A Hardline Approach on Hong Kong Will Backfire on Beijing, Say Experts

Hong Kong enjoys special economic, trade, and investment status, which redounds to Beijing's advantage
September 5, 2019 Updated: September 6, 2019

WASHINGTON—Hong Kong is a critical financial gateway for mainland China, therefore increased meddling in the city’s affairs by Beijing would backfire, causing significant capital flight, experts say.

Hong Kong is one of the largest hubs for equity and debt financing in the world. Thanks to its long history of good governance, ease of doing business, and sound judicial system, the city has been a boon for Chinese companies seeking foreign capital.

Chinese companies use Hong Kong’s capital markets to attract foreign investors, while international companies use the city as a base to expand into mainland China. Experts warn that Beijing would shoot itself in the foot if it takes an increasingly hard line against protestors, seriously damaging Hong Kong’s standing as a stable financial center.

There’s $3 trillion in dollar-denominated debt issued by Chinese companies, according to estimates. And Hong Kong, an important source of capital for China, provides roughly a trillion dollars of that amount, according to Victor Shih, a professor of political economy at the University of California–San Diego School of Global Policy and Strategy.

U.S. banks and investors have lent roughly $180 billion to Chinese banks and Chinese companies mainly through Hong Kong, Shih said in his testimony at a congressional hearing held by the U.S.–China Economic and Security Review Commission on Sept. 4.

U.S.-based pension and mutual funds also own additional billions in bonds issued by Chinese entities, he said.

“When you’re in debt to the tune of $3 trillion, you don’t want your creditors to suddenly compress your credit limit by $1 trillion,” Shih said at the hearing. “That would be a big problem for China. And I think that may be one of the reasons why China thus far has chosen, I would call it, a very moderate and soft-line approach in Hong Kong.”

The reason Chinese entities are borrowing through Hong Kong is that the financial institutions around the world, including the International Monetary Fund, legally treat Hong Kong as a separate entity, he said.

The debts are issued by the subsidiaries of Chinese companies headquartered in Hong Kong, allowing them to enjoy lower interest rates compared to debt issued in mainland China.

Hong Kong has also become a top destination for equity investments. The city led the world in initial public offerings (IPOs) in 2018, surpassing New York.

“Over 1,000 mainland companies with a market capitalization of $2.6 trillion are listed on the Hong Kong exchange,” Robin Cleveland, vice chair of the U.S.-China Economic and Security Review Commission, said at the hearing.

“They choose Hong Kong because there is no rule of law in the mainland to protect their interests,” she said.

Beijing’s Actions Threaten Hong Kong

From 2010 to 2018, Hong Kong was the venue for 73 percent of mainland Chinese companies’ offshore IPOs, 60 percent of all offshore bond issuances, and 26 percent of offshore syndicated loans, as well as the global center for offshore yuan trading activity, according to French global bank BNP Paribas.

Hong Kong’s benchmark Hang Seng Index has fallen by nearly 10 percent since April, when protests against the controversial extradition bill first escalated.

Beijing’s actions have threatened Hong Kong’s active and important role in global banking, finance, and investment, Cleveland said.

“If tension escalates, the Congress and administration will face a difficult challenge in assessing the threshold for revoking Hong Kong’s special status,” Cleveland said.

The increased meddling in Hong Kong’s affairs by the Chinese Communist Party despite the “one country, two systems” framework has been a growing concern for Washington for several years.

The “one country, two systems” is a constitutional principle that governs the relationship between Hong Kong and Beijing through 2047. It has allowed the city to retain extensive autonomy and freedoms, including a separate legal system following its 1997 handover to China from the UK.

This “one country, two systems” framework has enabled the United States to deal with Hong Kong as an entity separate from China in matters of economics and trade for more than two decades. Hong Kong, for example, doesn’t face the tariffs that the United States is imposing on Chinese imports.

Carrie Lam, Hong Kong’s chief executive, said on Sept. 4 that the government will formally withdraw a controversial extradition bill that ignited the city’s largest protest movement.

The bill would have allowed Hong Kong citizens to be sent to mainland China to face trial in the Chinese Communist Party’s opaque legal system, giving the Chinese regime sweeping powers.

The withdrawal, a key demand of protestors, came after months of unrest that have resulted in the arrests of more than 1,000 protesters. Protestors, however, say withdrawing the extradition bill is not enough, vowing to continue demonstrating until all demands are met, including exoneration of all protestors who have been arrested.

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