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Thursday, July 09, 2020
Hong Kong's International Financial Center Status Hangs in the Balance
ANBOUND

The U.S. has doubled down on sanctions in Hong Kong following the promulgation and implementation of the National Security Law. On June 29, the U.S. Department of Commerce's official website issued a statement stating it has revoked its preferential treatment towards Hong Kong, including the suspension of export license exemptions, and further actions to eliminate differential treatment, which are still being looked at. US Secretary of State, Michael R. Pompeo, stated exports for dual-use US products, which contain both military and civilian application, will be suspended. Previously, the US had proposed several sanctions over Hong Kong, including revoking the aforementioned preferential trade treatment, issuing travel warnings to U.S. citizens travelling to Hong Kong, and implementing sanctions related to Mainland China and Hong Kong officials. Currently, these sanctions that are targeting the trade and tourism industry do little to impact Hong Kong's economy. With the National Security Law in place now, however, Hong Kong's financial industry, along with its role as an international financial center are about to face greater challenges, assuming the U.S. takes further actions.

While the sanctions affect both countries' trade and investment, Hong Kong's issue is a political key point in the U.S.-China strategic competition, which means the U.S. is likely going to implement further sanctions towards Hong Kong apart from economic ones. This places the country under U.S. sanctions long term, and unfortunately for Hong Kong, it does not get a say in the matter. Naturally, if Hong Kong cannot guarantee its economic and social stability, it will not attract any international capital, let alone retain its international financial center status. Former Chairman to the Hong Kong Securities and Futures Commission, Andrew Sheng, said the financial center is safe haven for investors looking to trade, though this may no longer be the case due its political instability. Despite being free of technological and economic challenges, the country suffers from political unrest, and political stability happens to be the cornerstone to every country's financial and economic prosperity. Take Beirut, the capital of Lebanon as an example. What was once the financial center in the Mediterranean eventually lost its reign following frequent episodes of political crisis and violence, which escalated into countless bloodshed.

On top of affecting trade and investment, now that the U.S. has revoked Hong Kong's preferential treatment as a separate custom territory, certain chain-reactions will be affected long-term too. With Hong Kong's special status gone, many agreements between the US and Hong Kong will need to be revised. For example, the Air Services Arrangements between Hong Kong and the U.S., the bilateral tax information exchange agreements (FATCA Intergovernmental Agreements), Treaty on Mutual Legal Assistance in Criminal Matters to name a few. Furthermore, multinational companies will be hit as Hong Kong's business environment worsen, which means a dip in confidence, and therefore, more multinational companies withdrawing from the country and relocating to an economic and trade center like Singapore. Clearly, these chain-reactions harm Hong Kong's economic development greatly.

As for financial sanctions, the U.S. measures may affect Chinese-funded financial institutions' use of the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system, strengthen Hong Kong financial institution's anti-money laundering reviews, restrict convertibility between USD and HKD, and affect Hong Kong's linked exchange rate system. Though strictly speaking, these measures do not pose that great of a threat to Hong Kong. Hong Kong's Finance Secretary, Paul Chan Mo-po, also remarked on Hong Kong's good judgment skills, that even if the U.S. targets the country's independent customs status, sensitive technologies imports, or linked exchange rates, Hong Kong will have an adequate response to these measures, "The SAR government possesses foreign exchange reserves worth 440 billion US dollars, enough to cope with the fund conversion. Plus, the banking system is stable too, with a capital adequacy ratio exceeding 20%, far more than the international requirement of 8%."

These measures serve to further hasten the U.S.-China financial decoupling. After all, Hong Kong, being the window to China's trade and investment, plays an important role in the economic, trade and financial connection between China and the U.S. The financial decoupling between China and the U.S. will inevitably affect Hong Kong's financial industry, and it will certainly need to be prepared to undergo any restructuring to cope with the changes in the future market structure and geo-economics financial environment. Andrew Sheng stated that while Hong Kong is the main offshore renminbi (RMB) market, the country has yet seen any sufficient research in the cooperation of the RMB Internationalization from a long-term strategic perspective in the past decade. Establishing HKD and RMB markets in the country will not cut it and assistance from Hong Kong in cooperating with the development of RMB products and markets in Mainland China is much required to bear certain risks, as the ultimate purpose of the financial center is to manage risks.

Being an international financial center, Hong Kong is the link between China's external financial opening and the rest of the world, and will continue to remain so even in the presence of U.S. sanctions. International capital has always regarded Hong Kong as a gateway to China, thus the opening up in Mainland China's financial industry and the progress of the RMB Internationalization still require Hong Kong to play its part. MSCI Inc. Chairman, Henry A. Fernandez, recently expressed his beliefs that Hong Kong will continue to retain its status as an international financial and risk management center in the future. Even in the face of geopolitical tensions, China will be a large economy and financial market, nonetheless. International investors will look for ways to enter China, and Hong Kong fulfills that purpose. China needs a place to stay ahead in its laws, system, and regulation, which is where Hong Kong comes in. As for Hong Kong itself, the impact of future development and Mainland China's own policies and economic development will still play a greater role.

Hong Kong is subjected to sanctions from the U.S., and the mainland's offshore financial industry will suffer further losses. Once the U.S. imposes financial sanctions on Hong Kong, it will lead to a large-scale return of Chinese investment and trade in the U.S. Since last year, many Chinese companies listed on the U.S. stock exchange have begun returning to the Hong Kong Stock Exchange. If Hong Kong can make good use of these funds from mainland China, it can still serve as a window for China's opening-up. Fernandez also pointed out that Hong Kong's financial market has many advantages, including a large customer base, both internationally and regionally. Meanwhile, it also possesses ample liquidity in China, and has the ability to form an ecosystem for a Greater China region.

Should the Hong Kong Special Administrative Region handle the current situation with the utmost calm, and adhere to a free market economic system that maintains the freedom of trade, investment, exchange, and information flow, some analysts believe there will still be room for development. Therefore, if Hong Kong wishes to maintain its own prosperity and stability, and maintain its status as an international financial center, it should not be tempted to be self-isolated and refuse to make strides. On the contrary, it needs to take further initiatives to promote the transformation and reconstruction of the financial industry and market to adapt to the new geography and changes in financial market demand.

Final analysis conclusion:

While the U.S. sanctions on Hong Kong may not have a big impact on the Hong Kong in the short run, it still faces a long-term tightening of US policies as a result of the U.S.-China strategic competition intensifying, which poses challenges to the country's financial system and its status as an international financial center. Even if Hong Kong maintains its status as an international financial center in the future, it still has to prepare itself for transformation and restructuring to adapt to the new changes.

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