Breakingviews – Hong Kong spreads its wings, and its bets

HONG KONG, Feb 23 (Reuters Breakingviews) – For a sign that Hong Kong’s recovery is more than wishful thinking, look no further than the city’s Disneyland. Staffing up for an influx of tourism, its owner this month attracted some 3,000 people to a job fair ahead of its biggest expansion project so far. The house of Mickey Mouse is implicitly betting Hong Kong will soon be back, and bigger than before. The city’s leaders hope that what’s true for one magic kingdom might be true of another: Hong Kong’s finance industry.

Chief Executive John Lee and his central bank chief Eddie Yue are talking up Hong Kong’s potential for attracting business and talent, and for funnelling Chinese capital to foreign companies. The pitch is a little different this time, because while Hong Kong wants to return to being a global city, as it was before China indirectly shuttered the city’s economy in its bid to control Covid-19, it is also preparing to be less Western.

At its core, Hong Kong’s unique selling point is that it’s China-by-proxy for investors; enterprises in the People’s Republic account for 78% of the market capitalisation of Hong Kong’s main boards. The Stock Connect scheme run by bourse operator Hong Kong Exchanges and Clearing (0388.HK) lets money move across China’s capital controls in a limited way. Officials familiar with the situation say that it handles as much as 70% of all international investment flows into stocks listed in mainland China.

But even as Covid-19 has receded, political frictions between China and the United States are preventing that channel from working as well as it might. Global hedge funds have rushed back in and hold 90% of their historical peak allocation of Chinese equities, according to Goldman Sachs research published this month. Less mercurial buyers, however, are wary. Emerging market funds are at 77% of their historical allocations. Global ones excluding those from the United States are at 11%. Add back U.S. funds and it falls to 5%.

That hesitancy will no doubt turn up in the order books for the 100 or so initial public offerings waiting to take place whenever the market permits. Chinese ride-hailing firm Dida, a peer of Didi Global that this week filed for a listing, will be an early test for advisors China International Capital Corp(CICC) (3908.HK), , Haitong and Nomura (8604.T).

It’s not just investment flows that need rebuilding. Anti-government protests, pandemic and politics have all shrunk the economy. Hong Kong’s GDP contracted in three of the past four years. So did the population, which slimmed by 0.9% in 2022, according to new official data. Social and financial factors are driving working-age people away, not helped by Beijing’s role in setting school curriculums, or the national security law of 2020 that punishes subversion with possible life imprisonment.

Heads of global banks quip Chinese authorities are probably listening to everything they say – something their peers based in the mainland have half-joked about for years. American bankers also have one eye on Washington. All big firms in the city are alert to the possibility that President Joe Biden’s administration might limit their freedom to do business with China if relations worsen. Against such a backdrop, it’s logical that Hong Kong is trying to spread its bets.

CLOSER TO HOME

The first task is to make Hong Kong more of a destination for investment coming out of China. Lee and Yue have some powerful forces on their side. Chinese investors are hungry for new places to put their cash to work beyond the shares available on the mainland. One big change in the last two years is that Xi has made it clear that property in China is for living in, not speculation, meaning new sources of wealth must be found.

Hong Kong’s Connect programme is politically attractive to Beijing because it avoids unmanaged outflows. Sale proceeds go back to the mainland. The HK$31.7 billion ($4 billion) of China-to-Hong-Kong average daily trading through the scheme in the latest quarter was over 15% of Hong Kong’s cash-equities turnover, roughly triple the ratio in 2017.

The other side of Lee and Yue’s challenge is to bring in more companies and deals to feed the city’s financial machinery – notably from places other than the United States and Europe. Russia’s invasion of Ukraine has created common interest between Asia and the Middle East in shoring up long-term food, financial and energy supply. It’s inevitable more petrodollars will flow into China through Hong Kong.

Emblematic of these trends is Hong Kong’s six-year-long effort to convince Saudi Aramco (2222.SE) to list its shares in the Asian city. Hong Kong exchange boss Nicolas Aguzin’s pitch is strengthened by a Chinese plan to let overseas companies listed in Hong Kong be included in the Connect programme. That would make it the only international listing venue where foreign companies can get direct access to mainland investors’ capital through secondary trading. The city is also hoping to help finance the energy transition. In January, Hong Kong raised $5.8 billion through a triple-currency green bond.

Ultimately, Hong Kong has a new chance to style itself as a market where Chinese investors can buy everything from exchange traded funds tracking foreign companies and indices to wealth management and mutual funds products, as long as Beijing, always worried about capital flight, lets it.

The big question is whether it can reverse its brain drain. Hong Kong has lost some shine to Singapore for Western expatriates seeking a life of relative ease. But there are signs that professionals from other parts of Asia, including not just mainland Chinese financiers but an increasing number of Indian arrivals, will see Hong Kong as a more luxurious and efficient alternative to their home markets.

True, Hong Kong isn’t doing this from a position of strength. Failure to diversify away from Western capital as China-U.S. relations worsen would put the city in a more vulnerable place. But more than two decades after the hub first designated itself “Asia’s world city”, it has both the opportunity and the need to show the title is deserved.

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CONTEXT NEWS

Hong Kong’s resident population declined 0.9% to 7.33 million in 2022, shrinking for a third consecutive year, official provisional data released on Feb. 16 showed.

Updates Stock Connect figures in paragraph nine.

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