Image by Ruslan Bardash

Beijing's new security law 

and what that means for Hong Kong 

July 2020

Introduction 

Hong Kong owes its status as a flourishing financial hub to a number of factors; rule of law, an independent judiciary, relatively low taxes, a lack of capital controls and a huge concentration of financial and legal service providers, have all contributed to the city’s regional success. The city's access to mainland China and proximity to other countries in the region has also worked in its favor. Despite the growing significance of places like Shanghai and Shenzhen as financial centres within mainland China, Hong Kong has remained a key gateway connecting mainland China with global financial markets. 

Historically, mainland China’s extensive capital controls and frequent interference in its financial system have made Hong Kong’s comparatively open economy a compelling base for international firms to expand into mainland China. While Hong Kong's crucial role as a gateway for trade and financial flows with mainland China has gradually been eroded by the rapid growth of mainland China's financial centres (notably Shanghai, Beijing and Shenzhen) as well as the process of liberalization of mainland China's equity and debt market, it is mainland China’s increasingly stringent treatment of the territory’s quest for democratic autonomy that has simultaneously upset its position as an international financial hub and added fuel to the fire of the existing United States-China tensions. Prominent economists predict a flight of capital Hong Kong to more favorable destinations that will not get caught in the economic crossfire between United States and China. 

The Security Law

A good starting point to this analysis is to gauge a measure of the new Security Law and what it means to investors. The ruling Communist Party in China decided in May to tighten its grip on Hong Kong and the following are some of the noteworthy changes that are expected as a result of the new law.

  1. Anti-government protests in Hong Kong will no longer be tolerated.

  2. Advocates of secession will be sanctioned and punished.

  3. China’s security agencies will set up operations in Hong Kong for the first time.

According to The New York Times, these new rules are unfavorable for investors for a number of reasons.

  • Hong Kong’s status as a semiautonomous Chinese city with an independent judiciary is now at risk.

  • Free expression and assembly might come under pressure.

  • Business regulations in the country might become more stringent with greater influence from Beijing.

  • Low financial and trade barriers with the rest of the world might come to an abrupt end as China seeks control over Hong Kong’s trade policies.

 

The uncertainty surrounding Hong Kong’s future as an independent territory now hangs in the balance which is not welcome news for investors.

Hong Kong’s “special status” might soon come to an end

If China decides to go ahead with the Security Law, Hong Kong will likely lose the special status granted it by the United States. Secretary of State, Mike Pompeo, confirmed last week that Hong Kong can no longer be treated as an autonomous state that is independent of China. The American President later confirmed that the Federal government had begun the process of removing this special status. Once this is done, Hong Kong will cease to enjoy tariff exemptions, export controls, visas and law enforcement cooperation from the United States. This will significantly deteriorate Hong Kong’s image as a reliable global trade facilitator and will see a monumental exodus of capital from the territory. 

The rising trade tensions between the U.S. and China adds salt to the wound

Last December, the United States and China signed the Phase one trade deal, paving the way for reduced tensions between the two largest economies in the world. Enter the Covid-19 pandemic and America has been quick to blame the virus on China despite the latter’s denials and protests. The recriminations and denials have once again escalated trade tensions between the two nations and America is now targeting Hong Kong to further hurt China.

For instance, according to the South China Morning Post, 70% of China’s foreign direct inflows in 2019 came through Hong Kong. If the U.S. does decide to scrap the special status granted to Hong Kong, China might find it more difficult to attract foreign investment. 

As long as trade tensions persist, Hong Kong will be in the firing line and the new Security Law passed by the ruling party in China gives another reason for the United States to attack Hong Kong. Higher tariffs and export controls are bad signs for companies operating out of this region and will certainly drive investors to other, safer havens. 

 

Alternatives to Hong Kong

Taiwan is already drawing a plan to attract both residents of Hong Kong and international investors to the country. The President of the country, Tsai Ing-wen, recently published a Facebook post outlining a strategy to welcome residents of Hong Kong who are fleeing the country in light of the tightening security conditions:

“The Executive Yuan will propose a comprehensive and concrete plan as soon as possible. The plan includes Hongkongers’ right of abode and settlement. If the situation in Hong Kong worsens, and its autonomy and human rights are further suppressed, we will resolutely voice our concerns. We will continue to support Hongkongers’ determination to strive for democracy and freedom which are paramount to its peace and stability.”

Taiwan regulators are already taking steps to improve domestic investment and stop businesses shifting manufacture to China. Since January, the Taiwanese government has approved 188 investments in the country totaling $5.5 billion. A survey conducted by InvesTaiwan found domestic companies with offshore investments account for 39% of all new projects to be launched within the boundaries of the country. Taiwan’s onshore investments will therefore likely grow exponentially in the coming years, paving the way for the country to become an alternative to Hong Kong. 

To attract more offshore investment, the government is already looking at easing regulatory requirements pertaining to such investments.

Singapore is also another key contender to attract the billions of dollars that are expected to flow out of Hong Kong. According to data compiled by Goldman Sachs, Political unrest in Hong Kong in the latter half of 2019 as well resulted in investors moving out approximately $4 billion to Singapore in just three months after the riots began. This gives a clear indication of how attractive Singapore is for global investors. The passing of the new Security Law is likely to trigger a similar outflow of investment from Hong Kong to Singapore, which is often touted as one of the safest destinations for international investors.

Conclusion

The new Security Law passed by the ruling party in China calls into question Hong Kong’s autonomy. The escalating trade war between the United States and China has aggravated the situation and these factors have already led investors to move investments from Hong Kong to other regional countries that are seen as more favorable for foreign investors. The supply chain disruption that resulted as a result of manufacturing plant closures in China gives another reason for investors to move their investments out of this territory. If China goes ahead with the new law, billions of dollars are expected to leave Hong Kong, which is a massive opportunity for the likes of Singapore and Taiwan that are already preparing to win these investors. 

About the author(s)

Harold Alby is a managing director and chief operating officer at Inova Capital. Justin Inniss is a managing director at Inova Capital.For more details on our insights please get in touch with us at Inova Capital AG on +41 415616905. Inquire about our ideas and nowcasting capabilities.