https://www.investopedia.com/why-hong-kong-needs-autonomy-to-be-a-global-financial-hub-4690553
Qiáng lóng nán yā dì tóu shé
“Even a dragon finds it difficult to conquer a snake in its lair. Knowledge of local area and people gives them a distinct advantage even against a strong enemy”As the protests in Hong Kong have prevailed for 6 months, every global investor must be thinking: Can Hong Kong sustain itself as an international financial hub in Asia? Will China become the main North Asian destination alongside Tokyo for international trade and investment?
Hong Kong reported in late September that they were in a recession. GDP contracted 3.2% from the previous quarter, and GDP will contract 1.3% in 2019 from the previous year. This was not a surprise as indicators of recession are lagging indicators exacerbated by the US-China trade war. As of now, the odds are stacked against Hong Kong to remain completely independent from China for three contributing factors: increasing competition from China policies’ directives, its stock market and defeat on securing sizable IPO’s and Hong Kong’s pegged currency to the US Dollar.
This past February, Chinese policymakers released the blueprint for the Greater Bay Area (GBA), an accelerated plan for the region to become an important global center for advanced manufacturing. The GBA will focus on innovation, financial services, transport and logistics, trade, and tourism and leisure with the integration of nine mainland cities and two special administrative regions, Hong Kong and Macau with coordinated and complementary laws and policies.1
Chen Guanghan, a professor from Sun Yatsen University’s Research Institute of the Development of Guangdong, Hong Kong and Macao, commented that the “vision of the Greater Bay Area is far more than just a bridge or a railway. No country has ever tried something like this before, merging different tax and customs and legal systems.2
Shenzhen, China’s third largest city and proximity to Hong Kong has become a thriving international center and domestic stock market. Its special economic zone status has spurred Beijing to set Shenzhen as an “international innovation city” by 2025 and a “global benchmark city with competitiveness, innovation, and influence by 2050” with plans to integrate the financial markets in Shenzhen, Hong Kong, and Macau. Shenzhen will also lift some barriers to foreign investment.3
In the financial markets, China has slowly asserted itself as a Nasdaq competitor with its SSE Star Exchange that debuted back in July in Shanghai that aims to make it easier for high tech companies to access funding with relaxed rules for listing and trading at three months vs. years on China’s other stock markets. It’s still too early to gauge the success of the SSE Star Exchange and Shenzhen becoming a global model city, however, liquidity drives markets. The Hang Seng index is up about 3% YTD vs. Shanghai composite and Shanghai A shares are up about 17% each, respectively amid the US-China Trade Wars.
The primary reasons why companies choose to list in HK are that HSEx has objective listing qualifications, a well-established legal system, and strong bonds with China.4 The postponed and withdrawn IPOs listing in HK YTD in the chart below are prescient indicators of a risk-off investing environment in the Hang Seng Index.
Source: Bloomberg
The oversubscribed oil giant Saudi Aramco international’s planned IPO is now considering listing in Tokyo versus Hong Kong, a previous front -runner listing contender, due to protests in Hong Kong over an extradition law adding risk to a listing in the city.5
Additional proof of the Hong Kong Exchange's struggle is its failed bid for the London Stock Exchange Group this past September. The LSEG board rejected the unsolicited U$39 billion proposed takeover on fundamental concerns over the key aspects of the Conditional Proposal: strategy, deliverability, form of consideration and value. LSEG said it did not believe HKEx provides it with the best long-term positioning in Asia or the best listing / trading platform for China. LSEG reiterated it values its mutually beneficial partnership with the Shanghai Stock Exchange as its preferred and direct channel to access the many opportunities with China.
Finally, we need to answer the following question: is it correlation or causation that is affecting HK’s dependence on China on the long -term stability of HK’s currency peg and recent capital outflows?
The peg was initiated in 1983 and follows a narrow band of HK$7.75-HK $7.85 per USD since 2005. Despite Hong Kong’s economic dependence on China, its interest rate is tied to the monetary actions of the Federal Reserve.
Large IPOS, semi-annual / annual bank settlements and company-dividend payments are short term drivers that lift HK interest rates and the HK dollar.6 Recent external shocks such as the: on going protests, decelerating growth from the US-China trade war has already seen capital flows out of Hong Kong. According to Goldman Sachs, about U$4 billion has left Hong Kong and Singapore has seen the bulk of the net inflows.7
Kyle Bass stated in a Real Vision interview back in May that over the past year, HKMA (Hong Kong Monetary Authority) has sold 80% of its excess reserves in US dollars to prop up their currency and questions what happens if the remaining 20% is used, what other resources does HKMA have to defend the peg before there is a bank run on the currency.
Eddie Yue, CEO of HKMA, has made recent remarks about the “peg” being the most appropriate monetary system for Hong Kong and sees no intention of changing the system. His past experience of safeguarding HK from external shocks during the 1997 and 2008 financial crisis gives credence for the HKMA to defend the peg.8
We know that correlation does not imply causation and previous capital flows were caused more from the spread between the Hong Kong and the Fed Reserve rate. However, as Hong Kong becomes more entwined with China, then it’s not just correlation but also causation for the Hong Kong currency and maybe a different “peg”.
As humans, we hope that there will be a peaceful resolution to the Hong Kong protests soon. As global investors, we can only reduce the signal to noise ratio on our quest for price discovery of markets and the stability of Hong Kong’s.
Written by Himali Kothari, Founder of Aquamarine Value with contributions from Pamela Kustas.
1 The Diplomat: Is the Greater Bay Area China’s Future? Dingding Chen and Tiffany Chen, July 2019
2 The Diplomat: Is the Greater Bay Area China’s Future? Dingding Chen and Tiffany Chen, July 2019
3 The Epoch Times: Beijing Launches Plans for Shenzhen to Become World Hub, in Apparent Bid to Replace Hong Kong, Nicole Hao August 2019
4 GLI Global Legal Insights: Initial Public Offerings 2019 Hong Kong
5 Investor’s Business Daily: Surprise Front Runner Emerges to List Biggest IPO Ever, Most Profitable Company, Gillian Rich, August 2019
6 Bloomberg Intelligence: November 17, 2019
7 Markets Insider: Goldman Sachs says $4 Billion flowed out of Hong Kong to Singapore because of the protests, Yusuf Khan, October 2019
8 Hong Kong Monetary Authority, Remarks by CE/MA at Media Standup, October 2019