. More than 43,700 Hong Kong investors collectively lost almost $1 billion on investments in so-called minibonds, a type of derivative that the former investment bank sold locally as a supposedly conservative, low-risk product. The firm’s bankruptcy made those minibonds worthless overnight, prompting street protests by thousands of Hong Kong investors.
Chan worked closely with the city’s Securities and Futures Commission, the Hong Kong Monetary Authority and local banks that distributed the bonds to help reach a settlement last year under which the banks agreed to buy back the bonds for at least 60 percent of their face value. “I felt the regulators have actually done a good job in terms of doing investigations in a very short period of time and working with industry to come to a settlement with investors,” he says.
Prompted in part by the Lehman minibond experience, authorities have begun taking steps to strengthen regulation. Last year the SFC increased the blackout period for releasing sensitive information ahead of corporate earnings announcements to 60 days from 30, a move intended to prevent directors from profiting from share sales or purchases ahead of annual announcements.
Currently, the authorities are considering increasing penalties for violating listing rules, tightening regulations on how financial products are sold and establishing a financial dispute resolution center and an investor education council. “We would like to upgrade the quality of the market and to have a channel where investors can file their complaints and seek resolution through arbitration,” says Chan.
Activist Webb, a frequent critic of Hong Kong’s regulatory stance, believes the proposed measures are insufficient but at least point in the right direction. “The removal of [Chinese] capital controls will leave Hong Kong open to competition,” he says. “If we don’t then have a clear competitive advantage in terms of transparency, regulation and legal rights, then we risk losing ground to Shanghai.”
