HONG KONG: BANKING AND FINANCIAL SERVICES

Hong Kong is a fully-fledged international financial centre, and all types of financial services are readily available in a business environment which combines light but effective regulation with low taxation.

Banking

Hong Kong has one of the largest representation of international banks in the world: about three-quarters of the world's 100 largest banks have a presence there. Hong Kong is a top-ten international banking centre in terms of the volume of external transactions, and the second largest in Asia after Japan. The banking sector plays a vital role in establishing Hong Kong as a major loan syndication centre in the region.

The Hong Kong banking system has emerged from the financial crisis in much better shape than many of its counterparts in the US and Europe. According to the Hong Kong Monetary Authority, the aggregate capital adequacy ratio of the banking sector at the end of 2009 stood at 16.9% and the liquidity ratio at 47.8%. The classified loan ratio, despite an increase from 2008, remained low at 1.35% and other asset-quality indicators continued to be favourable.

At the end of June, 2010, there were 146 licensed banks, 24 restricted licence banks and 27 deposit-taking companies in business. These 200 authorised institutions operate a comprehensive network of 1,600 local branches. In addition, there are 70 local representative offices of overseas banks in Hong Kong.

Total Employment in the sector is around 80,000. Banking assets amount to more than HKD10 trillion.

The banking system in Hong Kong is characterized by its 3-tier system, which is formed by 3 types of banking institutions, namely licensed banks, restricted licensed banks and deposit-taking companies, which are authorised to take deposits from the general public. The 3rd tier of deposit-taking institutions operate under different restrictions. Only licensed banks and restricted licensed banks can be called banks.

China

China's WTO accession will mean that foreign banks, including Hong Kong banks can in the future provide meaningful competition to local commercial banks, since they will be allowed to conduct local currency business with local clients. At the same time, competition among foreign banks -- already present as well as new entrants -- will inevitably intensify. Under the provisions of CEPA, the asset requirement for Hong Kong banks to establish on the mainland is being reduced from a minimum of HKD20 billion to HKD6 billion, making it easier for many of the SAR’s banks to set up in China.

In December, 2006, eight foreign banks had applied for retail banking licenses in mainland China, as the country opened its banking market under WTO rules it agreed five years previously.

There are more than 70 foreign banks in China already, but until now most of them were limited to handling foreign currency business, and they hold just 2% of the country's banking assets. During the last few years the Chinese authorities have been racing to clean up major domestic banks, which were weighed down with bad debts and clunky administration.

The banks which have applied for retail licenses are Hong Kong's Bank of East Asia, Hang Seng Bank, Citigroup, Mizuho Corporate Bank, HSBC, ABN Amro and DBS Bank. Many of these banks had already taken stakes in mainland banks and created financial infrastructure to be ready for this moment.

There are still obstacles to the growth of foreign banks in China, however, including a 25% limit on foreign ownership of an existing Chinese bank. New entrants to the market have to incorporate in China as wholly-owned banks or joint venture banks. Few international banks have done this; to date, they have mostly operated through branches, which are not covered by the new regime, or through minority holdings in Chinese banks. It is not clear whether the requirement to incorporate wholly-owned subsidiaries is in conformity with China's WTO obligations, although the minimum capital requirement of USD10bn in assets does conform.

The new Regulations allow a fairly wide range of activities to wholly-owned and joint venture banks, but disallow bank card business for branches, something they were previously permitted to engage in under 2001 rules which have now been replaced.

2003 saw a number of moves towards greater banking integration between the SAR and the mainland. In August, the Hong Kong Monetary Authority (HKMA) and the China Banking Regulatory Commission (CBRC) signed a Memorandum of Understanding aimed at strengthening supervision of banks operating on both sides of the border. HKMA operates in effect as Hong Kong's Central Bank, while the CBRC was formed earlier in the year to to take over banking supervisory responsibility from the People's Bank of China. The 15-department CBRC says its major responsibilities include "formulating supervisory rules and regulations for banking institutions, (and) authorizing the establishment, changes, termination, branching out and business scope of banking institutions.'' It is also responsible for dealing with problem deposit-taking institutions. The MOU calls for the two regulators to share supervisory information for banks operating in China and Hong Kong and they will work together to ensure that a parent bank exercises "adequate and effective" control over the operations of cross-border branches and subsidiaries. They will also meet formally twice a year.

The Renminbi

An important Memorandum of Understanding (MoU) was signed between the the Hong Kong Monetary Authority and the People's Bank of China on July 19, 2010, which lifted restrictions on the provision of renminbi services by Hong Kong banks.

Following the expansion of the renminbi trade settlement scheme, the HKMA and the PBoC have agreed to strengthen co-operation and further promote Hong Kong’s status and role as a renminbi market platform in the process of developing renminbi business outside the Mainland. This is a milestone in the development of offshore renminbi business in Hong Kong and a very crucial step in the implementation of the two guiding principles set out in the HKMA circular issued in mid-February.

The PBoC and Bank of China (Hong Kong) Limited, the Renminbi Clearing Bank, also signed a revised Settlement Agreement on the Clearing of Renminbi Businesses.

The Chief Executive of the HKMA, Mr Norman Chan, said: "Following the revision of the Settlement Agreement, there will no longer be restrictions on banks in Hong Kong in establishing renminbi accounts for and providing related services to financial institutions; and individuals and corporations will be able to conduct renminbi payments and transfers through the banks. I expect that many more types of financial intermediary activities denominated in the renminbi will be introduced in the market, helping Hong Kong’s renminbi business platform leap to new heights."

The renminbi trade settlement scheme, which was introduced in July 2009, has been expanded to cover 20 provinces and cities1 in the Mainland, and their trade transactions with any part of the world can be settled in renminbi. Any enterprises in the relevant Mainland provinces and cities can settle their merchandise imports, service trades and other current account transactions in renminbi, while an expanded list of eligible enterprises will be able to settle their merchandise exports in renminbi.

"This is certainly good news to corporates and the banking industry in Hong Kong," said Hong Kong Financial Secretary, John Tsang. "With an expanded scope of trade transactions that can be settled in renminbi, corporates will be able to better manage any exchange rate risks associated with their operations. Meanwhile, our banks can also provide trade related services to customers not just in Hong Kong but also other parts of the world."

In 2007, the Hong Kong Securities and Futures Commission (SFC) also entered into a Memorandum of Understanding (MOU) with the China Banking Regulatory Commission (CBRC) for co-operation and information sharing with respect to Hong Kong licensed intermediaries who provide services to Mainland commercial banks conducting overseas wealth management business on behalf of their clients

“The MoU is conducive to further enhancement of the regulatory co-operation framework. It provides a solid foundation for the commencement of effective regulatory co-operation," stated Liu Mingkang, Chairman of the CBRC. "Through mutual assistance and information sharing, we can promptly identify risks, and take timely regulatory measures to protect the interests of investors.”

In February 2004 the eagerly anticipated move to liberalise trading and exchange of the yuan in Hong Kong took its first step forward after the city’s banks were given the go-ahead to begin taking deposits in the Chinese currency.

Analysts considered this an important first step towards Hong Kong becoming an offshore yuan trading centre. "The integration between the two places will be closer and closer, so that means that renminbi will co-circulate with the Hong Kong dollar in Hong Kong going forward," said Chris Leung, senior economist at DBS Bank, "Obviously, if that's the case, there's sort of a demand for renminbi storage with the banks. So it's a natural development, but the problem is there are many technicalities and contradictions in order for this to become a reality," Leung added.

The Hong Kong Monetary Authority (HKMA) announced in December 2007, that it will review its work in the area of banking stability, and appointed former Jersey banking regulator, David Carse as consultant to conduct the review.

The aim of the review was to make recommendations on how the HKMA can best discharge its functions in promoting the general stability and effective working of the banking system, taking into account recent and likely future developments in Hong Kong’s banking system, and the changing nature of the risks facing it.

The review was expected to be completed in about five months. It took into account developments including the globalisation of finance and banking business, the increasing integration of the financial systems of Hong Kong and Mainland China, the growing complexity of banking products, the increasing reliance of banks on information technology, the increasing need to combat financial crime, the changing nature of supervision, and the expectations of the community. Carse was charged with making recommendations on the focus and priorities of the HKMA’s banking supervisory functions over the subsequent 5 years.

Securities Markets

Hong Kong is a top-ten securities market globally and the second largest in Asia after Tokyo. As of March 2000 the Hong Kong Stock Exchange and the Futures Exchange were merged into Hong Kong Exchanges and Clearing. The launch of the Growth Enterprise Market (GEM) in November 1999 for smaller and high growth companies has broadened Hong Kong's stock market, although the timing of GEM's launch was unfortunate, and the 'dotcom' shakeout in 2000 weakened its initial impact.

Hong Kong's securities market has been increasingly internationalised. There has been a continued rise in the participation of international investors in the market. Many of the initial public offerings through the Stock Exchange are also made global. The majority of these issuers are supernational bodies, whose issues are almost invariably accompanied by global fund raising.

As at March 31 2010, 1,158 and 174 companies were listed on the Main Board and GEM respectively with a total market capitalisation of HKD18,055.6bn. In addition, there were 3,974 Derivative Warrants, 1,331 Callable Bull/Bear Contracts, 7 Real Estate Investment Trusts, 61 Exchange Traded Funds and 160 debt securities listed. The average daily turnover in the first quarter of 2010 was HKD64.2bn on the Main Board and HKD16.4m on GEM.

Of note during the first quarter of 2010 was the continuing development of the ETF market on HKEx. During this period, 18 ETFs were newly listed with 12 tracking Mainland A-share indices and 6 tracking overseas equity indices. The total number of ETFs listed on the Exchange increased by 42 per cent from the end of last year to 61, including 20 ETFs on Mainland A-share indices.

In the 2010/2011 budget, the Financial Secretary announced that a stamp duty concession in respect of ETF trading would be extended.

Another development for the exchange in the early part of 2010 was the launch of Flexible Index Options on February 8. Futures Exchange Participants can request HKEx to introduce customised strike prices and expiry months in Hang Seng Index (“HSI”) options and H-shares Index options for trading, subject to a volume threshold of 100 contracts. Flexible Index Options are bilaterally negotiated and executed as block trades. By providing central clearing and clearing house guarantee, Flexible Index Options allows HKEx to expand its services to the over-the-counter market for mitigating counterparty risk.

In 2010, the exchange is reviewing a proposal to introduce same-day securities and money settlement for stock exchange trades after a three-month consultation period closed on February 26, 2010.

Hong Kong Exchanges and Clearing (HKEx) introduced AMS/3, a third generation automatic order matching and execution system, in late 2000. In February 2001 it added an Order Routing System (ORS). ORS is an open system that enables investors to place stock market orders through the Internet, mobile phones and other electronic channels, which may be developed by HKEx or vendors. After an order is placed through an electronic channel connected to ORS, the system automatically sends the order to a Stock Exchange Participant for approval and submission to the market for matching and execution.

More than 100 Stock Exchange Participants have so far connected to ORS, and are able to offer their clients Internet trading. All Stock Exchange Participants, including those who have connected to the HKEx channel, will also be able to offer their clients electronic trading services, including Internet and mobile trading, through Proprietary Network System (PNS) channels provided by vendors.

CCASS provides settlement services under which securities are credited or debited to participants' CCASS stock accounts and funds are recorded in the participants' money ledgers on settlement day.

Details of all Exchange trades, including trade data and trade amendments, are electronically and automatically transmitted to CCASS by the Stock Exchange on each trading (T) day. There is no need for broker participants to input or further confirm their trade details in CCASS. Broker participants receive Provisional Clearing Statements of their stock and money positions through their CCASS terminals shortly after 1800 hours on each T day for reconciliation. Final Clearing Statements are available to broker participants shortly after 1400 hours on T+1 day for confirmation purposes.

Generally, online securities trading in Hong Kong was an early casualty of the dot-com meltdown and the international equity slump, with a number of major US brokerages retreating from the SAR in 2001 almost as quickly as they had arrived in 1999 and 2000, but by 2003 it seemed that on-line trading would finally have its day in Hong Kong, as a combination of better technology, burgeoning interest from mainland visitors and the impact of SARS pushed on-line trading volumes to historic highs.

Fund Management

Hong Kong is widely recognised as the leading fund management centre in Asia with the largest concentration of fund managers. The industry is characterised by its international and offshore nature.

In July 2010, Securities and Futures Commission's annual survey of fund management activities showed that fund management in Hong Kong rebounded strongly in 2009, despite the uncertain economic and investment climate.

The SFC says that the latest survey indicates that international investors continued to use Hong Kong as the platform for investing in the region, with fund management business growing to just over HKD8.5 trillion (USD1.1 trillion) as at the end of 2009, representing an increase of over 45% compared to 2008.

Overseas investors contributed almost HKD5.4 trillion (or nearly 64%) to that business, excluding real estate investment trusts (REITs). Meanwhile, the SFC has pointed out that an increasing number of Chinese mainland-related firms gained exposure to global investment practices via Hong Kong, using it as a springboard.

Licensed asset management and fund advisory houses continued to contribute the largest proportion of the combined asset management business in Hong Kong, recording the biggest year-on-year increase of 50% in the value of their aggregate asset management and fund advisory businesses, to a total of HKD6.45 trillion in 2009.

In addition, registered financial institutions recorded an almost 30% increase in their aggregate asset management and other private banking businesses, to HKD1.8 trillion last year.

Non-REIT asset management business increased by 57% to more than HKD5.8 trillion. Of this amount, HKD3.5 trillion worth of assets were managed in Hong Kong, with over 80% of these assets being invested in Asia. The market capitalisation of SFC-authorised REITs expanded 60% in 2009.

The report also highlights the growth of the exchange-traded-fund (ETF) market in Hong Kong, and the first-time cross-listing of ETFs in Hong Kong and Taiwan. As at the end of June 2010, 62 ETFs were listed in Hong Kong. The trading volume of the ETFs increased by 12.5% to an average daily turnover of almost HKD2 trillion in the year to June 2010, while their market capitalisation rose 30% to HKD180bn in the same period, making Hong Kong the second largest ETF market in Asia.

The report also notes the increasing number of mainland-related financial institutions setting up operations in Hong Kong. The total asset management and fund advisory businesses of mainland-related companies that participated in the survey increased 70% in 2009 to HKD155bn.

Separately, the SFC has reviewed the growth of the retail fund business in Hong Kong since the establishment of the SFC in 1989. It found that the number of retail funds offered to the public has grown from 783 at the end of 1989 to 1,980 in 2007. In value terms, the size of retail funds has grown 22 times, from HKD283 billion to HKD6.1 trillion over the same period.

Although many hedge funds have been managed from Hong Kong, until 2002 these were exclusively for professional investors. In 2002 however the Securities and Futures Commission issued guidelines permitting certain types of hedge fund to be offered to retail investors.

• close economic ties with the Mainland
• a well-established, deep and liquid market
• a world class regulatory regime
• a broad range of investment products
• a critical mass of financial talent with international exposure and Mainland
  experience

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