Hong Kong likely to endure despite China move

Hong Kong's status as Asia's premier financial center could prove resilient even as U.S. officials warn that heightened U.S.-Chinese political tensions could leave the territory much diminished.

Amid an increasingly volatile diplomatic dust-up between the two superpowers, money managers expressed confidence that Hong Kong will remain the financial center of choice for the growing ranks of investors expected to plow money into mainland stocks and bonds over the coming decade, even as some analysts see potential for the special administrative region to be hobbled by U.S. sanctions.

The immediate bone of contention is Beijing's push to impose a national security law on Hong Kong, which U.S. officials contend would violate China's commitment to leave such matters to Hong Kong's legislature for 50 years through 2047. The commitment was part of the "one country, two systems" framework agreed to at the time of the U.K.'s handover of the territory to Beijing in 1997.

U.S. officials warned last week that such an end run around Hong Kong's legislature would result in the territory ceding the dominant position it has held in the region in areas such as global banking, money management and corporate deal-making.

If China moves ahead with its plans, "I can't see Hong Kong remaining an Asian financial center the way it has been for many, many years," said Robert O'Brien, the U.S. national security adviser, in televised comments on May 26. The same day, President Donald Trump, through White House press secretary Kayleigh McEnany, doubled down on that point, saying, "it's hard to see how Hong Kong can remain a financial hub if China takes over."

On May 27, U.S. Secretary of State Michael R. Pompeo announced that for the first time since the 1997 handover the U.S. cannot certify that "Hong Kong maintains a high degree of autonomy from China." He described that decision as a "recognition of reality."

Despite that pressure, on May 28 China's legislature, the National People's Congress, approved a proposal to impose a new security law on Hong Kong, purportedly aimed at proscribing terrorism, secession and foreign interference.

Some observers say the U.S. administration's rhetoric is stronger than its bargaining position.

The leverage the U.S. has in this situation is "de minimus," said Nicholas Lardy, a Washington-based senior fellow with the Peterson Institute for International Economics. The administration's obvious lever — removing the preferential trade and tariff treatment the U.S. currently affords Hong Kong — would do more to hurt U.S. multinationals and the Hong Kong people than it would discomfort Beijing, he said.

Mr. Trump, in a short Rose Garden speech May 29, responded to Beijing's decision to move ahead with a Hong Kong security law, announcing that he would "begin the process of eliminating different and special treatment for Hong Kong."

Mr. Trump did not back away from the phase one U.S.-China trade deal signed last year, but he did direct the President's Working Group on Financial Markets to "protect the integrity of the American financial system" and examine Chinese firms listed on U.S. stock markets with an eye toward limiting American investment in the companies that "don't play by the rules."

Hong Kong officials have insisted the territory's citizens have nothing to fear from the new security laws, arguing the rights they've enjoyed since the handover in 1997 and the territory's respected rule of law will be preserved.

Others warn the prospect of China's security apparatus taking on a more direct role in Hong Kong at this point will prove unsettling for many foreign firms.

A number of projects and initiatives have come to a full stop, with many companies "completely reassessing" their plans going forward, said Frank T. Troise, Singapore-based CEO, Asia-Pacific, with fintech-focused investment bank SenaHill Partners, New York.

A Hong Kong where Beijing takes on a more direct role could make many international companies, and U.S. companies in particular, "reconsider their presence here," noted Stewart Aldcroft, a Hong Kong-based managing director and senior adviser with CitiTrust Ltd.

Ratings agencies, meanwhile, said the prospect of increasing integration between China and Hong Kong could weigh further on the territory's rating. Andrew Fennell, Hong Kong-based senior director, Asia-Pacific sovereigns, with Fitch Ratings, said while the U.S. signaling of a change in its long-standing policy toward Hong Kong "could heighten uncertainty and dampen investor sentiment," Fitch's April decision to lower the territory's ratings to AA-, one notch above its A+ rating for China, effectively captures that uncertainty.

Mr. Fennell said in an email that conclusion reflects Fitch's confidence "the territory will retain a high degree of autonomy over its most salient macro-institutional features such as an independently managed currency, fiscal framework, financial regulatory bodies, and the foundations of its business environment."

Moody's Investors Service — which in January cut its Hong Kong rating to Aa3, one notch above its A1 rating for China, on the back of concerns the territory's institutions and governance weren't as strong as previously thought — appeared less confident on that score.

China's new security law for Hong Kong could further reduce "the autonomy of Hong Kong's lawmaking and judicial institutions (with) negative implications for the effectiveness of Hong Kong's institutional governance," said Martin Petch, Singapore-based vice president and senior credit officer with Moody's sovereign risk group.

The resulting change in external perceptions of Hong Kong could "add to downward pressure on the rating, particularly "if the international response ... leads to a weakening of Hong Kong's role as an international economic and financial center," Mr. Petch said.

Additionally, equity index providers could now decide to take a fresh look at Hong Kong, which is currently in the MSCI World index with other developed markets. China is in the emerging markets index. It is unclear whether the most recent move would result in index providers treating Hong Kong the same as other Chinese cities, such as Shanghai and Shenzhen.

Whether such concerns prove to be more exception than rule is an open question for now, observers say.

"Financial centers thrive on attracting and retaining international talent, and it remains to be seen whether the security law will make Hong Kong a less attractive place to work," said Mike Wardle, the London-based head of indices with Z/Yen Group Ltd., a research firm that publishes a twice-yearly ranking of global financial centers.

In the firm's latest global ranking, released March 26, Hong Kong dropped to sixth place from third six months earlier, with one mention of the "social unrest" — sparked by the legislature's consideration of a bill that would have allowed its citizens to be extradited to the mainland — that had rocked the territory since mid-2019.

For the current security law contretemps, Mr. Lardy said the U.S. administration would be better served waiting to see how the new law is implemented before responding. Will the Chinese army's Hong Kong garrison be used to control crowds? Will people be whisked out of hotels or arrested in broad daylight and marched to China to be tried for crimes real or imagined, he asked.

Despite continued uncertainty, Mr. Lardy said his best guess is that Hong Kong remains "a very strong financial center," with substantial advantages over other financial centers in the region that can't be easily replicated elsewhere.

Some money management executives in the region say they're not worried about the new security law.

"I don't think there will be any change at all to Hong Kong's status as an international financial center," said Weijian Shan, chairman and CEO of Hong Kong-based private markets and alternatives investment firm PAG Group.

"Every country, including the U.S., U.K. and Singapore, has a national security law which doesn't weaken the rule of law, but protects it including all its ingredients such as the presumption of innocence, due process and judicial independence," Mr. Shan said.

Others say the global tug of war between China and the U.S. could, in some respects, even elevate Hong Kong's importance as a financial center. Legislation is moving through Washington now that could result in Chinese companies being delisted from U.S. stock exchanges, noted Thomas Cheong, Hong Kong-based president of Principal Financial Group's business in Asia.

If that occurs, the natural home for those listings would be Hong Kong, cementing the financial center's status as the first stop for the growing ranks of overseas investors looking to allocate more to mainland China stocks and bonds, Mr. Cheong predicted.

The loss of some of Hong Kong's freedoms — and vitality — would be missed, managers said. But with most firms already focusing on China's mainland market as their biggest growth opportunity in coming decades, that prospect is unlikely to scare many away, they said.

At the end of the day, a number of money managers said an end to the demonstrations — and occasional riots — that rocked Hong Kong much of the past year would be welcomed.

"Hong Kong as a city cannot live with the riots over the last year," said one veteran Hong Kong-based private equity investor, who requested anonymity.

"I love Hong Kong," said the investor. "It's unique, like no other city, a wonderful place, but we all have to get used to change," he said.

Bloomberg News contributed to this story.