CHINA'S INTERNATIONAL FINANCIAL CENTER: HK HOLDS

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 001163 SIPDIS STATE FOR EAP/CM, EEB/IFD/OMA, AND INR; TREASURY FOR OASIA E.O. 12958: DECL: 06/22/2034 TAGS: EFIN ECON HK CH SUBJECT: CHINA'S INTERNATIONAL FINANCIAL CENTER: HK HOLDS EDGE...FOR NOW REF: HONG KONG 1104 Classified By: Consul General Joe Donovan, Reason 1.4 b ¶1. (C) Summary: The Chinese Government's announcement that it would support Shanghai to become an international financial center by 2020 has many in Hong Kong wondering what role the Special Administrative Region will be allowed to play in China's development. Should Hong Kong increase cooperation with Shanghai? Will Hong Kong eventually be marginalized to a limited role providing financial services to the Pearl River Delta? Shanghai's rapid development may someday enable it to challenge Hong Kong,s role as the preeminent international financial center in the region, but, that said, the Chinese government's statements of support for Shanghai haven't prevented Beijing from moving slowly forward with measures that help Hong Kong,s financial services industry. Recent Chinese government announcements allowing Hong Kong banks to issue Renminbi (RMB) bonds in Hong Kong for the first time and the prospect of RMB trade settlement in Hong Kong are positive, if small, steps that benefit the SAR. Hong Kong already offers a limited range of RMB products and opportunities to invest in Chinese companies, further financial integration with the Mainland will help it serve the growing China market and attract international capital eager to make a "China play" from the relative safety of Hong Kong. End Summary. ¶2. (C) Comment: We agree with those who say Hong Kong,s rule of law, sophisticated and credible regulatory system, skilled bilingual workforce, and strong complementary service industries will allow it to remain at the center of international finance in Asia for years to come. Expanding the scope of RMB products and services is an important part of Hong Kong's development plans. But Hong Kong cannot rely on the Chinese market alone to guarantee its future success. As the failure of the 2007 "Through-Train" for Hong Kong stocks proposal illustrated, access to Chinese investors, currencies, and markets remains in the hands of decision-makers in Beijing who do not think solely of Hong Kong,s best interests. To remain competitive vis--vis Shanghai or any other budding rivals, Hong Kong must also build on the strengths that made it this region's pre-eminent financial center: strong and trustworthy laws and regulations that meet international standards, a business-friendly environment, development of well-regulated, innovative financial products and services, a talented multilingual workforce, and a high quality of life. That makes addressing concerns about tycoon dominance of Hong Kong's capital markets, insufficient prudential financial regulation, declining English skills, and deteriorating environmental quality crucial to Hong Kong's future economic success. End Comment. ============================================= = Shanghai 2020 Plan Strikes Fear into Hong Kong ============================================= = ¶3. (SBU) The People's Republic of China State Council announced in late March 2009 that it intended to build Shanghai into a major international financial center and shipping hub by 2020. Despite Premier Wen Jiabao's subsequent reassurances to the Hong Kong press that "Hong Kong's status as a financial center is irreplaceable," the State Council announcement created a round of soul-searching as Hong Kong financial leaders and pundits began a vigorous debate over the future of Hong Kong,s international financial center ambitions. ============================================= = Thinking About Hong Kong and Shanghai's Future ============================================= = ¶4. (SBU) Some foreign observers, like Yale University's Jeffrey Gartner, predict increasing cooperation between Shanghai and Hong Kong, with a "ShangKong" rising to be one of the world's premier financial centers (FT, May 10, 2009). Others, like Newsweek International Business Editor Rana Foroohar, wonder "Will Hong Kong Become a Has-Been?", (Newsweek, June 15, 2009) as China pushes State-owned firms to list on the Shanghai Stock Exchange rather than in Hong Kong. Views of analysts and policymakers in Hong Kong range across the spectrum, but in their discussions with Consulate General officers, several key themes emerge: -- Hong Kong and Shanghai have a long history of competition HONG KONG 00001163 002 OF 003 and collaboration, but the two markets have very different approaches; i.e., government v. private capitalism. -- Shanghai is attractive, particularly to Chinese companies who don't want too much oversight and no longer seek "international" approval. -- Shanghai cannot become an international financial center without a freely convertible currency and a long list of other regulatory and business reforms. -- Even when the RMB is fully convertible, Hong Kong retains significant structural advantages including rule of law, a simple, low tax system, a transparent and well-developed regulatory framework, freedom of information, strong human resources, and established relationships. -- Hong Kong, however, cannot stand still and must build on its strengths to remain competitive, including improving services like asset management, expanding RMB services and encouraging dual listing, and maintaining a regulatory and governance framework that meets international standards. ============================================= ============== If HK/Shanghai Are Like Brothers: Who is Cain, who is Abel? ============================================= ============== ¶5. (C) Hong Kong and Shanghai have a long history as both competitors and collaborators. In the 1950,s, Shanghainese migrants brought the industrial skills and capital that turned Hong Kong into a manufacturing and shipping hub. More recently, Hong Kong businesses have returned the favor, becoming the largest source for FDI in Shanghai, with Hong Kong official statistics reporting over US$5.5 billion invested in infrastructure, real estate, banking, tourism and retail trade in 2007. The Hong Kong and Shanghai Stock Exchanges signed a cooperation agreement in January 2009 committing them to additional information sharing, product development and personnel training. Yet the two exchanges also compete for lucrative Initial Public Offering (IPO) listings. Of the 1,269 companies listed on the HKEx, 471 are Chinese companies, which must receive approval from Mainland authorities before listing in Hong Kong. HKEx recently announced the appointment of Charles Li, formerly J.P. Morgan's China Chairman, to replace the current CEO Paul Chow. Li will be HKEx's first Mainland Chinese CEO and observers expect he will promote additional Chinese listings and cross-border products. Hong Kong,s representative in Shanghai, Patrick Chan told an audience of Hong Kong business leaders that the two cities are "like brothers," sometimes competing, but ultimately cooperating to promote Chinese development. However, Credit Suisse Managing Director Vincent Chan strongly disagreed. Money knows no familial loyalty, he said, and the market that is able to attract liquidity and best serve the needs of business will "kill" the other. ======================================= Still Can't Compare HK/Shanghai Markets ======================================= ¶6. (C) Bank of China Hong Kong Managing Director Tse Kwok-leung discounted local concerns about Hong Kong/Shanghai competition, noting that the two cities have very different markets with different roles to play in international and domestic finance. Shanghai's market is based on government-driven capitalism, said Tse, with SOEs accounting for close to 25 percent of listed companies in China and over 56 percent of market capitalization. With a large pool of domestic savings, investors with limited investment opportunities, and familiarity with local rules and requirements, it makes sense for Chinese enterprises to look to the Shanghai market to raise RMB funding. Hong Kong is a market-driven external financing center, where companies can go to raise hard currency and establish their credentials as international businesses. Chinese companies have traditionally sought overseas listings, including in Hong Kong, in part due to the stringent reporting and transparency requirements. An overseas listing, although costly, was seen as a badge of international approval as well as a route to international capital. The global financial crisis has reduced the appeal of that approval, making some companies reconsider the cost of compliance with Hong Kong regulations, said Tse. HKEx Managing Director Lawrence Fok agreed that Hong Kong,s level playing field and transparency are not always attractive to Chinese companies seeking to raise money, particularly when international markets are volatile, but he insisted that Chinese companies would continue to find Hong Kong IPOs attractive, despite their recent poor performance. HONG KONG 00001163 003 OF 003 ============================================= ===== It Takes More than RMB Convertibility to be an IFC ============================================= ===== ¶7. (C) RMB convertibility is a precondition for Shanghai to develop into an international financial center. Credit Suisse's Chan put it plainly, "before RMB convertibility, there can be no competition." Chan questioned what Chinese officials mean when they talk about Shanghai as an international financial center. An international financial center is more than just a big stock market, he said, and should include corporate headquarters, international standard capital markets (including fixed income as well as equities), a transparent and reliable legal/regulatory framework, free access to information, as well as knowledgeable financial experts and supporting service providers. Shanghai can take measures to increase the diversity of market players and improve its regulatory regimes, but even after the RMB is freely traded, it will take many years for Shanghai to develop the infrastructure necessary to be a true international financial center, said Chan. Despite Chinese government rhetoric about Shanghai's future role, Hong Kong has been the beneficiary of several small steps to bolster its ability to use RMB (reftel). Additional expansion of RMB business opportunities in Hong Kong is likely to precede full RMB convertibility and should give Hong Kong a headstart in providing RMB services to international clients. =========================================== Hong Kong Still Far Ahead, But Must Improve =========================================== ¶8. (C) Hong Kong remains an attractive location for international corporate headquarters with approximately 8000 foreign companies registered in Hong Kong; the HKG estimates close to 1000 of these are regional headquarters. International companies increasingly see the need to have operations in Shanghai, said Chan, but as long as key Chinese regulatory agencies are headquartered in Beijing, Shanghai will not attract large numbers of company headquarters, even if other necessary infrastructure is present. Low taxes, a skilled English-speaking local workforce, a high standard of living, access to international goods and services, access to information, ease of transport, a large number of international schools and easy to meet residency requirements continue to give Hong Kong an edge over other locations in China and the region. Shanghai's market capitalization is higher than the HKEx market cap, but does not take into account the fact that a significant percentage of Shanghai shares are non-tradable. Until Shanghai can accommodate a sell-down of the government's stake in traded companies and increase the market depth, Hong Kong still retains a strong edge in equities, said Chan. ¶9. (C) Even when the RMB becomes fully convertible, Hong Kong will likely retain structural advantages: rule of law, simple, low taxes, transparent and credible regulations, freedom of information, a talented and bilingual workforce, familiarity with large international corporations, government officials, and regulators. While some Chinese companies may be rethinking the value of a listing in Hong Kong (or hedging their bets through dual listings),multinational corporations continue to be attracted by Hong Kong,s legal and regulatory infrastructure, knowledgeable financial experts and supporting service providers, and the ease of doing business here, said HKEx's Fok. Despite the increasing need for regulatory reforms, as demonstrated by ongoing controversy surrounding the sale of complex structured products to retail investors, local telecom giant PCCW's failed bid to go private, and disputes over reporting requirements for listed companies, Hong Kong institutions are generally perceived as competent, clean, reliable and efficient. These structural advantages continue to make Hong Kong an attractive place for international companies to do business. DONOVAN