The ability of smaller international finance centres (IFCs) to provide a positive influence and confer significant benefits on both developing nations, as well as larger more established economies, is well regarded.
What is interesting within these relationships is how larger onshore counterparts have not just benefited from the presence of IFCs but positively depend on them.
In Asia, the symbiotic relationship between Hong Kong and China has helped China make great strides in terms of economic advancement and growth and these benefits should continue to flow to the extent that the relationship continues to be cultivated.
Benefits to China
Amid the rapid expansion of Asia and its rise in global economic importance, Hong Kong has been established as the key financial intermediary for China and as China's growth has outpaced the rest of the world, international recognition of Hong Kong as a primary IFC in the global financial architecture has increased.
The 2013 Global Financial Centres Index (GFCI) placed Hong Kong in third position, just behind London and New York and just ahead of Singapore in its table of the world's leading IFCs. Hong Kong's IFC activities have directed significant levels of foreign direct investment (FDI) into China, while Hong Kong has also played an important role as a trade agent for the vast country. The scale and prominence of this relationship is clear from figures, which demonstrate that over the past decade, China has accounted for some 46 per cent of Hong Kong's total imports, according to the Hong Kong Government's Monthly Digest of Statistics.
With FDI flows between the two regions continuing to gain momentum, as China continues to open its financial markets and industries to the West, this level of interdependence is unlikely to shift soon.
The Hong Kong Stock Exchange (SEHK) is a case in point within the story of symbiosis, which as Asia's second largest stock exchange by market capitalisation - behind Tokyo - is significantly more developed than any stock market inside China.
The SEHK's activities have played a major role in facilitating economic development and growth in China, notably the introduction of H shares in July 1993, which allowed the first companies incorporated in China to be traded on the Hong Kong market. This change has helped foster financial links between China and Hong Kong over the past 20 years, as outlined by the IMF (1) and there are currently 172 H share companies on the SEHK Main Board, with a combined market capitalisation of over HK$5 trillion. This number includes notable Chinese enterprises such as China Construction Bank Corporation, Industrial and Commercial Bank of China and Petro China, which have all welcomd the ability to list on an exchange with relative stability, as well as gaining a higher valuation than a domestic listing would provide.
Among the leading academics to weigh in on this issue, Professor Jason Sharman of Australia's Griffith University concluded that China's relative openness to interfacing with IFCs like Hong Kong has been a significant contributor to the higher growth rates and the reduction in poverty experienced since 1978. His paper 'International Finance Centres and Developing Countries - Providing Institutions for Growth and Poverty Alleviation' stated that lower transaction costs and the more efficient use of capital as a results of the IFC's activities were the primary drivers of this trend. The paper also demonstrated that while Hong Kong was the greatest source of foreign investment to China, the second biggest investor on the list was the British Virgin Islands.
Clearly China has had plenty to gain from its support and encouragement of Hong Kong's financial sector and its role as an IFC, which it has done over the years. Since British rule over Hong Kong came to an end in 1997, Hong Kong's economic relationship with China has grown and expanded significantly and will likely continue to grow further as China continues its integration with the world economy.
Benefits to Hong Kong
Hong Kong's reputation as a leading global IFC is reinforced by its close connections with China, with the China and Hong Kong Closer Economic Partnership Arrangement (CEPA) at the centre.
CEPA was the first free trade agreement between Hong Kong and China, signed in 2003, which liberalised trade between them, as well as enhancing economic cooperation and integration to encourage bilateral investment. CEPA opened up the huge market of mainland China to Hong Kong goods and services with preferential access and an absence of any tariffs or other barriers to trade. The mutual recognition of professional qualifications has helped in the provision of services by Hong Kong suppliers, while the greater cooperation has improved the general environment for business, particularly in the areas of finance, tourism, trade and investment.
CEPA has seen a succession of liberalisation measures introduced and the tenth supplement, signed in 2013, brought in a series of benefits specifically aimed at the financial services sector. Key amongst these changes was the ability for RMB banking services to be provided in Hong Kong to Hong Kong-owned Chinese enterprises. Hong Kong funded securities firms have an easier route to apply for Qualified Foreign Institutional Investor (GFII) status, improving access for foreign investors to the Chinese domestic securities market, while the foreign shareholding limit in Chinese fund management joint ventures has been increased.
A 2008 study by Cheng Hsiao, H Steve Ching and Shui Ki Wan, which looked to measure the benefits of political and economic integration between Hong Kong and Mainland China, concluded that CEPA has had a significant impact, raising Hong Kong's real economic growth rate by 2.82 per cent per year and goes on to say that Hong Kong's future hinges on its economic integration with China's mainland.
The SEHK's reputation as a leading offshore RMB player has been cemented by the CEPA developments and the amount of Chinese companies listed there. Exchange statistics show that at the end of 2013, 48 per cent of listed companies were Chinese enterprises, which accounted for 57 per cent of the total market capitalisation and 72 per cent of the annual equity turnover.
An Offshore Perspective
Hong Kong's role as an IFC also involves acting as a conduit for financial and corporate services from smaller offshore centres, such as the British Virgin Islands, the Cayman Islands or Jersey. Taking a look at the SEHK, the scale of this influence is clear with the majority of listed companies incorporated offshore and the Cayman Islands being the leading jurisdiction, accounting for some 41 per cent of all listings on the SEHK, according to exchange data.
Companies incorporated in both the British Virgin Islands and the Cayman Islands are ubiquitous in Hong Kong, underpinning structures for cross-border transactions. Where investments are being made into China, the corporate structure will invariably be built around either a Cayman Islands exempted company or a BVI business company, acting as the holding company. Therefore the operating company can then take advantage of the flexible corporate regimes within these jurisdictions.
Both the Cayman Islands and BVI offer highly sophisticated legal systems, based on UK common law and with ultimate recourse to the Privy Council in London. This aids international investors to increase certainty over local laws and regulations for disputes to have a greater certainty of outcome. Companies incorporated offshore in the Cayman Islands or BVI also do no attract any stamp duty where the transfer of shares is taking place, unless the company holds real estate in either the Cayman Islands or BVI. Legitimate privacy concerns also come into play, as the corporate registers in both the BVI and the Cayman Islands are generally private and are not publicly available.
Another string to the offshore bow is the statutory merger process, which exists in both Cayman and BVI. The statutory process provides a straightforward mechanism for two companies to merge and in the Cayman Islands, for example, can affect the merger of two Cayman incorporated companies - or in certain circumstances with a foreign company.
The useful legislative process is an option with wide appeal because of the low merger approval thresholds compared to a squeeze out following a takeover offer or a scheme of arrangement which may increase cost and time as the courts become involved. In recent years we have seen the Cayman Islands merger process used extensively as part of the 'take-private' trend, which has enabled many Chinese companies listed abroad and undervalued to delist from exchanges in the US, with a view to relisting either domestically or on the SEHK. By way of example, Walkers recently acted as Cayman Islands counsel to Tsinghua Unigroup Ltd in connection with its US$1.78 billion take-private acquisition of NASDAQ - listed Spreadtrum Communications, Inc, a Chinese mobile chip manufacturer backed by New Enterprise Associates.
On the investment funds side, Cayman Islands exempted limited partnership, are the preferred vehicle for private equity managers when attracting international capital to be invested in China. Similarly, Cayman Islands companies are utilised in hedge fund structures where the underlying investments are in China.
The People's Republic of China represents a significant piece of overall activity, which is still growing as China becomes further integrated with the West. In more recent years we have seen increased M&A activity, as Chinese enterprises expand beyond borders and international capital looks to target the huge opportunities within Mainland China.
IFCs complement developing countries and help engineer growth. The well-developed and sophisticated laws and regulations in Hong Kong's financial services sector have brought the jurisdiction to global prominence as one of the world's leading financial centres. Its special relationship with the Chinese mainland works both ways. Closer economic ties have been forged through listings on the SEHK and the implementation of CEPA with preferential accress to China for Hong Kong's financial services community, which continues to expand.
As China stays in the sights of global investors and its economy continues to expand, both China and Hong Kong will continue to thrive from this mutually dependent and mutually beneficial relationship.
Amelia Hall is Counsel in Walkers' Hong Kong office and works in the firm's Global Corporate and Investment Funds Group. Amelia specialises in corporate work with an emphasis on investment funds, private equity, joint ventures and listed company work.
Denise Wong is a partner in the Global Corporate and Investment Funds Groups of Walkers' Hong Kong office. She specialises in hedge funds and private equity funds, as well as all areas of corporate transactions including mergers and acquisitions, private equity investments and capital markets transactions.