Thursday, 28 May 2020

The End of Hong Kong’s Special Status Threatens China’s Grand Financial Ambitions

Scrapping the privileges the U.S. affords Hong Kong would downgrade the city’s economic role, but a broader basket of financial sanctions could be even more painful for China

Hong Kong is China’s main point of access to global finance.

PHOTO: NAVESH CHITRAKAR/REUTERS
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The U.S. determination that Hong Kong is no longer autonomous from mainland China has significant implications for the city’s exporters and businesses. But that could pale in comparison to further action by the U.S. to use its dominant position in the global banking system against Beijing.
The most immediate threat is the possible end of the city’s special status as separate from mainland China for import and export purposes under the Hong Kong Policy Act of 1992. Sensitive U.S. technologies could no longer be imported into Hong Kong, and the city’s exports might be hit with the same tariffs levied on Chinese trade.
But the act doesn’t cover the far more extensive role Hong Kong plays as China’s main point of access to global finance. That’s the context in which the Senate’s tentative discussion of penalties against banks that do significant transactions with “persons or entities that materially contribute to the contravention of China’s obligations” should be viewed.
As of 2019, mainland Chinese banks held 8,816 trillion Hong Kong dollars ($1.137 trillion) in assets in the semiautonomous city, an amount that has risen 373% in the last decade.
Cross-border lending by Chinese banks, by currencySource: Bank for International Settlements
.trillionOthercurrenciesU.S. dollarEuro2016’17’18’19’200.000.250.500.751.001.251.501.752.002.25$2.50Other currenciesxDec. 31, 2018x$0.71 trillion
That’s just a sliver of China’s $40 trillion in total bank assets, but much larger in relation to the $2.215 trillion that the country’s banks extend to borrowers outside the mainland. China’s banks do much of their international business, mostly conducted in U.S. dollars, from Hong Kong. With Shanghai inside China’s walled garden of capital controls, there is no obvious replacement.
While the U.S. doesn’t directly control Hong Kong’s status as a financial center, Washington has demonstrated its extensive reach over the dollar system, with penalties against KoreanFrench and Lebanese financiers for dealing with sanctioned parties. The U.S. recently threatened Iraq’s access to the New York Federal Reserve, demonstrating a growing willingness to use financial infrastructure as a tool of foreign policy.
Even though the U.S. can’t legislate Hong Kong’s ability to support Chinese banks out of existence, the role of an international funding hub is greatly reduced if your counterparties are too fearful to do business with you.
Putting the ability of Chinese banks to conduct dollar-denominated activities at risk would be deleterious to China’s ability to operate financially overseas, posing a challenge for the largely dollar-denominated Belt and Road global infrastructure initiative. It would also put the more financially fragile parts of the country, like its debt-laden property developers, under strain.
Beijing’s admittedly unlikely dream of an internationally influential currency also centers on Hong Kong as a viable global financial center—more than 70% of international trade in the yuan is done in the city.
Any action from the U.S. that strikes a serious blow to Chinese banks is likely to come in piecemeal stages rather than all at once. But the determination that Hong Kong is no longer autonomous could mark the beginning of a squeeze on China’s international financial operations, for which Beijing has no equivalent ability to retaliate.
Write to Mike Bird at Mike.Bird@wsj.com

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