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Hong Kong International Focus

By Lowtax Editorial
16 May, 2013

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%. 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%. In 2012, growth slowed quite alarmingly, to 1.8%, following up a 5% expansion in GDP in 2011.

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 largely 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. At the end of April 2013, there were 154 licensed banks, 21 restricted licence banks and 24 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 March 2013 when they stood at over HKD8.3 trillion (just over USD1 trillion), up from HKD7.6 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. RMB668bn (USD1bn) in renminbi deposits was held in Hong Kong banks at the end of March 2012, up from RMB554 a year earlier.

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 US$87.1 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, Financial Secretary John Tsang proposed in the 2013 Budget to extend 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.

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

A Base for Multinationals

The SAR’s investment promotion agency, InvestHK, assisted a record 316 foreign companies to set up or expand existing operations in the territory in 2012. These completed projects originated from 34 countries, with China the largest single source of investment into Hong Kong with a total of 62 projects. China was followed by the US with 54 projects, the UK (29), Japan (27) and Germany (17). The top three sectors were transport and industrial (48), tourism and hospitality (46) and innovation and technology (43). 

By region, Europe led the field with 110 projects completed, compared with 105 a year ago. Some 60 projects were from the eurozone economies, up by almost 16% compared to a year earlier. North America, including Canada, also reported growth, with 65 projects compared with 59 a year ago. Asia Pacific, excluding Mainland China, reported milder growth, with 74 projects, compared with 73 in 2011.

By market, Germany was the fastest growing from Europe, with 17 projects compared to seven in 2011 (up 143% from over a year ago).

"2012 was another record year for InvestHK in terms of completed projects," said InvestHK’s Director-General of Investment Promotion, Simon Galpin. "The positive results showed that Hong Kong continues to attract overseas and Mainland investors because of its enduring advantages and new business opportunities."

However, he noted that, "in the year ahead, we will remain cognizant of global economic trends and continue to identify the sectors and markets which will reap the best benefits for Hong Kong. Our targets will include both multinationals and start-up businesses, which aspire to set up in our city."

According to the results of an annual survey released by InvestHK and the Census and Statistics Department in October 2012, 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 2012, the total number of foreign parent companies with operations in Hong Kong had reached 7,250 companies, a 4.3% increase from 2011. Within that total, 1,367 operated as regional headquarters (RHQs), 2,516 as regional offices (ROs) and 3,367 as local offices (LOs), compared to 1,340, 2,412 and 3,196, respectively, a year earlier.  When choosing a location to set up RHQs/ROs/LOs, the top five factors rated as most important by respondents included: simple tax system and low tax rate; free flow of information; corruption-free government; political stability and security; and rule of law and independent judiciary.

With regard to the country of origin, almost half of the parent companies come from three countries: the United States (US) tops the list with a total of 1,388 businesses operating in Hong Kong, followed by Japan with 1,218 and Mainland China with 853. The major lines of business were mainly import/export trade, wholesale and retail; financing and banking; and professional, business and education services. Of particular note is the 8.8% rise in the number of companies engaged in financing and banking, which reflects the increasing appeal of Hong Kong as an international financial centre and its role as the Mainland's official offshore renminbi centre.

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 ninth phase of liberalisation measures by virtue of Supplement IX, which was signed on June 29, 2012, and took effect on January 1, 2013. Supplement IX provides for a total of 43 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. For example, market access conditions will be further relaxed in 21 existing sectors, including legal, accounting, construction, medical services, computer and related services, placement and supply services of personnel, printing, telecommunications, audiovisual, distribution, banking and securities, and tourism.

Hong Kong law firms that have set up representative offices on the Mainland are now allowed to operate in association with one to three Mainland law firms as a result of Supplement IX, while Hong Kong accounting professionals, who have obtained the Chinese Certified Public Accountants qualification, will be allowed to become partners of partnership firms in Qianhai on a pilot basis. In addition, in banking and securities, Hong Kong banks are now permitted to offer custodian services regarding settlement funds of customers of securities companies and margin deposits on futures transactions; and Hong Kong securities companies that satisfy the qualification requirements as foreign shareholders of foreign-invested securities companies, and Mainland securities companies that satisfy the requirements for establishing subsidiaries, are allowed to set up equity joint venture securities investment advisory companies on the Mainland. Such an equity joint venture securities investment advisory company shall be a subsidiary of the Mainland securities company, and the shareholding of the Hong Kong securities company can be a maximum of 49% of its total shareholding.

Including the measures in Supplement IX, the two sides have so far announced 338 liberalization measures in 48 service sectors under the CEPA.

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.

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 Companies Ordinance (CO) 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 Companies Ordinance draft Companies Bill was gazetted on August 10, 2012, following the passage of the Companies Bill by the Legislative Council on July 12. A government spokesman said at the time that: "The new CO, comprising 921 sections and 11 schedules, provides a modernised legal framework for the incorporation and operation of companies in Hong Kong. Its objectives are to enhance corporate governance, improve regulation, facilitate business and modernise the law with a view to strengthening Hong Kong's competitiveness as a corporate domicile and enhancing its status as a major international commercial and financial centre."

The new ordinance will commence operation on a date to be appointed by the Secretary for Financial Services and the Treasury. Before its commencement, the government will submit more than ten pieces of implementing subsidiary legislation to the legislature for vetting and enactment, and the new CO will start operation after their enactment, tentatively scheduled for 2014.

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. Hong Kong trust law is based mainly on common law, supplemented by the Trustee Ordinance and the Perpetuities & Accumulations Ordinance, which have not been substantially reviewed or modified since they were enacted in 1934 and 1970 and some of their provisions are 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 modernization 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, respectively, on the reform proposals. The reform package seeks to clarify trustees' duties and powers and better protect beneficiaries' interests. The major proposals would therefore introduce a statutory duty of care on trustees; provide trustees with general powers to appoint agents, nominees and custodians, as well as to insure trust property against risks of loss; allow professional trustees to receive remuneration; provide for a court-free process for the retirement of trustees on beneficiaries' directions; and impose statutory control on exemption clauses that seek to relieve professional trustees from liabilities. In addition, the bill would also allow settlors to reserve to themselves some limited power; abolish outdated rules against perpetuities and excessive accumulations of income; and relax the market capitalization and dividend requirements for investment in the equity market.

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."

The Trust Law (Amendment) Bill 2013, was gazetted on February 8, 2013 and was presented to the Legislative Council for first reading on February 20, 2013.

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.

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 (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 June 2012, China announced that it was preparing to issue sovereign bonds totalling RMB23bn in Hong Kong, including a new channel of issuance for foreign central banks and monetary authorities.

  • In December 2011, the RMB Qualified Foreign Institutional Investor (RQFII) scheme was launched 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, the RQFII threshold was increased from its initial RMB20bn (USD3.2bn) to RMB70bn, and then to RMB270bn in November. In May 2013, the list of types of institutions eligible to apply for RQFII was enlarged to cover Hong Kong subsidiaries of Mainland commercial banks and insurance companies or financial institutions which are registered and have major operations in Hong Kong. At the same time, the investment restriction on RQFII funds was also relaxed to allow institutions not only to invest in such things as RMB bonds, A shares or RQFII-ETFs, but also to design different types of products in accordance with market conditions.

  • In April 2012, Hong Kong Exchanges and Clearing Limited (HKEx) announced plans to introduce RMB currency futures, and this project was rolled out in the third quarter of the year following regulatory approval. The 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. Since the launch of RMB Currency Futures via a USD/CNH contract up to the end of March 2013, trading volume reached a single day record of 1,348 contracts on January 9, 2013 and the open interest hit a record high of 5,118 contracts on March 7, 2013. The total number of USD/CNH futures contracts traded in the first quarter of 2013 was 25,054 contracts (USD2.5bn) and the open interest at the end of March 31, 2013 was 4,791 contracts (USD479m notional).

  • In June 2012, the Hong Kong Monetary Authority unveiled a new facility for providing RMB liquidity to authorized institutions (AIs), against eligible collateral, from June 15. The facility makes use of the currency swap arrangement between the PoBC and the HKMA. Participating AIs are welcomed to use the RMB liquidity facility to manage their short-term liquidity needs and they may roll over the borrowings under this facility if needed. Nevertheless, it was stressed this facility should not be regarded as a steady source of funding for their business. Under its initial terms, acceptable collateral consists of Exchange Fund Bills and Notes, Hong Kong Government bonds, and RMB denominated bonds issued in Hong Kong by China’s Ministry of Finance.

  • In August 2012, HKEx announced that its intention to extend the coverage of its RMB Equity Trading Support Facility (TSF) beyond RMB-traded shares to equity-related exchange traded funds and real estate investment trusts traded in RMB, with effect from August 6, 2012. The TSF was designed to serve as a back-up facility to enable investors to buy RMB-traded shares in the secondary market with Hong Kong dollars if they did not have sufficient RMB, or had difficulty obtaining RMB. The TSF sources RMB from one or more banks (TSF Partner Banks) in Hong Kong and provides the RMB through its participating brokers to investors who wish to buy RMB shares in the secondary market. The TSF’s RMB-HKD exchange rates are set on a commercial basis by the TSF Partner Banks. When investors sell the RMB shares later on, they have to return the RMB proceeds to the TSF for the equivalent amount of HKD at the TSF’s exchange rate at that time. This so-called ‘HKD in HKD out’ mechanism ensures that the RMB supplied by the TSF stays in the secondary market and that the offshore RMB market in Hong Kong remains intact.

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. Speaking at the Renminbi Cross-Border Trade & Investment Forum in July 2012, Financial Secretary John Tsang confirmed that this is a role that Hong Kong will continue to play, observing that as a Special Administrative Region of China and working under the principle of ‘One Country, Two Systems’, Hong Kong will remain “front and centre” in the RMB liberalization process.

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.

After record levels of trading were seen in 2011 (when just under 40bn shares changed hands), HKEx described 2012 as a “down year” by comparison, an outcome it attributed to uncertainty about the health of the global economy and investors’ decreased appetite for risk. In the primary market, IPOs raised HKD90bn, a 65% decrease from 2011, while 62 companies were newly listed on the market, compared to 89 in 2011. In the secondary market, the year started relatively strong, with Cash Market average daily turnover (ADT) of HKD63.2bn in the first quarter, but trading activity gradually decreased, reaching a 2012 low of HKD46.4bn in the third quarter. The year ended with a fourth quarter ADT of HKD56.0bn. Total Main Board and small-cap market capitalisation increased 25% over the year however, to HKD21.9 trillion. At the end of 2012, there were 1,547 companies listed on the Main Board and the Growth and Enterprise Market, 3.4% more than at the end of 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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