Hong Kong: Banking and Financial Services

Hong Kong is a fully-fledged international financial centre, and all types of financial services are readily available in a business environment which combines light but effective regulation with low taxation.

Hong Kong has one of the largest representation of international banks in the world: about three-quarters of the world's 100 largest banks have a presence there. Hong Kong is a top-ten international banking centre in terms of the volume of external transactions, and the second largest in Asia after Japan. The banking sector plays a vital role in establishing Hong Kong as a major loan syndication centre in the region.

The Hong Kong banking system has emerged from the financial crisis in much better shape than many of its counterparts in the US and Europe. According to the Hong Kong Monetary Authority's (HKMA) Half-Yearly Monetary and Financial Stability Report, the consolidated capital adequacy ratio of locally incorporated authorised institutions edged up to 15.9% at the end of June 2011, from 15.8% at the end of 2010. The tier-one capital adequacy ratio (the ratio of tier-one capital to total risk-weighted assets) increased to 12.5%, from 12.2%.

In the first half of 2011, the aggregate pre-tax operating profit of retail banks’ Hong Kong offices rose by 22.4% from the same period last year. The return on assets also increased to 1.19% from 1.07%. According to the HKMA, the improvement was mainly due to higher fees and commission income and lower net charge for other provisions. Net interest income rose slightly as interest bearing assets grew fast enough to more than offset the effect of narrowing interest margin.

"The banking sector has so far been resilient to a number of external shocks, including the European sovereign debt crisis, a slowdown in the US economy and the US sovereign credit rating downgrade," the report observed. "However, given heightened uncertainties in the external environment and increased volatility in financial markets, continued vigilance is required about possible spillover effects of the debt crisis on the global banking system and the risk of a sudden outflow of funds."

The HKMA also cautioned that the increasing exposure of local banks to mainland China-related business in recent years should be
closely monitored, given the rate at which credit growth has outpaced economic growth in the past two to three years, contributing to surging property prices in China.

"The latent credit risk of rapid loan growth over the past two years, particularly in property-related lending and Mainland exposure, needs to be closely monitored. A forward-looking approach in managing the risk and sound underwriting standards are critically important in the current environment," the report noted.

At the end of September 2011, there were 151 licensed banks (128 of which were incorporated outside Hong Kong), 19 restricted licence banks (of which seven were incorporated outside Hong Kong) and 26 deposit-taking companies in business (all incorporated in Hong Kong). These 196 authorised institutions operate a comprehensive network of 1,300 local branches. In addition, there were 65 local representative offices of overseas banks in Hong Kong.

Total Employment in the sector is around 80,000. Banking assets amount to more than HKD10 trillion.

The banking system in Hong Kong is characterized by its 3-tier system, which is formed by 3 types of banking institutions, namely licensed banks, restricted licensed banks and deposit-taking companies, which are authorised to take deposits from the general public. The 3rd tier of deposit-taking institutions operate under different restrictions. Only licensed banks and restricted licensed banks can be called banks.

China

China's WTO accession, in addition to the Closer Economic Partnership Arrangement (CEPA) between Hong Kong and the mainland and the ongoing liberalization of the renminbi means that foreign banks, including Hong Kong banks can now provide more meaningful competition to local commercial banks. The Chinese authorities have also been racing to clean up major domestic banks, which were weighed down with bad debts and clunky administration.

Under the provisions of CEPA, the asset requirement for Hong Kong banks to establish on the mainland is being reduced to HKD6 billion (from HKD10 billion), making it easier for many of the SAR’s banks to set up in China. The major market liberalization measure in the banking sector under CEPA VII, which took effect on January 1, 2011, is that a Hong Kong bank that has maintained a representative office in China for more than one year can now apply to set up a wholly foreign-funded bank or a foreign bank branch. A Hong Kong bank's operating institution in China can apply to conduct renminbi business, if it has been operating for more than two years and has been profitable for one year prior to the application.

In December, 2006, eight foreign banks had applied for retail banking licenses in mainland China, as the country opened its banking market under WTO rules it agreed five years previously.

As of June 2011, there were 127 foreign banks in China, but until recently most of them were limited to handling foreign currency business, and in 2010 foreign banks accounted for just 1.83% of the country's total banking assets, or RMB1.7 trillion, up from 1.7% in 2009. Locally-incorporated foreign banks now total 40, and data from the China Banking Regulatory Commission shows that they accounted for 87% of all foreign banking assets at the end of 2010.

Nonetheless, foreign banks operating in China are "surprisingly confident" about their prospects in the Chinese market according to a 2011 report by PwC, entitled 'Foreign Banks in China', which found that most foreign banks expect revenues to grow over the next three years as the Chinese economy opens up to foreign investment and the central government takes steps to liberalize the renminbi.

In addition to organic growth, PwC's report concludes that foreign banks are pursuing strategic partnerships and making acquisitions where possible in many different parts of the financial sector.

"Indeed, it is the inevitability of this gradual defined process towards greater internationalisation of the economy that is underpinning the foreign banks' optimism. They believe that the opening up of the economy and the transition to a convertible currency must lead to increased opportunities for foreign banks," the report states.

However, the report found that while foreign banks believe that China offers "rich opportunities", they will only be able to exploit these opportunities if the playing field is level and China's regulators continue along their liberalising path.

The report identified a select group of six six banks which are said to be ahead of the competition in terms of customer base and branch networks. These banks include Hong Kong's Bank of East Asia, Hang Seng Bank, Citibank, DBS Banks, HSBC and Standard Chartered. This group estimates that they will collectively operate a network of 500 branches and sub-branches by 2014. A second group of corporate and investment banks has also emerged, according to PwC, which includes some major European and American institutions. The report additionally observed the emergence of a third group of mainly Asian banks with close trading and business links with China, and a fourth group of banks of various sizes from around the world that are focussing on niche markets such as wealth management, trade financing and foreign exchange.

The 42 banks interviewed for the report expect to grow employment by more than 50% by 2014, to over 52,000 people.

The HKMA and the China Banking Regulatory Commission (CBRC) signed a Memorandum of Understanding aimed at strengthening supervision of banks operating on both sides of the border back in 2003. The HKMA operates in effect as Hong Kong's Central Bank, while the CBRC was formed earlier in the year to take over banking supervisory responsibility from the People's Bank of China. The 15-department CBRC says its major responsibilities include "formulating supervisory rules and regulations for banking institutions, (and) authorizing the establishment, changes, termination, branching out and business scope of banking institutions.'' It is also responsible for dealing with problem deposit-taking institutions. The MoU calls for the two regulators to share supervisory information for banks operating in China and Hong Kong and they will work together to ensure that a parent bank exercises "adequate and effective" control over the operations of cross-border branches and subsidiaries. They will also meet formally twice a year.

A further development on the regulatory front came in 2007, when the Hong Kong Securities and Futures Commission (SFC) entered into an MoU with the China Banking Regulatory Commission (CBRC) for co-operation and information sharing with respect to Hong Kong licensed intermediaries who provide services to Mainland commercial banks conducting overseas wealth management business on behalf of their clients

“The MoU is conducive to further enhancement of the regulatory co-operation framework. It provides a solid foundation for the commencement of effective regulatory co-operation," stated Liu Mingkang, Chairman of the CBRC. "Through mutual assistance and information sharing, we can promptly identify risks, and take timely regulatory measures to protect the interests of investors.”

Liberalization of the Renminbi

In February 2004 the eagerly anticipated move to liberalise trading and exchange of the yuan in Hong Kong took its first step forward after the city’s banks were given the go-ahead to begin taking deposits in the Chinese currency. Analysts considered this an important first step towards Hong Kong becoming an offshore yuan trading centre.

An important Memorandum of Understanding (MoU) was signed between the the HKMA and the People's Bank of China on July 19, 2010, which has lifted restrictions on the provision of renminbi services by Hong Kong banks.

Following the expansion of the renminbi trade settlement scheme, the HKMA and the PBoC have agreed to strengthen co-operation and further promote Hong Kong’s status and role as a renminbi market platform in the process of developing renminbi business outside the Mainland. This was a major milestone in the development of offshore renminbi business in Hong Kong and a very crucial step in the implementation of the two guiding principles set out in the HKMA circular issued in mid-February that year.

The PBoC and Bank of China (Hong Kong) Limited, the Renminbi Clearing Bank, also signed a revised Settlement Agreement on the Clearing of Renminbi Businesses.

The Chief Executive of the HKMA, Mr Norman Chan, said: "Following the revision of the Settlement Agreement, there will no longer be restrictions on banks in Hong Kong in establishing renminbi accounts for and providing related services to financial institutions; and individuals and corporations will be able to conduct renminbi payments and transfers through the banks. I expect that many more types of financial intermediary activities denominated in the renminbi will be introduced in the market, helping Hong Kong’s renminbi business platform leap to new heights."

The renminbi trade settlement scheme, which was introduced on a limited pilot basis in July 2009 covering a handful of cities, has been expanded to cover the entire country and more types of transaction. Under the scheme, enterprises in China can settle their trade transactions, including merchandise imports, service trades and other current account transactions, in renminbi, with any part of the world.

With an expanded scope of trade transactions that can be settled in renminbi, corporates will as a result be able to better manage any exchange rate risks associated with their operations. Meanwhile, Hong Kong banks can also provide trade related services to customers not just in Hong Kong but also other parts of the world.

RMB trade settlement conducted through banks in Hong Kong in the first four months of 2011 amounted to RMB445bn (USD68.7bn), as compared to some RMB369bn in 2010. In addition, in the first quarter of 2011, 86% of the Mainland's RMB trade settlement was conducted through banks in Hong Kong, showing that Hong Kong is the prime platform for RMB trade settlement.

Driven by RMB trade settlement, RMB deposits in Hong Kong have also increased significantly and RMB financing activities became more active. In 2010, RMB deposits increased from RMB60bn in January to RMB310bn in December, and further to RMB510bn as of end April this year.

As of end April 2011, there were a total of 173 banks participating in Hong Kong's RMB clearing platform. Among these participating banks, 151 were branches and subsidiaries of foreign banks and overseas presences of Chinese banks. They represent, he said, a global payment network capable of handling RMB transactions, and providing RMB clearing services between the Mainland and different parts of the world, as well as among various offshore markets.

Banking Stability Review

The Hong Kong Monetary Authority (HKMA) announced in December 2007, that it will review its work in the area of banking stability, and appointed former Jersey banking regulator, David Carse as consultant to conduct the review.

The aim of the review was to make recommendations on how the HKMA can best discharge its functions in promoting the general stability and effective working of the banking system, taking into account recent and likely future developments in Hong Kong’s banking system, and the changing nature of the risks facing it.

The review was expected to be completed in about five months. It took into account developments including the globalisation of finance and banking business, the increasing integration of the financial systems of Hong Kong and Mainland China, the growing complexity of banking products, the increasing reliance of banks on information technology, the increasing need to combat financial crime, the changing nature of supervision, and the expectations of the community. Carse was charged with making recommendations on the focus and priorities of the HKMA’s banking supervisory functions over the next five years.

Securities Markets

Hong Kong is a top-ten securities market globally and the second largest in Asia after Tokyo. As of March 2000 the Hong Kong Stock Exchange and the Futures Exchange were merged into Hong Kong Exchanges and Clearing. The launch of the Growth Enterprise Market (GEM) in November 1999 for smaller and high growth companies has broadened Hong Kong's stock market, although the timing of GEM's launch was unfortunate, and the 'dotcom' shakeout in 2000 weakened its initial impact.

Generally, online securities trading in Hong Kong was an early casualty of the dot-com meltdown and the international equity slump, with a number of major US brokerages retreating from the SAR in 2001 almost as quickly as they had arrived in 1999 and 2000, but by 2003 it seemed that on-line trading would finally have its day in Hong Kong, as a combination of better technology, burgeoning interest from mainland visitors and the impact of SARS pushed on-line trading volumes to historic highs.

Hong Kong's securities market has been increasingly internationalised. There has been a continued rise in the participation of international investors in the market. Many of the initial public offerings through the Stock Exchange are also made global. The majority of these issuers are supernational bodies, whose issues are almost invariably accompanied by global fund raising.

At the end of the first quarter of 2011 there were 1,258 companies and a total of 8,200 securities listed on the Main Board. On the GEM there were 168 listed companies at the end of Q1, 2011.

Exchange traded funds (ETFs) have been a strong growth area for HKEx since the first one was listed in 2000. As of mid 2011, there were 76 ETFs listed on the exchange, accounting for about 3.5% of market turnover.

In the 2010/2011 budget, the Financial Secretary announced that a stamp duty concession in respect of ETF trading would be extended.

Another development for the exchange in the early part of 2010 was the launch of Flexible Index Options on February 8. Futures Exchange Participants can request HKEx to introduce customised strike prices and expiry months in Hang Seng Index (“HSI”) options and H-shares Index options for trading, subject to a volume threshold of 100 contracts. Flexible Index Options are bilaterally negotiated and executed as block trades. By providing central clearing and clearing house guarantee, Flexible Index Options allows HKEx to expand its services to the over-the-counter market for mitigating counterparty risk.

In 2010, the exchange also reviewed a proposal to introduce same-day securities and money settlement for stock exchange trades after a three-month consultation period closed on February 26, 2010.

Hong Kong Exchanges and Clearing (HKEx) introduced AMS/3, a third generation automatic order matching and execution system, in late 2000. In February 2001 it added an Order Routing System (ORS). ORS is an open system that enables investors to place stock market orders through the Internet, mobile phones and other electronic channels, which may be developed by HKEx or vendors. After an order is placed through an electronic channel connected to ORS, the system automatically sends the order to a Stock Exchange Participant for approval and submission to the market for matching and execution.

More than 100 Stock Exchange Participants have so far connected to ORS, and are able to offer their clients Internet trading. All Stock Exchange Participants, including those who have connected to the HKEx channel, will also be able to offer their clients electronic trading services, including Internet and mobile trading, through Proprietary Network System (PNS) channels provided by vendors.

CCASS provides settlement services under which securities are credited or debited to participants' CCASS stock accounts and funds are recorded in the participants' money ledgers on settlement day.

Details of all Exchange trades, including trade data and trade amendments, are electronically and automatically transmitted to CCASS by the Stock Exchange on each trading (T) day. There is no need for broker participants to input or further confirm their trade details in CCASS. Broker participants receive Provisional Clearing Statements of their stock and money positions through their CCASS terminals shortly after 1800 hours on each T day for reconciliation. Final Clearing Statements are available to broker participants shortly after 1400 hours on T+1 day for confirmation purposes.

In October 2010, HKEx published a paper to provide market participants with information about upgrades of AMS/3 and Market Data System (MDS). The upgrades, which are named AMS/3.8 and MDS/3.8 respectively, are scheduled for completion by the end of 2011. HKEx says they will increase the market's efficiency and transparency and pave the way for future growth.

Fund Management

Hong Kong is widely recognised as the leading fund management centre in Asia with the largest concentration of fund managers. The industry is characterised by its international and offshore nature.

In July 2010, Securities and Futures Commission's annual survey of fund management activities showed that fund management in Hong Kong rebounded strongly in 2009, despite the uncertain economic and investment climate.

The SFC showed that international investors continued to use Hong Kong as the platform for investing in the region, with fund management business growing to just over HKD8.5 trillion (USD1.1 trillion) as at the end of 2009, representing an increase of over 45% compared to 2008.

Overseas investors contributed almost HKD5.4 trillion (or nearly 64%) to that business, excluding real estate investment trusts (REITs). Meanwhile, the SFC has pointed out that an increasing number of Chinese mainland-related firms gained exposure to global investment practices via Hong Kong, using it as a springboard.

Licensed asset management and fund advisory houses continued to contribute the largest proportion of the combined asset management business in Hong Kong, recording the biggest year-on-year increase of 50% in the value of their aggregate asset management and fund advisory businesses, to a total of HKD6.45 trillion in 2009.

In addition, registered financial institutions recorded an almost 30% increase in their aggregate asset management and other private banking businesses, to HKD1.8 trillion.

Non-REIT asset management business increased by 57% to more than HKD5.8 trillion. Of this amount, HKD3.5 trillion worth of assets were managed in Hong Kong, with over 80% of these assets being invested in Asia. The market capitalisation of SFC-authorised REITs expanded 60% in 2009.

The report also highlights the growth of the exchange-traded-fund (ETF) market in Hong Kong, and the first-time cross-listing of ETFs in Hong Kong and Taiwan. As at the end of June 2010, 62 ETFs were listed in Hong Kong. The trading volume of the ETFs increased by 12.5% to an average daily turnover of almost HKD2 trillion in the year to June 2010, while their market capitalisation rose 30% to HKD180bn in the same period, making Hong Kong the second largest ETF market in Asia.

The report also notes the increasing number of mainland-related financial institutions setting up operations in Hong Kong. The total asset management and fund advisory businesses of mainland-related companies that participated in the survey increased 70% in 2009 to HKD155bn.

Separately, the SFC has reviewed the growth of the retail fund business in Hong Kong since the establishment of the SFC in 1989. It found that the number of retail funds offered to the public has grown from 783 at the end of 1989 to 1,980 in 2007. In value terms, the size of retail funds has grown 22 times, from HKD283 billion to HKD6.1 trillion over the same period.

Although many hedge funds have been managed from Hong Kong, until 2002 these were exclusively for professional investors. In 2002 however the Securities and Futures Commission issued guidelines permitting certain types of hedge fund to be offered to retail investors. Hong Kong's Securities and Futures Commission (SFC) announced in February 2011 that it was proceeding with proposals to refine the requirements for evidencing whether a person qualifies as a high-net-worth professional investor.

The purpose of the proposals is to create more flexibility by adopting a principles-based approach whereby firms may use methods that are appropriate in the circumstances to satisfy themselves that an investor meets the relevant assets or portfolio threshold to qualify as a professional investor under the Securities and Futures (Professional Investor) Rules.

• close economic ties with the Mainland
• a well-established, deep and liquid market
• a world class regulatory regime
• a broad range of investment products
• a critical mass of financial talent with international exposure and Mainland
  experience

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