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Hong Kong International Focus

Sponsored by Paifang Limited
28 March, 2017

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 7m 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 centers.


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 defense, 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 center 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, with growth in the 2.5-3.0 percent range from 2013 to 2015. In 2016 the economy is expected to grow between 1.0 percent to 2.1 percent.

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 neighboring 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 February 2016, there were 157 licensed banks, 24 restricted license banks and 19 deposit-taking companies in business. In addition, there were 60 local representative offices of overseas banks in Hong Kong.

At the end of January 2016, total bank deposits stood at more than HKD10.9 trillion (USD1.4 trillion). 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. RMB deposits reached a peak of HKD1 trillion at the end of 2014. Since then, the level of RMB deposits has tailed off slightly, and by the end of January 2016, total RMB deposits in Hong Kong had fallen to HKD852bn. Nevertheless, this is still ten times the level held in Hong Kong banks in February 2004. During the same period, the number of financial institutions authorized to take RMB deposits has also soared, from about 30 to almost 150.

Hong Kong is also recognized as the leading fund management center 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 2015, hedge fund assets under management (AUM) in Hong Kong reached a record high in 2014. The report shows that as of September 30, 2014, hedge fund AUM in Hong Kong were USD120.9bn, an increase of 39 percent from the amount reported in the previous survey in September 2012.

Hong Kong has also established itself as the favored base for multinational companies looking to expand into Asia-Pacific markets. The SAR's investment promotion agency, InvestHK, assisted 375 overseas and Chinese Mainland companies to set up or expand in Hong Kong in 2015, an all-time high and a year-on-year increase of 5.6 percent. Mainland China continued to be the largest single source of investment into Hong Kong with a total of 78 projects, many of them using Hong Kong as a springboard to go global. The US followed with 49 completed projects, then the UK with 36, Japan with 31, and France with 20. For the first time, InvestHK helped two companies from Latvia and Seychelles to set up in Hong Kong.

In recent years, companies in asset management and biomedical sciences have been prominent among these new investors. However, in 2015 InvestHK also assisted a growing number of companies in emerging businesses, including the Internet of Things and financial technology industries (a total of 19 in 2015 compared with nine in 2014).

Indeed, Hong Kong continues to attract far larger volumes of foreign direct investment (FDI) than most industrialized economies. According to the United Nations Conference on Trade and Development's (UNCTAD) World Investment Report 2015, Hong Kong was ranked second in terms of FDI in 2014, behind only mainland China, with an inflow of USD103bn.

According to UNCTAD, Hong Kong continues to be one of the "major destinations" for the headquarters of MNCs targeting Asia Pacific markets.

Commenting on these impressive figures, the Director-General of Investment Promotion at InvestHK, Simon Galpin, said: "The numbers highlight Hong Kong's role as a 'super-connector' and a conduit for direct investment. Foreign investors use Hong Kong as a base to then invest in the rest of China and the region. Mainland companies increasingly use Hong Kong as a platform to make global investments and acquisitions."

"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, 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, and the government is now entering an increasing number of tax treaties of various types.

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, known as the Common Reporting Standard (CRS) 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 US 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 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.

Legislation which seeks to provide a legal framework for Hong Kong to implement the new international standard for automatic exchange of financial account information in tax matters was gazetted on January 8, 2016. Subject to the passage of the bill, the CRS will be implemented on a reciprocal basis with partners who meet standards on privacy protection and the confidentiality of information exchanged, and on ensuring proper use of the data, the Government has confirmed. Hong Kong will only conduct the exchange with jurisdictions that have signed comprehensive avoidance of double taxation agreements or tax information exchange agreements with Hong Kong on a bilateral basis, the Financial Services & the Treasury Bureau has further clarified.

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 liberalization measures by virtue of Supplement X signed on August 29, 2013, by Hong Kong's Financial Secretary, John C Tsang, and the Chinese Vice-Minister of Commerce, Gao Yan.

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.

The latest expansion of CEPA brings to 403 the total number of liberalization measures for trade in services under the agreement since its initial 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.

The scope of CEPA will be expanded further in 2016 thanks to a comprehensive new agreement to liberalize trade in services between Hong Kong and mainland China. The main text of the agreement, signed on November 27, 2015, sets out provisions for, among others, national treatment, most-favored treatment, safeguard measures, exceptions, and investment facilitation. The three annexes of the agreement set out respectively the specific commitments of the Mainland and Hong Kong in liberalization of trade in services, the definition of "Service Supplier" and related requirements.

The new agreement opens up fully or partially 153 services sectors in mainland China to businesses in Hong Kong and will be implemented from June 1, 2016.

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 center. 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 is ensured by means of the accuracy of information on the public register, an improved registration of charges scheme, and a more stringent enforcement regime through the Companies Registry. Reporting has also been eased for small- and medium-sized enterprises, which are able to prepare simplified financial and directors' reports.

In addition, par value for shares has been abolished and a mandatory system of no-par for all companies 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 has also been abolished, and only articles of association are now 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 was revoked under the changes. 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 modernize 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 center 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 internationalization of the Chinese economy. Indeed, Hong Kong's Secretary for Financial Services and the Treasury, K C Chan, believes that there are tremendous opportunities ahead for Hong Kong's financial center as China continues to liberalize the RMB.

In remarks at a seminar held by the London Business School in May 2015, Chan observed that Hong Kong has already been playing a "key role" in the RMB liberalization process, noting that the offshore RMB market was effectively born in Hong Kong in 2003. "The combined value of deposits and certificates of deposits in Hong Kong is about RMB1.1 trillion at the end of March [2015]," Chan said, adding that: "Offshore RMB bonds, dubbed 'dim sum' bonds, [were] first issued here in 2007. At the end of March, RMB614bn was raised through 498 'dim sum' issues."

According to Chan, the RMB is the fifth-most-used payment currency in the world. About RMB6.3 trillion, or 95 percent, of mainland China's total RMB trade was settled by Hong Kong banks. "We literally work around the clock to help RMB users settle their trades," Chan explained. "Our RMB real-time gross settlement system operates 20.5 hours a day to cover our European and American partners."

Chan told the gathering that Hong Kong is currently pushing for the use of the RMB as an investment currency. "Launched in 2011, the RMB Qualified Foreign Institutional Investor (RQFII) scheme opened the Mainland equity and bond markets to offshore RMB investors," he said. "At the end of January, we had 84 RQFII funds managing RMB72bn. Along with the 'dim sum' bonds, these funds are opened to investors from all over the world."

In November 2014, the RMB20,000 daily RMB conversion limit for Hong Kong residents was removed to coincide with the launch of the Shanghai-Hong Kong Stock Connect scheme, a mutual market access program that allows Mainland investors to trade stocks listed on the Stock Exchange of Hong Kong (SEHK) directly through the Shanghai Stock Exchange (SSE) – the Southbound Trading Link. At the same time, it also allows Hong Kong and overseas investors to trade stocks listed on the SSE directly through the SEHK – Northbound Trading Link.

The Stock Market

Hong Kong has established itself as the premier stock market for Chinese firms seeking to list abroad. As of December 15, 2015 there were 1,854 companies listed on HKEx markets, a rise of more than 100 from the end of 2014. Just over half of these were Mainland enterprises, constituting 62 percent by market capitalization, and 73 percent by annual equity turnover value.

In December 2015, HKEx confirmed that several new records were set in the securities and derivative markets over the course of the previous 12 months. The market capitalization of HKEx's securities market exceeded HKD31 trillion (USD4 trillion) in 2015 for the first time, with its market cap peaking at HKD31.6 trillion on May 26. Turnover in HKEx's securities and derivatives markets reached new annual highs of more than HKD25.5 trillion and 183.2m contracts respectively in 2015 (the previous records were HKD21.7 trillion in 2007 and 142.4 million contracts in 2014, respectively). Many products also had their highest single-year turnover ever, including exchange-traded funds, debt securities, and a number of derivatives market products.

In addition, IPO fundraising in the year to December 15, 2015, totaled USD31.8bn, the world's highest for the period, according to data from Dealogic. There were 125 new listings since the beginning of the year, and total equity funds raised (including IPOs and post-IPO fundraising) reached over HKD1 trillion, exceeding the full-year record high established in 2014.

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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