Commentary: To save its markets, Hong Kong needs to rely on China
Although there is no obvious capital exodus from Hong Kong yet, the US sanctions can be quite detrimental to the island’s financial and property markets, says CUHK’s Simon Lee.
HONG KONG: On Jul 14, US President Donald Trump signed the “Hong Kong Autonomy Act” and issued an executive order on Hong Kong Normalisation.
It states that “Hong Kong is no longer sufficiently autonomous to justify differential treatment in relation to the People’s Republic of China”.
This decision was taken by the Trump administration after “the National People’s Congress of China announced its intention to unilaterally and arbitrarily impose national security legislation on Hong Kong”.
If there is no differential trade treatment for Hong Kong, the city will be treated by external countries such like the US as the same as other cities in China in many aspects, including passport control and trade status.
Perhaps the only differences that remain between Hong Kong and other Chinese cities are the free flow of money, information, people and an independent judicial system.
Although there is no obvious capital exodus from Hong Kong yet, the US sanctions can be quite detrimental.
In 2019, according to the Hong Kong Trade Development Council, about 11.2 per cent of China’s exports were handled via Hong Kong. Imports and exports contributed 17.2 per cent of Hong Kong’s GDP, generating 376,600 jobs.
The total trade value between Hong Kong and the US was HK$517 billion (US$67 billion) with imports at HK$213 billion, domestic exports at HK$3.7 billion and re-exports, routed through Hong Kong, at HK$300.3 billion.
According to the President Trump’s Order, the US will revoke license exceptions for exports from Hong Kong, re-exports from Hong Kong, and transfers within Hong Kong of items subject to the Export Administration Regulations.
If there is no preferential treatment, these re-exports may no longer pass through Hong Kong. The impact to Hong Kong’s economy could be substantial, including specific sectors.
IMPACT TO THE FINANCIAL SECTOR
The Hong Kong Autonomy Act, targets the financial sector.
First is the identification of “persons” who are described as “materially contributing to, has materially contributed to, or attempts to materially contribute to the failure of the Government of China to meet its obligations under the Joint Declaration or the Basic Law”.
Second, the identification of “any foreign financial institution that knowingly conducts a significant transaction with a foreign person.”
The president can levy sanctions on these persons and foreign financial institutions.
Section 7(b) of the Hong Kong Autonomy Act states the potential sanctions such as prohibition from acting as a primary dealer in US debt, participating in foreign-exchange transactions that are subject to US jurisdiction, on the export of commodities or software to the financial institution, on any US person from investing in equity or debt of the financial institution.
It is obvious that foreign institutions would try to stay away from such foreign persons or otherwise as these institutions would be sanctioned by the US government. These financial institutions will not only suffer from sanctions in certain transactions but also suffer reputation loss.
If the US government sanctions a particular financial institution, its operation would definitely be seriously jeopardised.
According to global financial messaging service SWIFT, in May 2020, about 40 per cent of global payments were made in US dollars, 33 per cent in euros and only 1.79 per cent were in renminbi. The Hong Kong dollar accounted for only 1.41 per cent of global payments.
The US dollar is still the widest used currency in the world. Thus, any restrictions in foreign exchange transactions that are subject to the US jurisdiction and sanctions will undermine Hong Kong as an international financial centre in the region.
The US economy is also the biggest in the world, and the New York Stock Exchange (NYSE) and the NASDAQ are the two biggest stock markets globally with total market capitalisation of US$35 trillion.
Therefore, global financial institutions, which typically have shareholders from the US, cannot ignore American investors.
For example, dealers in US debt or foreign exchange transactions are subject to the US jurisdiction. Financial institutions may still be able to deal with US debt in an alternative way or have foreign exchange transactions not subject to the US jurisdiction, but the scale of such opportunities would be limited.
STOCK MARKET BENEFITS FROM CHINESE COMPANIES
Also, if other countries take a leaf from the US’ book to issue similar sanctions, then these financial institutions will not be able to provide full-scale global operations to their customers.
Already, Australia, the UK and New Zealand have all announced a review of policies that regarded Hong Kong as separate from China. The UK, for instance, suspended its extradition treaty with Hong Kong and extend its arms embargo with China to the island.
Will the stock market in Hong Kong collapse? It may not.
About 54 per cent of the weight of the Hang Seng Index stocks are mainland or mainland-related companies. As long as the economy of China performs well, international investors can still use Hong Kong to invest in these companies.
International investors can also invest directly in the Chinese markets through the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect but these are subject to a daily northbound quota for each market at 52 billion renminbi.
The utilisation of the north bound quotas is on average at a 40 per cent rate and it indicates that investors prefer to invest in mainland companies through Hong Kong instead of through the stock connect.
Financial services contributed to 19.8 per cent of GDP in 2018 and professional services such as accounting, legal and auditing, contributed another 1.4 per cent. Many of these activities are related to services for the listed companies and wealth management.
If President Trump sanctions the export of commodities or software to financial institutions, these companies may eventually not be able to receive the necessary information to perform some transactions.
Already, the disappearance of preferential treatment was seen even before the President’s Order.
In April, the Federal Communications Commission approved Alphabet Inc unit Google’s request to use part of a US-Asia undersea telecommunications cable. Google agreed to operate a portion of the Pacific Light Cable Network system between the US and Taiwan, but not Hong Kong as the US regulators had blocked its use.
This incident has revealed that even before the security law was passed, the US regulators were subjecting Hong Kong to the same wary treatment as China.
WILL INVESTORS STILL PAY PROPERTY MARKET PREMIUMS?
The Hong Kong property market has been relatively stable after the implementation of the national security law and Trump’s latest announcement.
As of Jul 17, the Centa-City Leading Index, which reflects Hong Kong's property price index, is at around 180.81 – which is 1.04 per cent higher than the previous week and 9.2 per cent lower than its historical high of 190 last July. The demand for housing is always strong in Hong Kong. Unless the core values of Hong Kong change, otherwise, the demand remains.
As the differences between Hong Kong and Chinese cities converge, foreign investors may start thinking it better to invest directly in other mainland cities rather than paying a premium cost to keep their operations in Hong Kong.
Investors have been willing to incur premium charges for office rentals and residential costs in Hong Kong because the city offered access to China while also retaining core values that they would be more comfortable with.
With a new national security law that came into effect on Jun 30, investors may feel that some of these core values may have changed or even disappeared, bringing into question if they would still feel the need to pay a premium to be in Hong Kong.
If Hong Kong’s role as an international financial centre and re-export hub between China and the US diminishes, the island stands to lose many business opportunities. The demand for housing may drop and level of premium paid by users will reduce.
If Hong Kong is treated as just another mainland city, salaries and house prices would be equalised eventually. It all depends on how the Hong Kong Autonomy Act is implemented and if President Trump wants it to be a symbolic gesture or if he is going to push for more sanctions.
Hong Kong has long occupied a crucial intermediary role for China's economic development. That should now count for more if the rest of the world is going to reduce economic ties with Hong Kong.
Simon Lee is Senior Lecturer at the School of Accountancy and Co-Director of the International Business and Chinese Enterprise Programme at the Chinese University of Hong Kong Business School.