Taxlinked (TL): Do you think the process of China opening up to the West over time hurts Hong Kong as it loses its importance as the gateway to China?
Kristina Koehler (KK): As Hong Kong strengthens its connection to the economic powerhouse of mainland China, it is likely to benefit in some way from the relationship. I don't see Hong Kong becoming more Chinese as an obstacle to its future growth. If you compare Singapore – it has yet to have success in China. It does not play its China access card because it does not have a China access card yet. Even with a stock exchange in Shanghai, mainland Chinese firms have preferred to list on Hong Kong's stock exchange and open offices there. As protests gripped Hong Kong and worries mounted about how China might respond, one of the most unsettling questions for the city’s residents has been whether its fate matters much to the rest of the country. Hong Kong has long served as the bridge between China and the world, conveying trade and investment flows both ways. That role has diminished in recent years as China has opened its borders and plugged itself directly into the global economy. Hong Kong's leaders warn that the unrest in Hong Kong has only resulted in Chinese businesses bypassing it even more. Judging by size, they have a point: Hong Kong is clearly less important than in the past. Its GDP has shrunk from 16% of China’s in 1997, the year it was returned to Chinese control, to 3% today. That has led many inside China and abroad to conclude that Hong Kong is fading towards economic irrelevance.
But the focus on size alone is too simplistic. With China’s development over the past two decades, growth has spread around the country—no one city can dominate GDP when there are now nearly 200 cities with populations of more than 1m people and rapidly rising incomes. But in the financial sphere Hong Kong has remained indispensable to China. And in several dimensions its position has actually been consolidated, not eroded, in recent years. Hong Kong has proved to be more reliable than the mainland as a source of equity financing. Since 2012, Chinese companies have raised $43 billion in initial public offerings in the Hong Kong market, versus just $25 billion on mainland exchanges. More than anywhere else in the world, Hong Kong has also provided Chinese companies with access to global capital markets for bond and loan financing.
What’s more, Hong Kong is the key hub for investment in and out of China. It accounted for one-third of foreign direct investment into China last year, up from 30% in 2005. Although much of this money is simply passing through Hong Kong, foreign companies also use the city as their staging post for investing in China as it offers them something that no mainland city does: a stable investment environment, protected by fair, transparent courts that enforce long-established rule of law. And it is not just foreign companies and investors that turn to Hong Kong. Over the past five years, the Chinese government has made the city a testing ground for a range of financial reforms: the yuan’s path towards acceptance as a global currency began in Hong Kong in 2009 with an experiment in trade settlement; Hong Kong is also home to the biggest “dim sum” bond market—yuan-denominated debt that is issued overseas; and the newly launched program that has for the first timeallowed any foreign investor to buy China-listed shares conducted via the Hong Kong stock exchange. Hong Kong has been only too willing to host these experiments believing, rightly, that they are crucial to its survival as a thriving financial center.
In short, China has benefited greatly from Hong Kong’s unique status. It is a city that is sealed off from the mainland but closely connected to it; a territory that is fully integrated into the global economy but ultimately controlled by the Communist Party in Beijing. Even with its unique status, however, there is no question where the balance of power lies in Hong Kong’s relationship with China: about half of Hong Kong’s exports end up in China; one-fifth of its bank assets are loans to Chinese customers; and tourism and retail spending, mostly from China, account for 10% of Hong Kong's GDP.
In the opposite direction, the Chinese economy’s direct exposure to Hong Kong is vanishingly small. But it would be a grave mistake to conclude that Hong Kong therefore does not matter to China. If China were to do anything that jeopardized their special relationship, Hong Kong would suffer most; but China would also pay a heavy price.
TL: Lately it has been observed that the banks in Hong Kong have increased their requirements for corporate bank account openings. What are your experiences with that topic and what are the reasons for these issues? Also, are there implications for entrepreneurs and companies expanding to HK?
KK: Recently numerous local and international associations in Hong Kong were reporting bank related difficulties to the government of the HKSAR. This is a current issue all over the jurisdiction, in the last months we’ve had a series of cases where the opening of a bank account was not possible or very hard to realize. Banks recently are doing more compliance work and require more transparency than before. There are several reasons for these changes.
Banking difficulties at the biggest bank in Hong Kong – the HSBC – indirectly are a consequence to the court trial in the US for covering money laundering activities of Mexican Drug Cartels and therefore had to pay a high penalty. HSBC was forced to accept the so-called Deferred Prosecution Agreement in order to not lose its US license. The consequences include a lengthy internal audit of the bank and its branches overseas to examine the bank’s internal standards and due diligence systems. This audit started in 2011, engaging over 2000 external lawyers paid by HSBC, and is still in progress.
Another reason for banking issues is the ratification of the international OECD Common Reporting Standard protocol (CRS) by the Hong Kong Monetary Authority (HKMA) in 2014. This protocol, in association with the international standard on Automatic Exchange of Financial Account Information in Tax Matters (AEOI), ratified in the same year, requires all Hong Kong-based banks, including Hong Kong branches of foreign banks to start or continue to properly conduct their due diligence and reporting obligations. In addition, according to the CRS and AEOI new due diligence procedures to onboard clients will be required to be in place in January 2017. These procedures need to have fines and penalties on non-compliance included in the legislation, which will apply to the directors, management and employees of the banks, as well as for the banks themselves.
Facing the new regulations of CRS and the AEOI, the banking industry has to get in line and deal with new provisions and deadlines. The Hong Kong government did not really foresee the consequences. Therefore, the gap between the well-known concept of “Hong Kong, the best place for startups” and the reality of bank account opening currently is immense.
As mentioned, the banks are required to thoroughly perform due diligence on their existing clients to ensure compliance and this - instead of onboarding new clients and reviewing bank account opening applications - seems to be at the top of the to-do list of their available staff at the moment.
An expert of a Hong Kong bank estimates that only 50% of their client base is potentially profitable. Through the intensified inspection they want to know if the company creates economic value, and in addition, they are pursuing to clarify who the ultimate beneficial owners of the companies are – which, through trust structures, sometimes is blurry – to know where the profits are ultimately going and last but not least to prevent tax evasion. From the bank’s perspectives, small accounts are usually more often subject to tax fraud than others.
However, as a consequence of these facts – if it comes to opening a bank account these days – banks are requiring companies to have substance in Hong Kong, which means a physical office and staff on-site, as these entities are considered as lower risk clients. Some banks in Hong Kong are bargaining either for huge bank deposits or commitment to cross-services of the banks from the applicants to newly open a bank account. Taking the direct insight and experience of our consultants into consideration, local banks seem to be slightly more flexible than foreign banks. The issue goes as far that many potential banking clients are rather considering to open up their bank account for their Hong Kong company in another jurisdiction, like Singapore, or settle for Singapore altogether.
The goal of the government of course is to keep Hong Kong attractive for companies – it will be interesting to observe the upcoming measures of the government to maintain Hong Kong as a start-up and SME- friendly place.
TL: How do you see Hong Kong’s position in the competition with Singapore as Asia’s financial hub and gateway to China and other Asian countries?
KK: Hong Kong is a global financial center and the business gatewaybut as pressure to conform with Beijing's wishesgrows in Hong Kong, multinational firms are seeing more stability inSingaporeand expanding their outlook to the broader Pan-Asian market.
Looking ahead, I think that Singapore has a distinct advantage. Hong Kong is becoming increasingly a part of China, with the Chinese government interfering more and more, which will compromise the quality of governance. There is growing popular discontent.
China's decision to limit free electionsin HK has spurred greater unrest in Hong Kong as locals resist growing central power over the former British colony's democratic systems. Although the changes will not shake Hong Kong's status as a financial center, unease over the political situation has been at the back of people's minds since Beijing took control in 1997.
Consistently ranked as top places in the world to do business and offering an English-speaking environment with highly developed infrastructure, Hong Kong and Singapore have served as Western business bases in Asia for many years. Multinational companies such as Unilever, DHL, Merckand, IBM have had regional operations in Singapore for decades. On the other hand, financial firms such as JP Morgan Chasehave their Asia Pacific headquarters in Hong Kong. Recently, however, several big companies have moved their regional headquarters to Singapore from China, signifying a shift in market strategy. Companies are not abandoning China but increasingly looking at Asia beyond its largest economy.
Analysts said that Singapore's quality of life (higher than Hong Kong and all Chinese cities), including a relatively pollution-free environment and attractive education options, are appealing for senior management who are often relocated with their families to Asia.
Singapore hosts 40.8 percent of Asia Pacific headquarters among 319 global Fortune 500 companies. In contrast, Hong Kong hosts 34 percent, and the remainder of China 15.8 percent. In terms of wealth, in 2012 Singapore had a per capita GDP of $54,000 compared with Hong Kong's $37,000, according to the latest World Bank report.
However, Singapore as a city-state needs to overcome a few challenges to continue attracting and anchoring future global corporates. Firstly, it needs to help local businesses invest more on productivity and be less reliant on labor. Secondly, to retain its competitiveness and enhance cross-border trade and investments, Singapore should try to renegotiate its old tax treaties and seek to have a tax treaty with the US. A tax treaty with the US will help Singapore-based companies access the US market and also manage any potential cross-border tax disputes. Thirdly, Singapore needs to continue building strong relationships with regional countries. In particular, Singapore should take a leading role in facilitating ASEAN integration so as to promote market access - only when there is a bigger market in this part of the world would multinationals anchor their headquarters here. Singapore has already created new economic space by establishing industrial parks in the region, for instance, in China, India, Indonesia, the Philippines and Vietnam. The building of such overseas economic space will not only supplement the domestic economy, but will also stimulate cross-border business activity in the region. For example, the recent appointment of a consortium of Singapore companies as master planners for the new capital city of Andhra Pradesh state and its surrounding region provides opportunities for Singapore companies seeking further expansion in India.
TL: If you personally would have to choose: Would you rather live in Hong Kong or in Singapore? And where would you most likely open a business in the long term?
KK: I am personally from Hong Kong – born and raised so therefore I would always choose Hong Kong over Singapore for my own personal reasons. But if I needed to take a business approach then it would really depend on the industry, the budget and the target market.
Allow me to reflect this on a client case study:
Client X is a startup. The entrepreneur moved to Hong Kong from Cambridge in 2009. His firm, a semiconductor company, designs and supplies low-cost, energy-efficient chips which increase the power supplies of laptops and phone chargers. Within a year of arriving in Hong Kong he had produced his first product, and now ships millions of chips each year, mainly to Taiwan and China. He employs 10 people at his lab in the Hong Kong Science Park. He moved because of incentives offered by the Hong Kong government, which included a HK$3m interest-free loan and free rent for two years, with a 50% reduction for the next two. He set up in Hong Kong firstly because of the access to Chinese and Taiwanese customers, but also because the rule of law means that contractually it’s a much safer place to protect your design – IP is much better protected in Hong Kong. This client did his business plan and investigated where he could obtain financing, where he could obtain preferential policies, where he could find skilled laborers and finally who was his target market. Hong Kong as a jurisdiction made sense for him.