Hong Kong has historically thrived as Asia's global financial center, serving as a conduit for capital moving to and from mainland China as well as an operational base for companies in the region. That status did not change after the handover of the city from capitalist Great Britain to communist China in 1997, even though civil liberties slowly eroded once Beijing was in charge.
The recent passage of controversial national-security legislation could be a game changer for Hong Kong though. The law criminalizes sedition, subversion, terrorism and collusion with foreign forces. Those offenses are punishable by up to life imprisonment. Suspects can be extradited to the mainland. The law also asserts extraterritorial reach over non-Hongkongers: Anyone in the world who violates the law is subject to punishment.
China's ruling Communist Party unveiled and passed the law at warp speed. Just six weeks separated the first mention of the law and its formal enactment on June 30. Beijing caught the city and world, distracted by the coronavirus pandemic, off guard.
By ramming such a harsh law through Hong Kong's legislature, Beijing dealt a death blow to "one country, two systems," the model of governance that has provided Hong Kong with a high degree of autonomy from the mainland since the handover. Hong Kong may not yet be "just another Chinese city" but it is certainly no longer an exception to the mainland's rules.
The question is, what can anyone do about it? By the Communist Party's reckoning, not a whole lot. Even if the U.S. sanctions both Hong Kong and the largest mainland banks – a definite possibility – Chinese leader Xi Jinping and his colleagues believe they can absorb the hit. Their priority is the pacification of Hong Kong, which in their view has become a dangerous beachhead for opposing CCP rule. The violent protests that wracked the city last year were the last straw for Beijing, which has long sought to bring Hong Kong to heel.
From the standpoint of international finance, the biggest problem with the national-security legislation is that it undermines Hong Kong's robust rule-of-law tradition. If the long arm of mainland law can reach into Hong Kong, the city loses much of its appeal as a freewheeling but safe hub for global capital.
That is not the case for Chinese companies, who are familiar with the mainland and its legal system. Despite the political turmoil engulfing Hong Kong, the city has been one of the world's hottest IPO markets since the fall of 2019 on the back of mainland investment. Alibaba's US$14 billion secondary share listing in November 2019 rejuvenated investor confidence, paving the way for a steady stream of deals that only ebbed at the height of the pandemic in China early this year.
From January to June, the HKEX was the world's fourth busiest stock exchange with US$4.17 billion in deals, behind only the Nasdaq, China's Star Market and the Shanghai Stock Exchange, according to Refinitiv.
Some of the most anticipated deals of the year have happened since the national-security legislation was announced. Tencent-backed payments service provider Yeahka debuted in Hong Kong on June 1, raising US$197.3 million in an IPO that was oversubscribed 640 times. Also in June, gaming firm NetEase and e-commerce giant JD.com listed on the HKEX, raising US$2.7 billion and US$3.9 respectively. Both firms are listed on the Nasdaq and sought to raise new capital closer to home amid a looming U.S.-China financial war.
Deal flow has remained robust thus far in July. Chinese e-cigarette and vape maker Smoore International raised US$918 million in its Hong Kong IPO, the largest listing of the year so far. Tianjin-based China Bohai Bank, which is backed by Standard Chartered, aimed to raise about US$1.8 billion in its Hong Kong debut on July 16.
PriceWaterhouseCoopers expects up to 180 companies to raise as much as HK$260 billion (US$33.4 billion) on the HKEX this year.
At the same time, foreign financial firms dependent on Hong Kong and mainland China business are falling into line, in some cases overtly signaling their support for the national-security law.
"HSBC reiterates that under the ‘one country, two systems’ principle, it respects and supports all laws that stabilise Hong Kong’s social order and boost the economy to develop prosperously," the London-based bank said in a June WeChat post.
"We believe the national security law can help maintain the long term economic and social stability of Hong Kong," Standard Chartered said in a June statement on its website.
Known unknowns and unknown unknowns
The most likely outcome for Hong Kong is that persistent mainlandization of the city naturally orients its financial sector towards the mainland. The steady stream of Hong Kong IPOs from Chinese firms represents the capital markets side of this trend.
With the Greater Bay Area mega-project, Beijing aims to more closely link the financial sector in Hong Kong, Macau and Guangdong Province. Under a new pilot program, mainland residents of the Greater Bay Area (GBA), which includes Guangzhou, Shenzhen and seven other Guangdong cities, will be allowed to open special investment accounts with banks in Hong Kong and Macau to buy approved wealth-management products (WMPs). The scheme also permits Hong Kong and Macau residents to buy WMPs sold by mainland banks operating in the GBA.
The mainland has a dominant share of Hong Kong's next-generation banks as well. Of the eight virtual banks approved to operate in the city, just one, WeLab, is a local Hong Kong firm. The other seven are consortia largely composed of mainland tech giants and finance incumbents. Airstar Bank, for instance, is backed by Chinese smartphone maker Xiaomi, while ZA Bank is backed by insurance giant ZhongAn Insurance, Ant SME is a subsidiary of Alibaba's Ant Group and Fusion Bank is a joint venture between Tencent and the International and Commercial Bank of China (ICBC).
Beijing's reluctance to reform its financial sector also bodes well for Hong Kong, ensuring that the city remains China's financial window to the world. The renminbi will not float freely anytime soon, nor will China open its capital account. On the contrary, Beijing will likely tighten capital controls amid economic malaise.
What may augur less well for Hong Kong is the fallout from the national security law among major democracies. The U.S. is best positioned to inflict maximum pain on the city, but not without harming its own interests. Large U.S. banks and other firms have significant Hong Kong operations.
Some officials in the Trump administration have raised the possibility of undermining the 37-year-old peg of the Hong Kong dollar to the U.S. dollar. That could be accomplished by limiting the access of Hong Kong banks to American dollars.
That move appears overly risky, and might fail anyway. Hong Kong has US$440 billion in foreign-exchange reserves supporting the peg, more than double the amount of money circulating in the city. In June, Hong Kong Financial Secretary Paul Chan said that the People's Bank of China could provide U.S. dollars if Hong Kong needed them amid U.S. sanctions.
Washington would also have to factor in how undermining the Hong Kong dollar's peg to the greenback would affect the global financial system. It would bring into question the viability of other dollar pegs, while rattling markets – "an outcome abhorrent to the White House ahead of the November presidential election," Stephen Innes, chief global market strategist at AxiTrader, told Agence France Presse in July.
However, Hong Kong will have to contend with greater competition among Asian financial centers in the future. Before Beijing moved to integrate the city's political and security system with the mainland's, there was little impetus to challenge Hong Kong's preeminent position. Now that Hong Kong has less autonomy from the mainland, the situation has changed. While no other city can directly challenge Hong Kong yet, over time, other financial centers could chip away at its dominance.
Singapore is one alternative to Hong Kong. While the city-state lacks Hong Kong's access to mainland China, it offers an attractive base for Southeast Asia operations. Rule of law remains ironclad in Singapore as well. Companies there need not fret about arbitrary political interference in their affairs.
To be sure, Singapore has an authoritarian streak, but the law is clear about what is permitted and forbidden. That's not the case with Hong Kong's national-security law, which vaguely defines offenses that could result in life imprisonment.
At the same time, the Chinese Communist Party's creeping influence in Hong Kong has spurred Japan to offer Tokyo as an alternative. The Japanese capital is not an obvious choice, with its relatively high taxes and low English proficiency. Still, Japan may offer perks to lure finance professionals from Hong Kong, such as tax breaks and an accelerated path to permanent residency. A project team set up by the ruling Liberal Democratic Party will prepare a package of recommendations this year.
Satsuki Katayama, a conservative member of Japan's House of Councillors, said in June that Hong Kong has the type of high-level global talent that Japan has long wanted to attract. She expects Hong Kong's star to fade. “There’s no way one can continue as an international financial center in an environment with no rule of law,” she was quoted as saying by The Wall Street Journal.