A day before Beijing passed a decision paving the way for its national security law for Hong Kong, the global index provider MSCI decided to relocate its financial derivative products from Singapore to Hong Kong, citing its confidence in Hong Kong as an international financial center for “years and decades to come.”
Perhaps one should not be too surprised by MSCI’s move. For a long time Hong Kong has been blessed by the fact that China-U.S. decoupling is taking place in everything but finance. Even as Beijing and Washington traded barbs over tariffs, technology, and indeed Hong Kong’s own future, the financial arena has been curiously ringfenced.
As a result, Hong Kong as a global financial hub has continued to prosper amid mounting political tension, even to the point of overtaking Singapore in terms of foreign exchange turnover according to a 2019 survey by the Bank for International Settlements.
Unfortunately, this happy state of affairs for Hong Kong could be over. Beijing’s unilateral decision to impose a national security law on Hong Kong despite local and international opposition is bound to trigger an equally forceful response by the United States. As President Donald Trump’s re-election bid looks increasingly remote amid the COVID-19 outbreak and ensuing economic recession, he may be tempted to seize his “Falklands moment” in Hong Kong.
On May 29, Trump vowed to revoke Hong Kong’s preferential status and impose sanctions on officials. However, these measures are no longer the “nuclear option” once thought to be. They are, in the words of House Speaker Nancy Pelosi, “nothing new and do not articulate a real or serious strategy to confront China’s actions.” Meanwhile, U.S. stocks rebounded as investors took relief from the ephemeral easing of China-U.S. tension.
Given Beijing’s dramatic escalation in Hong Kong, one cannot help but think that U.S. revocation of the city’s privileges is merely an appetizer. Sooner or later Trump will feel urged to up the ante to match Beijing’s move. One possibility is financial sanctions.
The local financial community is already bracing themselves for this possibility. Felix Chung, leader of the pro-Beijing, pro-business Liberal Party, warned that the United States could target Hong Kong’s currency peg with the U.S. dollar. “If the U.S. denies Hong Kong its access to the U.S. dollar, this will be the end of Hong Kong,” said Chung.
This will, indeed, also be the end of the Chinese economy as we know it. It is useful to be reminded of the strategic importance of Hong Kong to China. As China’s only global international center, Hong Kong alone controls over 70 percent of China’s global renminbi payments. Hong Kong also holds the key to China’s financial liberalization, accounting for more than half of overseas holdings in Chinese onshore equities.
More fundamentally, Hong Kong offers the only meaningful way for Chinese capital to access dollar financing, without which China will be cut off from the global economy. It is no coincidence that at a time when the United States is tightening listing requirements for Chinese firms, the likes of Alibaba and JD.com have been seeking a secondary listing at the Stock Exchange of Hong Kong.
Any U.S. financial sanctions on Hong Kong will therefore break the financial lifeline for China. On the other hand, it is inconceivable that the United States will target Hong Kong’s currency peg directly, as it is the city’s own prerogative to decide which currency to use. More important, the United States is not yet ready for outright financial decoupling from China, which will deal a devastating blow to the virus-stricken U.S. economy.
More plausibly the United States will resort to selective financial decoupling to contain the spillover to its own economy. A potent weapon could be a threat to impose financial sanctions on the Bank of China (Hong Kong), or BOCHK. Given that BOCHK is the sole clearing bank for offshore renminbi in Hong Kong, U.S. sanctions will spell the end of renminbi internationalization in a single stroke.
This is not all. As one of the three note-issuing banks in Hong Kong, BOCHK is mandated to back up every unit of Hong Kong dollars it issues with an equivalent amount of U.S. dollars. A sanctioned BOCHK will therefore suffer from the sterilization of its holdings of U.S. dollars and Hong Kong dollars at the same time. This is enough to trigger a major financial crisis in Hong Kong and, by extension, China.
What is truly scary about this scenario is that it is possible at all. What could be done to BOCHK has been performed on ZTE in 2018. If the United States objects to Chinese access to dollar financing on Nasdaq, there is no reason why it will not object to such in Hong Kong in principle. The United States, to be sure, will likely sanction some second-tier Chinese financial institutions before setting its sights on BOCHK, but the underlying logic remains that sanctions of this kind will hurt China way more than the U.S. itself.
Perhaps China-U.S. financial decoupling will happen anyway, regardless of whether financial sanctions will be implemented. Megvii, a $4 billion Chinese facial recognition champion under U.S. sanctions, was forced to let its Hong Kong IPO application lapse in May 2020 after a group of local citizens accused it of violating sanctions-related listing rules. Similarly, Sensetime, another sanctioned Chinese artificial intelligence giant, has aborted its $750-million IPO plan in Hong Kong in favor of private funding.
At any rate, Beijing’s financial firewall in Hong Kong is showing its first signs of cracking. In a recent interview, Hong Kong’s financial secretary Paul Chan defended the national security law for strengthening Hong Kong’s role as “the doorman for China’s financial security.” With the threat of U.S. financial sanctions looming, it is not clear if the proverbial door is any more secure than before.
Macro Yuk-sing Kwan is Editor at Resonate, a Cantonese Periodical. The piece is part of Project 2047, a flagship project of the Hong Kong Global Research Council (HKGRC) that covers viewpoints from both ends of the political spectrum.