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Hong Kong International Focus

Sponsored by Paifang Limited
15 December, 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 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.

The Economy

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 percent in 2009. In between these two downturns, the territory enjoyed growth rates of between 6 percent and 8 percent and rebounded sharply in 2010 when it grew by 6.8 percent. Since then the economy has grown at a more modest pace: after expanding by 2.9 percent in 2013, year-on-year growth of 2.4 percent was achieved in the first three quarters of 2014.

A Financial, Business and Investment Hub

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, particularly 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 November 2014, there were 159 licensed banks, 20 restricted licence banks and 23 deposit-taking companies in business. In addition, there were 62 local representative offices of overseas banks in Hong Kong. Total bank deposits stood at more than HKD10 trillion (USD1.3 trillion) at the end of October 2014. 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. By the end of September 2014, total RMB deposits in Hong Kong had grown to HKD944.5bn, over ten times the level in February 2004. During the same period, the number of financial institutions authorised to take RMB deposits has grown from about 30 to almost 150.

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, hedge fund assets under management (AUM) in Hong Kong increased 38 percent from the time of the last survey in September 2010 to USD87.1bn as of September 30, 2012.The number of hedge funds managed by the SFC-licensed hedge fund managers in Hong Kong surged to 676 as of the end of September 2012, up more than 25 percent compared to 538 funds two years previously.

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 337 overseas and Chinese Mainland companies to set up or expand in Hong Kong in 2013, representing a new record and an almost 7 percent increase over the previous year. Mainland China continued to be the largest single source of investment into Hong Kong with a total of 71 projects, many of them using Hong Kong as a springboard to go global. The US followed with 48 completed projects, Japan with 37, the UK with 36, and France with 16. For the first time, InvestHK also assisted a company from Bahrain to set up in the city.Companies in asset management, particularly fund-management houses, biomedical companies and financial technology companies were prominent among these new investors.

Indeed, Hong Kong continues to attract far larger volumes of foreign direct investment (FDI) than most industrialised economies. According to the United Nations Conference on Trade and Development's (UNCTAD) World Investment Report 2014, Hong Kong was ranked fourth in terms of FDI inflows in 2013, behind only the United States, Mainland China, and Russia. With an inflow of USD77bn, Hong Kong continued to be the second largest FDI recipient in Asia after the Mainland (USD124bn).

The UNCTAD report added that Hong Kong had been "highly successful" in attracting multinational companies, with almost 1,400 such regional headquarters operating in Hong Kong at the end of 2013. It confirmed that Hong Kong continued to be one of the "major destinations" for the headquarters of MNCs targeting Asia Pacific markets.

The Director-General of Investment Promotion at InvestHK, Simon Galpin, said: "It is encouraging to see that Hong Kong continues to be one of the leaders in global and regional FDI. It shows that our city continues to be an important FDI conduit given its enduring advantages including low and stable tax, free market access, and easy business environment."

"Offshore" But Onshore

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 percent, 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 percent, or on a progressive scale between 2 percent and 17 percent. 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.

Tax Agreements

Until June 2001, the territory had no comprehensive double taxation agreements in place. Since under the "territorial principle" only Hong Kong source income is taxable the double taxation of income does not usually occur thereby obviating the need for double taxation treaties. However the government is now entering an increasing number of tax treaties of various types. Under article 151 of the Basic Law the territory can negotiate its own double taxation treaties independently of China using the abbreviation Hong Kong, China.

Legislation which came into operation in March 2010 allows Hong Kong to enter into comprehensive DTAs, incorporating the Organisation for Economic Cooperation and Development (OECD) international standard on exchange of information. In 2013, it also put in place a legal framework for entering into standalone tax information exchange agreements with other jurisdictions.

Financial Secretary John C Tsang stressed how Hong Kong has made substantial efforts to introduce the new global standard for the automatic exchange of tax information, while also ensuring data confidentiality, during his speech at the first Certified Tax Adviser Conference on November 28, 2014.

Hong Kong has indicated its support for implementing the new global standard, on a reciprocal basis, with those partners that can meet requirements on the privacy and confidentiality of information exchanged and the proper use of the data, Tsang said.

Nevertheless, he clarified that "automatic exchange" does not mean that there will be free flow of information to all jurisdictions. The exchange partners need to enter into a Competent Authority Agreement, which provides the legal basis for the exchange, which has to be conducted within the confines of the agreement signed between the tax authorities of the jurisdictions concerned.

"In enhancing tax transparency," he added, "we are mindful of the need to protect the privacy and confidentiality of information exchanged. The new standard offers explicit clauses on protecting confidentiality. And we would strive to uphold confidentiality rules and safeguards consistent with the international standard."

With regard to compliance by Hong Kong's financial institutions, he pointed out that the city has signed an inter-governmental agreement with the United States to facilitate compliance with the Foreign Account Tax Compliance Act (FATCA). "We believe that financial institutions in Hong Kong could use their institutional arrangements for FATCA to meet the reporting requirements under the new international standard."

However, the Government also recognizes that differences remain between the arrangements required to comply with both, including with the respect to reportable accounts and due diligence procedures. Discussion with the financial sector and the taxation institute will continue to address their concerns about implementing the new standard.

Hong Kong's target is to begin its first information exchanges by the end of 2018, on the condition that the necessary domestic legislation can be put in place before then.

Hong Kong and China's Closer Economic Partnership

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 percent) of the 303 companies it assisted in 2010 indicated that the CEPA was one of the 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 latest phase of liberalisation measures by virtue of Supplement IX implemented in January 2012. Supplement X to the CEPA was signed on August 29, 2013, by Hong Kong's Financial Secretary, John C Tsang, and the Chinese Vice-Minister of Commerce, Gao Yan, and 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 its signing in 2003. Tsang said that, among the supplements made since that original signing, Supplement X contains the greatest number of measures. "Some of the measures are more liberal than those contained in recent supplements," he added, "and some have been longed for by the trades for a long time."

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 has further relaxed market access conditions for all these sectors, with effect from January 1, 2014.

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 Law Streamlined

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 former Companies Ordinance was amended on a piecemeal basis, and was widely regarded as outmoded compared to other financial jurisdictions.

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 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."

The exercise was brought to completion with the passage of the Trust Law (Amendment) Ordinance 2013 in July 2013.

The Renminbi

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, and during a speech at the Boao 2014 Asia Forum in Hainan on April 10, 2014, Chief Executive CY Leung confirmed that Hong Kong will maintain its pioneering role in offshore renminbi business development.

Speaking on Hong Kong's opportunities and challenges in the process of RMB internationalization, he pointed out that Hong Kong remains the premier offshore centre for RMB business, not least through its pioneering role in the development of that business since 2004.

However, as a first mover in offshore RMB business, Leung said that "Hong Kong is now happy to see the development of RMB business in different parts of the world, as this represents more opportunities for Hong Kong to further develop its leading role and hones the city's competitiveness as a financial super-connector linking China with the rest of the world."

He noted that, by the end of February 2014, the aggregate amount of RMB deposits and certificates of deposit in Hong Kong reached RMB1.128 trillion (USD181.6bn), representing the largest offshore RMB liquidity pool in the world.

Leung concluded that: "The continued growth of RMB liquidity in Hong Kong and elsewhere has been the fundamental driving force behind further innovations in the offshore market, meeting the needs of individuals, enterprises and financial institutions for consumption, investment and capital requirements from around the world."

The Stock Market

Hong Kong has also established itself as the premier stock market for Chinese firms seeking to list abroad. At the end of 2013 there were a total of 1,643 companies listed on HKEx markets. Of these, 797 were Mainland enterprises, constituting 57 percent by market capitalization, and 72 percent by annual equity turnover value.

At the conclusion of 2013, the total market capitalization of the securities market was just over HKD24 trillion (USD3.1 trillion) – 10 percenthigher than at year-end 2012.Total securities market turnover in 2013 was HKD15.26 trillion, up 15 percent year-on-year. The average daily turnover for the overall securities market in 2013 showed an annual increase of 16 percent to HKD62.6bn, with a highest single-day turnover of HKD128.4bn on February 4, 2013, compared with a high of HKD127.3bn during 2012.

Although revenue and other income increased by only 4 percent year-on-year to reach HKD4.6bn (USD596m) in the first half of 2014, companies returned to the initial public offering (IPO) market to raise funds in Hong Kong. With IPOs raising HKD82.1bn – an increase of 107 percent when compared with the first half of 2013 – Chow Chung Kong, HKEx's Chairman, pointed out that, among the 20 largest IPOs, 4 were listed on Asian exchanges and 3 were in Hong Kong.

Eight exchange traded funds (ETFs) were newly listed during the first six months of this year, including the first Renminbi Qualified Foreign Institutional Investor (RQFII) ETF tracking the Mainland's bond market, as well as the first RQFII sector ETFs. There were 124 ETFs, 11 real estate investment trusts, and 531 debt securities listed.

Chow confirmed in the first half report that HKEx is continuing to make good progress on various initiatives under its 2013-2015 strategic plan. In particular, the Shanghai-Hong Kong Stock Connect (SHKSC),was successfully launched on November 17, 2014, allowing mutual stock market access between the two cities. As had been expected, on the first day of trading, north-bound trading (from Hong Kong to Shanghai) exceeded south-bound trading (from Shanghai to Hong Kong), as international investors took the advantage of the new way of purchasing Mainland Chinese shares. Sentiment was also said to have been helped by the recent confirmation that trading in Mainland shares had obtained a Chinese capital gains tax exemption.

In Summary

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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