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Hong Kong Focus

By Lowtax Editorial
15 May, 2014

It’s hard to classify what Hong Kong actually is in one neat description. It isn’t technically offshore, it’s not really a country, but it’s more than just a mere city. What is clear though is that this densely populated 400 square mile peninsula and collection of islands in south eastern China, home to more than 7 million people, certainly punches above its weight in international terms, and in this feature we explore what makes Hong Kong tick as one of the world’s major business and financial centres.

One Country, Two Systems

A former British colony, Hong Kong is now in fact a Special Administrative Region of China and has been so since 1997. Its constitution, known as the Basic Law, is modelled on the constitution of the People’s Republic, under the guiding principle of "one country, two systems", which was established before the handover. This has not brought about more state interference from Beijing, however; under the Basic Law, the Chinese government agreed that Hong Kong's capitalist system would remain unchanged until the year 2047. Thus, except in the areas of foreign policy and defence, which remains the exclusive domain of Beijing, policy makers in Hong Kong have been free to continue pursuing the same laissez faire economic policies which have positioned it on the map as the world’s third financial centre after New York and London, and Asia’s most important.

The Economy of Hong Kong

One of the consequences of Hong Kong’s economic openness and its reliance on international financial services has been its vulnerability to regional or global economic shocks, and for this reason its economy has tended to see-saw in recent years. Growth fell in the aftermath of the Asian financial crisis of the late 1990s for example, and the economy contracted during the global recession of 2009, by 2.7%. However Hong Kong enjoyed growth rates of between 6% and 8% in between, and economic growth rebounded sharply in 2010 when it grew by 6.8%, before falling to 5% in 2011 and just 1.8% in 2012. Growth in 2013 was 2.9% and the economy is forecast to grow by 3 – 4% in 2014.

Business Environment

Hong Kong offers an unusually stable and efficient business environment with the modern infrastructure and telecommunications that could be expected of the world's 9th largest economy. The territory's economy could rightly be described as the most laissez faire economy in the world. The government's policy is strictly non-interventionist.

Bankers, accountants, lawyers, and other professionals who serve multinational firms have thrived in a community of local firms that has become increasingly transnational since the opening of the Mainland to foreign trade and investment in the late 1970s. This deep-rooted local familiarity with the needs of international business makes Hong Kong an easy place in which to find joint-venture partners and to find expatriate professionals. Local staff can easily be recruited from local companies which have a ready familiarity with the dispersed operating needs of a multinational business.

Hong Kong is unsurpassed in the extent to which it brings local and overseas firms together into a single business community. The constant interaction between thousands of overseas firms and local businesses in a supercharged business environment generates growth opportunities for both sides in setting up international networks, entering new lines of business, finding new sources of supply and new markets and linking up with business partners from Hong Kong, China and elsewhere. As one local business executive observed: "For multinational firms which seek out and thrive from interaction with the local environment and local firms, Hong Kong is the Asian location without par."

Hong Kong is a leading telecommunications hub for the Asia-Pacific region. Residential fixed line and household broadband penetration rates have exceeded 100% and 80% respectively. Mobile subscribers in Hong Kong have exceeded 17 million, of which 70% were 2.5G and 3G/4G mobile subscribers, more than double the total population in Hong Kong. There are now over 20,000 public Wi-Fi access points.

Hong has the fastest average peak internet speed and the third-highest average connection speed in the world, according to a report by cloud service provider Akamai, published in January 2014. The study found that Hong Kong has an average peak internet speed of 65.4Mbps, ahead of South Korea, Japan, and Singapore. However, South Korea came first for average connection speed, at 22.1Mbps, while Hong Kong came third, after Japan, at 12.5Mbps. Further, 81 percent of Hong Kong's connections were above 4Mbps, and 38 percent were above 10Mbps.

Financial Services

Low-value manufacturing used to be the mainstay of Hong Kong’s economy, but this industry has now largely decamped to neighbouring Chinese provinces, with the territory’s economy now based predominantly on re-exporting and financial services. Banking is a major constituent of Hong Kong’s substantial financial services industry. Tokyo aside, Hong Kong is Asia’s largest banking hub in terms of external transaction volume. As at end-2013, there were 201 authorised institutions and 62 representative offices in Hong Kong. Total loans provided by the authorised institutions to finance international trade and other loans for use outside Hong Kong totalled USD71bn and USD248.8bn respectively. According to the Bank for International Settlements, Hong Kong is the third largest foreign exchange market in Asia and the fifth largest in the world, with the net daily turnover of forex transactions reaching USD275bn in 2013. Deposits in the Chinese currency, the renminbi (RMB), have also mushroomed over the past few years as China accelerates the pace of internationalization of the currency.

Hong Kong is also recognised as the leading fund management centre in Asia, with the industry defined by its international and offshore characteristics, and it has become a popular choice for hedge fund managers, especially since the government granted an income tax exemption to offshore funds owned by non-resident entities administering a fund in Hong Kong. According to the Hong Kong Securities and Futures Commission's (SFC) last survey report of the sector, released in March 2013, assets under management or advisory in Hong Kong increased 38% from the time of the last survey in September 2010 to USD87.1 billion as of 30 September 2012. The number of hedge funds managed by the SFC-licensed hedge fund managers in Hong Kong stood at 676 as at September 30, 2010, up more than 25% compared to 538 funds as of September 2010.

To attract more private equity funds to domicile in Hong Kong, in his 2013 budget speech Financial Secretary John Tsang announced the extension of the profits tax exemption for offshore funds to include transactions in private companies, which are incorporated or registered outside Hong Kong and do not hold any Hong Kong properties nor carry out any business in Hong Kong.

A Base for Multinationals

Hong Kong has also established itself as the favoured base for multinational companies looking to expand into Asia-Pacific markets.

Based on a government survey, as of June 2013, there were 3,835 regional headquarters (RHQs) and regional offices (ROs) in Hong Kong representing their parent companies located outside Hong Kong, an increase of around 20% from a decade ago. Of these companies, some 80% were responsible for business in the Chinese mainland, confirming Hong Kong's role as a conduit for doing business with the mainland. These companies came from diverse countries and sectors. The US had the largest number of RHQs/ROs in Hong Kong (21%), followed by Japan (19%), the UK (9%) and the mainland (7%). Most of the RHQs/ROs in Hong Kong were in import/export trade, wholesale and retail (52%). Others are in professional, business and education services (18%), finance and banking (11%), and transportation, storage and courier services (8%).

Low Taxation

Unlike most onshore jurisdictions, income tax in Hong Kong is levied on a territorial basis, which means that tax is due on locally-sourced income only. What’s more, a number of taxes that are levied in other jurisdictions do not exist in Hong Kong; for example, there are no capital gains taxes, no withholding taxes, no sales taxes, no VAT, no annual net worth taxes and no accumulated earnings taxes on companies which retain earnings rather than distribute them. While corporate income tax (known as Profits Tax), at 16.5%, is higher than in most offshore jurisdictions, it is still substantially lower than in most OECD countries, even accounting for the fact that corporate tax rates around the world have tended to fall in recent years.

Personal taxation is also low by international comparison. Income tax, known in Hong Kong as Salaries Tax, is paid at either a flat rate of 15%, or on a progressive scale between 2% and 17%. Taxpayers may elect to choose to pay tax under either of these systems, depending on which one gives them the lower tax liability. Individuals are only assessed on annual employment income which is defined as wages, salaries, bonuses, commissions, payments by the employer into a pension fund for the employee and gratuities. Non-employment source income such as share dividends and capital gains realized on the sale of shares are not taxable in the territory. In addition, the definition of income does not include either a pension from a source outside Hong Kong or compensation for loss of employment.

The Closer Economic Partnership Arrangement

Foreign companies are also flocking to Hong Kong to take advantage of the Closer Economic Partnership Arrangement (CEPA) between the SAR and the People’s Republic, which has substantially liberalized trade in goods and services between the two locations. According to InvestHK almost one-third (31%) of the 303 companies it assisted in 2011 indicated that the CEPA was one of their considerations in their decision to locate in Hong Kong.

After signing the first CEPA agreement in June 2003 for implementation in 2004, the Central and Hong Kong governments have signed several yearly Supplements, with the tenth phase of liberalisation measures by virtue of Supplement X signed on August 29, 2013.

Supplement X provides for a total of 73 services liberalization and trade and investment facilitation measures, strengthens co-operation in areas of finance, trade and investment facilitation, and further promotes the mutual recognition of professional qualifications in the two places. It brings to 403 the total number of liberalization measures for trade in services under CEPA, since 2003.

Under CEPA and previous Supplements, 28 sectors have already been partly liberalized for Hong Kong, including legal services, computer and related services, real estate, telecommunications, banking, securities, tourism, and maritime, air and road transport. Supplement X, which went into effect on January 1, 2014, further relaxes the market access conditions for all these sectors.

With regard to legal services, Guangdong law firms will be allowed to enter into agreements with representative offices set up by Hong Kong law firms in Guangdong Province, while, in banking, a Hong Kong bank's operating institution in the Mainland, after obtaining approval to conduct renminbi business for Hong Kong enterprises, may provide services to enterprises in the Mainland that are recognized as owned by Hong Kong investors, despite investors of those enterprises being based in a place other than Hong Kong.

Hong Kong-funded securities companies will be allowed to make reference to the total securities assets being managed by their group when applying for Qualified Foreign Institutional Investor status; and Hong Kong-funded financial institutions will be allowed to set up joint venture fund management companies in the Mainland with a shareholding greater than 50 percent.

In addition, Hong Kong-funded financial institutions, which satisfy the requirements for establishing foreign-invested securities companies, will now be allowed to set up one fully-licensed joint venture securities company each in Shanghai, Guangdong Province and Shenzhen, with a maximum Hong Kong shareholding percentage of 51 percent.

In telecommunications, for example, Hong Kong service suppliers will be allowed to set up joint venture enterprises in Guangdong Province to provide online data processing and transaction processing services. Hong Kong service suppliers' shareholding should not exceed 55 percent.

For a number of sectors, contractual service providers employed by Hong Kong service suppliers are to be allowed to provide a temporary service in the Mainland for the performance of the service contract(s) secured in the Mainland by their employers. The contractual service providers should each hold a Hong Kong identity document and their employers should be Hong Kong service suppliers without a commercial presence in the Mainland.

With regard to financial co-operation, the Mainland has agreed to actively study the mutual recognition of fund products between the Mainland and Hong Kong, and to actively support qualified Hong Kong insurers to take part in compulsory traffic accident liability insurance business in the Mainland.

There have been complaints by some businesses that China has yet to fully sweep away the sort of restrictive practices that have been a barrier to Hong Kong firms seeking to expand into the Chinese market under the CEPA. For example, businesses in the professional services sector have pointed out that Chinese company registration procedures are overly complex and time-consuming, while tax professionals in Hong Kong have reflected that the rules and regulations of China’s State Administration of Taxation are subject to different interpretations in different cities. In addition, Hong Kong’s accountants and lawyers have reported that restrictions remain on the scope of business they want to develop on the Chinese mainland, while they have difficulties in employing mainland practising accountants and lawyers. But on the whole though, the CEPA seems to have been fairly successful; by the end of April 2012, more than 81,000 applications for Certificate of Hong Kong Origin under the CEPA had been approved, with the total export value of the goods amounting to more than HKD40bn (USD5.1bn). According to Hong Kong Financial Secretary John Tsang, tariff savings for Hong Kong-based firms doing business in China amounted to RMB2.8bn (USD440m) by the end of March 2012.

Company and Trust Law Updates

The government hopes that a major reform of Hong Kong’s company law will also help to consolidate the SAR’s status as a major international business and finance centre. Based on British law dating back to the 19th century, the previous Companies Ordinance (CO) had been amended on a piecemeal basis, and it was widely believed that Hong Kong's company laws had become outmoded compared to other financial jurisdictions. Therefore, in December, 2005, the government announced a major overhaul of the Ordinance, in what came to be the most substantial law reform exercise in its history.

A comprehensive exercise to rewrite the CO was launched in mid-2006. Following five rounds of public consultations and numerous discussions during a series of public forums and seminars over the years, the Companies Bill was finalized and introduced into the Legislative Council (LegCo) in January 2011. After 44 meetings lasting a total of over 120 hours and consideration of over 200 papers or submissions, the Bill was passed by LegCo on July 12, 2012 and came into effect on March 3, 2014.

The major initiatives within the new CO, which consists of 921 sections and 11 schedules, include measures to strengthen the accountability of directors and to clarify the directors' duty of care, skill and diligence with a view to providing clear guidance, while it also enhances shareholder engagement and protection in a company's decision-making process.

Public companies and the larger private companies (that do not qualify for simplified reporting) now need to prepare a more comprehensive directors' report, which includes an analytical and forward-looking "business review," although private companies are allowed to opt out by special resolution.

Auditors are empowered by the new CO to require a wider range of persons accountable for the company, or its subsidiary undertakings' accounting records, to provide information or explanation reasonably required for the performance of the auditor's duties.

Better regulation will be ensured by means of the accuracy of information on the public register, an improvement to the registration of charges scheme, and a strengthening of the enforcement regime through the Companies Registry. There will be easier reporting for small- and medium-sized enterprises, which will also be able to prepare simplified financial and directors' reports.

In addition, par value for shares is abolished and a mandatory system of no-par for all companies is instituted, with the objective of not inhibiting the raising of new capital or unnecessarily complicating a company's accounting regime. At the same time, the requirement for companies to have a memorandum of association is abolished, and only articles of association are required.

Conditions contained in the memorandum of existing companies are deemed to be provisions of their articles, except those relating to authorized share capital and par value, which are regarded as deleted under the new CO.

The power of companies to issue share warrants to bearers is revoked. It is considered that share warrants are undesirable from the perspective of anti-money laundering because of the lack of transparency in the recording of their ownership and the manner by which they are transferred.

To facilitate implementation of the new CO, 12 pieces of subsidiary legislation have been made to provide for the relevant technical and procedural matters. In parallel, the Companies Registry has enhanced its information system, carried out an overall review of its policies and procedures and specified new forms for the implementation of the new legislation.

Trust law is another area which the Hong Kong government has modernised to bring the jurisdiction into line with other comparable common law jurisdictions such as the United Kingdom and Singapore. Until new legislation went into force in 2013, Hong Kong trust law was based mainly on common law, supplemented by the Trustee Ordinance and the Perpetuities & Accumulations Ordinance, which had not been substantially reviewed or modified since they were enacted in 1934 and 1970. Thus some of their provisions were considered outdated and unfit for meeting present-day trusts' needs. Following a review of the Trustee Ordinance and the Perpetuities and Accumulations Ordinance, and in response to the various modernisation proposals put forward by the trust industry and recent trust law reform in the United Kingdom and Singapore, the Government conducted public consultations in 2009 and 2012. The exercise was brought to completion with the passage of the Trust Law (Amendment) Ordinance 2013 in July 2013.

The reform package seeks to clarify trustees' duties and powers and better protect beneficiaries' interests. The new law therefore introduces a statutory duty of care for trustees; provides trustees with general powers to appoint agents, nominees and custodians, as well as to insure trust property against risks of loss; allows professional trustees to receive remuneration; provides for a court-free process for the retirement of trustees on beneficiaries' directions; and imposes statutory control on exemption clauses that seek to relieve professional trustees from liabilities.

In addition, the bill also allows settlors to reserve to themselves some limited powers; abolishes outdated rules against perpetuities and excessive accumulations of income; and relaxes the market capitalization and dividend requirements for investment in the equity market.

In his speech at the recent Hong Kong Trustees' Association Conference 2013, the Secretary for Financial Services and the Treasury, Professor K C Chan, confirmed that the Government is keen to promote Hong Kong as a global centre for trust services.

Chan called the trust industry "an indispensable pillar that cements our standing as a premier international asset management centre." It offers a diverse range of services and products, including individual wealth and estate planning, as well as corporate trust services, such as trust administration and acting as a custodian. In addition, financial structures and products have been developed that utilize trusts, such as pension funds, real estate investment trusts and hedge funds.

He cited the many advantages that have set Hong Kong apart as a premier trust administration centre. In particular, its proximity to the Mainland means the industry can offer its services to ultra-high-net-worth Chinese individuals who are seeking ways to manage their assets, as well as looking to preserve wealth and family businesses for passing on to future generations.

At the end of 2011, Hong Kong’s trust industry held assets of an estimated HKD2.6 trillion (USD335bn), and more than 60% of the city’s asset management business originated from funds from non-Hong Kong investors.

China’s Offshore Financial Centre

Ultimately however, it is Hong Kong’s unique relationship with China, serving as the unofficial offshore financial centre of the People’s Republic, that is underpinning much of the SAR’s economy at present. This association has allowed the territory to be at the forefront of, and benefit from, the on-going liberalisation of the Chinese economy.

According to the Hong Kong Trade Development Council, in 2013, 62% of re-exports were of China origin and 55% were destined for the Chinese mainland. Hong Kong is the second largest trading partner of the Chinese mainland after the US, accounting for 9.6% of its total trade in 2013.

Hong Kong is also the largest source of overseas direct investment in the Chinese mainland. By the end of 2013, among all the overseas-funded projects approved in China, 44.3% were tied to Hong Kong interests. Cumulative utilized capital inflow from Hong Kong amounted to USD664.6bn, accounting for 47.7% of the national total.

China is also the leading investor in Hong Kong, and the stock of Hong Kong's inward investment from the Chinese mainland amounted to USD457bn at market value or 37% of the total at the end of 2012. As of December 2013, there were 11 licensed banks and four representative offices, incorporated in the Chinese mainland, operating in Hong Kong. Big lenders including the Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China and China Construction Bank have opened their branch operations in Hong Kong. Mainland commercial banks including Bank of Beijing, Bank of Dongguan, China Guangfa Bank and Ping An Bank have representative offices in Hong Kong.

Hong Kong is also a key offshore capital-raising centre for Chinese enterprises. As of December 2013, 797 mainland companies were listed in Hong Kong, comprising H-share, red-chip and private companies with total market capitalization of USD1.8 trillion, or 56.9% of the market total. Since 1993, mainland companies have raised more than USD400bn via stock offerings in Hong Kong.

Furthermore, Hong Kong is playing a major role in the gradual internationalisation of the Chinese currency, the renminbi (RMB). Since the introduction of the Pilot RMB Trade Settlement Scheme by the Central Government in July 2009, Hong Kong has succeeded in expanding its RMB business by offering a number of RMB-denominated financial products and services, including trade finance, stocks, bonds and funds. Since the debut of the scheme, the related cross-border remittances totalled RMB8.7 trillion and RMB deposits in Hong Kong had surged over tenfold to RMB860bn as at end-2013. In 2013, issuance of RMB bonds in Hong Kong (Dim Sum Bonds) reached RMB117bn.

In October 2012, the RMB-traded shares of Hopewell Highway Infrastructure Ltd were listed on Hong Kong Stock Exchange (HKEx) by way of placing under the “Dual Tranche, Dual Counter” (DTDC) model, which was the first RMB-traded equity security outside the mainland.

Hong Kong has also established itself as the premier stock market for Chinese firms seeking to list abroad. As at end-2013, Hong Kong's stock market ranked the second largest in Asia and the sixth largest in the world in terms of market capitalisation. There were 1,643 companies listed on HKEx, including 179 companies on the Growth Enterprise Market and the total market capitalisation of Hong Kong's stock market reached USD3.1 trillion. Hong Kong is also the second largest private equity centre in Asia, managing about 19% of the total capital pool in the region as at end-2013.


So, in summary, while the light-touch economic and regulatory approach established by its former British colonial masters helped Hong Kong to grow in stature economically, clearly its unique position as the gateway for investment entering and leaving China is the key to its recent prosperity, as well as its future growth.


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