Hong Kong: capital flight fears as tensions rise

For investors Hong Kong has long been the glob­al finan­cial system’s friend­ly go-between with Chi­na, now the sec­ond-largest econ­o­my in the world. Smooth run­ning mon­ey mar­kets, an inde­pen­dent legal sys­tem, a live­ly inde­pen­dent press and free speech has seen free­wheel­ing cap­i­tal mus­cle in and tal­ent flock to the for­mer British colony for decades. But times are chang­ing.

After a year of social unrest, the appa­ratchiks in Bei­jing are fed up, impos­ing a sweep­ing new nation­al secu­ri­ty law on a ter­ri­to­ry that was sup­posed to have semi-auton­o­my with a “one coun­try, two sys­tems” approach until 2048. The law will ban sub­ver­sion, seces­sion and sedi­tion.

Hong Kong’s posi­tion won’t be erod­ed overnight, but with­out assurances…overseas firms will over time shift their oper­a­tions else­where

This evolv­ing rela­tion­ship between Hong Kong and Chi­na has fired up geopo­lit­i­cal ten­sions with the West, rais­ing con­cerns among glob­al traders. Now the poten­tial for flight of cap­i­tal is pal­pa­ble.

“Chi­na is set­tling into a more antag­o­nis­tic rela­tion­ship with the rest of the world. Hong Kong’s posi­tion won’t be erod­ed overnight, but with­out assur­ances that com­pa­nies and staff there will enjoy strong legal pro­tec­tion and aren’t sub­ject to the arbi­trary treat­ment found on the main­land, over­seas firms will over time shift their oper­a­tions else­where,” says Mark Williams, chief Asia econ­o­mist at Cap­i­tal Eco­nom­ics.

Con­fi­dence in Hong Kong’s rep­u­ta­tion as a glob­al finan­cial cen­tre for investors seek­ing expo­sure to China’s vast mar­kets and com­pa­nies has tak­en anoth­er blow after Amer­i­ca said it’s seri­ous­ly con­sid­er­ing mea­sures to restrict mon­ey flow through the ter­ri­to­ry. Mean­while, the British gov­ern­ment says the new nation­al secu­ri­ty law is a clear vio­la­tion of China’s inter­na­tion­al oblig­a­tions. Ten­sions have been raised.

All this could hurt Hong Kong. The region is Asia’s third-largest cap­i­tal mar­ket, nine of China’s ten most valu­able com­pa­nies are list­ed there and two thirds of the funds Chi­na rais­es over­seas are chan­nelled through the city. It’s also a gate­way for investors in China’s $10-tril­lion bond mar­ket. And the cur­ren­cy that speaks the loud­est is not the ren­min­bi (RMB), but the green­back.

“I think it’s in the best inter­est of Chi­na to keep Hong Kong as its buffer zone. It’s also in the best inter­est of for­eign pow­ers not to ruin Hong Kong’s spe­cial sta­tus. But I hope with this new law we can restore sta­bil­i­ty, because pro­tes­tors have col­lapsed the city’s ‘can-do’ spir­it,” says Ronald Chan, chief invest­ment offi­cer at Chartwell Cap­i­tal.

A demon­stra­tor waves a black flag dur­ing June protests mark­ing the first anniver­sary of a his­toric march against the extra­di­tion bill

A safe pair of old China hands

This glob­al finan­cial cen­tre has his­tor­i­cal­ly been one of the world’s safest and most effi­cient places to trade, despite protests, clash­es and tear gas. As inter­na­tion­al mar­kets go, Hong Kong is as free as you can get. This city on the Pearl Riv­er delta has also helped Chi­na reach out and lib­er­alise its finan­cial mar­kets with the Stock Con­nect scheme.

“Equi­ty prices in the broad­er Chi­na mar­ket and Hong Kong specif­i­cal­ly are more attrac­tive than the aver­age. How­ev­er, it’s worth not­ing that these mar­kets are both volatile and this volatil­i­ty may increase dur­ing the cur­rent polit­i­cal sit­u­a­tion,” says Dan Kemp, chief invest­ment offi­cer, Europe, Mid­dle East and Africa, at Morn­ingstar.

Yet Hong Kong is also the ulti­mate sur­vivor. Brav­ing the 1997 han­dover to Chi­na by Britain and Asian finan­cial cri­sis, its banks were also large­ly unscathed by the glob­al finan­cial crash of 2008. It’s main­tained some of the low­est tax­es in the region and is one of the largest wealth man­age­ment cen­tres in Asia. The rela­tion­ship between Hong Kong and Chi­na is buoyed by mete­oric eco­nom­ic growth rates on the main­land.

Smart mon­ey also still needs a place, with enough capac­i­ty and sophis­ti­ca­tion, to park and grow. This is why Hong Kong remains attrac­tive.

“It is very pos­si­ble that the new nation­al secu­ri­ty law for Hong Kong will reduce risks. For instance, insur­ers and long-term real estate investors should now have a clear­er view about trends post-2048, which could be ben­e­fi­cial as they look to invest long-term cap­i­tal,” says James Tunkey, chief oper­at­ing offi­cer at I‑OnAsia, a risk man­age­ment con­sul­tan­cy.

The biggest fear that Hong Kong has always had is that if trad­ing isn’t com­pet­i­tive then busi­ness will go else­where. It’s arch-rival Sin­ga­pore, hard­ly a bas­tion of free speech and democ­ra­cy, con­tin­u­al­ly nips at its heels. If you remove Hong Kong’s auton­o­my and its impar­tial legal sys­tem, then you might as well invest in Shang­hai. Now the wild card is how Pres­i­dent Don­ald Trump’s Amer­i­ca deals with Chi­na in this pres­i­den­tial elec­tion year.

Were Chi­nese com­pa­nies delist­ed or refused list­ing in New York, they may think twice about Hong Kong

“The US can­not act uni­lat­er­al­ly to revoke Hong Kong’s spe­cial sta­tus, but it can cre­ate sig­nif­i­cant dif­fi­cul­ties for how main­land Chi­nese com­pa­nies using the territory’s mar­kets are per­ceived by investors. The US’s pur­suit of Huawei is an exam­ple of the type of non-tar­iff mea­sures Amer­i­ca could pur­sue,” says Dr Dami­an Tobin, researcher at the Cork Uni­ver­si­ty Busi­ness School.

“Hong Kong has long offered main­land Chi­nese com­pa­nies a route to exter­nal cap­i­tal and this mar­ket would be jeop­ar­dised by any per­cep­tion that its mar­kets are no longer inde­pen­dent. For exam­ple, were Chi­nese com­pa­nies delist­ed or refused list­ing in New York, they may think twice about Hong Kong. Remem­ber this is not about val­u­a­tions since these are typ­i­cal­ly much high­er in Shang­hai.”

An issue managing two systems

Hong Kong’s use to Chi­na is also to do with the US dol­lar fund­ing it sup­plies; there is no mech­a­nism Chi­na has to replace this right now. The issue is whether Bei­jing is will­ing to risk dam­ag­ing this and the very foun­da­tions of the for­mer British colony’s suc­cess to assert greater con­trol.

But if investors believe the new nation­al secu­ri­ty law will bring sta­bil­i­ty, they may have to think care­ful­ly. There’s more at stake than slick mon­ey mar­kets and juicy returns. An uncer­tain ele­ment in this pow­er play is the Hong Kong peo­ple them­selves. Hav­ing to nav­i­gate the one coun­try, two sys­tems they inher­it­ed from the colo­nial era may just be too much for the territory’s politi­cians. It doesn’t help that ordi­nary peo­ple aren’t see­ing much in the way of eco­nom­ic prospects either. Here may lie the answer.

“The issue at stake is a per­sis­tent decline in gov­er­nance. There is lit­tle atten­tion giv­en to this issue. From Beijing’s side the secu­ri­ty law reflects a fail­ure by Hong Kong’s politi­cians to read the pub­lic mood and man­age the ten­sions asso­ci­at­ed with man­ag­ing and reg­u­lat­ing two sys­tems,” explains Tobin.

“It’s not just to do with finan­cial mar­kets. There is a fail­ure to find an effec­tive way of ensur­ing ben­e­fits flow to the wider soci­ety. The dai­ly vol­ume of Hong Kong to Shang­hai finan­cial flows increased from just over RMB5.5 mil­lion in 2017 to 21 mil­lion in the first three months of 2019, but this has had a very lim­it­ed impact on liv­ing stan­dards for a large swathe of Hong Kong’s res­i­dents.” Trad­ing strate­gists take note.