The Taiwan Banker

Hong Kong's offshore financial sector has been highly successful, at least when measured by increased size. The bank assets-to-GDP ratio expanded from 462% in 2002 to 921% in 2021. Since the introduction of the currency board in 1983, Hong Kong has managed to keep the currency pegged and stable amid the political risks that have arisen from time to time. As the Hong Kong dollar (HKD) is closely pegged to the US dollar (USD), accessing Hong Kong's banking system and currency means access to hard currency. Driven by a desire for access to USD, Hong Kong's financial system is now increasingly dominated by Mainland Chinese banks. At the same time, overseas bank assets held by Mainland Chinese banks are heavily concentrated in Hong Kong. This significant exposure means that the destiny of Hong Kong as an offshore financial center depends much more on Mainland China than the rest of the world now. Mainland Chinese financial institutions have expanded 3.4 times since 2010, reaching $1.2 trillion in total asset size in Hong Kong. While Hong Kong's bank assets have grown quickly, Mainland China has outpaced other countries. Their share of assets in Hong Kong's banking sector increased from 22% in 2010 to 36% in 2020, even before Hong Kong's social unrest and Covid started. This surge is in stark contrast to European banks, which have barely increased their exposure in Hong Kong, and the much slower pace of Japanese and American players. While Hong Kong's offshore center is increasingly dependent on Mainland China, it is essential to note that Chinese financial institutions and corporations are increasingly reliant on Hong Kong for their overseas financing. Between 1997 and 2021, Hong Kong is the home to 75% of Chinese entities' offshore equity financing. It shows Hong Kong has been a critical funding venue as the onshore Chinese market has generally been perceived as too volatile and sometimes faces regulatory restrictions to curb stock price volatility. More recently, the access of Chinese entities to overseas financing beyond Hong Kong has become much harder. The US Securities and Exchange Commission (SEC) blocks new listings of Chinese companies unless they share internal audit information, among other requirements. If this were not enough, the SEC threatened to delist several of the 270 Chinese companies listed on the US stock exchanges. The much more limited access to hard currency financing makes Hong Kong even more critical for Mainland China. The trend is even more the case as stock exchanges in Mainland China have remained less relevant than Hong Kong for Chinese corporates' equity financing for years. The establishment of new stock exchanges, such as the Shanghai Stock Exchange Science and Technology Innovation Board, also known as the STAR market, and the Beijing Stock Exchange, aimed to improve corporates' access to onshore stock markets. However, it will take time to see results given the current bear market. Hong Kong is also the most significant offshore center for bond placement by Chinese companies moving to bond financing. While offshore issuance is limited in size due to the rapid growth of the onshore bond market, contributing 11% of total issuance between 1997 and 2021, offshore bond financing is tough to replace. The share of offshore bond issuance increased in 2014 and has remained high ever since. Looking at the different industries, Chinese financial institutions and property developers are the most dependent on Hong Kong. While banks fundamentally need access to USD liquidity due to the higher share of overseas loans, real estate developers are more likely to be pushed by tight domestic financial conditions. Given the severe financial difficulties of real estate developers, access to Hong Kong's offshore bond market, especially the high-yield one, seems essential. On policies, Hong Kong plays a vital role for Mainland China in renminbi (RMB) internationalization and further opening up through the Bond and Stock Connect schemes. For the former, Hong Kong is the home of 54% of offshore RMB bond issuances and more than half of RMB deposits offshore. In addition, the Bond Connect has become increasingly important for foreigners to enter China's onshore bond market. All in all, Hong Kong has evolved into a Mainland China-centric offshore center role. The change is, no doubt, important for Hong Kong. Finance is by far the most critical sector for the Hong Kong economy. However, Hong Kong is also important for Mainland Chinese corporations since it is their most significant source of hard currency financing. It is even more the case since US regulators have pressured Chinese corporates to leave US stock exchanges. In other words, we can think of Hong Kong as Mainland China's financial firewall at this time of high geopolitical tensions.