Is Hong Kong’s role as offshore financial center under threat?

Inflows from Mainland China will support the city, but issues are challenging this role.

Whilst Hong Kong’s role as an offshore financial centre–described as the "cornerstone of Hong Kong’s economy"–remains competitive, it is being challenged by a triple whammy of issues.

“All in all, we are confident that Hong Kong will still be able to attract capital as the Chinese economy and its financial system continue to increase their size relative to the rest of the world,” Natixis Asia Research wrote in a report. “But the real question is whether Hong Kong can keep its relative importance as an intermediator under the evolving global trend.”

The COVID-19 pandemic, geopolitical tensions worldwide, and lingering effects of the social unrest from 2019-2020 are all challenging its role as a financial centre.

Currently, Hong Kong reportedly remains influential in channelling foreign direct investment (FDI) into the Asia Pacific (APAC), with a market share rising from 40% in 2015-2019 to 46% in 2020. 

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Mainland China is the main contributor, according to Natixis, with 71% of its inward FDI coming through Hong Kong in 2020. In regards to the rest of the region, Hong Kong’s role is more limited, although it has grown from 29% by end-2019 to 35% in 2020.

Regarding portfolio flows, Hong Kong has retained its role as a key intermediator in and out of China, Natixis analysts Alicia Garcia Herrero and Gary Ng wrote in the report.

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“Mainland Chinese firms now have a bigger share of Hong Kong's financing and investing activities. With acquisitions and rapid expansion, mainland Chinese banks also gained a larger slice of Hong Kong's banking sector,” Garcia Herrero and Ng said. 

Expanded interconnection mechanisms, chiefly the Wealth Management Connect and ETF Connect, should see capital flows continue to grow between Hong Kong and mainland China. Hong Kong also remains as the largest offshore center for RMB internationalization.

But Hong Kong is also underperforming in several areas. Chiefly, its equity market performance diverged between -25% in Hong Kong and almost unchanged for APAC since June 2019, Garcia Herrero and Ng said.

Changes in government policies, including the Covid-related measures, are also weighing down Hong Kong.

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Garcia Herrero and Ng compared performance of key statistics in Hong Kong to regional rival Singapore. Both Hong Kong and Singapore reportedly an office vacancy rate of 4.1% in 2018, but the former surged to 10.9% and the latter fell to 3.3% in March 2022. Notably Hong Kong's air passenger capacity also remains at 4% in May 2022 whilst Singapore recovers to 66%, dragging down its competitiveness at least in the short run. 

On the other hand, Hong Kong’s equity market is still 8 times larger than that of Singapore, thanks to the influx of mainland Chinese firms. In contrast, Singapore’s market capitalization remains relatively flat.