London bridges gap between UK and China - World -

Despite the uncertain political climate, London has emerged as a global hub for Chinese finance, although Brexit could yet throw a spanner in the works. 

Dragon

If the growing rivalry between China and the US is set to define the geopolitics of the next century, then the UK is asleep at the wheel. Today, London finds itself caught between the two powers – trading blows in a technological Cold War – without so much as a plan. This failure has been years in the making; successive UK governments have approached relations with China, in particular, with an “indifference bordering on complacency”, according to Professor Kerry Brown, director of the Lau China Institute at King’s College London. This absence of clear, strategic thinking has contributed to damaging policy vacillation. 

The UK government’s decision to strip Huawei from its 5G network is symptomatic of its haphazard approach. Boris Johnson’s administration attracted the ire of Washington for initially agreeing to a limited role for the Chinese telecommunications giant in the national network, before deciding to remove Huawei’s equipment completely by 2027. In response, the Chinese Ministry of Commerce stated that it would “take necessary measures” as a result of the “discriminatory” ban. 

Much to play for

For the UK, much is at stake as it navigates the uncertain waters of its post-Brexit future. Safeguarding its vital economic, commercial and financial interests, particularly as they relate to China, will be paramount. Indeed, the country has a lot to lose if its relations with the world’s second largest economy sour. 

However, the absence of a comprehensive strategy towards Beijing has not prevented London from emerging as a global hub for Chinese finance; from offshore renminbi trading, to the issuance of dim sum bonds, to the presence of a growing constellation of Chinese financial institutions. 

Indeed, finance has emerged as the quiet success story of the Sino-British relationship, with London as the crown jewel in this particular nexus. “I think from the global financial crisis onward, London positioned itself well to deal with Chinese capital flows, Chinese banks and renminbi trading. It’s probably one of the lowest profile stories [in the relationship], but it’s one of the most successful,” says Mr Brown. 

Today, London is home to close to 40 Chinese financial and professional services firms, while the city has emerged as the leading renminbi trading hub outside of Greater China. Between December 2019 and February 2020, a total of Rmb2.8tn ($400bn) was cleared through London, representing an expansion of 32.8% year-on-year. Similarly, total cross-border renminbi settlement between the two countries increased by 71% over 2019, while dim sum bond issuance on the London Stock Exchange (LSE) increased by more than 15% for the year. 

The 2019 launch of the Shanghai-London Stock Connect has been another boon for Chinese finance in London, even if the mechanism remains embryonic and has been slow to develop meaningful activity. Nevertheless, the landmark listing of $1.8bn in depository receipts from China Pacific Insurance in June 2020 arguably points to the longer-term possibilities underpinning the project. “London as a gateway to China’s capital markets is an attractive goal. There is still some way to go before it gets there,” says Gerard Lyons, chief economic strategist at Netwealth.

Two factors account for the UK capital’s outsized global role as a centre of Chinese finance. First is the inherent attraction of being one of the world’s top global financial centres. “In terms of the City of London, recent years have seen a number of Chinese financial institutions developing their presence. That reflects both China’s global growth and London’s position as one of the top two global financial centres. Chinese institutions are using their base in London to facilitate business opportunities around the world,” says Mr Lyons. 

Beyond this, however, were the few years in which David Cameron’s Conservative government (2010-2016) courted Chinese finance and investment as a function of what was billed, at the time, as a ‘Golden Era’ between the two countries. Under this approach, which exclusively focused on commercial, investment and trade ties, London received a boost from closer relations between the two countries, even if the UK failed to construct a more comprehensive approach towards China. 

“You could argue that under David Cameron’s leadership the UK’s strategy towards China was reasonably clear,” says Andrew Cainey, co-founder of Asiability, a UK boutique consulting and business advisory firm dealing with China. “That is not the case today. Different ministries and government departments have diverging stances towards China, so the national approach is less integrated.” 

Where next? 

The question facing policy-makers in the UK, as well as in China, is where the relationship goes from here, and to what extent political tensions might hinder economic, commercial and financial ties. “It’s difficult to know how things will unfold in the future because it’s not just about what happens between the UK and China but also about other relationships, in particular between China and the US. It’s also about what China itself does both domestically and overseas. As a result, it’s now a far more complex relationship,” says Mr Lyons. 

Recently, China has pursued a more assertive foreign policy on the global stage, which has contributed to rising bilateral tensions with a number of its key trading partners. In early 2020, Beijing slapped an 80% tariff on Australian barley exports, coupled with a ban on certain beef products, in response to Canberra’s call for an international investigation into the origins of the Covid-19 pandemic. In August, Chinese authorities floated the possibility of tariffs being placed on Australian wine imported to China. 

And there are no shortage of possible future flashpoints between the UK and China. The British government’s offer to provide passports to Hong Kong citizens with British National Overseas status, as well as their dependents, in response to the imposition of a new national security law by Beijing on the territory, has incited a strong response from the Chinese government. Liu Xiaoming, China’s ambassador to the UK, stated that Britain “will bear the consequences” of any hostilities that it generates between the two countries. 

“Among the major European economies, the British government seems to be taking the hardest line with China, primarily because of what is happening in Hong Kong,” says Max Kärnfelt, an analyst with the Mercator Institute for China Studies. 

For now, however, the implications of a more tense Sino-British relationship don’t appear to be grave for the financial nexus between the two countries. A shifting geopolitical landscape, in particular, is tilting the scales in the UK’s favour. As the diplomatic temperature between Washington and Beijing plummets, the attractiveness of London as a place in which to do business has only increased. 

“The question is where does China access global markets in different ways? You’ve got Hong Kong and you’ve got the US. The US is looking riskier. And then Hong Kong has some uncertainty around the national security law and global financial institutions’ reaction to that. I think these trends could be to London’s benefit,” says Mr Cainey. 

But perhaps more importantly, Chinese policy-making is above all driven by self-interest. So long as the UK capital remains an attractive platform from which the country’s financial and professional service firms can do business with the rest of the world, few other considerations will come into play, at least for now.

“China’s decisions will be purely pragmatic and commercial, regardless of whatever political rhetoric is going around. I think on [the example of] Huawei, the Chinese attitude is that Britain has shot itself in the foot but that they have plenty of other places to turn to. On finance, it will be the same. Does China get what it needs from London? If it doesn’t, they will go elsewhere,” says Mr Brown. 

London's market strength

In terms of offshore renminbi trading, there is little prospect of London failing to provide what China needs. As the largest foreign exchange (FX) market in the world, the UK capital dwarfs its nearest rival, New York, by some margin. In addition, no other European financial centre can come close to London’s FX trading proposition. London’s advantages, which include limited political and institutional interference, high liquidity and broad investor profiles, are mirrored nowhere else in the region. 

As such, a likely increase in European exports to China over the coming years, in line with their expansion over the past decade, will be a clear driver of London’s position as a renminbi trading hub. This is particularly true given that European businesses can more easily settle renminbi payments today than at any time in the past. 

“A Chinese company will buy goods from a German company and pay for the transaction by depositing a renminbi sum into a German bank account. The German bank will then transfer this money to London and exchange it in the foreign exchange market. These funds are intermediated by London bankers who move it over to Hong Kong, and use something like the Hong Kong Stock Connect to get it back into mainland China where they can generate a return,” says Mr Kärnfelt. 

Meanwhile, London’s dim sum bond market seems similarly impervious to the current political climate. By the end of February 2020, 116 of these bonds were listed on the LSE with an outstanding value of Rmb37.6bn. The attractive yields on offer in London present unique opportunities for Chinese financial institutions, limiting the prospects of Beijing imposing restrictions on the issuance of renminbi bonds in London if the bilateral relationship were to deteriorate in the coming years. 

“China could restrict its banks from issuing renminbi bonds in London. But the yield on an renminbi bond with a similar maturity in London is lower than it is in Hong Kong or mainland China. So if you’re a Chinese bank, you can actually finance yourself with lower interest rates than in mainland China. This means that if China were to tell its own banks that they can’t raise money in London, it would ultimately be an act of self-harm,” says Mr Kärnfelt. 

Ultimately, the internationalisation of the renminbi remains a key Chinese objective, even if this process is taking time. According to Mr Kärnfelt, this ambition diminishes the prospects of China restricting the functioning and presence of Chinese finance in London, irrespective of the political climate between the UK and China. “China wants to internationalise the renminbi and wants to increase the usage of the renminbi. If they are going to restrict foreigners’ access to the currency, or restrict their own companies from raising renminbi abroad, they will be undermining their own objective of renminbi internationalisation.” 

Brexit worries

In the short term, at least, it may not be a worsening political relationship between Beijing and London that undermines the UK’s position as a global hub for Chinese finance. Rather, a negative outcome in Brexit negotiations with the EU is likely to do more damage. In particular, if London-based financial firms were to lose significant access to the EU’s financial market, be the subject of punitive restrictions on advertising financial services in the EU, then this could clearly undermine London’s standing.

“The ongoing success story of London as a centre of Chinese finance will be contingent, to some degree, on what relationship emerges between the UK and the EU moving forward. This is purely a question of whether China sees London as a gateway to other Western capital markets and services markets. Will China continue to have that view if there is not a clear deal at the end of December 2020?” asks Mr Brown. 

If a positive outcome between the UK and the EU can be agreed, particularly in the context of financial services, there is no reason why London’s position as the go-to destination for Chinese finance outside of Asia will not be supercharged. For the most part, this possibility reflects China’s economic development curve, as the country moves beyond manufacturing and exports to professional services and consumption. 

“In terms of China’s rapid economic success up until now, the biggest European beneficiary has been Germany because of its capital goods exports and its industrial machines. But I would argue that, given the next stage of Chinese development, there’s a greater opportunity for the UK given its services-dominated economy,” says Mr Lyons. 

Indeed, financial market liberalisation is occurring at pace in China today. US firms Morgan Stanley and Goldman Sachs both secured regulatory approval for majority control of their local joint venture securities’ businesses in the country in early 2020, even as political relations between Washington and Beijing were in free fall. Similarly, JPMorgan received state approval to operate China’s first fully foreign-owned futures business in June 2020. For London, this liberalisation could offer sizeable long-term growth opportunities, as the exchange of skills and expertise on a range of issues and services gathers pace. 

“Chinese firms are coming into London and taking advantage of the expertise and developing new business skills. They are also transferring some of these skill sets back to China. [In particular], London’s status as a global centre for the issuance of green bonds is an important dimension of the city’s relationship with China. The green agenda is important for both countries and their respective financial sectors,” says Mr Lyons. 

Furthering relationships

Looking ahead, the extent to which London can continue to benefit from its deep relationship with China, and Chinese finance, over the long term remains somewhat unclear. Though self-interest from both sides has, until now, governed the profile of bilateral relations, a changing geopolitical environment now means that questions of politics are entering the equation. “Politics is dominating the economics in today’s China-UK relationship,” says Bill Allen, visitor with the National Institute of Economic and Social Research. 

To navigate this more uncertain long-term future, the UK will need to think carefully about its relationship with China. This will require the development of a comprehensive and far-reaching strategy that will shape the country’s policy towards Beijing over the coming years. Though the onset of the Covid-19 pandemic has stimulated more thinking towards Beijing in British parliamentary and governing circles, the results have been hawkish. The parliamentary China Research Group is a case in point.

On China, the UK will need to act quickly, while considering the nuances of the bilateral relationship, in order to secure its future in a changing world. “How does one engage with such a large economy while protecting one’s own interests, values and security?” asks Mr Cainey. 

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