Just by looking at Hong Kong’s stock exchange, it wouldn’t be immediately obvious that US-Chinese relations are at their lowest point in a generation, or that the city has become a point of conflict between world powers.
Amid the political upheaval, the share price of Hong Kong Exchanges & Clearings (HKEx) has soared, and the company has reclaimed its crown as the most valuable exchange operator in the world by market capitalization. The exchange is a surprise winner from the decoupling between the world’s two biggest economic powers. It can also be seen as a proxy for how things are faring for the rest of Hong Kong’s financial sector.
If banking and other types of services were drying up, the thinking goes, it’s unlikely investors would remain bullish on the exchange, which has roots going back more than a century and provides venues for trading assets like stocks, commodities, and derivatives. “If Hong Kong is OK, then the exchange is OK,” said Dennis Lam, co-deputy head of research in Hong Kong at DBS, a Singaporean bank.
That resilience is a sign that China has the wherewithal to resist international pressure, and could undermine one of the key messages of the city’s pro-democracy protesters. They’ve warned that China’s crackdown on civil liberties—particularly through the implementation of a sweeping national security law in June that covers everyone on the planet—will damage Hong Kong’s prestige as one of the world’s pre-eminent financial centers. But if the exchange’s stock price is any indication, that hasn’t happened, at least yet.
As Beijing’s grip tightens on Hong Kong, it’s clear that the city is running ahead of schedule in becoming less Western and more Chinese. The question is whether its recent success is a fleeting sugar high, and whether deeper structural factors—fewer freedoms and changes to the rule of law—will erode Hong Kong’s financial stature over time.
For now, the turmoil has probably worked in HKEx’s favor. American politicians, no doubt mindful that it’s an election year, have threatened to delist Chinese companies from US exchanges unless they submit to the same audits as domestic firms. For all the bluster, they have a point: US watchdogs acknowledged in April that their capacity to actually regulate companies in emerging markets, notably China, is lacking. One recent example is Luckin Coffee: The Starbucks competitor lasted a little over a year on the Nasdaq exchange after it emerged that hundreds of millions of dollars worth of sales had been fabricated.
Tech superstars like Alibaba and JD.com, meanwhile, have led a parade of Chinese companies taking out secondary listings in Hong Kong, as Washington and Beijing spar over everything from trade to tech to the coronavirus. Ant Group, the financial arm of Alibaba, is planning a massive listing in Hong Kong and mainland China—a turnaround from 2014, when e-commerce giant Alibaba went public in New York.
“The worsening (US-China) relationship has prompted more Chinese companies to consider raising their US dollars elsewhere, and that will come to Hong Kong as an alternative to the US,” DBS’s Lam said of HKEx’s rising market value, which has been buoyed by more listings and trading volumes.
There are other factors at work, too. Charles Li, the chief executive of HKEx, has taken steps to woo China’s tech heavyweights, and to make the exchange more competitive with the likes of the New York Stock Exchange (NYSE) and Nasdaq. A key sticking point for some tech companies like Alibaba was that HKEx, unlike NYSE, didn’t allow dual-class shares—a controversial structure that can give a handful of executives voting power that’s far in excess of their actual stock holdings.
In 2018, Li opened the gates to dual-class shares as well as biotech companies that have yet to generate revenue. That influx has changed the profile of Hong Kong’s equity market, which used to be seen as a relatively staid venue full of finance and property companies.
One country, one system
When Beijing passed the national security law, the city’s autonomy effectively withered away, as did the commitment to maintain the “one country, two systems” policy until 2047. The vaguely worded law criminalizes acts of succession or subversion of China’s authority, and violations carry penalties including lifetime imprisonment.
In doing so, the Chinese Communist Party showed that it was more concerned about cracking down on the months of widespread protests than it was about Hong Kong’s financial stature, said George Magnus, former chief economist at Swiss bank UBS. The law raises questions about what people in Hong Kong, including investors and financial analysts, can say or do if they’re perceived as critical of Beijing.
“They were probably aware of the risks they were taking in passing this law, in terms of what it would do to Hong Kong, but for them that was their priority,” Magnus, author of Red Flags: Why Xi’s China is in Jeopardy, said.
Part of Hong Kong’s success is probably owed to the freedoms not available on the mainland. If analysts there can no longer offer their views honestly because it might get them in trouble in Beijing, those markets will become less efficient. Hong Kong also has its own legal system—if the strengths of its courts and legal contracts are diminished under the party’s leadership, business could begin to flow elsewhere.
HKEx’s Li says that isn’t happening, as China is reforming its financial system based on Hong Kong’s model rather than the other way around. “The new law is unlikely to bring about any meaningful changes to the fundamentals of Hong Kong’s international financial market or to the way it operates,” Li said in a recent blog post. “The security law will have no bearing on any laws and regulations governing commercial activities, contractual arrangements, financial transactions, capital flows, dispute resolutions, and the movement of people/talent and flows of information and data.”
Hong Kong’s securities regulator acknowledged last month that it had been fielding calls from global financial institutions about the controversial law. The Securities and Futures Commission posted a statement to reassure executives, saying it will continue regulating markets they way it did before, while noting that stock trading has been lively and orderly. Hong Kong’s financial secretary claimed the executives it had spoken to were in favor of the law.
“Their general feedback is that the Law will help resuming a safe and orderly business environment, which is of utmost importance for Hong Kong’s continued development as an international financial centre,” the secretary said in a blog post.
Not everyone agrees with that assessment. The security measure contains “provisions that are incompatible with the rule of law,” and will change the court system in ways that are “extremely concerning,” wrote David O’Mahony, a barrister in the UK and member of the Bar Council’s International Committee. Experts warn that the law has already undermined Hong Kong’s common law system of judicial precedent—a legal pillar that global business executives rely on.
One reason Hong Kong punches above its weight is because it offers access to mainland China, which JPMorgan economists think will grow more than 2% this year even as most other countries’ economies shrink. The other reason is that Hong Kong is a conduit for US dollars. Its interbank plumbing handled an average of $43 billion of daily transactions last year, up from around $10 billion in 2009. That payment infrastructure plugs right into America’s, a currency thoroughfare that sees trillions of dollars of transactions each year.
If they were feeling really lucky, US officials could try to yank Hong Kong’s access to dollars. This is seen as highly unlikely, because companies from the US, UK, and Japan have thousands of offices there, and it’s hard to predict how the instability from such a move would ripple through the financial system. Given the enormity of such a detonation, American officials don’t seem to be taking this type of action seriously. Instead, the US has asserted the dominance of its currency through sanctions on Hong Kong and Chinese officials, which has reportedly forced not only American but also Chinese banks to reassess their ties to these individuals in order to ensure they can continue getting dollar funding.
China, too, runs the risk of accidentally pushing the wrong political button. For now, foreigners in Hong Kong are making the most of the city, with its low taxes, pleasing lifestyle, and linkages to mainland China. But that’s not to say the ground hasn’t shifted underneath them. That attitude could change quickly if a Western professional gets arrested for saying or tweeting something considered subversive.
Carson Block, a well-known short seller who made his name betting against Chinese companies, said the calm veneer among expatriates ignores how profoundly things have changed.
“The American business person can always return home to America, and these poor people are stuck,” Block, who founded hedge fund Muddy Waters, said of Hong Kongers. “These are people who just got their liberties absolutely snatched away from them in one stroke. They are much worse off.”
Hong Kongers have been offered sanctuary in Britain and Australia, and it’s not hard to find citizens who are considering or already making plans to leave.
One key plank to Hong Kong’s success—the freedoms for open discussion, and its rule of law—seems clearly to have been damaged. However, its access to dollars appear stable, and its connections to the mainland have arguably gotten stronger. Meanwhile, Western investors’ appetite for opportunities within China’s economy and its homegrown tech titans appears undiminished. In a sign of how the wind is blowing, HSBC and Standard Chartered, two banks headquartered in London but who do much of their business in Hong Kong, have, to the dismay of the UK government, backed the national security law.
For its part, Beijing would probably rather the access to its riches runs through Hong Kong instead of New York. That shift appears to have accelerated.