Hong Kong democracy act and future of ‘one country, two systems’ worry investors as city reels from protests

Finbarr Bermingham

Investors are closely watching the progression of the Hong Kong Human Rights and Democracy Act in Washington, for fear that it will further sharpen the risk of making investments in the city.

For the moment, the city remains the primary offshore hub for those wanting to do business in mainland China despite over five months of disruptions caused by anti-government protests, with the main damage thus far to sentiment rather than material loss of earnings.

But equally unanimous is the feeling that with the pace of the escalation in Hong Kong’s situation in recent months, this could very change quickly, with the bill that could pave the way for diplomatic action and economic sanctions against the city’s government adding to the pressure.

For many, the act, which was passed by the US Senate on Tuesday, is just the latest in a long line of issues to have damaged the city’s risk profile over the past six months, adding to a complex and uncertain picture, almost a parallel reality to Hong Kong’s erstwhile image as a stable, secure trade and financial hub.

“If you’ve got more business in India or Japan, then you may look to put some headcount in Singapore or Tokyo,” said one banker. “But at this stage, most are only scouting for office space.”

But the application of the “one country, two systems” framework for China’s relations with Hong Kong, and Washington’s treatment of Hong Kong as an independent entity, the city’s status as a beachhead for investment in mainland China is far from guaranteed in the long-term.

Currently, 70 per cent of all investments in mainland China go through Hong Kong, but in the future, investors may feel that Shanghai, for example, is a more stable option.

If you’re doing business in the mainland, at least you know what you’re getting into – the framework is there [in China]. Investors hate the uncertainty in Hong Kong

Finance industry professional

“If you’re doing business in the mainland, at least you know what you’re getting into – the framework is there [in China]. Investors hate the uncertainty in Hong Kong,” said one finance industry professional, who asked to remain anonymous.

Despite the protests, direct investment in China rose by 2.9 per cent to US$100.78 billion in the first nine months of 2019 compared to the same period last year, with investment from Hong Kong increasing by 8.1 per cent between January and September.

“That bill has definitely amplified the focus on Hong Kong at the moment,” said Gary Kirk, the co-founder of London-based investment firm TwentyFour Asset Management. “One of the key drags on sentiment at the moment is what is going on between the US and China. Hong Kong is an integral part of that – and it's become even more integral.”

The graphic images of police and protester violence beamed around the world have already led to the cancellation of many investor roadshows and visits by fund managers, but whether that will lead to a slowdown in investment will only be apparent next year.

“Most of their money is stored offshore anyway, so it’s not absolutely necessary to put boots on the ground,” said a financial industry insider.

But some feel that it has already become difficult to raise funds in Hong Kong in recent weeks, with one investor in the city fielding calls from American fund managers worried that the government could exercise further executive orders to restore control, such as restricting internet use, having already used the power to impose a controversial anti-mask law.

Even if these measures are not deployed, the fact that prominent investors are openly discussing the possibility shows how much concern there is over the city’s status, said the source, who added that “risk averse US investors are often looking for any excuse not to invest”.

Indeed, one diplomat in the city confirmed that staff have sourced satellite phones just in case the government moved to restrict the city’s internet in some way, although they were keen to stress that this would be the “worst case scenario” and that they were strictly contingency plans.

“If you are a big investment house, then [internet restrictions] would not be such a big deal, but if you’re a start-up fund in Hong Kong, would you be able to trade out of your position?” asked the anonymous investor.

If you are a big investment house, then [internet restrictions] would not be such a big deal, but if you’re a start-up fund in Hong Kong, would you be able to trade out of your position?

Anonymous investor

For one prime broker at a major bank in Hong Kong, the passage of the Washington bill, which still needs to be signed by US President Donald Trump to become law, is far from his biggest concern. Instead, the furore over September’s anti-mask legislation is causing consternation among the investor class.

At the start of October, Chief Executive Carrie Lam Cheng Yuet-ngor used the Emergency Regulations Ordinance (ERO), a colonial-era law that had not been used in nearly half a century, to impose a ban on the wearing of masks at all protests.

The law was challenged at the High Court and found to be unconstitutional, which in itself provoked an angry response from the Chinese government. Legal scholars warned that Beijing’s statement suggesting it seek to overturn the ruling by reinterpreting the Basic Law - a move that could potentially make the city’s courts unable to rule on constitutional matters. If that happens, it could spell the end of one country, two systems.

“Most fund managers in Hong Kong are fairly hardy – if they can weather [extremely strong] typhoons, they’ll stick it out through most things. We are more worried about the mask ban and the use of ERO powers,” said the broker, with the suggestion that investors may be spooked by the prospect of further interference by Beijing.

Markets have remained surprisingly robust, with one senior figure at a major international law firm saying that the Initial public offering (IPO) market “appears to be unaffected, surprisingly”.

“We are still getting requests to quote on new IPOs, and this has not cooled off versus 12 months ago. However, we are watching carefully, as the university events generated great publicity,” the lawyer said.

The recent escalation in the Hong Kong crisis has “sent ripples through companies”, confirmed the chair of a major European chamber of commerce in Hong Kong, who also wished to remain anonymous.

A days-long standoff between protesters and the Hong Kong Police Force at Hong Kong Polytechnic University followed a surge in violence and disruption to the city’s transport network.

They added that the process for international companies setting up or expanding in Hong Kong is a “pipeline process”, meaning many have been underway since the protests began in earnest in June, and that it will only be possible to tell if this has tailed off after the first quarter of next year.

“But over the last couple of months, if you’re sitting on a board outside of Hong Kong, you’re not going to want to make any big decisions on that front,” said the source.

The US bill is a big deal for American asset management firms, who will be able to sell their own funds through a wholly-owned entity in mainland China next year

Jason Wright

Jason Wright, managing partner at business intelligence firm Argo Associates, has been fielding a higher volume of calls from big finance companies as the situation has escalated.

“The US bill is a big deal for American asset management firms, who will be able to sell their own funds through a wholly-owned entity in mainland China next year,” Wright said.

As part of its efforts to further open up its financial markets, in August, China confirmed it will allow global asset managers to apply for retail mutual-fund businesses through private fund units operating in the country.

“Some are applying for licenses at the moment, but what happens if the bill passes and some of the sanctions under that act are issued? Not only does it cut away business in Hong Kong, but it also means that in China, you might see US firms have problems with licenses or even suffer from consumer boycotts,” added Wright.

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