China is cracking down, but Hong Kong’s economy is too precious to kill

Originally published as an op-ed in the Barron’s

In the 1990s, financiers used to mock “the FILTH”: British bankers or business people who “fail in London, try Hong Kong.” If you couldn’t make it anywhere else, you could still make it om the shores of the fragrant harbor whose ever-rising tide floated all boats. Hong Kong was the Manhattan, Las Vegas, and Los Angeles of Asia, all rolled into one—money, nightclubs, fast cars, world-class restaurants, stock-market booms, beaches, yachts, and dodgy go-go bars. It was a boomtown because it was the gateway to China. This was the staging post for the greatest gold rush of the 20th century: the reawakening of the Chinese dragon. Despite the recent crackdown on civil liberties, Hong Kong is far from turning into a financial backwater. As long as opportunity still exists, it will continue to attract foreign investors who feel more at home there than on the mainland.

Expats have long preferred Hong Kong to Shanghai or Beijing. The city boasts better schools, hospitals, and espresso bars. Google still works. Unlike on the mainland, business and society has felt free. While the British had never granted Hong Kong true democracy, the rule of law was clear. Private-equity firms enjoyed a fairly level playing field, taxes were low, the press was free, and the judiciary was independent. That’s why Britain fought so hard for the principle of “one country, two systems,” which was enshrined into law, for 50 years, when Hong Kong reverted to Chinese rule. China promised to give Hong Kong the democracy that Britain had denied its colony. Of course, the truth has emerged rather differently.

Suddenly, Hong Kong is out of fashion. Riots, the Covid-19 pandemic, and Chinese government repression have combined to scare away those same expats who made it their home. Six weeks ago, China imposed a broad national-security law on Hong Kong banning secession, subversion, and collusion with foreign countries. It’s already having a dramatic effect on the city’s media and politics. The new law eliminates civil rights that local residents have long exercised, and raises the specter of foreign business people being arrested for vaguely defined offenses and being deported to stand trial in China.

Beijing, far from liberalizing, is cracking down on dissent inside and outside its borders. The new security law explicitly applies beyond Hong Kong and covers non-Hong Kong residents, making this once freewheeling city dangerous for anyone viewed unfavorably by Beijing. Growing economic tensions between the U.S. and China have also led to tariff and nontariff barriers.

Last week, more than 200 police officers raided the head office of Apple Daily, the city’s most-read pro-democracy newspaper. Several managers were arrested, including the paper’s high-profile, millionaire owner, Jimmy Lai. Lai faces an array of charges, notably collusion with foreign countries, under the new law. He has a good relationship with the Trump administration and has testified before Congress in the past.

At the same time, China is trying to reassure the world that it should still do business with Hong Kong. For the foreseeable future, the city will still be the hub for inbound and outbound mainland investment. While Singapore has gained traction with private-equity professionals, boasting a transparent legal framework and increasingly broad tax treaty, Hong Kong is countering with incentives of its own. A new Limited Partnership Fund Bill hopes to establish Hong Kong as a prime Asian destination for private-equity and venture-capital funds. The legislation proposes Hong Kong as a domicile for private equity, venture capital, and real-estate funds and will attract private funds and family offices to Hong Kong. Domiciling in Hong Kong would give these firms direct access to the region and to Hong Kong’s robust capital markets. It will be a catalyst for growth in tech and financial services. 

Officials have also announced plans to introduce a new carried-interest tax scheme, expected to be one of the world’s most liberal, intended to make the city a viable alternative to the Cayman Islands, especially for Asia-focused funds. The Hong Kong government is also planning to provide extensive tax concessions for private-equity funds’ “carried interest” performance fees. Singapore offers similar advantages, but Hong Kong is aiming to be even more generous to investors.

All of this will be attractive to investors as Hong Kong is still swimming in wealth. Tycoons have outperformed almost everyone else. With a population of only 7.5 million, the territory ranks seventh in the world with 96 billionaires and a combined wealth of $280 billion, according to Wealth-X’s Billionaire Census 2020. Of all world cities, only New York can boast more billionaires.

Hong Kong is clearly now part of the People’s Republic of China and, prompted by the government, mainland money is pouring in,but there’s little sign of foreign capital fleeing. Foreign investors who want to share in China’s economic growth have little choice but to use Hong Kong’s capital markets as their main vehicle. The Hong Kong dollar has held its trading band against the U.S. dollar. The stock market has seen heavy inflows from mainland institutions, and there are more and more “red-chip” companies, based in mainland China, but listed on the Hong Kong Stock Exchange. The Hang Seng Index fell sharply in the first quarter but has recovered 14% from its March low. The index is still 9% off its peak from two years ago, yet rumors of Hong Kong’s demise may be exaggerated, or just plain wrong.

Even though China has put a harness around the neck of its golden goose, Hong Kong’s economy is too precious to kill. Vietnam and Singapore are certainly benefiting from Hong Kong’s recent woes as expats move in and fund managers direct more money into those markets. Still, as long as Hong Kong’s financial advantages remain, Western professionals and investors may find themselves back in the gleaming office towers of Hong Kong Central quicker than they expect.

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