Only a couple of years ago, Hong Kong officials fretted openly that the giant economy across the border on the mainland posed a serious competitive threat to the city’s financial sector. With Chinese banks boasting the world’s biggest balance sheets and market caps, and cities like Shanghai and Shenzhen looking to grow their financial markets, some feared that the writing was on the wall for Hong Kong’s status as a major global financial center.
Today those fears seem quaint. Instead of bowing before a mainland onslaught, Hong Kong’s financial sector has ridden the Chinese economy to even greater prominence. The city has extended its lead over rival centers as a location for initial public stock offerings. It has become a hotbed of activity for global investment banks, fund managers and hedge funds looking to exploit the vibrant economies of China and other Asian nations. And in a development with huge potential for the future, local officials working in close cooperation with the authorities in Beijing are laying the groundwork to turn Hong Kong into the leading center for trading the renminbi and products denominated in the Chinese currency.
“I don’t think Hong Kong has to do anything to increase its attractiveness to global financial firms and other global practitioners — it’s all driven by macroeconomics,” says Philip Lynch, Hong Kong–based CEO for Asia ex-Japan and the Middle East at Nomura International. “Take the IPO business: More IPOs are being done in Hong Kong than on any other exchange. Take the internationalization of the Chinese renminbi, a currency that will grow only more important. Hong Kong just has to sit in the middle of those flows and it will be a very attractive place to do business.”
As bright as the outlook is, Hong Kong officials aren’t just sitting still. The government has identified three priorities to strengthen the city’s status as a global financial center: promoting capital formation, growing the asset management sector and creating an offshore center for trading the renminbi. K.C. Chan, secretary for Financial Services and the Treasury, talks like a business executive when it comes to the competitiveness of the city’s financial sector. “I think Hong Kong has to be clear about our strategic positioning, who we are competing with, what needs are we serving, who are our customers,” he tells Institutional Investor in an interview. “By fulfilling those, we can be very competitive.”
Capital formation is the city’s strong suit. For the past two years, Hong Kong has topped global league tables in IPO volume. Seventy-seven companies raised a total of $53 billion with IPOs in Hong Kong in 2010, compared with 82 IPOs and $34.6 billion raised in New York and 201 IPOs and $29.8 billion in Shenzhen. The figures include a portion of the record $22 billion IPO of Agricultural Bank of China, which floated its shares jointly on the Hong Kong and Shanghai stock exchanges.
To be sure, Hong Kong benefits first and foremost from its proximity to China. There are 265 Chinese companies currently listed on the Hong Kong stock exchange, a total that seems destined to grow rapidly. Last year, Chinese companies raised a combined $104.4 billion through IPOs, or 37.3 percent of the global market, according to data provider Dealogic. With China’s economy expected to grow by more than 9 percent again this year, analysts believe that demand from Chinese corporates to tap the equity markets will remain strong. “The IPO boom will accelerate in Hong Kong in 2011,” says Paul Schulte, chief Asia equity strategist at CCB International in Hong Kong.
Hong Kong’s success is more than just a China story, though. Government officials are working with executives of Hong Kong Exchanges and Clearing, operator of the local stock exchange and futures markets, to attract listings from a wider array of overseas companies. Chan led a team of officials and HKEx executives to London in November to tout the city’s attractiveness at a financial conference. Officials plan to hold a similar event in New York in March. “We will tap into business opportunities in Russia, Central Asia, India, South America and other emerging markets,” Chan says. “We hope to attract more large enterprises with diverse backgrounds to list in Hong Kong and to make use of Hong Kong’s well-established financial and trading platform to expand their international business.”
The campaign is already off to a running start. Last year, Russian aluminum producer United Co. Rusal raised $2.2 billion in a secondary listing in Hong Kong, while cosmetics maker L’Occitane International raised $707 million with an IPO, the first by a French company in Hong Kong.
To grow asset management, the government’s second priority, the authorities have taken a number of steps in recent years to attract more fund managers to Hong Kong. Since 2006 the government has abolished all estate taxes and exempted offshore funds from the profits tax. Last year the government introduced fresh tax incentives for exchange-traded funds, qualified debt instruments and offshore funds engaged in futures trading. Among the most significant changes, the authorities extended a tax exemption for ETFs to funds that have as much as 40 percent of their holdings in Hong Kong–listed equities.
The development of an offshore market for the renminbi, also called the RMB, presents a rich opportunity that Hong Kong officials are only too happy to seize. The Hong Kong Monetary Authority has worked closely with Chinese authorities to promote renminbi trading since 2004, when Beijing made its first tentative steps to free up the currency by allowing Hong Kong residents to open renminbi savings accounts. Last year the HKMA clarified its rules to specify that even non-Chinese banks could develop and sell renminbi-denominated bonds and other investment instruments, an opening that Deutsche Bank, HSBC Holdings and Standard Chartered, among others, have grabbed. HSBC sold its first renminbi-deliverable swaption in November to France’s BNP Paribas, with a one-year maturity and a strike rate of 3.45 percent. The bank declined to comment on the size of the transaction.
The market’s growth has accelerated since July, when the HKMA and the Chinese central bank, the People’s Bank of China, signed an agreement to expand renminbi trade settlement. At the same time, the PBOC and Bank of China (Hong Kong), the official clearing bank for renminbi traders in Hong Kong, signed a revised agreement allowing all types of financial institutions to offer renminbi products and services, and permitting corporations registered in Hong Kong to issue renminbi financial instruments. The agreement also removed restrictions on renminbi interbank transfers between personal and corporate accounts, enabling the industry to launch an array of products, including insurance, bonds, equities and investment funds denominated in the Chinese currency.
The market has been quick to respond to those openings. So far, 41 entities — including banks, corporations and China’s Finance Ministry — have raised about 74 billion yuan ($11.2 billion) through the sale of renminbi bonds in Hong Kong. Chief among the foreign issuers were McDonald’s Corp., which raised 200 million yuan in September, and Caterpillar, which raised 1 billion yuan in December.
The next big step, which is whetting the appetites of bankers and officials in Hong Kong, is expected to be the introduction of renminbi-denominated share issues, a move that could take place before the end of this year. According to market sources, Cheung Kong (Holdings), the property development flagship of Hong Kong’s richest man, Li Ka-shing, is likely to be one of the first companies to raise renminbi with a secondary share placement. Cheung Kong executives declined to comment on the speculation.
HKEx is prepared to launch such share offerings on the Hong Kong exchange as soon as the authorities give the green light, says chairman Ronald Arculli. “We developed our market infrastructure for trading and clearing in RMB before the end of 2010, including collection of stamp duties, securities and money settlement and so on,” he says. “We are working with some banks and the Hong Kong Monetary Authority to explore the feasibility of developing an RMB liquidity pool as a facility for investors who do not have RMB but are interested in investing in RMB-denominated securities. We believe that for RMB IPOs, the key is liquidity.”
Liquidity seems to be gaining momentum. Although renminbi-denominated deposits were first introduced in Hong Kong in 2004, growth didn’t really take off until last year, when the volume of deposits surged to 280 billion yuan in November from 62 billion in January.
“If AIA wanted to raise $20 billion in RMB, that would be a tough task,” Arculli says, referring to last year’s $20 billion Hong Kong IPO of American International Assurance Co., the Asia subsidiary of American International Group. “Initially, RMB IPOs would be of modest size, but it will grow in time. We are cautiously optimistic that this can happen.”
The growth of liquidity hinges on how quickly companies in Hong Kong will accept renminbi instead of dollars for settling sales of global exports. Last year companies accumulated 50 billion yuan as a result of trade settlement. Hu Yifan, the Hong Kong–based global chief economist for Beijing’s Citic Securities Co., estimates that trade settlement could rise to 800 billion yuan a year by 2015.
In January, Chinese authorities announced a new liberalization that will allow Chinese enterprises to use renminbi to make overseas deals and acquisitions; this may further deepen liquidity. However, companies may be slow to take advantage of this opening, analysts say. With most forecasters calling for the renminbi to continue to appreciate against the dollar (it has risen by 3.5 percent since Beijing reverted to a carefully controlled float last June), analysts expect many enterprises to keep their currency at home for now. Yet as the renminbi grows in importance as a global currency, so too should Hong Kong’s role as the primary offshore trading center.
“China has entered a new phase of development,” says Financial Services secretary Chan. “In the past, it was an importer of capital. In the future, China will be an exporter of capital. That means Hong Kong will have an additional role to play to help Chinese companies invest abroad. We have a role to help China to internationalize the RMB.”
That role stops well short of abandoning Hong Kong’s currency peg to the U.S. dollar and linking to the renminbi, at least for now, the authorities say. The peg “remains appropriate” for Hong Kong’s small, externally oriented economy because the dollar is the most commonly used currency for trade and financial transactions, Eddie Yue, deputy chief executive of the HKMA, tells II in an e-mail reply to questions. “Even when the RMB becomes fully convertible at some stage and free of capital controls, it remains to be seen whether it would be a good anchor currency for the Hong Kong dollar, which would depend on factors such as the stability of the currency, the transparency of the monetary framework and the depth of the RMB financial markets,” he adds.
The boom in equity issuance, the budding development of renminbi-denominated products and Hong Kong’s status as a gateway to the wider Asian market are making the city a magnet for investment banks and fund managers. Major financial institutions are boosting their head counts in Hong Kong, where financial services is the second-largest sector of the economy, behind merchandise trade, accounting for 16 percent of GDP and 6 percent of employment. Many bank executives say they have been inundated with résumés from bankers and traders in London and New York, where firms cut back sharply during the financial crisis. A personal income tax rate of no more than 15 percent is an added lure, especially for bankers coming from London, where the government has raised the top tax rate to 50 percent to close a big budget deficit.
“People are incredibly excited about the opportunities here because of the growth,” Nomura’s Lynch says. “It’s not hard to recruit people here. I’ve never had a problem recruiting people.”
Nomura, which took over Lehman Brothers Holdings’ non-U.S. operations in late 2008, has made Hong Kong the base for its Asia ex-Japan operations. The firm employs 1,200 people in the city; the team includes Jasjit (Jesse) Bhattal, head of global wholesale banking, and Rachid Bouzouba, global co-head of equities. The firm continues to hire “selectively” in Hong Kong, Lynch says.
“After the financial tsunami that came after the collapse of Lehman Brothers, we have seen the economic gravity shift to Asia,” says Edward Leung, chief economist for the Hong Kong Trade Development Council, the government agency that oversees global trade and marketing. “We see many financial institutions expanding here and more hedge funds coming here to look for opportunities.”
Big regional players that avoided big losses during the financial crisis have been the most aggressive in expanding in Hong Kong, but even Western banks that suffered large losses have been hiring in the city recently, seeing Asia as one of the most promising growth markets. “The banks that were not damaged by the financial meltdown of 2008 were Standard Chartered and Asian banks, and they were in constant hiring mode,” says CCB International’s Schulte. “Their businesses blossomed while the other Western banks were in survival mode. Now banks like Citi and HSBC are roaring back. JPMorgan is stabilizing. So is Morgan Stanley. So Asian banks now face intense pressure from Western banks.”
Citigroup, which last year repaid its U.S. government bailout funds, is selectively hiring across the board, executives say. The bank is one of the largest financial employers in the city, with more than 4,000 staff, and was lead coordinator of AIA’s IPO last year. “Hong Kong is one of Citi’s most important markets globally, and we are investing more into Hong Kong than at any point in our history to support our clients,” says Stephen Bird, the Hong Kong–based CEO for Asia-Pacific, adding that Citi expanded its Hong Kong branch network from 25 to 43 last year. “Hong Kong is also now clearly a major global listing hub, and with our global franchise we are also seeing increased interest from our global clients to raise capital from Hong Kong.”
Tokyo-based Daiwa Securities Group, which spent $1.2 billion last year to acquire the global convertible bond and Hong Kong–based Asia equity derivatives businesses of Belgium’s KBC Group, invested an additional $1 billion in global expansion in 2010, much of it centered on Hong Kong. The firm now employs 530 bankers and support staff in the city, more than twice as many as it did in 2009, according to Kozue Niida, head of corporate planning.
Hong Kong is also benefiting from an expansion of Chinese institutions, which regard the city as their doorstep to the global markets. Citic Securities, China’s largest brokerage house by market capitalization, has hired more than 150 bankers and support staff in Hong Kong since the outbreak of the financial crisis, bringing its total head count in the city to 350.
Even smaller players are keen on expanding in Hong Kong. RBC Capital Markets, a subsidiary of Royal Bank of Canada, last year moved Mark Lowings, head of treasury for Europe and Asia, to Hong Kong from London. “It is part of our view and commitment to this part of the world,” says Andrew Turczyniak, CEO of RBC Capital Markets Asia. “We had a treasury team of two and now have a team of six. Liquidity is rising, and there is rising demand among Asian clients for treasury management.” The firm has also tripled its Hong Kong currency and fixed-income trading desk, to 104 staff from 35 in 2007.
Banco Bilbao Vizcaya Argentaria, Spain’s second-largest bank by assets, has seen the share of its profits generated in Asia rise from next to nothing four years ago to 5.8 percent in the first nine months of 2010, largely because of earnings from its investment in China Citic Bank Corp. In the past few years, BBVA has invested a total of $5 billion for a 15 percent stake in China Citic Bank and a 30 percent stake in its Hong Kong subsidiary, Citic International Financial Holdings. China Citic Bank, like Citic Securities, is a subsidiary of Citic Group, a leading Chinese financial and industrial holding company.
BBVA is also building up its own presence in Hong Kong. The bank has expanded its staff in the city from 20 to 200 in the past four years, with more than half of those employees working in investment and corporate banking. “In the next two years, we plan to hire at least 100 people,” says Manuel Galatas, the bank’s head of Asia operations. The growth will focus on servicing Asian customers investing in Latin America, where BBVA has a major presence, and helping Latin American companies raise capital in Hong Kong.
“When I came to Asia, my superiors told me to pick between Beijing, Shanghai and Hong Kong,” Galatas says. “The decision was easy. In terms of corporate and wholesale banking and trade finance, and in terms of finding human resources to service these key businesses, Hong Kong is the best place to have regional responsibilities. Most of the people we have been hiring have some sort of China experience, given our relationship with Citic.”
Thanks to Hong Kong’s strong fundamentals, Galatas, like most bankers in the city, is bullish on the outlook for growth. “Hong Kong today has become as important as New York for BBVA’s treasury business, and we have been in New York for 50 years,” he says.
