Hong Kong: the fast mover

Author: | Published: 25 Sep 2012
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Unlike the long-established financial hubs of New York and London, Hong Kong has experienced a meteoric rise that has resulted in its position as Asia's financial centre. Admittedly, its proximity to China has contributed to its success. But many laud the ease of doing business, its commitment to free markets and its networking potential as reasons for continued growth.

Although Hong Kong's close relationship with China is key to its global prominence, businesses and citizens alike are wary of the mainland's intentions for the city-state. Questions about the one country, two systems policy arise not only in political circles, but also in regulatory developments.

Hong Kong faces competition closer to home, as well. Sources say that Singapore is a challenger due to Indonesia's growth and frontier markets such as Cambodia, Vietnam and Myanmar. Looking further into the future, Shanghai may challenge Hong Kong as a renminbi (RMB) hub.

The evidence

CNMC: On June 29, China Nonferrous Mining Corporation became the first Africa-based company to list on the HKEx. Impressively, HKEx did not require a waiver for the Zambian copper company's listing. The HK$2.44 billion IPO shows that African operations may be able to satisfy HKEx's listing requirements, and lawyers expect it to spark a wave of copycats.

Listed equity securities: January 1 to August 31 2012

Red chips and H-shares

According to many, a key difference between Hong Kong, London and New York is that Asia is where the money is. Davis Polk & Wardwell partner Antony Dapiran says sentiment isn't as good in the US and Europe, which are the markets traditionally serviced by New York and London. "In Asia, investors are looking to invest and companies are growing and raising capital," he says.

Although high-profile IPOs of international corporates such as United Co Rusal and Prada attract media attention, they are not the norm. Instead sources agree that the Hong Kong stock exchange (HKEx) is the ideal listing venue for Chinese companies. Those listed in New York suffered low valuations following accounting scandals at Sino-Forest Corporation and Longtop Financial Technologies. Closer to home, they receive more reflective valuations. In a report published by the HKEx on August 31, H-shares (Hong Kong-listed companies incorporated in China) and red chips (China-based companies incorporated internationally) account for 45.8% of market capitalisation.

But sources believe the HKEx's listing requirements are particularly prescriptive. A financial services firm says the rules are perceived as relatively process-heavy in balancing investor protection with efficiency.

IPO volume has slowed due to the China's economic slowdown; also because most Chinese state-owned enterprises are already listed. As of September, the HKEx's largest IPO of 2012 was that of Inner Mongolia Yitai Coal, which raised $903 million. The Wall Street Journal cited a report by Haitong Securities stating that funds raised from Hong Kong IPOs fell 77% year-to-date from HK$190.4 billion in 2011 to HK$43 billion in 2012. There is hope that IPOs will return in Q3. At the time of press, Zhengzhou Coal Mining Machinery Group was preparing for a listing tipped to raise up to $500 million.

One country, two systems

Hong Kong's market regulator, the Securities & Futures Commission (SFC), has been active in implementing and investigating issues related to transparency and corporate governance. This year it introduced a positive obligation on the officers of listed companies to make disclosure of price-sensitive information as soon as reasonably practicable. A Hong Kong-based regulatory partner believes this is a major step forward, especially since standards and timeliness of disclosure have been poor in Hong Kong in the past. "I would like to see criminal penalties for non-disclosure in especially bad cases," the partner adds.

Following a spate of accounting scandals from US-listed Chinese companies, the SFC has also been active in investigating companies for alleged fraudulent activity. But the People's Republic of China's (PRC's) state secrecy laws make it a criminal offence to disclose corporate records and require work drafts compiled within China by securities firms and other agencies must remain within the country. This is hindering investigations.

A seminal case in this regard is the SFC's legal action against Ernst & Young, which commenced this August. This will determine whether the regulator's demands under Hong Kong law outweigh China's secrecy laws. Ernst & Young, as auditor, refused to disclose the work papers of Chinese company Standard Water, which had applied to list in 2009. After the advisory firm abruptly resigned in 2010, Standard Water pulled its listing. But Ernst & Young's mainland joint venture partner refused to comply with the SFC's demands for the work papers, citing PRC law.

One regulatory lawyer says that this is a dormant issue, and that only now – 15 years since the city-state's handover – that these practical issues are being addressed. "There is a huge gulf between mainland and Hong Kong law, and there are practical implications for 'one country, two systems' arising from this case," he says.

Alleged accounting scandals may damage investor confidence in H-shares and red chips, lowering valuations of listed Chinese companies. But corporate governance activist David Webb says that they should not receive special treatment. He comments: "If China isn't going to play ball, it will raise issues about having it both ways: while Chinese companies can raise capital in international markets, they can't be subject to regulations."

Global clearinghouse

Given its proximity and relationship with China, it is no surprise that Hong Kong is the world's RMB clearinghouse. Although Hong Kong, London and Singapore are vying to become offshore RMB trade centres, counsel say Hong Kong benefits from the competition.

Clifford Chance partner Francis Edwards emphasises that RMB liquidity in other jurisdictions support Hong Kong. For example, to clear RMB funds in London, transfers must be made through Hong Kong's settlement systems because the infrastructure required for the currency's clearing is based in Hong Kong.

Taipei may offer further competition, after Taiwan signed a memorandum of understanding on currency clearing with China on August 31. When it takes effect at the end of October, Taipei will become only the second centre where Chinese currency will be deliverable, beating Singapore and London which were also vying for offshore RMB clearing.

However, the agreement seems largely symbolic, and designed to ease cross-strait relations rather than support material change in the international use of the RMB. Most believe that its impact will be limited, as it will not reach new RMB investors in Europe or Southeast Asia.

Hong Kong's appeal, however, lies in its innovative RMB-denominated instruments. On September 17, the HKEx introduced RMB currency futures, which had been eagerly anticipated by the market. It is also looking to develop RMB markets in fixed income, currencies and commodities.

Information networks

Sources unanimously agree that Hong Kong boasts the best networking opportunities in Asia. Jason Sambanju, co-head of Paul Capital's Asian operations, says: "Hong Kong feels like an information hub. Exchange of information happens quickly via formal or informal networks – informal networking is especially important because this is such a densely concentrated market."

Most of Hong Kong's office buildings and expatriate residences are located in the 12.5 square kilometer Central and Western district, which comprises the central business district and the Mid-Levels residential area. Nearly all sources note that chance meetings with acquaintances occur frequently due to the area's density, and that those impromptu connections often lead to deals.

Moreover, the centre has strong inter-Asia connections. A multinational financial services firm says that one of Hong Kong's advantages is that it is a two-hour flight to most major Chinese cities and only six hours from half the world's population. A lawyer in the private equity industry agrees: "Hong Kong is the hub of emerging Asia, and is where you can plug into any network you want."

Because of the concentration of people with similar interests, sources frequently compare Hong Kong's influence on Asia's financial sector to that of Silicon Valley's on the technology sector. Most sources agree that camaraderie flows out of Hong Kong's light regulatory touch, and that the free flow of information and transparency draw a stark contrast to other Asian countries.

China's double-edged sword

While counsel concur that Hong Kong's proximity to China is helpful, they agree that there are some drawbacks; most notably, its reliance on China's economic growth.

Akiko Mikumo, managing partner of Weil Gotshal & Manges Hong Kong says the China risk is Hong Kong's biggest. "It's not a negative, because China has a developing legal system and a developing economy that shows how much it has been able to achieve in the last 40 years," she says.

But China's ascendance may ultimately challenge Hong Kong as a financial centre. In March 2009, China's State Council announced an initiative promoting Shanghai's evolution into a fully-fledged international financial centre by 2020 following capital markets development and possibly the full convertibility of the RMB.

Hong Kong's rule of law, however, may prove its most important asset. Sources believe that Shanghai will be a domestic financial hub, but will be unable to reach the same heights unless it is able to meet the same level of predictability and reliability.

Financial hub of tomorrow, not today

Ultimately Hong Kong's advantage over both its regional and international rivals is a lenient regulatory environment. Dapiran says Hong Kong hasn't adopted the batten-down-the-hatches mentality that the US and Europe seem to have in the last few years, which is why it's remained so dynamic.

The regulatory partner agrees, adding that it's quite refreshing for people to come here compared to the mound of regulations coming out under Dodd-Frank. However the counsel warns that the impact of US legislation on Asia remains a significant concern.

Most sources admit that Hong Kong is not yet an international financial centre at the level of London and New York, although its regional role means it is poised for future growth. Mikumo says Hong Kong is a more regional financial centre than New York and London. "As Asia becomes a global financial power, Hong Kong will be a beneficiary," she says. "However, all good businesses, including investment houses and law firms, need to be in three places at a minimum: London, Hong Kong and New York."

For the rest of IFLR's October cover story, see:

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