Integration with the mainland best option for HK's financial sector

Hong Kong as an international financial center has enjoyed the benefit of "One Country, Two Systems" for 20 years so far. A major concern of the special administrative region government and local society is how the city should develop as an international financial center in the next five to 10 years, because finance is still a pillar industry. That is why it must handle three issues properly in the years to come.

The first issue is that Hong Kong must end the financial industry's unhealthy over-dependence on the property market.

Finance runs on two basic rates - interest rate and exchange rate. After the Bretton Woods System collapsed in the 1970s developed countries such as the United States soon replaced their fixed or stable interest rates with floating or fluctuating credit costs to stimulate the trading of financial products, which in turn drove the quick expansion of financial capital (hot money) and led to the disconnection of the financial market from real economy in those developed countries. The financial sector still served other sectors back then but it began to be obsessed with "making money for itself". Most if not all large financial firms saw their own proprietary trading units expand every day until this day, showing no sign of restraint even after the devastating "financial crisis of the century" in 2008. In today's global currency market, speculative trading by investment banks still accounts for 95 percent of all transactions; only 5 percent concern the real economy.

The Hong Kong dollar is pegged to the US unit. Hong Kong's interest rates formerly followed US rates exclusively but now also follow yuan interest rates. This means Hong Kong cannot cultivate financial derivatives and transactions based on movements of the HK dollar exchange rate and interest rate. Hong Kong is a city with little or no agricultural or mineral production, meaning it has nothing to offer as commodities for futures trading. However, its financial market is deeply intertwined with the real estate market and has turned the latter into a formidable bubble like no other. One proof of this phenomenon is that even after the recent mortgage interest-rate increases by major banks, the prevailing mortgage interest rate is still 2.75 percentage points lower than the prime lending rate. Normally the mortgage interest rate should be slightly higher than the prime lending rate.

From a medium- to long-term point of view Hong Kong must develop new pillar industries that are crucial for developing a knowledge-based economy. The banking industry should support these pillar industries and shake off its over-dependence on the property market. In the meantime, Hong Kong's banking industry also needs to expand the scale of its yuan business.

Shanghai is working toward the goal of developing itself into an international financial center focused mainly on yuan-denominated financial transactions and clearing. To reach this goal the central government must make the yuan fully convertible in the next two or three years. Anyone who knows a thing or two about finance understands that when Shanghai reaches the goal of becoming an international financial center after the yuan becomes fully convertible, Hong Kong will have less space to advance its status as the leading offshore yuan trading hub, and may find it impossible to grow and even begin withering in the not so distant future.

That leads to the second major issue Hong Kong as an international financial center must address properly - innovatively resolving the relationship between the HK dollar and yuan without affecting implementation of Article 111 of the Basic Law, which stipulates: "The Hong Kong dollar, as the legal tender in the Hong Kong Special Administrative Region, shall continue to circulate."

Currently many retailers already accept the yuan as payment in Hong Kong; while local banks are working on increasing their yuan savings. Hong Kong's interbank yuan settlement system is connected with the mainland's inter-bank settlement system through Shenzhen. Problem is that the scale of yuan business in Hong Kong is still rather limited and not enough for Hong Kong to compete with Shanghai for international yuan business if the latter becomes an international financial center in its own right.

The third major issue Hong Kong must handle properly is further developing its securities market.

It is public knowledge that, since 2003, mainland-based enterprises have become the main driving force behind the Stock Exchange of Hong Kong's (SEHK) growth, be it the number of initial public offerings a year, total market capitalization or daily turnover volume. In the past 10 years the SEHK and SAR government worked hard to attract enterprises registered with other jurisdictions to list in Hong Kong. Before March 2007 all companies listed in Hong Kong were registered with one of four jurisdictions - Hong Kong, the Chinese mainland, the Cayman Islands and Bermuda. Since then 25 more jurisdictions have been admitted to the list. So far 42 companies registered with 12 of those 25 jurisdictions are now listed Hong Kong.

Without question Hong Kong should continue attracting companies registered with other jurisdictions to list here but the SAR must also focus on enhancing its stock connects with Shanghai and Shenzhen in the years to come.

Summing up the three major issues, we can conclude that, in the next five to 10 years, the HKSAR must step up theoretical studies and institutional build-up for economic integration with the mainland, including the integration of their financial markets.

(HK Edition 06/07/2017 page8)