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Is This Hong Kong's End Game?

Hong Kong is experiencing an identity crisis. The city was not a democracy under British rule, but the local people knew the meaning of individual liberty. Before the new national security law passed in June 2020, Hong Kongers have long valued their established social norms, rule of law, and way of life. That’s the fundamental drive underlying social movements like the Occupy Central, Umbrella Movement, and the Anti-extradition Movement in the past decade. As the social and political circumstances fluctuate into instability and uncertainties, Hong Kongers may have to adjust to the new reality because things will be different in a new Hong Kong.

From the perspectives of the young Hong Kong protesters, they seem to be sending a message through the protests: this may be the last fight to protect their political and civil liberties and their Hong Kong identity. The U.S. government echoed and supported these protesters with sanctions on Hong Kong officials and related entities. But with the US-China confrontations looming large and the economic decoupling seems to be on the path toward the point of no return, Hong Kong’s status as an international city is at stake. In fact, the city is facing the most critical challenges it has ever seen before.

In 2019, Hong Kongers took to the street to protest the extradition bill, which allows fugitives to be transferred to mainland China. One year later, the pass of the national security law has ushered in a new area for the city. Photo Credit: Reuters

Hong Kong is in transition

The extradition bill introduced by the Hong Kong government in 2019 set the city on fire as it stipulated that Hong Kongers could be sent to jurisdictions in mainland China. To many Hong Kongers, this means that they will be receiving the same legal treatment as citizens living in the mainland. Thus, it is no surprise that the bill triggered mass protests that lasted from 2019 to 2020. When Beijing passed the security law in June 2020, many Hong Kongers considered this policy as an outright and direct infringement of the independent legal system it has enjoyed under the “One Country, Two Systems” framework. Under this principle incorporated in the Basic Law, Hong Kong could still be partially autonomous until 2047. So the big question for Hong Kong now is: will the city maintain its autonomy and for how long?

With Beijing’s increasing involvement in Hong Kong’s legal system, the tensions between the locals and the Hong Kong government and its sponsor – the Chinese government, have been rising in recent years. Responses from the Hong Kong government and public institutions to the security law have further infuriated the public. A 2020 survey conducted by the Chinese University of Hong Kong found that an overwhelming 72 percent of respondents attributed containing covid-19 to community response instead of the management efforts by local government. Clearly, trust in Hong Kong’s public institutions is collapsing.

One implication with the security law is that Hong Kong may become more like a Chinese mainland city once the people exercise their political rights in a shrinking civil society. The city’s economy will be hit directly, especially its financial sector which has attracted global investors and enterprises over the past decades. These stakeholders choose to be present in Hong Kong because the city is renowned for its independent court system, solid financial infrastructure, and responsible regulatory system that make investors and multinationals feel safe and secure to do business here. It is exactly for these reasons that these entities and individuals may have already felt the chilling effects of the security law.

In the foreseeable future, Hong Kong also has to cope with the consequences of U.S. sanctions. After the final passage of the security law, the White House has officially announced that Hong Kong will not be considered an autonomous region and hence would stop receiving preferential treatment. This would also send a clear signal to the U.S. allies to reevaluate their positions on Hong Kong. Furthermore, the U.S. can also select more deadly weapons from its sanction toolbox, such as making the Hong Kong dollar inconvertible to the US dollar.

As a financial center, Hong Kong is unique because its currency is pegged to the greenback and it is a dominant offshore dollar funding center. This convertibility mechanism is exemplified in daily financial activities such as currency trading, cross-border loans, and derivatives, denominated in US dollars. The US targeting this currency arrangement would actually push Hong Kong to a tough spot as the city will have to be extra cautious when it plays its role as a financing center for China’s outbound investment.

With the special trading privileges, Hong Kong receives lower tariffs when exporting to the U.S., compared to mainland China. If the U.S.-China trade war is to continue in the coming years, Hong Kong will have to bear higher tariffs for its goods and services. Without this preferential treatment and favorable policies, Hong Kong may gradually lose its edge in the global economy. In early 2020, Moody’s downgraded Hong Kong’s credit ratings, citing social unrest, ineffective governance, and pressure from Beijing. In the short run, global investors may still keep their portfolios in Hong Kong, but they very likely will relocate to other more stable places like Singapore and Tokyo.

On the corporate level, international companies have already felt the pressure and discomfort under the new security law. Some tech companies, such as Oursky, a software company, have real concerns that overseas clients may hesitate to work with them because of their identity as a Hong Kong-based company and the data risks associated with the new security law. So the option for these companies is either be careful not to violate the security law or just leave the city. In August 2020, about 39% of 154 companies in a survey conducted by the American Chamber of Commerce in Hong Kong (AmCham) have considered moving capital, assets, or business operations out of the city at some point in the future because of the uncertainties lying ahead. It is reasonable to speculate that the rest of the companies in the survey are in a wait-and-see mode, and they will adjust their plans based on the trajectory of the U.S.-China tensions and how the security law is implemented.

If the overall circumstances in Hong Kong continue to deteriorate, its reputation and attraction as a global financial center will be weakened. On the one hand, its signature role of being a gateway connecting China and the international financial markets will be cast into doubt as China pushes liberalization for its financial sector. Last year, Citigroup became the first American bank to receive a domestic fund custody license in China. Vanguard, BlackRock, and more global financial companies are following in its step.

Meanwhile, Singapore is already an alternative for international companies to stay in the Asia-Pacific region. With its robust regulatory oversight and transparency in conducting business, Singapore took over Hong Kong as the top country on the 2020 Index of Economic Freedom list. As the city-state offers political stability, ease of doing business, and highly developed infrastructure, it is an ideal place for businesses to relocate their operations from Hong Kong.

How long can Hong Kong remain as a financial center?

Despite facing internal problems like social instability and external challenges from regional competitors, it is still too soon to claim that Hong Kong as an international financial center is doomed.

As an international financial and trading center, Hong Kong has been a formidable player in the global economy. Due to its unique history, the city has also absorbed the best parts of Western and Chinese cultures in the past. But, the road ahead for Hong Kong seems to be unpredictable and winding. Photo Credit: Stockbyte/istock

Hong Kong is deeply connected to the global economy and the international financial system. Currently, over 200 international banking institutions from 34 countries are operating in Hong Kong, including 78 of the 100 world’s largest banks. Its stock market is the fifth largest in the world in terms of market capitalization. It is also one of the most active markets for raising initial public offering funds, with a US $40.1 billion in 2019. By 2020, 9 of the most valuable Chinese companies are listed in Hong Kong (except Kweichow Moutai, a liquor company listed on the Shanghai Stock Exchange in 2001).

International companies are not likely to exit Hong Kong like escaping disasters. More than 9,000 overseas companies are present in Hong Kong, with over 1,300 U.S. companies operating here. These companies choose to do business here because of Hong Kong’s solid economic foundations, world-class financial infrastructure, and connection to the Chinese economy. Even though some global companies have concerns that the new security law will bring uncertainties to their business plans in Hong Kong, most companies are very likely to stay in the short term and assess the implications because it may still take some time for these companies to grasp how the security law would affect their businesses.

But, the newly proposed data laws by Hong Kong’s Privacy Commissioner to crack down on doxing behaviors – spreading private information online, usually with malicious intent, has raised business concerns for some global tech giants such as Google, Facebook, and Twitter. It still remains to see how this confrontation will lay out and whether this strife between the local authority and international tech companies would revolve around the principles of free expression and protection of personal information, which would eventually affect Hong Kongers’ way of life.

For China, Hong Kong is still important in the years to come because it offers benefits no other mainland cities can match, at least for now. For decades, Hong Kong has been a gateway for China as a conduit of international capital flows. In 2019, more than two-thirds of China’s US$ 139 billion foreign direct investment (FDI) came through Hong Kong, making it the world’s second-largest recipient of FDI. It is also the largest and most important offshore RMB transaction center, sharing about 75% of the world’s RMB payments, where Chinese and foreign companies find their ways out of and into the Chinese market.

Hong Kong is a vehicle for China to connect with the global financial markets and for external investors to tap into the Chinese market. For instance, the Stock Connect arrangement, which connects the Stock Exchange of Hong Kong (SEHK) with the Shenzhen Stock Exchange and Shanghai Stock Exchange, acts as a channel so that Chinese and global investors can trade stocks directly via the SEHK. The Bond Connect, launched in 2017, allows access to the Chinese interbank bond market to global investors through Hong Kong. Despite Hong Kong’s position as an international financial center has been politicized recently, the city’s government has strengthened its connection with the mainland China capital markets by opening the Shanghai Star market, with a $487 billion in market value, to global investors where they can trade stocks of tech companies.

In the coming years, Hong Kong’s position still depends on U.S.-China relations. First of all, it has to reposition itself and redefine its brand as an international financial center. With its strong financial sector and its connection to the Chinese capital markets, global investors will still find Hong Kong one of their favorites, a city never short of business and investment opportunities. Given that an increasing number of overseas Chinese companies are flocking to Hong Kong for secondary listings and the city itself is actively integrating into the Greater Bay Area (a geographical region incorporating Hong Kong, 9 cities from Guangdong province, and Macau), Hong Kong may transform into an offshore center of the Chinese financial system, or become a mainland city with its unique characteristics.

Besides, if the economic decoupling and the competition between the U.S. and China are to become the new normal, Hong Kong will have to find a resilient strategy to weather the coming storms. Economically, the U.S. will view Hong Kong more as a Chinese city, such as treating exporting goods from Hong Kong as “Made in China” instead of “Made in Hong Kong”. Beijing will still take Hong Kong as its own rebellious child who needs more discipline, obedience, and perhaps patriotic spirit.

But in the end, Hong Kong’s fate is still in the hands of its 7.4 million citizens. Throughout the social protests, young Hong Kongers are picking up Vaclav Havel’s The Power of the Powerless, a long essay dissecting the post-totalitarian system in former Czechoslovakia, the question is, do these young people, who have not lived under the grip of the Chinese political system and intend to challenge its style of ruling, believe that they have the power and wisdom to play a constructive role in redefining Hong Kong’s identity in a new era?

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