One country, two international financial centres?
That's the question facing Hong Kong as Shanghai starts to flex its commercial muscle. In July 2009, when Beijing really started to push its currency offshore, it picked Hong Kong to be the sole proving ground to settle cross-border trade in yuan. It was among the first steps in a long-term plan to turn the yuan, which isn't easily convertible, into a global currency.
The idea is partly to use the special administrative region as a laboratory to internationalise the currency by letting individuals and companies outside the mainland buy and sell yuan. For now, Chinese officials paint Shanghai's role as being complementary to that, mostly concentrating on building an onshore yuan trading market, while Hong Kong develops as an offshore yuan business centre. But there is cause for future unease.
"If the yuan became fully convertible some day, the offshore yuan market would of course be gone. Then, Hong Kong will have to find its new way," said Gonzalo Torano, head of Asia-Pacific at BBVA, Spain's No 2 bank, which has 200 staff at its Asia-Pacific headquarters in Hong Kong, and maintains a small representative office in Shanghai. "By then, perhaps we will move our regional office to Shanghai and our size [in Shanghai] will be bigger than in Hong Kong."
What's more, in the near term, London and Singapore are nipping at Hong Kong's heels to become premier offshore centres for yuan-related business for Europe and Southeast Asia, respectively.
Since Britain handed free-wheeling Hong Kong back to China 15 years ago, the city has operated under the concept of "one country, two systems", giving it certain advantages. For a start, Hong Kong offers rule of law, making it a comfort zone for international financiers.
The city is already a recognised global financial centre with a deep pool of capital- markets-related expertise and a major stock exchange. Hong Kong also boasts an attractively low individual tax rate of 15 per cent. In Shanghai, by comparison, this can reach 45 per cent, a particular worry for well-paid expatriate bankers.
Over the past three years, bankers in Hong Kong have been busy increasing offshore yuan-related transactions. Financial institutions have built up a pool of yuan deposits in Hong Kong that totalled about 560 billion yuan (HK$686.6 billion) in February and created investment vehicles, including yuan-denominated "dim sum" bonds issued by local banks and big multinationals such as McDonald's and Ford Motor.
Sales of such bonds reached US$14 billion in Hong Kong in 2011, almost three times the amount sold in 2010, according to data provider Dealogic. A year ago, the Hong Kong stock exchange welcomed its first yuan-denominated initial public offering in the form of Hui Xian Real Estate Investment Trust, backed by Asia's richest man, Li Ka-shing. Other investment channels are being created, including derivatives such as yuan currency futures.
Shanghai has historically served as the mainland's commercial hub. In the 1930s and '40s, it was a well-known international financial centre. In that period, trading volume at the Shanghai stock exchange was at one point ranked the world's second largest, after New York. The city was nicknamed "Paris of the East", while Hong Kong was a relative backwater under British rule.
In the late 1940s, when the Communist Party looked set to win the civil war, the dynamic between Shanghai and Hong Kong began to change quickly. Many wealthy people, who were fearful of communist rule, fled Shanghai for Hong Kong during and after the war, eventually making Hong Kong their new home. They included Tung Chee-hwa, scion of a rich shipping family, who became Hong Kong's first chief executive after the British handover.
Shanghai, like elsewhere on the mainland, was badly hit during the Cultural Revolution, between 1966 and 1976. Thanks to the late paramount leader Deng Xiaoping's efforts to open the mainland economy - such as fast-tracking official permission for foreign companies, including banks, to set up in Shanghai's Pudong New Area - the city has caught up quickly with Hong Kong over the past two decades in terms of reducing commercial red tape and raising living accommodation to an international standard.
Over the past decade, Shanghai has been building up yuan-related business such as foreign-exchange and commodities trading, developing local bond markets and asset management companies, and expanding its stock market with a significant number of big listings.
Earlier this year, Beijing-based Bank of China set up a second headquarters in Shanghai. Other big state-owned banks are likely to follow suit, with dual headquarters split between the capital and Shanghai, underpinning the latter as a financial hub.
Several foreign banks already maintain big offices in Shanghai. Deutsche Bank, for instance, now has 340 staff mostly focused on sales and trading and wealth management, up from just 20 a decade ago. The big German bank maintains its AsiaPacific headquarters in Hong Kong, where it employs 1,700 people.
By 2015, the central government's goal is for Shanghai to have significantly expanded the city's pool of internationally trained finance professionals and to boost trading volume in areas other than foreign exchange to one quadrillion yuan annually, enabling the city to stack up well against other global financial centres such as New York and London. Ultimately, Shanghai's burning - and well publicised - ambition is to become China's international financial centre by 2020.
Underscoring the rivalry, the Pudong New Area now boasts a landmark skyscraper named Shanghai IFC, built by the same developer who built one of Hong Kong's tallest office buildings, Two IFC, at the International Finance Centre.
In April 2009, the State Council, China's cabinet, led by Premier Wen Jiabao , announced the central government would pull out all the stops to make Shanghai an international financial centre by 2020. The decision was made "to reflect China's economic power and to show the importance of the yuan on global stage", the cabinet said at the time.
In January, Beijing rolled out a follow-up plan to make Shanghai the country's largest onshore yuan market within three years, which many bankers and analysts say will pose a direct challenge to Hong Kong's offshore yuan market in terms of trading volume and business potential.
The expected ascent of Vice-President Xi Jinping to the top position of president in a once-in-a-decade leadership change later this year won't hurt Shanghai's chances of winning policy favours from the central government either. Xi has close ties to Shanghai and was previously the city's top boss. He has said he believes the financial industry is key to Shanghai's development.
But signals emanating from the top ranks are mixed. When Li Keqiang , one of four vice-premiers and the heir apparent to Wen, made an official visit to Hong Kong in August, he assured the Hong Kong people that the financial industry was "crucial to the future development of Hong Kong" and that the central government would support Hong Kong continuing to be "a leading financial centre for the world and Asia".
Partly to cool the growing tension between the two cities, the top Communist Party boss in Shanghai, Yu Zhengsheng , said at a meeting of the National People's Congress in March that "China is such a big country that the two cities (Shanghai and Hong Kong) can certainly find the most suitable function for each."
Yu also noted it is not necessary for China to have just one financial centre, but he didn't answer the question that has bothered the public, and in particular the financial community in Hong Kong and Shanghai, for years: which city is going to play the leading role for China?
Currently, because of Shanghai's high tax rate, many senior bankers prefer to be based in Hong Kong, from where they can oversee their lower-level employees in Shanghai. The local government of Shanghai is aware of the tax issue and it has tried to offer up to 20 per cent tax rebates for selected senior executives at major international financial institutions that agree to set up China or Asia-Pacific regional head offices in the Pudong New Area.
But given many limitations and the relatively small number of people who would actually get the tax relief, the effort is not attractive enough to build a base for a global financial centre, according to senior executives at foreign banks in China.
Wang Qishan , a vice-premier who is the most senior official at cabinet level in charge of the country's financial industry, paid a visit to Shanghai late last month and praised the city for its "so far, so good" development towards becoming a global financial centre. But critics say there is a lot further to go in terms of boosting trading volume and diversifying financial products in a more transparent market environment.
Also, Shanghai's record for implementing market developments is patchy. For instance, the city has been talking for years about creating a so-called international board to provide secondary listings for interested overseas multinationals such as Coca-Cola. But the board's launch has been repeatedly put on hold.
"To be an international financial centre, you have to basically meet four requirements: you need to have a large amount of investors; a large amount of companies willing to issue securities; a large amount of intermediaries such as brokerages, accounting firms and law firms; and a solid legal infrastructure," said Fang Fang, head of China investment banking at JPMorgan. "In my view, Shanghai still has a long way to go as an international financial centre."
The bottom line, some foreign and mainland bankers say, is that eventually Hong Kong will have to face facts. "While many doubt whether Shanghai has the soft power, such as talent, rules and regulations, to become an international financial centre overtaking Hong Kong by 2020, we believe all these obstacles can be overcome gradually," said Erwin Sanft, chief strategist for Asia equities at BNP Paribas.
(Additional reporting by Lulu Chen and May Chan)
Photos: Chinese flags seen on the Bund, Shanghai's historic waterfront; The headquarters building of Bank of China on the Bund (George Chen/SCMP)
Q & A
Two financial industry veterans share their views with George Chen about Shanghai and Hong Kong. Bob Partridge, an American who is managing partner, Greater China, for transaction advisory services at global accounting firm Ernst & Young, lives in Hong Kong but splits his time between the two cities. Christine Ip is Hong Kong chief executive of Singapore's United Overseas Bank. A native of Hong Kong, she lived in Shanghai for more than five years while holding senior posts at Standard Chartered and ANZ Bank of Australia.
Why do you like to live and/or work in Shanghai?
Bob Partridge: Many multinational corporations use Shanghai as their China headquarters. In working with clients, it's critical to spend time with the people.
Christine Ip: I feel I can be part of the ''growth story'' of China when I am in Shanghai.
Why do you like to live and/or work in Hong Kong?
Partridge: Hong Kong is filled with great [international] communities, a welcoming sense for anyone not originally from Hong Kong. It has the best airport in the world.
Ip: Financial innovation, freedom of speech … plus a deep talent pool.
What do you dislike most about Shanghai?
Partridge: The traffic. In Shanghai, you often need an extra 30 to 45 minutes to plan on getting anywhere.
Ip: The lack of a truly international legal framework, and an uncontrolled agenda from the government and the [Communist] party.
What do you dislike most about Hong Kong?
Partridge: The summer humidity.
Ip: Aggressive media, and the Hong Kong government's poor management.
Do you believe that Shanghai can overtake Hong Kong by 2020 to be China's dominant international financial centre?
Partridge: By 2020 Shanghai will achieve its goal of being a major global financial centre. It is more likely that Shanghai will be on par with Hong Kong.
Ip: No, I don't think so. Again, because of the lack of a truly open international legal regime. In this case, Shanghai can only be the national financial centre for China.
What is Hong Kong's biggest advantage that will be difficult for Shanghai to copy?
Partridge: There are two of them – the low-tax environment, which is very attractive – and the wealth of talent in the services industries.
Ip: A legal regime and upright sense of anti-corruption.
What is Hong Kong missing to compete effectively against Shanghai?
Partridge: There isn't a specific thing that Hong Kong lacks. Hong Kong should stay focused on some of its core competencies such as services.
Ip: Size of market. Hong Kong is still like a ''stepson'' [to China] while Shanghai is the legal son.
Hong Kong or Shanghai Where will you advise your children to live and work in the future?
Partridge: As I do not have children, I have encouraged my nephew to study Mandarin and to find an opportunity in Shanghai.
Ip: Shanghai, where they can really grow together with the China story.
(This article was first published in South China Morning Post on May 18, 2012. The author is Financial Services Editor for the Post.)