Module 18 International Financial Centre Supplementary Notes PDF

Form 3 Life and Society Module 18: Global Economy: International Financial Centre 1. What is finance? Finance means to effectively direct savings to economics activities and investments. Financial markets exist to allocate savings, transferring capital from the owners to those who are in need of f...

Form 3 Life and Society Module 18: Global Economy: International Financial Centre 1. What is finance? Finance means to effectively direct savings to economics activities and investments. Financial markets exist to allocate savings, transferring capital from the owners to those who are in need of funds. There are buy side (those who have money) and sell side (those who need money) in the financial market. For example: Buy side Sell side Individual investors Investment banks Institutional investors, e.g. o Mutual funds o Pension funds o Insurance companies o Private equity Buy side earns profit by “buying low and Sell side earns profit through fees and selling high” commissions In theory, the transfer of money from investors to those who are in need of funds can be negotiated on a case-by-case basis. However, this would be time-consuming and costly. Hence, financial instruments (or financial products) exist to facilitate the process. Common financial instruments include: Shares: this refers to a certain percentage of ownership of a company or a fund Funds: it pools capital from multiple investors to invest in financial instruments based on certain criteria Bonds: certificate issued by a borrower to prove that an investor lends money to the borrower for a set period of time, in exchange for regular interest payments. Derivates: they are complex financial instruments. Some examples are “options” (the right to buy or sell a set quantity of asset at a fixed price), “futures” (the obligation to buy or sell a set quantity of asset at a future date). 2. What makes an international financial centre? An international financial centre is basically a financial market of significant size that is international in nature. Features of an international financial centre include:  o Presence of investors (i.e. capital / money) from around the world o Presence of financial instruments issued by companies / institutions from around the world o Presence of financial institutions from around the world o Presence of financial related services, such as asset management, banking, insurances, legal and accounting services, etc. o Having a mature market The size (or maturity) of the market can be indicated by: o Total Market Capitalisation: Market Capitalisation is the market value of a company, calculated by the current market price of its shares (i.e. share price X total number of shares issued). Total Market Capitalisation of a stock market is the sum of market capitalisation of the companies listed in the stock market. o Daily Turnover: the total value of share traded each day 3. Reasons for Hong Kong developing into an international financial centre Close connections to the Mainland China market: Hong Kong is the preferred market for many Mainland corporations to obtain international finance. Majority of the Initial Public Offer (IPO) in Hong Kong are made by Mainland companies. Almost 2/3 of China’s inward and outward investment was originated and intermediated via Hong Kong Hong Kong also has access to the financial markets in the Mainland through the Southbound Stock Connect (where Mainland investors can invest in the Hong Kong stock market) and Northbound Stock Connect (where Hong Kong investors can invest in the Shenzhen and Shanghai stock markets). Time zone: Hong Kong is in a time zone (GMT +8) in between the US (GMT -4) and the European market (GMT). This allows investor to trade while other markets are closed. Free flow of capital: Hong Kong has no foreign exchange control policies, and this is guaranteed by the Basic Law (Article 112). Hong Kong Dollar (in which shares in Hong Kong’s financial are denominated in) is freely convertible and is pegged with the U.S. Dollar through the linked exchange rate, thereby reducing exchange rate risks of investors. Hong Kong has no capital gains tax (i.e. tax on the profit gained by selling asset) and no dividend tax (dividend is the payment of a company to its shareholders). Rule of law: Private property rights are protected in Hong Kong. This protects investors’ interests. Well-educated labour force: Hong Kong has a biliterate (Chinese and English) and trilingual (Cantonese, Putonghua, and English) workforce that support the financial industry. 4. Impacts of being an international financial centre on Hong Kong  The financial sector is a pillar industry in Hong Kong. It accounts for nearly a quarter (22.4%) of Hong Kong’s GDP, and 7.5% of employment. A vibrant financial sector also drives the growth of related sectors, such as legal, accounting, insurance, etc. A mature financial market means that businesses and individuals in Hong Kong have more opportunities to invest their monies, and businesses have more chances to raise funds. Financial markets are volatile in nature. In addition, as there is no foreign exchange control in Hong Kong, investors can easily withdraw money from Hong Kong market if the market sentiment is pessimistic (or if they consider it more profitable to invest elsewhere). The fluctuation of the financial market can affect other business sectors in Hong Kong. A booming financial industry may drive up the cost of doing business (e.g. office rent and labour cost), making it harder for other businesses to operate. The financial industry requires a highly educated workforce. Its development can only benefit a small number of people. As there are a wide range of investment products sold in Hong Kong, individual investors may be attracted to complex investment instruments without understanding their risks. This means more investors’ education / greater regulations are needed. 5. Challenges faced by Hong Kong as an international financial centre Competition from other financial markets: Due to the globalise nature of capital, investors can shift their money to other markets that generate higher returns. Similarly, companies in need of money can turn to other financial markets to raise capital. Advantages Disadvantages U.S. - Well established, largest total - Not favourable to Chinese market capitalisation in the companies due to geopolitical world risks Singapore - Chinese speaking; familiarly - Relatively small market with the Southeast Asian capitalisation market; knowledge in Islamic finance Shanghai / - Large market capitalisation; Has foreign exchange control Shenzhen suitable for Chinese companies Slower growth in the Mainland China: the market value of Mainland companies account for over 70% of the total market capitalisation in the Hong Kong stock market. When the economy in the Mainland slows down, or when international investors are pessimistic about the outlook of the Mainland economy, the financial market in Hong Kong will be affected. 6. Recent policies to strengthen the position of Hong Kong as an international financial centre Develop new financial products (e.g. RMB bonds, Green Bonds) Explore new market (e.g. attracting Middle Eastern companies to list in Hong Kong; developing the family office market)