China Still Needs Hong Kong
The Alibaba listing shows how critical the city is for the financial future.
After another massive march on the weekend, Hong Kong’s protests have passed the six-month mark. Since they started, the protests have taken a toll on the economy and the city has fallen into its first recession in 10 years. Hong Kong is expected to run a budget deficit for 2019, the first since 2004. Increasing violence and a growing sense of unease are leading to predictions that Hong Kong is finished as a business hub and that it has outlived its usefulness for China.
Nothing could be further from the truth.
If the protests continue to grow and cause more unrest, this will certainly affect Hong Kong’s business hub status as multinationals might move their operations and capital elsewhere to places like Singapore. But while Beijing wants to diminish Hong Kong’s political rights and autonomy, it also wants to exploit its status as a global financial center – and it doesn’t have any easy options to replace it, as two recent events show.
In mid-November, Chinese logistics giant Alibaba launched its secondary market offering in Hong Kong, raising more than $11 billion, making it the biggest public offering globally in 2019. Then, at the end of November, U.S. President Donald Trump signed the Hong Kong Human Rights and Democracy Act. The law requires the United States to conduct an annual review of Hong Kong’s autonomy, with the ability to revoke economic privileges that treat Hong Kong as a separate economic entity and exempt it from sanctions and tariffs imposed on China. Beijing lashed out angrily at the United States, threatening dire consequences. It’s not surprising—because if the United States ever suspended its economic privileges for Hong Kong, this would not only be a massive blow to Hong Kong, but also severely damaging to China.
True to form, at the start of December, China banned U.S. naval ships and military aircraft from visiting Hong Kong and sanctioned U.S. nongovernmental organizations such as Human Rights Watch. Then, on the weekend, the chairman and president of the American Chamber of Commerce in Hong Kong were detained for two hours and denied entry to Macao.
One of the most common statistics thrown about regarding Hong Kong’s loss of significance is that its gross domestic product is only equivalent to 3 percent of China’s, down from more than 20 years ago when it was 18 percent. But given Hong Kong’s population of 7 million is less than 0.5 percent of China’s population of more than 1.4 billion, Hong Kong is clearly still punching far above its weight.
More importantly, Hong Kong’s worth has never been about the size of its GDP, but its functions as a business hub. Hong Kong facilitates the majority of investments and other financial transactions between China and the world. Hong Kong is also a major stock market for top Chinese firms such as Alibaba to launch IPOs, and it is the world’s top non-mainland yuan clearing center. In short, Hong Kong is China’s top international business hub. If Shanghai was capable of taking over Hong Kong’s role, it would have done so years ago.
Alibaba’s secondary market offering (its IPO was in New York in 2014) was hailed as a vote of confidence for Hong Kong. But Alibaba wasn’t just doing Hong Kong a favor; it was using the city in the same way that more than 1,100 mainland Chinese companies, including Tencent, Xiaomi, Haier, and state-owned enterprises have.
As a result, Chinese firms account for half of all entities on the Stock Exchange of Hong Kong and represent more than two-thirds of capitalization and 79 percent of turnover. As one of the world’s major international stock exchanges, Hong Kong has a wide pool of international investors, which mainland stock markets in Shanghai and Shenzhen lack. Hong Kong’s more established financial infrastructure and clearer regulations make getting listed a smoother and clearer process than on the mainland.
Hong Kong is also by far the biggest offshore clearing hub for the renminbi, accounting for more than 70 percent of deals. This is despite a growing number of cities, including London, Toronto, and Zurich, that also act as offshore renminbi hubs.
Meanwhile, almost two-thirds of direct investment into and out of China originate or are transacted through Hong Kong. Again, clear regulations and lack of capital controls mean it is much easier for investors to channel funds to or from the mainland through Hong Kong rather than directly. Simply put, Hong Kong is an indispensable gateway for foreign funds to China.
All these functions cannot be quickly taken over by Shanghai or Shenzhen anytime. Hong Kong possesses several key advantages that can’t be found in those cities or elsewhere on the mainland.
First, despite the Communist Party’s best efforts, it maintains rule of law which includes a legal system based on common law and an independent judiciary that is not directly controlled by the government. China’s notoriously opaque legal system is built on ambiguous and arbitrarily applied laws, secret kidnappings, and courts completely under the rule of the government. That renders business dealings deeply uncertain, and financial transparency often nonexistent.
Second, there are no capital controls, allowing for the free flow of funds into and out of the territory. On the mainland, strict controls limit how much money can be transferred outside of China by both individuals and corporations to prevent capital flight. Third, it features a relatively free press environment (which has come under threat in recent years) as well as uncensored internet. Contrast this to the mainland, where in addition to politically sensitive topics, even economic news can be censored.
In August, China came up with a plan to make Shenzhen a “model city” that would supposedly enable it to supersede Hong Kong. The information released by Beijing stated that Shenzhen would be able to carry out pilot administrative and legal reforms that also involved opening up its financial market and widening connections with Hong Kong. Just like a lot of plans Beijing has issued over the past few years, this one is full of grandiose language about innovation and global competitiveness, but short on actual substance.
While the central government is willing to preserve Hong Kong as a financial center, it continues to undermine its political rights. In mid-November, after the Hong Kong High Court ruled that the local government’s ban on face masks was unconstitutional and had to be ended, Beijing reacted furiously and stated that only the Standing Committee of China’s National People’s Congress, the country’s top legislative body, had the right to decide on Hong Kong constitutional matters. Consequently, the Hong Kong court suspended its ruling on the face mask ban, allowing it to stay in place for a week, while the authorities unsuccessfully appealed to keep the ban in place. The government can never make the kind of commitment to independent, transparent resolution on the mainland that Hong Kong enjoys—indeed, the fuss over court rulings favoring protesters has made it clear how much Beijing loathes the existence of the Hong Kong courts in the first place.
So far, China has not intervened directly in violently quelling the Hong Kong protests as originally feared. That is not because China is being patient or tolerant and doesn’t need Hong Kong. The truth is that as much China may want to crush the protesters, as it did in Xinjiang and Tibet, it still desperately needs Hong Kong.