The Next Big Financial Hub

With the recent establishment of its free-trade zone, is Shanghai going to overtake Hong Kong as the next major international financial center?

By Louisa Wah Hansen

The opening of Mainland China’s very first free‐trade zone has aroused both enthusiasm and skepticism on whether Shanghai would replace Hong Kong as the next big international financial center.

The free‐trade zone, approved in July by the State Council and officially opened on September 29, aims to be a pilot test for liberalizing interest rates based on market needs. It also will allow freer reminbi (RMB) convertibility on the capital account, so that firms, including foreign companies, can use the RMB in cross‐border business.

Some economists believe that the Chinese government is seeking to raise the status of Shanghai as a major international financial center through the free‐trade zone. As a result, many companies may choose to transfer their principal business activities from Hong Kong to Shanghai.

Should Hong Kong be worried that its status as an international financial center may soon be replaced by Shanghai?

Asia’s wealthiest man Li Ka‐Shing recently warned that the development would have a big impact on Hong Kong and that the city may lag behind if it does not catch up quickly.

Prof. T.J. Wong, Dean of the Chinese University of Hong Kong Business School, says he is impressed by the speed of development in Shanghai and the determination of the new administration in deepening its reform. He especially welcomes the latest announcement by Beijing to lift the ban on access to politically sensitive foreign websites such as Facebook and Twitter.

“Having free flow of information is one key factor for developing an international financial center. I’m happy to see such a development in China but I do worry about Hong Kong,” he comments. “We do need to come up with a better plan to face this new challenge. This may involve changing our financial policy and speeding up our product innovation, and perhaps a better integration with Shenzhen and the Pearl River Delta region so that we could form another center that competes with the Yangtze River Delta.”

Overall, Prof. Wong thinks that if Shanghai succeeds in this pilot plan, it means the rest of China will follow suit to reform its banking and financial system. “This will be good news for the banking and finance reform in China,” he says.

He explains that the lack of market mechanism in the financial system in Mainland China has been a huge obstacle for the sustainable growth of the Chinese economy. Allowing market forces to self regulate trade, banking and finance will serve as a catalyst for robust and sustainable growth in the future. As such, the Shanghai experiment will benefit everyone in China.

Mike Rowse, former Director-General of InvestHK, however, believes that Shanghai is far from being a threat to Hong Kong in terms of replacing it as an international financial center.

He points out four criteria that qualify a city as a truly international financial center: complete freedom of movement of capital private ownership of the banking system, with the government stepping in only as a regulator to ensure fairness in the industry; total free flow of information an independent judiciary that protects private property and is separate from political control.

“These are the four things that you absolutely must have to be an international financial center,” reiterates Rowse. “Hong Kong has them all. Call it an accident of history or what you will, but we have them all.”

Rowse is especially skeptical of the full convertability of the RMB and a true liberalization of the banking system.

“In 1995, people told me: ‘Oh, RMB would be freely convertible within five years, and by then Hong Kong will be finished.’ In 2000, they said: ‘Oh, five more years, definitely RMB will free.’ In 2005, the head of People’s Bank of China came out and said: ‘Maybe by 2020.’ So yes, it will happen, but it’s going to be huge and it has to be handled carefully. And that’s the easy one. Private ownership of the banking system has been ruled out by the Politburo. This is one of the core industries the government has always controlled and the party has always controlled. And as long as the party controls it, you’re going to have political interference in the allocation of loans, which you see all the time inside China.”

His conclusion: “It is not that Beijing and Shanghai cannot be important financial centers. They are and they will continue to be financial centers for the domestic economy. But they cannot be international financial centers until they meet all those four criteria.”

Jennifer Wilson, Principal at Roland Berger Strategy Consultants’ Hong Kong Office, believes it will take time for Shanghai to become a threat to Hong Kong.

“Because of the taxation and RMB convertibility issues, and the highly regulated financial system, Shanghai will not be able to replace Hong Kong’s role as a financial center. Not tomorrow, and probably not even within the next three to five years. It’s still too highly regulated to be a financial center like Hong Kong and New York,” says Wilson. “Transparency is another issue. The IMF monitors the transparency level in financial markets around the world. To get to the same level as Hong Kong, Shanghai needs to improve its financial transparency.”

Despite the gap between Hong Kong and Shanghai, Wilson cautions that Hong Kong should not rest on its laurels. “I think Hong Kong needs to be aware and invest in more innovations that can differentiate it from other markets,” she concludes.