Hong Kong Builds Financial Bridge to Mainland

Terry Flanagan

Due to the close geographical and political relationship between Hong Kong and mainland China, understanding of and access to mainland markets is better in Hong Kong than anywhere else globally.

In recent years, this access to the mainland market has significantly changed and increased the importance of Hong Kong as a financial market especially for investors looking to trade China.

Hong Kong serves as the main bridge for this inward investment and there are programs such as the Qualified Foreign Institutional Investor (QFII) program, RMB QFII and regular foreign direct investment (FDI). In addition, there are also some indirect ways to access the market such as investing in Chinese companies listed on the Hong Kong Exchange (HKEx), according opt a report by data center provider Equinix.

“Hong Kong is trying to become the hub for trading in and out of mainland China,” said Barry Smith, head of capital markets at Equinix. “The number of listings of Chinese companies in Hong Kong is almost 50%. As that growth continues, people need an easy efficient mature market to tap into those markets in the equities side.”

With the growing trading volume of institutional investors and foreign investors, the demands for high frequency trading, algorithmic trading and global portfolio management are increasing which is pushing the need for faster hardware speed and a larger tech footprint in order to establish a competitive advantage in trading, according to the report.

The Hong Kong FX market is the 6th largest FX market in the world, and market makers consist of commercial banks, deposit-taking companies and FX brokerages. FX spot, forwards, swaps, options and other derivatives are traded in the HK FX market. Derivatives including swaps, futures and options are traded in the OTC market and include FX, Interest rate commodity and equity related derivatives.

“In FX, the issuance of bonds has increased significantly throughout Asia. A lot of that has been driven by China and the growth of their infrastructures,” said Smith. “As their government floats out more renminbi, the FX pie should get bigger.”

Hong Kong’s OTC derivatives market has been developing alongside the debt market with a strong focus on interest rate derivatives. “As bonds float, international investors who hedge currency and interest rate risk associated with that drives other derivatives instruments, whether FX derivatives or interest rate swaps,” Smith said. “We should see growth in those areas.”

Previously, manual confirmation CDS and IRs derivatives trading led to high latency and operational risks in the OTC derivatives market. Still, although electronic trading has increased, only a minority of the IR and CDS products traded OTC are traded electronically. This will likely shift in the future as trade “electronicification” of OTC trading is a focus of Hong Kong regulators, the report said.

With the implementation of Basel III, banks no longer find it attractive to lend to long term infrastructural projects because of the higher capital charge required to hold these assets on their books. “Many European banks, which were very active in infrastructural financing in Asia in the past decade, have reduced their exposures in this area and will continue to do so in the future,” said Norman Chan, chief executive of Hong Kong Monetary Authority, in a February 28 speech. “So many infrastructural projects in Asia are now finding it increasingly difficult to secure the necessary finance.”

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