Why China will not replace Hong Kong

According to the Global Financial Centre Index in 2014 Hong Kong is ranked third behind London and New York. The index chooses 75 of the world’s major cities and measures their state of competitiveness in the financial sector.

It seems that Hong Kong is once again set to take on the leading role in the Asia Pacific region in this sector.

The relative success comes from the fact that both foreign companies entering the Chinese market and Chinese companies expanding offshore will still want the reassurance of Hong Kong’s strong legal framework, transparent markets and financial know-how.

Financial centers become international hubs only when investors perceive they provide a level playing field. This requires transparency, an independent legal system, and a willingness to adopt international norms. None of this is in place today in China.

In addition Hong Kong is a paradise for innovative start-ups and SMEs wanting to stake a claim in Asia. Its melting pot of cultures, qualified and skilled labor, attractive tax scheme and ultra-simplified administrative setup make it an ideal place to setup shop.

The government can also provide a lot of help: subsidized office space, funds available for marketing, financial guaranties, etc.

So what and where are the risks for Hong Kong?

External forces have boosted Hong Kong’s financial development but at the same time have brought new challenges to the sector. The city is now confronted by increasing domestic competition from Shanghai in the form of its Shanghai Pilot Free Trade Zone as well as Qianhai, a special economic zone in Shenzhen, due to the liberation of the Mainland economy.

Hong Kong continues to aim to be THE Renminbi (RMB) offshore centre. For a decade Hong Kong has been the only city allowed to conduct offshore RMB business, but with increasing internationalization of the yuan, it now faces fierce competition to maintain its role as the top RMB hub.

In 2012 Beijing started to offer incentives to cities within the country to conduct RMB business. The central government has earmarked Shanghai and Qianhai as well as other cities as testing grounds to realize free convertibility (although with no clear implementation guidelines as of yet).

How can Hong Kong stay attractive?

The city should continue to benefit from the opportunities provided by Mainland companies in trade, investment, finance and business. Invest Hong Kong (InvestHK) announced that it assisted 337 overseas and Mainland companies to set up or expand in Hong Kong in 2013.

Mainland China continued to be the largest single source of investment into Hong Kong with a total of more than 20%of the projects, many of them leveraging Hong Kong's advantages to go global.

Given Beijing’s fondness for tight and slow reformation, it remains to be seen just how fast China’s currency, interest rate and capital account reforms will occur.

Given the experience of many emerging markets of late, there is a legitimate worry that loosening currency controls on the capital account will leave China more vulnerable to sudden, potentially destabilizing inflows and outflows of investment capital than it would like to be.

Officials have promised that the RMB will be fully convertible, but many observers still think that’s highly unlikely in the near-term.

All that said, if China’s financial and legal systems do eventually mature enough to satisfy foreign businesses and investors – and that’s still a very big IF — then Hong Kong will certainly have to step up its game to stay competitive.

Hong Kong will have to strive hard for greater advancement than they have achieved in the past so that the city can maintain a leading edge over the mainland.