Is Hong Kong heading for meltdown?


For several decades, there has been no safer place to invest than within the extremely stable economies of Singapore and Hong Kong.

A tremendously successful and sophisticated financial markets economy has been built up in the Asian regions, with its roots in the historic days of the British Crown Colony of Hong Kong which was established in 1842, elevating the territory to elite status within the Asia Pacific region and drawing numerous global financial giants to the island.

In 1998, however, China resumed control of Hong Kong, with Singapore remaining to this day an independent nation. This had several implications for Hong Kong, as it remained a special administrative region of China, however was ultimately incorporated under China’s communist rule.

Despite this, Hong Kong’s seemingly cast iron economy and financial modernity continued to hold the island as a world leader in electronic trading and banking – until now.

Political unrest has swept Hong Kong over recent weeks, as a result of one of the less friendly aspects of Chinese communist jurisdiction – freedom, or lack thereof, of political preference.

At the commencement of the electoral disarray which resulted in thousands of Hong Kong residents taking to the streets and voicing their discontent for what they perceive to be a totalitarian political system by rioting and clashing with the authorities, who returned the sentiment with forceful policing and water canons.

Of course, political demonstrations are not new, and many nations have recently witnessed them, including many European nations such as Greece, Cyprus, Ukraine and Ireland. The difference is that whilst violent demonstrations are not uncommon in Hong Kong, it is relatively unusual for politically motivated demonstrations to shake the financial system and as a result, concerns over economic implications emanating from these protests have been notable by their complete absence.

Until now.

The Hong Kong Monetary Authority (HKMA), which is the national financial markets regulatory authority for Hong Kong, has been busily engaged in publishing information on its website during the last day, largely concerning the closure of banks and temporary decomissioning of ATM machines.

With Hong Kong being a region which performs a vast number of institutional FX order flow, as well as interbank activity which has been conducted without any inkling of instability in times gone by, this is most certainly a matter of potential concern for many companies.

Western retail FX firms which established branch offices in Hong Kong are aplenty, all of which chose the destination as a safe, secure and reputable gateway to the lucrative Asian market, with a particular focus on China. Only a year and a half has passed since Cyprus was awash with FX firms and retail customers lining up outside Laiki Bank and Bank of Cyprus in order to attempt to withdraw funds for fear of losing up to 60% of their deposits as the two banks imposed a controversial bail-in which sought to make client funds available for the settlement of the unrepayable debts which the banks had amassed, leading to their insolvency.

Indeed, Cyprus does not compare with Hong Kong in its reputation as a financial powerhouse, hence this dynamic is perhaps even more grave. Cypriot FX firms were often established in order to approach the European market with CySec regulation but many are owned by overseas entities with their funds being held outside Cyprus. This is not necessarily so for Hong Kong, due to its status as a prominent center for worldwide financial markets.

Today’s report by the HKMA states that among the region’s banks, 6 branches of 6 banks were affected and remained temporarily closed as of 8.00am today. Suspended ATMs in the affected areas have largely resumed normal operation. The HKMA has requested banks to resume other services as soon as circumstances permit. Customers should pay attention to the relevant banks’ announcements regarding affected branches and ATMs.

In these post-financial crisis times, when bank runs have taken place in 2008 across Europe and North America, followed by Cyprus last year, the investing public and corporations alike have become very sensitive to situations which result in unscheduled bank closures or ATM decommissioning, thus perhaps leading to the notion that Hong Kong’s investors may rush to pull their funds out and reinvest them in nearby Singapore or South Korea.

The HKMA had issued a statement last week that interbank market functioned normally in general as September drew to a close and the political tensions rose. HIBOR and CNH HIBOR remained steady and the banking sector had ample liquidity and that tightness was absent.

As of September 30, the Hong Kong dollar, RMB, US dollar and Euro Real Time Gross Settlement systems recorded a total transaction volume equivalent to HK$1.7 trillion, which was about normal. As morning gave way to afternoon, however, a total of 33 branches of 19 banks were temporarily closed. Customers were advised by HKMA to pay attention to the announcements of relevant banks.

Subsequent to the public holidays of October 1 and 2, the HKMA began to closely monitor developments in the Hong Kong Dollar FX market to maintain the normal operation of the Currency Board system and the stability of the Hong Kong dollar exchange rate. The regulator pledged to maintain close contact with banks and make arrangements as appropriate to ensure that the banking system will function normally after the public holiday.

Whilst the HKMA is certainly a prudent regulatory authority and is well organized, factors such as geopolitical circumstances are often beyond the control of even the most highly respected organization. The idea that Hong Kong could become a hotbed of social discontent raises questions for bankers about how long the city can expect to receive the special treatment that has helped it to generate enormous business from China’s strategy of internationalising the yuan.

“Hong Kong has served its purpose and maintained its lead because it is a Chinese city with Western characteristics,” said the Asia-Pacific treasurer for a European company in Hong Kong who requested anonymity. “The city risks squandering that advantage quickly if the political uncertainty continue.

This is particularly alarming as Shanghai has continued its direction of allowing certain free trade in specific areas of the city, attracting international firms. With China’s enormous government resources and extreme drive toward national success, investment in broadening China’s horizons in the international markets is easy for the vast country. China’s government has immense buying power, and its population have become accustomed to unrelenting obedience to the point of serving the largely state-owned corporations for little pay or benefit whilst the country’s communist government continues to acquire enormous wealth that Hong Kong’s more free market economy cannot compete with.

Bankers elsewhere in Asia have expressed candid views on this matter. “This hurts Hong Kong’s status as the biggest offshore yuan hub in the long term because the political risk has increased significantly,” stated Sean Yokota, head of Asian strategy at investment bank Skandinaviska Enskilda Banken AB, in Singapore this week.

Whilst many FX firms abroad are adding the Hong Kong-administered Chinese Offshore Yuan (CNH) to their list of currency pairs as Chinese business continues to be a very high priority internationally, could Hong Kong’s days be numbered, giving way to the free trade zones of Shanghai and Beijing as veritable aircraft carriers for western firms to offer the CNH?

If so, it leaves Singapore as the prestigious home to Asia’s bank order flow, and China as the land of opportunity for all retail FX firms.

Photograph courtesy of The Guardian

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Is Hong Kong heading for meltdown?

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