For the past 18 months Hong Kong has been playing up talk about the potential of the offshore renminbi (CNH) market, and with good reason. Gaining exposure to the closely controlled currency of the second-largest economy in the world has appealed to many companies and investors. But all of this potential overlooks one simple fact: the CNH market has a very limited period in which to enjoy its ascendancy.
Beijing is placing greater emphasis on opening China’s own capital markets and making its currency more flexible. As it does so, Hong Kong’s role as the gatekeeper to the mainland will diminish—along with its leverage in the worldwide financial system.
At that time the CNH currency would disappear as the renminbi becomes freely convertible. There’s already indication that the offshore and onshore markets are converging as spreads between the CNH and renminbi bond market narrows.
This process will take time. But not as much as the city’s leaders may think. Mark Walton, senior economist at CLSA, tells Asiamoney PLUS that Hong Kong may have as little as five years before this point arrives.
"It’s inevitable that Hong Kong will have to stand increasingly alone over time," he said. "Hong Kong has had the advantage of being a Western city with a Chinese framework and for being a gateway from China to the West and the West into China. But that role won’t exist in the same way anymore."
Instead, investors would be able to entirely bypass Hong Kong in favour of directly accessing China’s onshore market. The city is unlikely to disappear as a financial hub—the strength of its rule of law and depth of its equity markets should help sustain it—but it can expect to see banks and financial services firms shift some of their key resources onshore.
The bustling financial hubs of Cheung Kong Centre and International Commerce Centre could become shadows of what they once were.
One possible outcome of all this is that Hong Kong in effect becomes just another tier 1 city in China, albeit one with some legal peculiarities. A logical outcome of that process would be the end of the Hong Kong dollar, and thus the Special Administration Region’s financial autonomy. Such a fate could come well before 2047, which is the official date at which Hong Kong becomes a fully integrated with the rest of the mainland.
In order to avoid such a fate Hong Kong must ramp up its capabilities while it can.
This means incentivising trade settlement through greater CNH liquidity. The Hong Kong Monetary Authority (HKMA)loosened its policy regarding banks’ CNH reserves in January, which has helped to boost CNH lending and trading. But the market wants more.
Politicians, bankers and investors have all called for a wider array of CNH financial products, whether that’s more offshore dim sum bonds, renminbi qualified foreign institutional investor (RQFII) funds, derivatives or equities. Quickly introducing more of these would help to sop up the Rmb576 billion (US$91.4 billion) of deposits sitting in Hong Kong.
Hong Kong can also strengthen the interbank’s clearing platform network to encourage more trading. According to the HKMA, 187 banks participate in Hong Kong’s CNH clearing platform, and cover more than 30 countries. By linking with even more markets now by using its clout as a trade partner, more overseas corporates and banks would have access to the currency, prompting more widespread trade activity.
There are more widespread solutions that Hong Kong can implement to reinforce its role as an international finance centre that extends beyond its CNH market development. The city’s financial sector is valuable because of its human capital, and the city must do as much as possible if it is to entice banks to keep their regional headquarters in the city.
This would be helped by cleaning up air quality and controlling property prices.
Hong Kong’s regulators could manage such changes independent of Beijing, and they would help it create more widespread opportunities.
The special administrative region’s government could also aim to broaden its strengths away from purely financial services. CLSA’s Walton points to Singapore as an example. The city state has invested a lot of time and money to lure the pharmaceuticals industry, for one.
Whatever the strategy, Hong Kong regulators must prepare for the fact that the region’s dynamics are changing—and not in Hong Kong’s favour. The city must introduce plans to maximise the city’s value now while it still enjoys world-class financial infrastructure and human capital.
Fail to do so and ‘Asia’s World City’ could yet end up ending up as an unremarkable southern China backwater.