Supporting a more international role for the renminbiSo far, Hong Kong’s claim to be a renminbi hub has largely rested on having the largest amount of offshore renminbi deposits. It has been slow to develop more of the yuan-denominated investment products that must be available offshore to encourage wider acceptance of the Chinese currency in international trade. Far more concerted efforts are required to build this ecosystem of renminbi products to meet growing demand.
Hong Kong, however, must also anticipate that greater international usage of the renminbi in financial markets will involve products issued and traded in other financial centers. The success of London, Brussels and Luxembourg in cementing lynchpin roles in the Eurodollar system has relied on post-trade services, including clearing, cross-border settlements, securities safekeeping, and collateral management. Here, Hong Kong’s competitive advantage will derive from catering to international investment needs of mainland investors, but it must invest in developing world class post-trade systems and capabilities.
Servicing the financial needs of the wider Asian time zoneFor far too long, Hong Kong has neglected the huge opportunities in Southeast Asia and beyond. Rapid growth in both GDP and wealth makes the Asian region one of the most exciting prospects in global markets. But the fragmented nature of the region’s capital markets, with multiple national exchanges, each with limited liquidity, has been an obstacle to attracting international investors and to retaining issuance activity by their local corporations. Nevertheless, intraregional rivalries and failure to develop a regional central securities depository (CSD) to support cross-border settlements have stymied past attempts to pool regional liquidity, such as the ill-fated ASEAN Trading Link.
Competitive and geopolitical tensions mean that Hong Kong will face institutional and political resistance if it were to seek dominance as an IPO center for Southeast Asian issuers. Yet, helping to connect mainland Chinese and international investors in the Hong Kong market to other financial regional markets would be a win-win proposition.
Another major challenge for Asian countries has been the limited acceptance of their sovereign securities as good collateral in international markets. At this point, it is unknown whether growing questions about the dollar system will result in a bipolar global currency regime, in which the renminbi becomes the clear alternative to the greenback, or if we will move to a more multipolar system. Hong Kong should prepare for each eventuality by supporting the expansion of Asian local currency markets through facilitating acceptance of regional sovereign securities as good collateral.
As HKEX develops more derivatives based on regional benchmarks, there are natural reasons for Hong Kong’s clearing houses to accept regional government bonds to meet their margin requirements. But by developing its collateral management capabilities, Hong Kong could also support placement and acceptance of these securities as collateral across the region. This would help lower borrowing costs for Asian governments and corporates, and reduce their foreign exchange risks.
Capturing the four opportunities outlined above will require Hong Kong to develop itself as an international depository and collateral management center. Offering safekeeping for the international securities of Chinese investors would address mainland policymakers’ need for transparency and protection against foreign sanctions. Facilitating the placement and acceptance of mainland Chinese securities of international investors that are already safekept in Hong Kong as collateral in international markets would provide international investors with far greater capital efficiency and liquidity from these holdings, thereby expanding demand for Chinese securities. Playing a central role in the safekeeping and cross-border settlement of renminbi securities would also give Hong Kong a slice of the action on the trading of yuan investment products in other markets, as the global renminbi ecosystem develops. Furthermore, by taking advantage of the scale of Chinese cross-border investment to serve the needs of other Asian countries, Hong Kong could unlock huge opportunities for China, its neighbors in the region, and itself.
Realizing this vision, however, will require developing closer relationships with other financial centers across Asia, reasserting its value to the US and other international constituencies, addressing the potential financial security concerns of other countries, enhancing the competitiveness of Hong Kong’s financial infrastructure, and developing and retaining top-tier talent.
Beyond the technical question of connecting its depository infrastructure with regional CSDs to facilitate cross-border settlement and collateral management, if Hong Kong is to play such a strategically important role for China and international capital markets, it must build sound foundations of trust and address the potential concerns of other countries. The city has long played a critical role in serving as a regional hub for US and international corporations doing business in China and across Asia. Notwithstanding the withdrawal of recognition of Hong Kong’s autonomy by the US during the administration of Donald Trump, Hong Kong’s leaders must strive to serve as a bridge between China and the West, helping to increase mutual understanding and resolve disagreements.
But building better relationships requires more than just catering to the commercial interests of other countries. Hong Kong must continue to provide an attractive environment for members of the international community to live and work in, with freedom of movement and expression, as well as rich and diverse cultural offerings, to supplement its robust judicial and regulatory systems.
There should be no illusion that, in the current geopolitically fraught environment, other countries will be willing to rely solely on Hong Kong’s legal and regulatory protections. After all, laws and regulations can be changed. No country today will be willing to support the emergence a financial ecosystem that might give China excessive leverage over them in the future. For Hong Kong to serve as an international depository center, the system must be underpinned by structural protections that guarantee security for all travelers on the global financial highways.
One way in which this could be achieved is through “designed vulnerabilities”, or mutual dependencies, that guarantee that no one country can weaponize the financial system against others without causing catastrophic harm to itself. This could be by splitting core functions within the system across multiple financial centers. For example, where Hong Kong serves as the center of collateral safekeeping and management, and other countries serve as the centers of collateral usage, the operation of the whole system would depend on a nexus between Hong Kong and one or more other jurisdictions. This would limit China’s ability to inflict unilateral sanctions on other countries without seriously damaging its own interests, and vice versa.
Substantial investment will be required to develop and upgrade Hong Kong’s financial infrastructure. The city’s post-trade systems serving the equities and fixed income markets were introduced in the 1990s and, compared with those of other major financial centers, are highly inefficient. But merely a large one-time investment in bringing those systems up to date is insufficient. To foster an environment of innovation that will sustain its long-term competitiveness, Hong Kong must introduce real competition among its financial market operators.
Developing and retaining the talent needed to support all of this will require investment and reforms across Hong Kong’s educational system to ensure that not only the children of affluent families but all young people are given access to world-class education and training.
One factor that has held back innovation in the SAR’s financial markets has been a regulatory philosophy centered on supervising the suitability of financial products and the selling processes of financial intermediaries, but which neglects looking at investors themselves. In an environment of free information and capital flows, rules around product availability that are too restrictive will simply drive investors to other financial centers. By investing in improving financial literacy from an early age and developing a better-informed investing public, Hong Kong could not only better protect its retail investors but also create a deeper professional talent pool for the future.
Finally, Hong Kong needs to rekindle a belief in itself. The city has seen many tough times over its history and experienced numerous existential crises, but it has always bounced back stronger than before. Achieving this ambitious vision to enhance Hong Kong further as a leading international financial center will require marshaling its people’s famed “Lion Rock Spirit” to get the necessary things done.