Washington's Warning on Hong Kong Is a Wakeup Call

The US says the global financial hub is being used to skirt sanctions. Time for some damage control.

Hong Kong's reputation as a top-tier global financial hub has taken another hit. A recent US advisory is urging American companies operating there to consider the legal and regulatory risks they may face, including possible sanctions violations. Doing business in the city, the alert argues, is the same as operating on the mainland, because of the similarities Hong Kong's national security laws share with Chinese legislation.

That is increasingly true, but the hub's story as a financial center isn't over - it's just different. Hong Kong's authorities must accept that it no longer plays the role it used to as a key pillar of the US-led Western world order. It's future is firmly with China, and by default, with countries like Russia.

The city's officials have already issued their objections, accusing the US of creating "panic." They point to rankings in the World Competitiveness Yearbook, published by the International Institute for Management Development, where it came in fifth this year, and to the world's fourth­ largest flow of foreign direct investment. This is why, they say, the financial center's image won't be affected by a "so-called 'business advisory."

But those statistics don't tell the full story.

Research from Bloomberg Intelligence notes that Hong Kong's growth will moderate to 2.4% this year because of China's economic slowdown. The city mimicked many of Beijing's strict Covid-19 policies, closing borders and isolating itself for nearly three years. When doors opened, the keenly anticipated recovery failed to materialize, delivering only a sluggish performance after an initial boost.

Retail sales and visitor arrivals have yet to reach pre-pandemic levels, a sign of weakening confidence both in and outside the territory. Meanwhile, US­ China tensions are a further drag, as is Beijing's tighter grip on the city's governance. Heightened geopolitical rivalry has been a key feature of the relationship since former President Donald Trump launched a trade war against Beijing. Hong Kong has been caught in the middle.

Adding to those worries is its worsening reputation as an illicit trading center. As the US advisory asserts, "Russia is increasingly using third countries and jurisdictions such as Hong Kong to evade sanctions and continue its procurement of certain critical items." According to Washington, the city acts as a transshipment hub, facilitating the trade of dual-use goods re-exported to Russia, effectively supporting its war against Ukraine. Hong Kong says it's only required to follow United Nations sanctions, a convenient justification given that the body is handicapped by the veto power Russia holds as a permanent Security Council member.

The alleged sanctions-busting is directly related to "increased subservience to China," according to the Carnegie Endowment for International Peace. Hong Kong now sits firmly in the camp of an emerging China-Russia axis, the think tank says. It's a relationship that has gone from strength to strength: President Xi Jinping and his Russian counterpart Vladimir Putin met for a second time this year, with Xi saying ties between them are "at their best in history."

The State Department's Investment Climate 2024 report said that the legal system, long considered a bastion of independence, has been compromised. Concerns have been raised about the rule of law: one of the key reasons why international businesses have historically picked the city as their Asia base. Human-rights protections and freedom of the press are also under pressure.

None of this means that Hong Kong is over, writes Steve Vickers, chief executive officer at Steve Vickers and Associates, a political and corporate risk consultancy. But the city is on a new trajectory, pivoting from being a gateway to China for mostly Western investors toward a new role as China's financial center.

Companies that want access to the huge Chinese market will stay, as will those from the mainland. China was the top source of companies investing in Hong Kong in the first six months of this year. That dominance is reflected in the equity markets, too - at the end of 2023, 1,447 mainland firms were listed on the city's exchange, accounting for 77% of combined market capitalization.

Beijing's influence in Hong Kong will only grow. It is increasingly a case of "one country, one system," as demonstrated by recent changes to the school curriculum. Secondary school students now have to learn "Xi Jinping Thought," part of an ongoing campaign to expose Hong Kong's youth to Communist Party principles.

No matter who makes it to the White House this November, don't expect any shift in US policy. For companies that still want Hong Kong as their regional base, compliance is key to avoiding sanctions. Understanding where the risks are - from trading of restricted stocks to carefully vetting cross-border transfers of data - is essential. The financial community should also consistently highlight the challenges of operating in such an environment, both publicly but also in private discussions with the government, which wants Hong Kong to regain its former crown as the region's pre-eminent business capital.

Hong Kong's reputation has already taken too many hits. Denying reality is just delaying the inevitable. Urgent damage control is necessary.