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Hong Kong International Focus

Sponsored by Paifang Limited
28 May, 2012

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 clearly 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.

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.

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 by 2.7% in 2009. The territory has, however, enjoyed growth rates of between 6% and 8% in between, and the economy rebounded sharply in 2010 when it grew by 6.8%. A similar level of growth looks set to have been achieved in 2011.

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 largely on re-exporting and 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. At the end of February 2012, there were 153 licensed banks, 20 restricted licence banks and 25 deposit-taking companies in business. In addition, there were 60 local representative offices of overseas banks in Hong Kong. Total bank deposits grew steadily in the 12 months to the end of January 2012 when they stood at over HKD7.6 trillion (just under USD1 trillion), up from HKD6.86 trillion a year earlier. 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. As much as RMB588.5bn (USD93bn) in renminbi deposits was held in Hong Kong banks at the end of 2011, five times more than was held in mid-2010.

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 2011, assets under management or advisory in Hong Kong increased 14% from the time of the previous survey in March 2009 to USD63.2bn as at September 30, 2010. The number of hedge funds managed by the SFC-licensed hedge fund managers in Hong Kong stood at 538 as at September 30, 2010, nearly five times the level in 2004, the earliest year covered in similar SFC surveys.

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

The SAR’s investment promotion agency, InvestHK, assisted a record 303 foreign companies to set up or expand existing operations in the territory in 2011. These completed projects originated from 39 countries, with China the largest single source of investment into Hong Kong with a total of 56 projects. China was followed by the US with 48 projects, the UK (30), Japan (23) and Australia (19). The top three sectors were tourism and hospitality, transport and industrial, and innovation and technology, respectively.

The list of companies expanding into Hong Kong last year included such household names as General Electric and Schneider Electric. However, Hong Kong also remained attractive to small and medium-sized enterprises from overseas, largely due to its ready pool of talent and simple business procedures. “The numbers are testament to the enduring advantages of Hong Kong as the preferred location for overseas investors and present a substantial vote of confidence in our city," said the Director-General of Investment Promotion at InvestHK, Simon Galpin.

According to the results of an annual survey released by InvestHK and the Census and Statistics Department in October 2011, the total number of overseas and Mainland Chinese parent companies running business operations in Hong Kong also reached a record level, as did the number of those operating regional headquarters. By June 2011, the total number of foreign parent companies with operations in Hong Kong had reached 6,948 companies, a 5.9% increase from 2010. Within that total, the number of regional headquarters was 1,340, an increase of 4.3%. Furthermore, of the 6,948 companies in the survey, 24% indicated that they plan to expand their business in Hong Kong in the next three years. This was a 4% increase compared with 2010. With regard to the country of origin, roughly half of the parent companies come from four countries: the United States (US) tops the list with a total of 1,328 businesses operating in Hong Kong, followed by Japan with 1,150, Mainland China with 805 and the United Kingdom with 562. The major lines of business were mainly import/export trade, wholesale and retail, financing and banking, professional, business and education services, and transportation, storage and courier services.

In the survey, when choosing a location to set up such businesses, a simple tax system and low tax rate is counted as one of the most important factors by the parent companies of these Hong Kong businesses, and this is an area where Hong Kong has a particular advantage.

Unlike most onshore jurisdictions, income tax in Hong Kong is levied on a ‘territorial’ basis, which means that income 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.

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 last year 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 ninth phase of liberalisation measures by virtue of Supplement VIII implemented in January 2012. Supplement VIII provides for a total of 32 services liberalisation and trade and investment facilitation measures, while it also strengthens co-operation in areas such as finance, tourism, innovation and technology. The latest Supplement allows Chinese banks to make use of Hong Kong's international financial platform to develop their international businesses, and supports Hong Kong insurance companies entering the market through the setting up establishments or taking capital participations, to participate and share in the development of the Mainland insurance market. As of December 2011, the CEPA covers more than 1,600 products and 40 services sectors.

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. 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.

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 Companies Ordinance has until now been amended on a piecemeal basis, and it is a widely held belief that Hong Kong's company laws have become outmoded compared to other financial jurisdictions. Therefore, in December, 2005, the government announced a major overhaul of the Ordinance, in what promises to be the most substantial law reform exercise in its history. Among other changes, the bill will introduce improvements in the area of corporate governance, including: improving the accountability of directors so as to enhance transparency and accountability, and clarifying the directors’ duty of care, skill and diligence; emphasizing shareholder engagement in the decision-making process; improving the disclosure of company information; and strengthening auditors’ rights. In addition, 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 Registrar. There will also be easier reporting for small- and medium-sized enterprises (SMEs), while SMEs will also be able to prepare simplified financial and directors’ reports.

In February 2009, the government released the third public consultation conclusions on the Companies Ordinance rewrite covering share capital, capital maintenance regime and statutory amalgamation procedure.  One of key recommendations adopted by the government as a result of the consultation was the migration from the current par value system to a mandatory no-par value share regime. Under the existing regime, companies having a share capital are required to have a par or nominal value ascribed to their shares. Respondents generally agreed that the concept of par was no longer useful and might even be misleading. Another recommendation was to remove the requirement for authorised capital - i.e. the maximum amount a company is permitted to raise by issuing shares. Nevertheless, a company, if it so wishes, may specify the maximum number of shares it can issue in its Articles of Association.

The draft Companies Bill was gazetted on January 14, 2011 and introduced into the Legislative Council on January 26. The draft bill has yet to be approved, however.

Trust law is another area which the Hong Kong government is keen to modernise and bring itself into line with other comparable common law jurisdictions such as the United Kingdom and Singapore. Upon launching a two-month public consultation in March 2012, Secretary for Financial Services and the Treasury, Professor K C Chan, said: "The reform seeks to modernize Hong Kong's trust law to better cater for the needs of modern-day trusts and enhance the interests of parties to a trust. It is a major initiative to strengthen the competitiveness of our trust services industry and further consolidate our status as an international asset management 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.

A major component of this is the gradual internationalisation of the renminbi. We have already noted the rapid growth of renminbi deposits in Hong Kong banks, but there are a number of other initiatives under way to cater for the growing demand for renminbi trading. A brief overview of these schemes follows below:

  • In August 2009, the RMB trade settlement scheme was launched in selected Chinese cities on a pilot basis, and subsequently expanded nationwide two years later. RMB trade settlement conducted through banks in Hong Kong in the first four months of 2011 amounted to RMB445bn (USD68.7bn), more than the RMB369bn settled in the entirety of 2010. In addition, in the first quarter of 2011, 86% of the Mainland's RMB trade settlement was conducted through banks in Hong Kong, showing that Hong Kong is the prime platform for RMB trade settlement. RMB trade settled through Hong Kong in 2011 eventually totalled RMB1.9 trillion (USD247bn).
  • In August 2010, the People's Bank of China (PBoC) announced that eligible institutions outside the Mainland can take part in a pilot scheme to make use of their RMB funds to invest in the Mainland's interbank bond market. Then, in December 2011, the China Development Bank (CDB) announced that it would become the first Chinese bank to issue an RMB bond in Hong Kong through the bond tendering platform of the Hong Kong Monetary Authority’s Central Moneymarkets Unit (CMU). The Chinese government also issued RMB15bn of a RMB20bn bond issue through the CMU in 2011.
  • In January 2011, the PBoC announced the introduction of a pilot scheme for Chinese enterprises to settle overseas direct investments in RMB, and, in August 2011, the RMB Qualified Foreign Institutional Investor (RQFII) scheme was launched, also on a pilot basis, for qualified Chinese fund managers and securities companies to allow their Hong Kong subsidiaries to channel RMB raised in Hong Kong to invest directly in the China bond and equity markets (including the inter-bank bond market and the exchange-traded bond market).
  • In April 2012, Hong Kong Exchanges and Clearing Limited (HKEx) announced plans to introduce RMB currency futures in the third quarter of the year, subject to regulatory approval and market readiness. The planned USD/CNH (RMB traded in Hong Kong) futures contract is designed to provide a way for investors to hedge RMB exposure. The contract requires delivery of USD by the seller and payment of its final settlement value in RMB by the buyer at maturity.

Hong Kong therefore is playing a central role in supporting RMB business overseas and its RMB financial platform now supports banks and financial institutions around the globe. At the end of 2011, 15% of RMB corporate deposits were held by overseas companies, and of the 187 participating banks, 165 were foreign owned or located overseas, covering over 30 countries in six continents.

Hong Kong has also established itself as the premier stock market for Chinese firms seeking to list abroad. In 2011 mainland Chinese companies constituted about 43% of the firms listed on HKEx and accounted for about 56% of the Exchange's market capitalization. During 2011, 54 mainland Chinese companies listed on HKEx, taking the total to 640 by the end of the year, an 8% annual increase. Total market capitalisation of Chinese firms listed on HKEx was over HKD9.7bn on December 31, 2011.

In general HKEx saw record levels of trading in 2011, with just under 40bn shares changing hands, surpassing the 35bn in shares traded during the previous record year of 2010. The total number of companies listed on the Main Board at the end of 2011 was 1,326, a 7% rise compared with the end-2010 figure. Total Main Board market capitalisation fell 17% over the year however, to HKD17.5bn. Funds raised in initial public offerings on the exchange also fell sharply, from HKD449bn in 2010 to HKD258bn in 2011.

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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