Asia’s Capital Market Revolution to Challenge Hong Kong

As far as slogans go, the variations on “our business is business” Hong Kong has used over the years struck me as particularly succinct as I returned to Hong Kong this week for the Asian Financial Forum.

Hong Kong is a vibrant business centre that always ranks highly on indices of ease of commerce and financial deregulation. It is one of my favourite cities. And of course, as the mainland Chinese economic boom has developed, Hong Kong has been uniquely situated.

I am convinced the coming Asian century is real, that China will drive it and Hong Kong will remain in a unique position. But Hong Kong will also face new challenges to its status as Asia’s major financial centre.

ANZ is currently completing a major research project on just what the “Asian Century”, that catch-all phrase, really means for the development of financial markets in the region.

It highlights the region’s prosperity will be led by seven economies: China, India, Indonesia, Japan, Republic of Korea, Malaysia and Thailand. These seven economies represented 71 per cent of Asia’s population and 87 per cent of Asian GDP - US$15.1 trillion - in 2010. By 2050 their equivalent share will be 75 per cent of population and 90 per cent of GDP. Moreover, that equates to 50 per cent of global GDP and 53 per cent of the world’s middle class.

To support this growth the depth of Asia’s capital markets need to converge with developed economy norms. Asia should hold a similar amount of the world’s financial assets - that is around US$200 trillion in 2030 and as much as US$700 trillion in 2050.

But for such deepening of capital markets to occur there will have to be a significant step away from government control of bank-dominated systems to allow capital markets (primarily equity and debt) to flourish. Meanwhile Asia would by necessity become home to several financial capitals.

Yet we are well aware that to date Asia’s economic growth has not delivered financial deepening. Indeed, the globalisation of financial services means that Europe and the US perhaps over-deepened with Asia having effectively out-sourced much of its financial intermediation to New York and London.

A key impediment to deepening has been the lack of progress on capital account liberalisation in the region. The bullish scenario we reckon most likely is not the only possibility. There is the potential for some countries at least to fall into a middle income trap, where wealth per capita is held back by an economy failing to shift from lower to higher wage cost products and services.

Nevertheless our view is financial markets will deepen considerably and the regional architecture will be marked by greater integration as greater trade, foreign direct investment and portfolio flows become increasingly intra-Asian.

This is a great opportunity for Hong Kong as one of the leading financial centres in the region. It is a natural home for the institutions and markets required.

But others, including the mainland Chinese themselves, see this opportunity. The Shanghai Free Trade Zone has already exceeded the expectations of many and is clearly seen as a candidate for the major regional financial centre for Chinese flows.

Indeed it seems likely China will “on-shore” a lot of the activities such as RMB debt issuance now being undertaken in Hong Kong as it opens up the capital account and financial flow volatility eases.

There will evolve much greater specialisation of financial centres in the region. When we look around the world we see Chicago is a centre for commodities, New York for equities. London is a centre for lending.

Asia’s financial centres need to discover and develop their niche. I think Singapore will continue to dominate wealth management, Seoul should look at shipping or project finance or become a hub for technology boards. Dalian in China already has its own commodity exchange. There is scope for a multitude of financial capitals serving different needs.

Hong Kong will have to determine which business to make its business. Should it be a banking centre? It has the infrastructure and human capital and although our research suggests that banking market capitalisation as a percentage of GDP will decline from more than 200 per cent today to around 150 per cent in 2050 – this basically reflects the growth in GDP. But it will I think remain a more attractive location for human capital, an advantage it can build upon.

Financial deepening too implies much greater sophistication of financial products and services, in markets like derivatives, and this it strikes me is where Hong Kong has a strong competitive advantage. A new ASIFMA white paper noted OTC derivatives in the region are just 7 per cent of the global total, seriously underweight. Exchange traded derivatives are too. And credit derivatives.

Hong Kong has always been a hive of innovation which is vital for more complex markets. It has robust and trusted legal and regulatory regimes. Along with Singapore and Australia, ASIFMA ranks it the most natural location for “mature” financial services which require such regimes. Asia will grow in financial sophistication and Hong Kong is ideally situated to be among the best in business class.

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