20 April 2017
Belt and Road Opportunities for Hong Kong's Financial Services Sector
HKGCC magazine "The Bulletin"
The Mainland’s Belt and Road initiative seeks to promote regional economic growth through economic and trade cooperation among over 60 countries and regions along the Silk Route Economic Belt and 21st Century Maritime Silk Road. Of the initiative’s five major goals, policy coordination, facilities connectivity, trade and investment facilitation, financial integration and people-to-people bonds; facilities connectivity mainly in the form of infrastructure development has emerged as a top priority.
Hong Kong’s role in the Belt and Road Initiative
As the Belt and Road Initiative covers over 60 countries, this implies complex corporate treasury operations that include such elements as cash flow management, foreign exchange, cross-border payments, risks and liability control. Therefore, a regional corporate treasury centre (CTC) would be required to centralize all treasury functions so that multinational corporations can enhance operational efficiency, reduce foreign exchange exposure and risk, as well as achieve economies of scale in treasury operations.
Hong Kong is already a premier CTC in Asia. Hong Kong’s advantage lies in its well-developed financial infrastructure including but not limited to its deep and liquid foreign exchange and money markets, absence of capital restrictions, stable and free exchange rates, and concentration of the world’s leading banks. Furthermore, Hong Kong possesses a simple and competitive tax regime, a common law system, an excellent pool of well-educated labour force and business professionals, as well as world- class transport and telecommunications infrastructure. More importantly, its proximity to Mainland China and its position as a premier offshore renminbi centre makes Hong Kong a preferred location for fulfilling Belt and Road projects. For all these reasons, Hong Kong is the first choice by far in Asia for many corporations, especially Chinese firms, to raise funds.
Singapore, which also shares many of Hong Kong’s attributes, is another leading regional CTC in Asia. Compared to Hong Kong, Singapore is more attractive to corporates whose main business is in Southeast Asia and India. The city also offers a favourable tax rate of 8% for CTCs, as well as a number of incentive schemes for global treasury businesses. In addition, Singapore has a distinct advantage over Hong Kong in terms of the 80 Double Tax Agreements (DTAs) it has signed. This is in contrast with the less than 40 DTAs entered into thus far by Hong Kong.
Geographic proximity is considered an important determining factor for treasury operations to function effectively. To this end, London is less ideal despite its standing as an international CTC due to its distance from the Belt and Road countries.
In comparison, Hong Kong is an ideal CTC location for Chinese companies that are expanding globally (including those participating in Belt and Road projects). It is also the preferred location for MNCs’ corporate treasury operations, which are increasingly trading in renminbi.
As mentioned above, external financing will be needed to bridge the immense funding gap for Belt and Road projects. Debt financing or debt securitisation can be considered a useful means to provide funding for these projects. In contrast to equity funding, this option allows governments to retain control over public projects while providing long-term investors with guaranteed returns.
This method of financing also has the advantage of supporting another key objective of the Belt and Road Initiative, which is to promote the internationalization of the renminbi. A sizable and market-determined renminbi-denominated debt market is essential to encourage non-resident corporates and investors to hold and use renminbi. The absence of large and liquid capital markets (debt, equities, derivative and money markets) offshore has hindered the global expansion of the renminbi. There is an urgent need for the Mainland to either establish a sizable debt market offshore or open up its onshore debt market as soon as possible. How- ever, as the latter remains heavily regulated and is dominated by public debt, this is unlikely to meet investors’ demands in the foreseeable future.
This is where Hong Kong can play a role. Hong Kong possesses a developed financial infrastructure for both debt securitisation and project financing. Hong Kong also has a diversified investor and issuer base, with foreign currency debts accounting for up to almost half of the local market. Although Singapore shares similar characteristics, Hong Kong has the edge due to a bigger pool of offshore RMB bonds.
In addition, Hong Kong’s vast and diverse investor base includes 201 authorized institutions, 158 insurance and reinsurance companies, and 594 Hong Kong- domiciled SFC approved funds. It is perhaps noteworthy that in 2014, more than 70% of the combined fund management businesses with some US$2.3 trillion in assets were sourced from overseas investors.
Hong Kong is also considered a major offshore RMB debt centre for infrastructure investments, including both structured debts and infrastructure bonds, com- pared to around 20 other offshore RMB clearing centres around the world, including Singapore and London. By the end of 2015, the total value of outstanding Dim Sum bonds in Hong Kong amounted to around 368 bi lion RMB, which far outpaced that of its second-placed rival, Singapore, which accounted for some 50 billion RMB (Q2 of 2015). There is also strong local appetite for diversified and longer-term investment vehicles such as debt, given that the offshore renminbi loan-to-deposit ratio in Hong Kong is still very low at 29.4% in 2015 (versus the overall loan ratio of around 70%). Moreover, continuous improvement of the offshore renminbi market infrastructure in Hong Kong will help attract global investors to trade debt in Hong Kong.
The Hong Kong SAR Government should lobby the AIIB to set up its treasury centre in Hong Kong. This would give rise to a cluster effect by encouraging other enterprises that possess or are planning to set up a CTC to choose Hong Kong for their operations as transactions would be more cost-effective when conducted in one place.
Although the Hong Kong SAR Government has introduced a 50% cut on corporate tax rate on prof- its (i.e. 8.25%) of eligible CTCs that are established in Hong Kong, this is contingent on such CTCs being standalone corporate entities or those satisfying the safe harbour rule under the current regime. It is recommended that this requirement be removed so that multinationals do not have to alter their corporate structure to enjoy the tax benefit. To do otherwise would undermine the benefit of and objective behind the tax concession.
Furthermore, the Hong Kong SAR Government should enter into more regional DTAs to enhance its competitiveness versus Singapore. Presently, some 47 countries have signed a DTA with Singapore but not Hong Kong. Many of these countries are located along the Belt and Road. A special unit under the Office of Financial Secretary should be set up to lead and oversee the negotiation process, with the aim of expediting the expansion of Hong Kong’s DTA network.
Debt financing centre
In light of the vast potential in debt financing of Belt and Road projects, Hong Kong is being presented with an invaluable opportunity to build up an enviable debt market that is comparable in size to that of the U.K. The Hong Kong SAR Government should, in conjunction with the private sector, proactively lobby the AIIB, NDB BRICS and SRF to issue foreign currency bonds, Dim Sum bonds and infrastructure bonds in Hong Kong. The role of the Infrastructure Financing Facilitation Office under the Hong Kong Monetary Authority should be expanded to include the function of a marketing agency for attracting more of such activities to Hong Kong.
The Hong Kong SAR Government should consider providing tax incentives (such as the deductibility of interest income on corporate tax) for companies to hold debt. This includes the extension of a tax exemption on interest income and profits derived from debt instruments issued by governments and multilateral agencies in all types of currencies. Currently, under the Qualifying Debt Instrument (QDI) scheme, interest income and trading profits arising from certain debt instruments are exempted from profits tax in Hong Kong according to Sections 14A and 26A of the Inland Revenue Ordinance (Cap 112). This includes RMB-denominated bonds issued by the Central People’s Government of the People’s Republic of China in Hong Kong, Exchange Fund Bills and Notes, Hong Kong Government Bonds and Hong Kong dollar- denominated multilateral agency debt instruments. In addition, the Government can also consider exempting profits tax on interest income and trading profits from debt securities issued by specific funds for infrastructure projects.
This article was firstly published in the HKGCC magazine “The Bulletin” September 2016 issue. Please click to read the full report.