Chris Devonshire-Ellis: China’s Financial Center, Shanghai or Hong Kong?

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Op/Ed Commentary: Chris Devonshire-Ellis

Jul. 26 – One of Shanghai’s vice mayors, Tu Guangshao, stated last week that it would be preferable for Shanghai to be China’s main financial center, and should be promoted over Hong Kong to capture global attention on China’s markets. While Shanghai Communist Party chief Yu Zhengsheng has conceded that Shanghai would not catch up with Hong Kong until 2020, the polarization of both cities as China’s main financial center is an issue that still has a long way to go before being resolved.

Tu was the co-author of an influential report citing that Shanghai and not Hong Kong should be China’s premier international financial center in the longer term, and recommended measures to make Shanghai a top international financial center by 2020, a policy adopted by the State Council in 2009.

“In the long run, it is impossible for China to have two international financial centers,” said the report, which was issued by the Brookings-Tsinghua Center for Public Policy, the Beijing branch of the U.S.-based Brookings Institution. “China will finally have only one financial center and that is Shanghai.”

Several senior mainland officials co-authored the report, including People’s Bank of China governor Zhou Xiaochuan and Yi Gang, director of the State Administration of Foreign Exchange and deputy governor of the central bank.  John Thornton, chairman of the Brookings Institution and a former Goldman Sachs Asia chief also contributed to the report, which recommended making the yuan fully convertible within a decade, a prerequisite that will enable Shanghai to be an offshore yuan center.

Not all authors were in agreement. Tu mentioned that in the eyes of the foreign observers, “Hong Kong is not like Shanghai, for it is only a regional market. Overall, in foreigners’ eyes, Hong Kong is only part of China. Anyone having long-term strategic vision would say China’s financial center will be in Shanghai. It represents how the world looks at China.”

So which city should be the top dog for China?

The comparisons at times can be off-kilter, and Shanghai’s politicians are long noted for their aggressiveness in making statements concerning Hong Kong. I recall previous vice mayors stating that by the time of the Beijing Olympics, Shanghai would already have overtaken Hong Kong as a financial center, however this has not happened. What then, are the differences between the two cities and what needs to be done to truly make Shanghai an international financial center to rival or even overtake its southern counterpart?

Shanghai as a financial center
It is important to recognize that Shanghai today is not an international financial center, although the city certainly likes to promote the fact that it is. There are a number of restrictions that apply to Shanghai that do not apply currently to the markets and status of Hong Kong. These include:

  1. The RMB Yuan as an internationally tradable currency: Until China changes the current policy over the yuan and permits it to be a freely tradable currency, Shanghai cannot be an international financial center. The Hong Kong dollar is a tradable currency on the global currency markets. Consequently, currency trading is endemic in Hong Kong, and licensed money changers can be found on the streets. Mainland China maintains currency controls and until this is eased Shanghai will remain a yuan-denominated market only suitable for domestic China trade.
  2. Mainland China stock markets are not open to foreign investors: Although the indexes in Shanghai are quoted internationally as a benchmark, in reality they are no such thing. Foreign investors are not permitted to purchase Mainland China stocks on the Shanghai or Shenzhen bourses, and in any event, the proportion of stock held by the government remains unfeasibly high to evade concerns over market fixing or vested interests. There is, in short, no direct link between the Shanghai market and any impact on stocks held in international jurisdictions. Quite why the Shanghai index continues to be regarded as influential when compared to internationally tradable markets in Hong Kong, Singapore and Tokyo continues to bemuse me.

A reform program is to be put into place to permit foreign companies to list, but this is rather different from allowing access to mainland stocks by foreign institutional investors. The China government has a great need to get out of stocks it holds in its listed state-owned enterprises, and it needs to release the majority of these into public holdings. The problem is that in doing so, the massive amount of shares that would come onto the domestic market would seriously deflate prices. China is caught between managing stocks in companies it owns in a market it remains the regulator of, and the alternative is being out of stocks and appointing an independent regulator. Neither of these two scenarios is under state consideration at the present.

Hong Kong’s rule of law
Hong Kong still maintains a British-derived legal system, and has had a stock market since 1891. The market, Asia’s second largest after Tokyo, has developed and retains a sound legal and regulatory system used to the dealings, disputes, claims and liabilities of international finance. Although Hong Kong does have a regulatory conflict between its commercial and regulatory position, generally speaking the market is well managed and possesses global credibility. Market manipulators, insider dealers and fraudsters are routinely jailed when caught, and the city retains an independent commission against corruption to monitor and look into such activities.

Mainland China is not in a position to provide that for Shanghai unless a massive evolution in the regulatory conflicts between state and commerce is undertaken. The past behavior also of some of China’s own investment funds, including government-backed ones such as GITIC, and the constant play between China and Hong Kong over asset holdings and evasion of liabilities dictate that neither are many of mainland China’s financial and political hierarchy able to fully appreciate the concepts of transparency and financial responsibility.

China needs to implement an independent financial and regulatory body separated from the government; to ensure that financial trades and dealings are transparent, and to ensure that insider dealing and fraud are routinely punished by prison – no matter who they are. Hong Kong’s legal and regulatory system is in place, works, and is familiar to those who use it. For Shanghai to succeed, that complete infrastructure needs to be put into place from scratch. It is not in place at the present.

In terms of the Brookings-Tsinghua report, its Highlanderesque statement that “there can only be one” also seems odd. Why does there only have to be one? Last time I was in the United States, both Chicago and New York seemed to be doing OK in terms of having worked out their respective positions viz-a-viz competition and collaboration, and in any event Hong Kong and Shanghai, rather like Chicago and New York are totally different animals. The real issue today is that Shanghai serves, and will continue to develop to serve, the raising of capital in yuan denominations for business expansion on the Chinese mainland. The soon to be announced reforms that will permit foreign businesses to list in Shanghai are therefore to be welcomed. It’s a far more preferable route than having to bring in investment capital from the overseas parent as is currently the case. Hong Kong meanwhile remains a sensible choice for regional and Mainland Chinese firms to raise foreign currency for business expansion plans in Asia. The system is far from broke, and there isn’t any real need to change it.

The real concerns about Shanghai and its taking over from Hong Kong remain much the same: a Mainland China government far too involved with commerce, heavily invested in its own listed companies, and practicing the self regulation of its own market. Add to that concern over China audit capabilities, transactional transparency, rule of law and a basic understanding of what a free market really is, and Shanghai remains not 10 years behind, but decades.

Chris Devonshire-Ellis is the principal of Dezan Shira & Associates, a foreign direct investment practice he founded 18 years ago. The firm provides corporate establishment, due diligence, and business advice, in addition to tax, accounting and audit assistance. The practice maintains ten offices in China, five in India, and two in Vietnam. Contact:

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18 thoughts on “Chris Devonshire-Ellis: China’s Financial Center, Shanghai or Hong Kong?

    Tim says:


    Excellent analysis posts recently. This appears to be an issue that comes up once or twice every year. The very fact that the government believes that they can determine which city will become the international financial center underlines, for me, the fault in their reasoning.

    Chris Devonshire-Ellis says:

    Thanks Tim. China’s A shares just tanked by 23% the last quarter so it’s not going to be easy for them. I predict a rather bumpy ride ahead. As for Shanghai, it’s all nonsense really. No fund management talent, no experience in running an international financial center, and no regulatory infrastructure. If they promote that ahead of Hong Kong it’ll be time to head for the hills. Or India, where they do know how to run such things. – Chris

    Jeffrey Jin says:

    “Mainland China stock markets are not open to foreign investors”–this is not accurate i.e. the QFII system exists, despite its limitations.

    “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.

    Jacks says:

    I think Vice Mayor Tu Guangshao can project, and wish as he likes, but Shanghai is no Hong Kong and never will be.

    Chris Devonshire-Ellis says:

    @Jeffrey – thanks, yes I recognise your point. But QFII is still rather small, although has potential, especially for Hong Kong. All countries have government involvement in commerce, including the US of course, but I don’t think to the extent China currently has. Getting the China government out of business is going to take awhile and is a reform process;
    @Jack – Vice-Mayor as salesman perhaps? It is part of the job description I usually find.
    Thanks for your comments – Chris

    Jeffrey says:

    Chris – read your article but think some content there are rather dated and thus could result in a misleading conclusion. I am a Shanghainese so could be biased – but I’ve worked in China, HK, UK and US, and have quite a few years of trading experience in various markets in NY, HK, Shanghai and London, so I’ll speak my minds here anyways.

    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.

    Chris Devonshire-Ellis says:

    Very good points and arguments for Shanghai Jeffrey, I appreciate your sharing them with us. I’m sure you’re right in the longer term, however I thin k you’re painting a scenario that will be possible in 25 years and not ten as the Shanghai Vice Mayor suggested. But that timeframe and the issues you pointed out are more than feasible. Many thanks – Chris

    RW says:

    Hong Kong has to pull the Shenzhen card in order to be relevant on the mainland.

    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.

    RW says:

    Shanghai’s gain via RMB convertibility and rule of law is Shenzhen’s gain as well.

    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.

    Russell Jacobsen says:

    Chris, I like this article on shanghai vs china

    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.

    Steve says:

    This topic was actually the front page story of the national newspapers in Oman today…

    Big Ben says:

    Hong Kong and Shanghai basically complement each other more than being rivals. Basically Hong Kong is increasingly more similar to London while Shanghai could become like New York or Tokyo. Technically, one can describe the difference between a “global financial center” (more offshore focused activities) and an “international financial center” (onshore domestic focused). Even when the RMB opens up, there will be more than enough room for both cities to prosper as neither Shanghai or HK would not have the capacity to become both onshore and offshore.

    Big Ben says:

    If we take Tokyo, for example, it’s primary a market place for domestic participants to which foreign players are granted access to Japan. Whereas London is characterized by foreigners trading with each other. With New York, it has both largely because the importance of the USD and the US economy, but it is relatively much more domestic (a byproduct of the sheer size of the US domestic market). Hong Kong is moving towards the London model while Shanghai will end up being more like New York and Tokyo.

    Yup, some interesting points. Hong Kong is essentially China’s opening to international finance, and Shanghai to domestic finance. That will become more obvious when finally foreign companies are allowed to raise RMB for expansion into China; at present that has to be all foreign invested, which is not normal for an economy the size of China’s. A couple of trials are taking place right now. When that happens the distinction between the two cities will become more obvious.

    大元 says:

    I would say Shanghai is China’s financial center while Hong Kong is Asia’s financial center.

    …and what about Shenzhen then, China’s hottest investment bourse this year to date? – Chris

    大元 says:

    Shenzhen is ultimately an extension of Hong Kong, part of the Pearl River Delta.

    ‘One Mega-City, Many Systems’: The Evolution of Hong Kong

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