Hong Kong is booming. The local stock market is at an all-time high, investment banks are reaping record profits, and advisory firms are unable to find enough staff. How did a jurisdiction that consists of 1,042 square kilometres of land and 252 islands get to punch so far above its weight in the international community?
A lot has to do with mainland China, which lies immediately to the north of Hong Kong. In fact, the southern part of China is economically integrated into Hong Kong. Manufacturing operations have been driven out of Hong Kong to southern China because of high costs and lack of available land, but these operations are largely owned and managed by entrepreneurs and services centres in Hong Kong. To examine Hong Kong in isolation from mainland China would be very misleading.
It is because of the China connection, and because of the intrinsic economic benefits that this connection confers, that Hong Kong has been able to be complacent when analysing its attraction to foreign investors. A useful contrast can be made with Singapore, which has a similar type of economy when viewed on a stand-alone basis, but which does not have the 'backup' of a powerful mentor in its geographical vicinity.
Indeed, Singapore and its neighbours compete for international business, and this has forced Singapore to be more flexible as it continually seeks to keep itself attractive to foreign investors. Singapore is nimble and quick to react to economic and business trends in terms of identifying emerging industries and taking positive targeted steps to attract such industries to Singapore.
One day it actively promotes the computer chip industry, the next day the biotechnology industry, and the next day the funds industry. All the elements in Singapore that are responsible for regulating business are commonly aligned - the investment authorities, the tax bureau, and the government ministries. Even the Chief Justice of Singapore gives public talks extolling Singapore's virtues and promoting it as a business centre, as most recently evidenced when he spoke at the annual STEP conference to commend Singapore's role as a trusts centre in Asia.
By contrast, Hong Kong remains complacent. It takes the view that Hong Kong's economic and tax systems are incentives enough, and that it does not need to promote itself by targeting specific industries with focused incentives. Indeed, this policy served Hong Kong well when its tax rate was 16 per cent and Singapore's tax rate was 36 per cent. However, today the Singapore tax rate is 18 per cent and Hong Kong's is 17.5 per cent. Indeed, corporate tax rates across Asia have declined over the last two decades. Were it not for the China connection and for the need for China focused business to be based in Hong Kong, one can speculate how attractive Hong Kong would actually be today.
So it is with the private banking industry. Hong Kong is a regional hub for private banking and trustee activities, servicing key markets such as Taiwan, Korea, Philippines, and Japan. But today, the focus of these industries is on mainland China, where wealth is compounding. Many years ago, reputable institutions were concerned that wealth in China came from illegal activities, but this is no longer the case. "Know your customer" is no longer impossible. The goal today for the Hong Kong private banking industry is to tap into this emerging wealth in mainland China, and to manage it on behalf of its owners.
Indeed, China has made this goal easier to achieve. Exchange control laws have been relaxed to enable more mainland residents to remit funds abroad for investment. Mainland insurers are now permitted to invest one-half of their assets outside Hong Kong. Mainland banks have been authorised to direct investors' funds to stock markets outside China, and, in some areas of China, private investors are now permitted to invest in offshore securities.
In addition, China is becoming a capital exporter, and more mainland enterprises are diversifying by investing abroad, much as US companies started doing in the late 1940s. Capturing these assets for management is a lucrative business for Hong Kong-based managers.
China has also encouraged foreign securities firms, banks, and insurers to invest in enterprises within China, thus giving fund managers the ability to develop a lucrative domestic wealth management industry in mainland China. The grail of "selling a knife and fork to 1.3 billion people in China" remains a magnet for foreign investors. And many of these investors are based in Hong Kong.
As rosy as this picture looks, these developments do not mean that Hong Kong can remain complacent. There is a risk that Hong Kong will be increasingly bypassed in this process, and will eventually be forced to fend for itself.
By way of example, it is no longer necessary to fly via Hong Kong to enter China, and increasing numbers of foreign investors are setting up their China offices on the mainland, rather than in Hong Kong. Hong Kong, therefore, needs to reinvent itself and to carve out its own niche in the international community, independent of its China connection.
The first question this raises is does the Hong Kong government recognise these trends? The second question is does the government have the foresight, willingness, and ability to re-define Hong Kong for the 21st century?
There are signs that the government is stepping up to meet this challenge. In the private banking sector, the government has finally responded to long-standing calls from the trusts industry to take the step of modernising Hong Kong trusts law to enable the jurisdiction to become the preeminent trusts centre in Asia. The Chief Executive recently announced that the government will "review the provisions in the Trustee Ordinance with a view to strengthening the competitiveness of Hong Kong's trust services industry and enhancing Hong Kong's position as an international financial centre". The government will make the necessary changes over the next 18 months. This is coupled with an existing project to modernise Hong Kong's company laws.
Taken together, Hong Kong will be able to reassert its role as the major centre in Asia for the trusts and private banking industries, and to meet the recent challenges from Singapore which has already taken its own steps to seek to develop these businesses There is still more to be done. Hong Kong must clarify its tax laws so far as they relate to the taxation of trust income and private wealth management profits. In addition, Hong Kong faces a more fundamental challenge to attract other industries.
The key question is whether the "level playing field" that has served Hong Kong so well in the past will be sufficient to achieve this objective, or whether it will need to move towards a more "Singaporestyle" system of targeting specific incentives at particular industries, as indeed it recently did when it enacted an express tax exemption for the funds industry in Hong Kong.
This is the most immediate challenge Hong Kong faces today.
Michael Olesnicky Senior Consultant in Tax, Baker & McKenzie in Hong Kong, formerly Senior Advisor at KPMG in Hong Kong. He has more than 25 years’ experience advising on corporate tax, wealth management, trust planning and estate succession matters. Since 1986, he has been the Chairman of the Joint Liaison Committee on Taxation, a quasi-governmental committee interfacing between tax practitioners and the Hong Kong Inland Revenue Department. Olesnicky is also the Chair of STEP in Hong Kong and chairs its China sub-committee.