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China volatility cements HK's finance hub crown
Hong Kong's status as Asia's capital hub is likely to be enhanced by the ructions in China, as the city's track record for financial security and booming listings market attract investors eager to escape the volatility on the mainland.
Hong Kong is already the world's second most competitive economy, behind the U.S., according to a ranking by the IMD World Competitiveness Center earlier this year, thanks to high efficiency levels and business-friendly policies like zero export tariffs.
"China's volatility will further lift Hong Kong's reputation as an international financial center," said Daniel So, strategist at CIMB International Securities.
"There were fears that Hong Kong would be overtaken by Shanghai or Shenzhen once Beijing's capital market liberalization took off but now we've seen the latter two are not yet ready to be financial hubs," he continued, referring to the Beijing's seemingly botched management of stock markets.
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After engineering an equity market bubble that took the Shanghai Composite (Shanghai Stock Exchange: .SSEC) to seven-year peaks in early June, Beijing began a series of aggressive, and often contradictory, policy measures once the market started tanking, such as halting initial public offerings (IPOs) and leveling accusations of malicious stock selling. Analysts and investors alike have told CNBC these actions were "immature," saying Beijing's poor planning represented a market still in its infancy.
Hong Kong's bread and butter remains servicing the needs of investors hoping to participate in China's growth story, explained So. The city is investors' preferred method of gaining exposure to the world's second-largest economy, thanks to Hong Kong's core values such as corporate governance, something mainland shareholders have long bemoaned.
"Without these values, in the long term Hong Kong won't be much different than Shanghai."
The city already boasts Asia's highest levels of corporate governance, according to a 2014 study by CLSA, on the back of clear legal framework and consistent disclosure levels. New changes introduced last year emphasized annual risk management reviews and greater board responsibility for issuers.
Perhaps the most telling sign of a city's appeal to foreign companies is the strength of the local initial public offering (IPO) market.
The first six months of the year saw the Hong Kong Stock Exchange (HKEx) become the world's largest IPO market in terms of funds raised, with IPO proceeds hitting $17.3 billion, a 45 percent increase on-year and around eight times higher than rival Singapore's performance.
"I think the difference between Hong Kong and the other centers in the Asian region is that we are more specialized in certain aspects of the financial market, for example, equity," K.C. Chan, Hong Kong's Secretary for Financial Services and the Treasury, told CNBC.
The IPO momentum is unlikely to stop, with a healthy pipeline scheduled for the remainder of the year.
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China Reinsurance Group, the mainland's largest re-insurer, filed an IPO application last month that could raise up to $2 billion in the fourth quarter, according to Reuters estimates. Meanwhile, China Huarong Asset Management, the mainland's largest bad-loan buyer by assets, could raise as much as $3 billion in an offering expected in late September or October.
"With a number of sizable deals up for listing in the second half of the year, we maintain our forecast for 2015 for an estimated 110 IPOs raising over $26 billion despite global market uncertainties," KPMG said in a July report.
Moreover, the anticipated launch of the Shenzhen-Hong Kong Stock Connect in the second half is expected to boost the Hong Kong stock market and positively impact IPOs, the report added.
The new Stock Connect will allow Shenzhen investors to buy Hong Kong-listed shares and vice-versa, similar to last year's Shanghai-Hong Kong Connect. The program is currently pending regulatory approval, HKEx CEO Charles Li said in August.
Steady financial policy is also a vital component of Hong Kong's international attraction.
Beijing's decision to devalue the renminbi (Unknown: CNY00H=) (RMB) last month sparked initial speculation that Hong Kong could delink its local dollar (HKD) from the U.S. dollar (USD), but experts say that's unlikely to happen.
"De-pegging the HKD from the USD means, most likely, it will be pegged to the RMB, given that economic cycles between the mainland and Hong Kong have converged over the years," Aidan Yao, emerging Asia economist at AXA Investment Managers, said in a recent report.
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"However, pegging the HKD to the RMB poses one obvious problem, being that the yuan is not yet fully convertible, with its capital account still subject to various restrictions."
Chan does not see Hong Kong abandoning the dollar peg either.
"The Hong Kong dollar is very unique because number one, it is a currency used in HK and the other thing is that we are also the currency for international transactions," Chan said.
"The dollar peg gives HK dollar huge confidence and it's a very important currency for intermediation in the market," he said.
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Ensuring free flows of capital is essential for a financial hub like Hong Kong, so subjecting its currency to capital controls is an unlikely scenario since it would just undermine the city's global position, he explained.
Moreover, Hong Kong's $340 billion in currency reserves, roughly 120 percent of gross domestic product, ensures protection from a looming U.S. interest rate hike.
However, the city's political future is more complicated.
Stability was threatened last year following a flood of pro-democracy protests aimed at granting the city direct elections without intervention from Beijing. But after Hong Kong lawmakers rejected a China-backed electoral reform package in June, the odds of further protests are reduced, for now.
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