Hot money's growing underground flow

PUBLISHED : Wednesday, 14 March, 2012, 12:00am
UPDATED : Wednesday, 14 March, 2012, 12:00am


Along a narrow lane in Hong Kong's Western district sits a clutch of money changers doing more than swapping banknotes for tourists. They are quiet channels of illicit 'hot money' that flows between the mainland and Hong Kong.

Today, a young investment banker is visiting the lane for the first time to do a deal that will skirt the mainland's tight capital controls and, the banker hopes, pay off big time. The 28-year-old mainlander, identified only by his family name of Li, plans to wire about HK$300,000 to his bank account in Beijing and then invest the money in stock market index futures. Li figures he can reap an annual gain of roughly 9 per cent from his bets, bringing him closer to his goal of having the seed capital to set up his own hedge fund on the mainland.

Hot money travels across the border in various ways, from suitcases to doctored trading invoices. Li is part of a groundswell of individuals in Hong Kong opting to move cash through local money changers, many of whom also act as remittance agencies, handling two-way trade and mimicking the hawala banking networks that operate in South Asia and the Middle East.

In Hong Kong, some people use remittance agencies to wire funds to the mainland to buy a house, or support their elderly parents, or bet on investment products. Conversely, individuals on the mainland use them as conduits for capital flight, fuelled by worries over the outlook for the Chinese economy. All the activity is drawing unwanted attention from the mainland's regulator, the State Administration of Foreign Exchange. According to a recent Safe report, the regulator cracked down on 210 underground remittance agencies on the mainland involving more than 100 billion yuan (HK$122 billion) from 2007 to 2011.

On the mainland, 'underground remittance agencies not only violate foreign-exchange regulations, they also undermine macro-governance of China's financial markets and have created avenues for tax evasion and money laundering which are hard to monitor and control', says Patrick Phua, a Beijing-based partner specialising in financial services and regulatory issues at Australian law firm Mallesons Stephen Jaques.

Peng Jian, director of the Beijing Huahuan Law Firm, says individuals who use their services are usually fined at most 30 per cent of the violation amount, and typically don't face jail time. But the remittance agencies risk being charged with 'engaging in unauthorised foreign exchange business' and 'evasion of foreign exchange restrictions', and risk severe punishment such as five years or more in prison, he adds.

Last year, for instance, 46-year-old Li Fochan was sentenced to more than seven years in prison for running an underground remittance agency in Dongguan, in Guangdong. She and her five accomplices also were fined about two million yuan in total, according to Guangzhou Daily.

The legal situation is trickier in Hong Kong, where there are no laws against such money transfers but participants, at least, violate the spirit of regulations intended to damp hot money flows. At worst, people risk being charged with 'the common law offence of conspiracy' for violating regulations of other jurisdictions, which could result in imprisonment, says Charles TL Wong, from Lo, Wong & Tsui Solicitors in Hong Kong.

Legislative councillor Chan Kam-lam says that even if Hong Kong had a law, it would be hard to enforce because there is no physical transfer of money and their operations cannot be traced.

Hong Kong boasts 2,710 remittance agents and money changers, according to registrations filed with local police. Among them, 1,568 were run by companies and 1,142 were owned by individuals.

Speculative inflows, which boost asset prices, complicate mainland efforts to fight inflation. On the flip side, besides facilitating tax evasion, the outflow of liquidity triggers downward pressure on the yuan, and, ultimately, economists say, could destabilise financial markets and the economy itself.

To restrict the flow of funds, the People's Bank of China, the mainland's central bank, set down rules that are overseen by the Hong Kong Monetary Authority. Banks in Hong Kong doing yuan business cannot exchange more than 20,000 yuan a day for individuals. And individual bank account holders in Hong Kong are limited to wiring 80,000 yuan a day to accounts on the mainland held in the same name.

Without special approval, individuals on the mainland cannot receive more than the equivalent of US$50,000 in their foreign currency accounts annually. According to Safe, mainland residents and non-residents usually cannot carry more than 20,000 yuan and the equivalent of US$5,000 at the same time when crossing mainland borders.

Companies that need to transfer money out of the mainland have to show supporting documents for most transactions, such as international trading contracts and invoices from overseas companies to banks.

In addition to serving individuals, remittance agencies are 'a common way for [small] businesses to move funds across the border', which is known as hawala-style banking, or money transfer without money movement, says Stephen Green, regional head of Greater China research for Standard Chartered Bank.

The typical transaction with a remittance agency requires two individuals with mirror needs, funds that need to move in opposite directions, and this depends on trust, Green says. Under mainland rules, the transaction is basically illegal, but because no funds actually cross the border 'this method is difficult to detect and, unfortunately, impossible to measure', he adds.

In Li's case, the Hong Kong remittance agency had a partner on the mainland with a bank account. Once Li handed over his Hong Kong dollars, the agent called his partner on the mainland to transfer the equivalent amount of yuan from his account to Li's bank account in Beijing. The whole process took less than half an hour, and no money left Hong Kong.

A similar transaction could easily have taken place in reverse.

Li, who has been working in Hong Kong for three years, first heard about the services offered by Hong Kong remittance agencies from a mainlander colleague, who also used them to transfer cash from Hong Kong to buy a flat in Shenzhen as well as to send some of his Hong Kong dollar savings to his parents who needed yuan. All told, the colleague has wired about HK$200,000 to the mainland and is a satisfied customer.

The remittance agency makes its profit from the spread between the Hong Kong dollar and yuan rates. Generally the agencies don't charge for transactions of HK$100,000 or more, but add HK$50 for lesser amounts. One operator said his agency generated annual revenue of about HK$400,000.

Rates vary slightly between agencies, so Li shops around. Each one of the four he visits says their shop can wire as much as HK$20 million in one deal. The one Li picks says it transfers roughly HK$3 million a day between the mainland and Hong Kong.

When a wary Li asks the operator about the risks of getting caught, he replies: 'We wire millions of dollars this way every day. But nobody has the time to inspect such small sums.'


The number of registered remittance agents and money changers in Hong Kong