Just some additional thoughts though, one very important thing we cannot overlook… talent. Can Shanghai actually attract and pull the talent away from Hong Kong? Not in my career. first, the tax regime is almost double. Non-Americans only pay 16%ish in both Singapore and HK. Are jobs in Shanghai going to tax equalize that gap? Why would they. second, quality of life. I lived in Shanghai for 4 years and speak Mandarin, and I loved my time there. But we are decades away from Shanghai being in the state that HK is in, in terms of being cosmopolitan and being able to survive on English only. As they have been saying about shanghai for a decade already, the hardware is all there, but the software is 20 (people/culture) years behind. Just some thoughts.

It can only help accelerate the merger of HK-Shenzhen.

China’s gain is HK’s gain, if HK can position herself correctly as an onshore city and not be marginalized.

HK has a delicate game to play, but like New Yorkers, they cannot be #2, HK will be pragmatic like she has throughout her history.

HK’s foreign status, though sheltered her, allowed her to groom rule of law, independent financial market, is GOOD up until China can do the same.

Then, HK must adapt and play the Shenzhen card to be relelvant.

Hong Kong-Shenzhen merger in 2047 when SAR status end, I GUARANTEE YOU that NPC/CCP will make Hong Kong-Shenzhen their primary financial center.

HK-Shenzhen will give Shanghai a run on her money.

To me, the answer to your question is a no-brainer – it has to be Shanghai. To qualify for a country’s “financial center”, where the entire nation’s wealth/capital changes hands every second, it has to be within that country. US is NOT going to have its financial center in BVI or Cayman, even if tax rate there is zero and there is free flow of capital…and they even use US$. You can think for a second why that’s the case. To a foreigner, HK might have been part of China already for a long time, but to mainland Chinese, it’s still very foreign. As a Chinese citizen, I need a visa to go to HK, although that process has been simplified because I’m Shanghainese. Try someone from a smaller town, chances are they’d need months, if at all possible, to go to HK, even today. HK essentially uses US$, a foreign currency, however convertible that is. The Mandarin capability of average people in HK is disappointing to say the least. In addition, legal system, business practice are very different. Maybe these may sound non-issue, maybe even advantage from a foreigner’s perspective, these are distinct disadvantages for HK from a Chinese perspective. Imagine yourself being a Chinese entrepreneur or a Chinese investor, why would you go to a place this “foreign” if you can do easily in a familiar place as Shanghai where you can go anytime you want, use your own currency (no exchange inefficiencies), and talk the same language? From the Chinese (or any major economy) government’s perspective, it’s main financial center has to be onshore – otherwise how would you regulate and control it? Remember capital is lifeblood of an economy. As long as HK stays offshore (needless to say other soft “foreign” components), the best role it can play is an offshore financial center and by definition secondary.

Even if HK resolves all the above issues, HK’s ability to become a true financial center is questionable from its track record. HK has had a free capital market for a while, however, I’m very surprised at HK’s current level of sophistication and innovation in financial products and services offered. The stock market is still very retail; margin trading/shorting is not commonplace; an investor can’t write stock options, which in itself is very limited in offering in the first place. HK has also missed the recent development in commodities – Singapore, its southern cousin, has a much better grasp there. Is this co-incidental? I don’t know, but it appears to me there is just not enough local talents in this small island – most talents are imported. There is nothing wrong being “imported”, but innovation and change need to be driven by the local people, not those imported who tend to come and go quickly.

One explanation to the above is any innovative product/service must be driven by demand. Being offshore, you are far from buy side and it’s just difficult to be innovative if what you sell is very likely to be restricted by Chinese regulation in the end. Of course that still does not explain why Singapore can do so much better in financial innovation than HK so far.

On the other hand, as an onshore center, Shanghai has all the advantages HK does not have. Moreover, when you have a big country like China, talents/innovation will emerge over time in line with domestic demand. You should remember who bid $1.6M to lunch with Buffet the year before – he and some of his friends in that lunch are running a few good hedge funds in China. Check out if you have not heard of them.

Lastly, about rule of law/regulation vs. functioning markets – I think a financial market is first developed when there is demand. The market itself will then force regulation to improve. Even in the US, things are being improved all the time. China may still have a lot of issues in its market regulation today, the pressure from its own economy for an efficient capital market is huge and increasing. Regulatory changes will be forced to follow – whether that happens proactively or passively. Whilst even if you have a very functional market, demand might not follow.

If you are still not sure of Shanghai market’s market cap and liquidity, check out yourself. To me, after seeing how world markets reacted to Shanghai stock market in end March 2007 (I might be wrong in the year), I know we are entering a stage of mutual influence and correlation. If you can somehow trade the Shanghai stock market, you’ll know what I mean. It’s no longer that isolated – and the messsges from the Shanghai market has been apparently influencing other markets, vice versa. On top of that, Shanghai’s commodity markets (particularly copper, and more recently steel) are very obviously gaining importance on world stage – guess it’s not too surprising for the world’s largest commodity consumer to have a liquid commodity market…

To summarize, it’s natural for a large economy such as China to have its own major financial center. But that has to be onshore. Offshore is just complement. US has its financial centers in NYC and Chicage, but not BVI or Cayman. HK can become a successful wealth management center, but to become China’s primary financial center, it has a big barrier to overcome to even be able to compete with Shanghai.

“The real concerns …a [] government far too involved with commerce, heavily invested in its own listed companies, and practicing the self regulation of its own market”–well, I could fill in the blank with “US” and the sentence would still work wouldn’t it? I agree that Shanghai is still way behind but I do not believe these are the real reasons.