Image Attributed to @LucianoInf

Now second only to South Korea as the biggest crypto market in Asia, Hong Kong's future might be one of decentralised ledgers, Bitcoin and Crypto-Currencies.

Hong Kong will always hold a special place in my heart. For just shy of two years from 2016 to 2018 I lived and worked in the city, and still today it sits close to the top of the list of my preferred jurisdictions for business incorporation. Hong Kong is, as ever, a great place to do business and with its grit and its tenacity is very much the New York City of East Asia, or at least, it was.

Every so often a need arises to clear up some business or banking in the city and so I find myself landing at its world class airport and dining at its world class restaurants with old friends and contacts. People who are close to the action and keyed in to the city's inner workings. Yet, as an infrequent visitor my eyes and ears observe changes not so obvious to those stuck in the daily grind, in the same way the ageing process is invisible from one day to the next, but stark and profound as the years roll by.

Hong Kong is struggling to reinvent itself. Before you boomers get all giddy with your 'muh China', hold on. This isn't an article about the Chinese Government, I rather want to lay out my thoughts around Hong Kong itself, as well as the city relative to its immediate region. I don't intend to make the case for Singapore, which, despite being arguably the greatest beneficiary of Hong Kong's headaches, is still a top contender for title of the most boring place in Asia. I intend only to outline the unique challenges and opportunities faced by one of the most magnificent - and least boring - cities in the world.

Gateway to the Middle Kingdom

Incorporating your business in Hong Kong still makes sense in many cases. Hong Kong is pragmatic, with systems and infrastructure that is well established to facilitate commerce and trade. Structures can be highly tax efficient, and while getting a bank account has become more difficult, once established, the banking services at your disposal are second-to-none. Hong Kong is still a respected jurisdiction globally.

Yet for entrepreneurs and companies alike the case for incorporating in Hong Kong has often been as part of an overall strategy to do business in and with the mainland. Because of the prevalence of a legal system and system of governance with its foundations in the British style, foreigners could come to Hong Kong and feel just enough familiarity not to be scurrying back to wherever they came from (and often this meant quite a lot of familiarity was on offer).

Recently a contact of mine who does business in the mainland linked me to a new structure in Shanghai for establishing 100% foreign owned companies. While the corporate tax rate on the mainland is higher (25% vs 16.5% in Hong Kong), the fees associated with establishing such an entity are far lower, and skipping Hong Kong to go directly to the supplier or client has the benefit of reduced friction and complexity.

There is no obvious remedy to this dilemma for Hong Kong. As companies have become more confident engaging directly with the mainland, the appeal of Hong Kong in this respect has waned. Added to this the fact that Hong Kong itself is too small to be a genuine start-up hub, there exists a need for the city to take a new approach.

Economic Woes

At the same time as Hong Kong's role as gateway to the mainland has diminished, there has been an ever growing inflow of both capital and people from the mainland. Every year the prevalence of Mandarin on the streets of the city grows, but, in the wake of the pandemic, this growth has been offset by an exodus of both Hong Kongers (primarily to the UK, Canada and Australia) and Western Expats. This population shuffle fundamentally changes the fabric of Hong Kong society, and is a phenomenon seen elsewhere, including for example in Germany. Those leaving Hong Kong are by-and-large wealthier than the average Hong Konger, and with them goes their skills and capital worsening the city's already pessimistic demographic outlook (with a Total Fertility Rate of 0.7 according to the World Bank, Hong Kong's ageing population - an almost worldwide issue - is one of its greatest challenges in the years ahead).

Arrivals from the mainland have helped to offset this exodus, but only so much, and with the collapse in the Yen, Tokyo is increasingly attractive to wealthy Chinese looking to diversify themselves both financially and by way of residency. The fact that Hong Kong remains one of the most expensive places in the world only adds fuel to the fire. As the saying goes, one man's (or city's) loss is another's gain, and as already mentioned, Singapore has been effective in attracting capital and businesses included in the exodus. At the same time, countries such as Malaysia with its sizeable Chinese diaspora and corporate structures offering tax rates as low as 3% (via the Labuan incorporation route), are also seeing an uptick in interest from those who might otherwise have stayed in the Fragrant Harbour.

While the economy on the mainland has been sluggish, the PBOC has adjusted rates downwards. Hong Kong's peg however has dictated that the Hong Kong Monetary Authority has followed the Fed's increases over the past few years. This has resulted in a policy rate that sits at 5.25% vs 3.10% for the PBOC at the time of writing (5 years ago the PBOC rate stood at 4.31% while the HKMA policy rate was around 1%). While the increase in rates in the USA was implemented to reign in inflation, Hong Kong suffered no such comparable phenomenon - although it did suffer significant capital outflows - and the increase in rates has been in direct contradiction to conventional economic wisdom that may have encouraged a policy of easing rather than tightening over the last few years had it not been for the peg.

Crypto

In February 2022, with the invasion of Ukraine by Russia marking a dramatic escalation in hostilities, Chinese policy makers and tycoons alike were undoubtedly keenly observing the geopolitical fallout. If not already clear, this event and the close to three years since has demonstrated the closeness of these two civilisational states. However, and perhaps more importantly, it has exposed the extent to which the United States will go to both pursue sanctions and weaponise the financial system that it controls via the greenback.

Many, including myself, did not think that Vladimir Vladimirovich Putin would do it, and many others believed that the Russia - which had popularly, and falsely, been described by many in the West as a 'gas station masquerading as a country' (John McCain, 2015) - would quickly crumble under the weight of economic exclusion. As is usually the case, pretty much nothing happened according to consensus. Russia which had been so successful in its quick, practically bloodless annexation of Crimea, did not scare the Ukrainians back to the negotiating table. Conversely, the Russian economy has actually experienced something of an economic boom. However, and the point I want to drive home, from the perspective of those in Asia, it was a test case for what Hong Kong may face in the wake of any escalation in the straits of Taiwan.

China's approach to crypto-currencies has been mixed at best. While officially there are bans on crypto, it is no coincidence that Hong Kong, which initially pushed back so hard on this financial innovation, has now seen a dramatic uptick in crypto assets. In a recent report by Chainalysis Hong Kong saw the fastest growth in its region at 86% from July 2023 to June 2024. In light of the situation in Ukraine, it is possible that crypto could be considered a useful tool in mitigating the effects of an economic war, such as that which the West has waged on Russia. At the very least, it does provide an incentive for regulators to look the other way or turn a blind eye.

Conclusion

With approximately 7.5 million inhabitants, Hong Kong just doesn't have the scale to make it a stand-out start-up hub, and its role as a conduit into the mainland will in all probability be further eroded by the likes of Shanghai and Shenzhen. Nevertheless, its role as a critical financial centre may be reinvigorated by a realignment towards crypto-assets and the newly emerging financial paradigm unfolding before our very eyes.

Whether Trump's reelection will inspire a rapprochement and deescalation of the now vivid geopolitical schism calving up the world is yet to be seen. Nevertheless, one thing is abundantly clear, if Hong Kong is to retain its prestige and replicate its past success, things will need to change.