SandaireJune 4 2020

Sandaire’s Chief Investment Officer Update – Hong Kong in the US China struggle

3 mins read

Written by StJohn Gardner, Sandaire Chief Investment Officer

The troubled US-China relationship took another knock last week.

In Beijing, the Chinese parliament approved national security laws for Hong Kong aimed at reducing foreign influence and imposing China’s more authoritarian rule of law. It said that Mainland agencies will now establish themselves in the city to enforce the law and would be aided by new ‘special institutions’. The full details will not be available for a few months but it is expected to be operational by August. To a certain extent it simply formalises what has been occurring for years now anyway, with the Ministry of State for Security taking up downtown offices that will oversee political expression, media commentary and academic studies. However, the biggest unknown is the change to the judicial system whereby the application of common law principles will be replaced with a mini-constitution that enshrines basic rights, with all the potential for legal stagnation that creates. Today, an individual can sue the government and stand a fair chance of winning – it seems difficult to see how Beijing will continue to accept that state of affairs as it stamps its authority on the ‘special administrative region’.

Clearly this has rattled many residents as another step on the slippery road to full absorption into China. It is also seen as a violation of the 1997 hand over agreement with the UK, which promised a 50 year period in which two separate systems would continue to operate. Indeed it was this arrangement which led most countries to grant Hong Kong special trade and travel status.

The imposition of the new national security law in Hong Kong caused the White House to state that it no longer views Hong Kong as a self-autonomous region. This could cause a chain of events that ends its status as Asia’s primary international trade and financial services centre. The US is joining other Western nations in pressuring China to back down, or moderate a proposal, with President Trump announcing his intention to withdraw Hong Kong’s special trade status for US businesses and citizens, and consider other sanctions. These may be mere threats, however, as Trump failed, at a recent press conference, either to provide further details or to take action such as withdrawing from the US China January phase one trade agreement, or imposing sanctions on Chinese officials or persons close to the regime.

This latest exchange has sent the Hang Seng on a roller coaster ride this week.

This failure on the part of the US to act is perhaps in response to a lack of full details from Beijing on its intended implementation. Beijing is also unlikely to be cowed by threats, probably rightly calculating that Washington’s response will not attack Hong Kong’s fundamental functions as a US dollar funding centre. Nevertheless, the new expected legal environment is likely to be incompatible with running a lot of international activity, so the nature of the services and transactions conducted in Hong Kong could change, and it may become a less dynamic and less creative centre in due course.

On the bright side, however, having previously been scared off by political risk following the street protests last June, this affirmative move by Beijing could make Hong Kong “safe” for mainland Chinese investors and institutions, and spur more capital flows and risk-taking. With the authorities taking firm ownership and political control, mainland entities confidence will grow and Hong Kong is likely to become the major listing destination for Chinese companies as they pull back from or are pushed out of the US or other western exchanges.

On balance, the effect will be to make Hong Kong a more Chinese city, whose economic success is tied to international transactions being undertaken by mainland businesses. The focus of economic activity will shift even more towards mainland capital-raising and the process of internationalising the renminbi. Thus, even as Hong Kong loses its unique historical identity and is potentially excluded by a range of western institutions on a stand-alone basis, it is plausible that it sees more capital flows and risk-taking activity emanating from its fast growing neighbour and owner.