Cepa paves way from Hong Kong

When Hu Jintao, China’s president, visited Hong Kong last weekend to mark the 10th anniversary of Chinese rule in the city, he arrived bearing goodwill and gifts.

The city received a pair of young pandas, which are already drawing crowds of locals and tourists. Mr Hu also officiated at the opening of a new highway linking Hong Kong to neighbouring Shenzhen. Perhaps the most important gift, however, was the pronouncement he made after inaugurating Hong Kong’s new cabinet, hailing a further expansion of the Closer Economic Partnership Agreement.

Beijing and Hong Kong originally signed this trade accord in 2003 after the Sars epidemic had left Hong Kong’s economy in the doldrums. The first phase eliminated tariffs on Hong Kong products entering the mainland but Cepa has since been expanded to give service providers preferential treatment in entering otherwise closed Chinese market sectors. Cepa has so far generated an additional HK$5.1bn ($650m) of capital investment in Hong Kong and HK$9.2bn in the mainland from companies from the two regions and overseas, the Hong Kong government says.

The openings are intended to give Hong Kong companies an advantage over foreign groups in entering the vast Chinese market. But Cepa has also benefited foreign companies that have set up operations in Hong Kong. Under Cepa rules, companies need only to be incorporated in Hong Kong and have had three to five years of substantive operations in the city to be eligible.

Just hours before Mr Hu landed in Hong Kong on Friday, his commerce minister, Bo Xilai, oversaw the signing of the fourth phase of Cepa, under which the central government is to implement 40 liberalisation measures in 28 services areas. The new agreement, which will take effect next year, expands Cepa to cover elderly care, green technology and public utilities, and also furthered liberalisation of the banking, legal and tourism sectors. Hong Kong banks with assets of at least $6bn, for example, are now eligible to acquire a stake in a mainland bank. The previous requirement, which still applies to foreign banks, is for investing institutions to have at least $10bn in assets.

Beijing had been expected to allow Hong Kong securities brokerages to set up branches on the mainland. Instead, mainland fund management companies will now be able to set up subsidiaries in Hong Kong.

“It is bringing only competition and not business,” says Joseph Tong, executive director at Sun Hung Kai Financial Group, Hong Kong’s largest local non-bank financial institution. SHK, which manages more than HK$50bn, courts wealthy mainland investors who can invest outside China using foreign currency. Like many foreign brokers and wealth managers, however, the company has so far been barred from directly entering the mainland market.

In theory, foreign groups could buy up to 33 per cent of a mainland brokerage, but the China Securities Regulatory Commission stopped taking investment applications two years ago. So far, only UBS has succeeded, winning regulatory approval in 2005 to buy 49 per cent of Shenzhen-based China Dragon Fund Management. The CSRC is expected to review requirements on foreign acquisitions of domestic brokers in December.

“Our strategy is simple: We always try to grab the high growth area,” Mr Tong says.

While unable to offer its services within China, SHK has set up liaison offices in Shanghai, Shenzhen, Nanjing and Guangzhou and holds investment seminars in those cities in partnership with mainland brokers. Chinese investors who can bypass capital controls find the Hong Kong market attractive because of the large discount shares of the dual-listed companies usually trade at in Hong Kong as compared to Shanghai. Recent market jitters in Shanghai have let to a surge in queries for SHK.

“It is not really a hedge for [mainland investors] since the Hong Kong shares would also be affected if a company’s Shanghai shares crash, but it is a good diversification,” Mr Tong says.

He fears, however, that after the latest Cepa agreement, these mainland investors will prefer remaining with mainland fund managers when investing in Hong Kong. “If I were a Hong Kong official, I would not have accepted this.”

At the signing of the latest agreement, Henry Tang, Hong Kong’s former financial secretary, said: “The implementation outcomes indicate that Cepa is a mutually beneficial arrangement, allowing Hong Kong to explore the vast mainland market while assisting the mainland in integrating with the world economy.”

That process of integration, however, will still take several years, says Mr Tong. In the meantime, Hong Kong wealth managers and brokers will still have an advantage over mainland counterparts. “We have been here almost 40 years. We know the Hong Kong market well and can give good advice on stocks,” he says. “But they will also improve themselves.”