On the 50th floor of an international bank’s Hong Kong headquarters, its CEO is showing off the view. “You could see all the protests from up here last week when Queensway was occupied,” he says.
It is rather surreal to be looking down at what had been one of the hubs of Hong Kong’s pro-democracy protests, while talking about markets, growth and expansionary strategies. This surrealism, however, defines the way in which the financial sector navigated the Hong Kong student-led demonstrations.
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While Hong Kong citizens camped out on the streets to fight against what they see as Beijing’s pretence at fair voting rights for Hong Kong, the city’s banks were largely unworried about the political situation. Hong Kong’s bankers remain extremely hopeful about capitalising on a maturing dim sum market, China’s policy reforms and catering to growing Chinese outbound investment and corporate treasury operations in renminbi. They would be much more worried if there were any brake on these reforms as this would suggest China’s government had de-emphasised the importance of Hong Kong to its growth plans.
China is after all less dependent on Hong Kong for business than it used to be. Twenty years ago, Hong Kong accounted for 15% of China’s economic output. That figure has now dropped to 1.7%. But Hong Kong’s exemplar rule of law – which bankers believe remains sacrosanct even with Beijing’s greater involvement in running the city – its client network and business ethos make it sufficiently important for China not to discount its contribution to the mainland’s growth trajectory. This remains the case even after October’s protests. (Article continues below video)
The Umbrella Revolution
Hong Kong and China have been operating under a one-country, two-systems framework since the UK’s handover of the city to the mainland in 1997. This meant Hong Kong would have a high degree of autonomy other than in foreign relations and defence for at least 50 years after the handover.
Hong Kong’s first ever election of its chief executive via universal suffrage is due in 2017. While the mainland agreed to grant Hong Kong citizens one person, one vote, it also announced on August 31 it would vet candidates for the role of chief executive.
To qualify as a chief executive candidate, the support of more than half of the 1200 nominating committee members is required. This gives an automatic advantage to pro-Beijing candidates, argues Martin Lee, Hong Kong pro-democracy activist, lawyer and former legislator.
“This would give Beijing the clearest possible majority. They would have control of more than 80% of the nominating committee members. Even if pan-democrats represent 20% of the committee, this still falls short of the required half,” he says.
Universal suffrage
To the protestors in Hong Kong, many of them students, this does not define true universal suffrage. They also complain about what they say is an alliance between business and the status quo in Beijing. Equally, many of those belonging to an older generation in Hong Kong prefer to see this alliance preserved and argue that it has served the city well.
Despite political turmoil, market participants argue that the internationalisation of the renminbi, which remains key for the city’s financial sector to thrive, will not be affected. “The offshore renminbi market remains an international one. For example, an offshore US dollar centre might have political issues locally, but it doesn’t mean they will affect dollar usage outside the domestic market,” says Becky Liu, senior rates strategist at Standard Chartered in Hong Kong.
In her opinion, the unrest will not deter even sovereign countries looking to benefit from renminbi internationalisation. “This could be the biggest story in the coming decade. With such an opportunity, their top concern is what is best for their own nation,” she says.
Triangle of dispute
An example of the protestors’ complaints is the row in June over HSBC, Standard Chartered and Bank of East Asia pulling advertising from Hong Kong newspaper Apple Daily. The paper, and its owner Jimmy Lai, have vocally criticised Beijing and sided with Hong Kong’s pro-democracy cause. The students and the publisher claim that this was politically motivated but HSBC and Standard Chartered have said the decision was made on purely commercial grounds.
HSBC spokesperson Gareth Hewett says: “Our choice of marketing platform and format is commercial according to the market and target segment.” Standard Chartered says it reviews its advertising strategy from time to time to ensure it can achieve the maximum impact in promoting its business. It would not comment on individual organisations.
More broadly, the banking and business community is relatively unconcerned that the protests will disrupt Hong Kong’s economic success story. Market participants believe its transparency and reliability – a key attraction to investors and firms globally – are here to stay.
“A sound legal system is essential. Nobody would put their personal wealth in a jurisdiction where somebody could overrule local laws and take away what belongs to you. Whoever will decide about [Hong Kong’s rule of law] needs to carefully balance this,” says one head of private banking based in Hong Kong.
Private banking heads in Hong Kong say they are not experiencing capital flight or investor panic. “Fears of China interfering with Hong Kong’s rule of law were a reality leading up to 1997 and led to trust and asset planning in the 1980s and 1990s. Most people who had left have come back. I am not aware of anyone rushing for the exit at the moment,” says another head of private banking based in Hong Kong.
Although Beijing has made its presence felt in Hong Kong with its August announcement on election candidate vetting, the city’s overall economic path seems undiminished.
Stock Connect ‘freebie’
To market participants, the Shanghai-Hong Kong Stock Connect – a pilot programme to be launched in coming months that will establish mutual stock market access between Hong Kong and mainland China – is proof that Hong Kong remains significant in China’s policy reform path.
“China gave Hong Kong a freebie in Stock Connect. China could have massively expanded the Qualified Foreign Institutional Investor [QFII] allocation and made investment go through Shanghai. But creating a role for Hong Kong recognises… that China feels ownership in the ongoing prosperity of Hong Kong. So it designs policies including it,” says one CEO at an international bank in Hong Kong.
Until now, investors have mostly used QFII quotas to invest onshore. Stock Connect will be more flexible in that there will be no investment quota, no approval needed, no lock-up period and no need to make applications from specific financial centres.
Stock Connect is important to Hong Kong as an Asian wealth management hub. It adds eye-catching investment solutions for private banking clients for whom renminbi has become an absolutely necessary and expected alternative currency, says a private banking head in Hong Kong.
Chinese offshore bonds remain private banking clients’ preferred renminbi investment solution. But even if Chinese equities are now rather cheap as they have not performed well recently, Stock Connect’s efficiency could help attract more investors to Chinese stocks.
Outbound investment
Hong Kong banks’ well-developed global networks make them particularly well placed to also service China’s growing outbound direct investment (ODI). This trend has expanded to several sectors and jurisdictions; from infrastructure capital investments across Africa and the Association of South-east Asian Nations, to nuclear projects in Somerset, the UK, to real estate in the US, with China insurance company Anbang purchasing Manhattan’s Waldorf Astoria hotel in 2014.
While Chinese ODI has increased significantly in recent years, renminbi ODI payments still accounted for only 15.7% of overall Chinese ODI transactions by the end of 2013. By comparison, renminbi foreign direct investment payments accounted for 62.9% of all foreign direct investments into China.
Candy Ho, global head of renminbi business development at HSBC in Hong Kong, says: “China outbound investment will be a key area of growth for the country and for us as a bank. We expect offshore direct investment in renminbi to increase. It brings a lot of business opportunities to international banks while helping the local economies receiving infrastructure investment.”
Infrastructure supporting growing outbound investment in renminbi is also relatively undeveloped. “Offshore centres need significant liquidity to support renminbi capital investment, whose volume is a lot bigger than bilateral trade. A capital investment could be billions or trillions of renminbi. A cross-border trade can be less than Rmb1m [$163,000],” says Ms Ho.
However, ballooning renminbi use worldwide bodes well for increases in offshore liquidity that is necessary for large ODI transactions. Today, daily turnover of renminbi short-term forwards in global foreign exchange swap markets is about $20bn equivalent. It was below $10bn only a year ago.
“Diversification of Chinese outbound investment will continue and that is why we are focusing on this trend. After all, when a currency internationalises, it cannot only be one way and the bulk of renminbi liquidity cannot just sit in Hong Kong,” says Ms Ho.
Treasury quest
With the China (Shanghai) Pilot Free Trade Zone continuing to launch policies that accommodate international corporates, Hong Kong banks are seizing business opportunities as advisory specialists helping companies into the free-trade zone.
International firms are now able to manage and move renminbi funds in and out of the mainland with greater flexibility. This is making companies reconsider their liquidity management and at times set up treasury operations in China.
“A lot of automation will be needed. Finding a good banking partner to help you out is also very important. You really need someone who has a very good offshore and onshore presence, and a good liquidity management platform to help you with your business,” says Carmen Ling, global head of renminbi solutions at Standard Chartered.
Hong Kong banks are also poised to help multinational corporations navigate what is sometimes the cumbersome task of establishing an entity within the free-trade zone to fully enjoy its innovative policies. “This requires a new legal vehicle, which may involve board approval and changes to the corporate’s whole structure in China,” says Ms Ling.
Dim sum holds ground
Future mainland policy reforms permitting, China’s onshore bond market – the Panda sector – could soon become the next sensation in global capital markets and potentially challenge the offshore renminbi market, which has its deepest liquidity in Hong Kong.
But this year’s record-breaking issuance volumes and increasing sophistication have proved that the dim sum market is maturing and is no longer a market used by investors mainly for foreign exchange play. This could mean that one of Hong Kong’s strongest competitive advantages as a financial centre is out of harm’s way.
“In the first half of 2014, the renminbi was the worst performing currency in Asia, but that is when the dim sum market hit record issuance,” says Ms Liu. By the end of September 2014, offshore renminbi issuance sat at Rmb440bn, already in excess of figures for the whole of 2013. HSBC predicts the dim sum market will reach Rmb520bn to Rmb570bn by the end of the year.
“Even when the onshore market opens up, we think the dim sum market will retain its attractiveness. There will be a correction of pricing because people will be able to get cheaper products onshore, but people will then value the benefits they can achieve in Hong Kong, including its great degree of flexibility,” says Ms Liu.
Firstly, Hong Kong’s documentation requirements are fewer and more efficient than in China, where issuers need to declare how proceeds will be used before printing Panda bonds. Hong Kong being a low-tax centre with no capital controls also helps increase its attractiveness over the mainland in borrowers’ eyes.
In addition, market participants believe Hong Kong’s investor pool to be vastly deeper than the Panda sector’s. This is highly valued by global issuers seeking low-credit risk pricing. Corporates started buying dim sum in 2014 as a growing derivatives market helps them hedge all the foreign-exchange (FX) risk.
“They buy certificates of deposits printed by Chinese state banks and use the offshore derivatives market to hedge FX risk. In the end, it becomes a dollar-in, dollar-out investment. From their perspective they are only doing a US dollar deposit,” says Ms Liu.
Significant hikes in offshore renminbi yields early this year also attracted first-time Middle East investors. Ms Liu says: “They had never traded renminbi products before and were not familiar with the risk. But yield pick-up was so strong that they became as comfortable as with a pure dollar investment.”
New borrowers
The eclectic mix of offshore renminbi issuers in 2014 is further testament to the market’s growing resemblance to larger international bond sectors. The UK became the latest sensation in this market when it became the first foreign country in October to print a dim sum bond – a Rmb3bn 2.7% three-year. It was the largest ever offshore renminbi note issued by a non-Chinese borrower.
Market participants predict more sovereigns will follow the UK’s deal. “As more pension funds and insurance companies come to the dim sum market, there will be higher demand for top-quality [sovereign, supranational and agency] names,” says Ms Ho. This would add a new asset class to a market heavy in corporate and bank paper.
The dim sum market could resemble established global bond sectors even more if US investors are lured in. “To do so, we need to start seeing dim sum bonds issued under 144A offerings. [Offshore renminbi] bonds are still issued in Reg S format,” says Ms Liu. Regulation S bonds can largely be sold only to buyers based outside the US, whereas 144A notes include US citizens and so would open up an additional pool of investors to the dim sum market.
Offshore renminbi bonds complying with the US Securities and Exchange Commission’s 144A rule still have not materialised since issuance sizes are not large enough to justify 144A’s stricter documentation requirements and additional effort and cost, including roadshows in US time zones, to borrowers.
With Hong Kong’s government and protesters still at an impasse on the question of what constitutes universal suffrage for the 2017 elections, the protests may continue. But with mainland China showing no signs of excluding the city from its growth plans, Hong Kong is still well placed for a positive future. Hong Kong remains the darling of Asian financial centres, for now at least.
