Feature Article on the 10th Anniversary of Hong Kong Hangover.
Tim Freshwater, Asia vice chairman of Goldman Sachs Group Inc., gazes across the Hong Kong skyline from his 68th-floor window toward a rectangular building that houses the barracks of China’s People’s Liberation Army. “Re- member all that fuss about the PLA marching in?” says Freshwater, 62, re- calling the dawn scenes on July 1, 1997, when 4,000 Chinese troops rolled across the border hours after Britain handed sovereignty back to Beijing, ending 156 years of colonial rule. “There was all sorts of drama about what might happen to the war memorial.”
Ten years later, Britain’s memorial to the war dead remains undisturbed. The PLA’s solders are mostly confined to barracks, surrounded by a growing army of bankers, fund managers, lawyers and accountants. The newcomers pay as much as US$17.50 a square foot a month—rivaling London and New York—to lease the glass-and-steel offices that now tower over the beige, 28-story symbol of Chinese military power.
When mainland Chinese leaders fly down from Beijing to celebrate the handover anniversary on July 1, they will find that the teeming, 450-square- mile (1,165-square-kilometer) enclave on the Pearl River delta has even stronger capitalist characteristics than it did in its colonial days.
Hong Kong is now home to the world’s fifth-biggest stock market (up from eighth in 1997), and last year it overtook New York to become the biggest market after London for initial public offerings. Its island-studded harbor, overlooked by the gravity-defying apartment blocks that cling to the slopes of Victoria Peak, is also the world’s second-busiest container port. In January, Hong Kong was named the world’s freest economy for the 13th year by the Heritage Foundation, a Washing- ton-based advocacy group, which cited its low taxes, openness to investment and lack of tariffs. “Our main target is to turn Hong Kong into a New York or London of the East Asia time zone,” says Donald Tsang, Hong Kong’s Beijing-sanctioned chief executive.
Not all of the changes since the hand- over have been for the better. The city today is swathed in pollution, with air quality so poor that the government advised people with asthma or cardiovascular disease to stay indoors on 41 days last year. The city is facing increased competition from Shanghai and other locations such as Singapore. (See “Singapore’s Challenge,” page 116.) Hong Kong’s leaders are struggling to deliver on promised democratic re- forms, while the gap between rich and poor is growing.
“We have a split economy,” says Marc Faber, 61, who oversees $300 million at Marc Faber Ltd. in Hong Kong and has managed money in the city for 34 years. “The super-rich, the money shufflers and lawyers, are doing exceedingly well. How- ever, the lower and middle classes are doing just so-so.
Hong Kong today is extremely dependent on the financial sector, and it could suffer rather badly in a downturn.”
Under the arrangement known as “one country, two systems,” the city in 1997 became a Special Administrative Region of the People’s Republic, with Beijing guaranteeing it autonomy over its own affairs, except over defense and foreign policy, for 50 years.
China’s communist leaders pledged not to tamper with Hong Kong’s way of life and its laissez-faire economy. It would retain its own currency—the Hong Kong dollar, which is pegged to the U.S. dol- lar—and its British common law system, administered by judges in horsehair wigs. Beijing also agreed to let Hong Kong keep other forms of economic and legal independence, including separate mem- bership in the World Trade Organization.
Unconvinced, 545,000 people—one- twelfth of Hong Kong’s population— mostly refugees or the children of refugees from communism, emigrated between 1984 and 1997. The oldest Brit- ish-owned company, Jardine Matheson Holdings Ltd., moved its headquarters to Bermuda and its stock listing to Singa- pore. Fortune magazine ran a cover story titled “The Death of Hong Kong.” Milton Friedman, the late U.S. Nobel Prize–win- ning economist, predicted that within two years of the handover, Beijing would impose capital controls and do away with the Hong Kong dollar.
Instead, China stuck to the deal, says Chris Pratt, chairman of Swire Pacific Ltd., a British-owned company that opened its first office in Hong Kong 137 years ago. Swire controls Cathay Pacific Airways Ltd., the world’s eighth-largest airline by market value, which in 1997 did not fly to the mainland. Today, Cathay has 400 flights a week to the mainland—more than any foreign-owned carrier—most through its Dragonair subsidiary. Cathay bought the 82.2 percent of Dragonair it didn’t already own last year for $1.1 billion and doubled its stake in Air China Ltd., the mainland carrier, to 17.5 percent. “We took the view China meant what it said about HongKong," says Pratt, 50.
Hong Kong’s historyhas been marked by boom- and-bust cycles. Lon- don started calling the shots in 1841, when it seized Hong Kong island, whose name means “fragrant harbour” in Chinese, a 26- square-mile chunk of granite one mile off the South China coast, after a war sparked by Britain’s illicit trade in opium. In 1860, China ceded the tip of the adjacent Kowloon peninsula as well. Then in 1898, Britain more than doubled the size of Hong Kong’s territory by acquiring an- other chunk of mainland, known as the New Territories, on a 99-year lease.
THE PLA’S BARRACKS TODAY IS SURROUNDED BY A GROWING ARMY OF BANKERS AND ACCOUNTANTS.
British companies that set up there were known as hongs, or trading companies, and the men in charge were taipans, which means great managers in Cantonese. Four of the hongs grew into global companies. In addition to Swire, they are: HSBC Holdings Plc, founded in Hong Kong in 1865, and now the world’s fourth-biggest bank by market value; Hutchison Whampoa Ltd., now owned by billionaire Li Kashing, and the world’s biggest port operator; and Jardine Matheson, once known as the Princely Hong and con- trolled by the Keswick family, descendants of William Jardine, which operates the MDandarin Oriental hotel chain.
During World War II, British Prime Minister Winston Churchill considered Hong Kong indefensible. He was proved right. On Dec. 8, 1941, a day after the Japanese bombed Pearl Harbour, they attacked Hong Kong. Defense forces strung across the New Territories, known as the Gin Drinkers’ Line, fell within a day. Hong Kong island surrendered on Christmas Day after barely a week of fighting.
Three years and eight months later, the British survivors emerged from their prison camps to find Hong Kong in ruins and the population reduced to 600,000 from 1.6 million before the war. That was soon swelled by the arrival of millions of refugees from the civil war in China and subsequent vic- tory of Mao Zedong’s communists.
HONG KONG WENT THROUGH A BUBBLE IN 1997, BILLIONAIRE VICTOR FUNG SAYS. ‘NOW, WE ARE ON VERY SOLID GROUND,’ HE SAYS
Energized by Chinese entrepreneurs and cheap labor, Hong Kong’s economy boomed and adapted. Yet crises in China reverberated across the border. In 1967, during the Cultural Revolution, pro-mainland protesters waving Mao’s Little Red Book battled police, overturned cars and stoned hotels. The stock and property markets crashed.
By the end of the 1970s, the question of renewing the leases on properties in the New Territories that expired after 1997 forced Britain to start talking to China about Hong Kong’s future. In 1984, Prime Minister Margaret Thatcher and paramount leader Deng Xiaoping signed a joint declaration guaranteeing the one- country, two-systems solution until 2047.
Fears for the future were heightened in 1989 when Chinese troops cracked down on democracy activists in Tianan- men Square. In Hong Kong, the stock market plunged 37 percent in three weeks, and a million people took to the streets in protest, according to the Hong Kong gov- ernment. Others headed for the airport. China’s economic growth slumped to 4.1 percent from the 11.5 percent it had aver- aged over the previous seven years.
In 1991, the mainland economy resumed its rapid growth. By the mid- 90s, returnees outnumbered those leav- ing the territory, now with the security of foreign passports. At the time of the hand- over, the Hang Seng Index had risen eightfold in as many years since Tianan- men, and property prices had hit records.
Just one day later—on July 2, 1997— the Thai baht collapsed, sparking a re- gional financial crisis. Hong Kong’s stock market plummeted 60 percent in a year.
In 2003, a mysterious pneumonia- like disease, Severe Acute Respiratory Syndrome, or SARS, swept across the border, killing 299. Shops, hotels, restaurants, subway lines, airplanes and even the normally packed Edwardian- era trams that still trundle between bank towers downtown lost business overnight. Those who did venture out hid behind white and blue surgical face masks. “SARS was in a sense worse than the Japanese occupation,” says Ronald Arculli, 69, chairman of Hong Kong Ex- changes & Clearing Ltd., who has child- hood memories of the war years. “This time, the enemy was faceless.”
Caught in a deflationary spiral that lasted until 2005, homeowners found their properties lost two-thirds of their value. Such a home price plunge would be unthinkable in the West, says Peter Churchouse, 57, a former Morgan Stanley property an- alyst who’s now director of Hong Kong–based property consultant Lim Advisors Ltd. “If you had a decline like that in America or Europe, there would be blood on the streets,” he says.
China came to Hong Kong’s aid, signing a trade agreement that allowed Hong Kong companies freer access to Chinese markets. It eased travel restrictions on main- landers visiting the territory, saving the SARS-ravaged tourism industry. “That was a huge boost that turned the economy around,” says Amar Gill, 43, an analyst at CLSA Asia-Pacific Markets. The of- ficial China Daily agreed. “The central government gave Hong Kong a big gift,” it said of the free trade deal.
China also allowed more of its giant state-owned en- terprises to sell shares on the Hong Kong market, which helped to boost stocks to 20,449.43 on April 11, down from January’s record 20,971. Chinese companies now make up half the market capitalization of the Hong Kong exchange, up from 10 percent a decade ago. Eight of the 15 largest stocks in the Hang Seng Index are Chinese companies. Hong Kong’s economy has grown 7.6 percent annually for the past three years, and gross domestic product per capita on a purchasing power parity basis will be $37,385 this year—higher than the $31,585 of its former colonial ruler. Property prices for offices in the central business district and luxury apartments and houses on the slopes of the peak are also back to 1997 levels, ac- cording to Lim Advisors.
This time, Hong Kong isn’t heading for another bust, says billionaire Victor Fung, a former Harvard Business School professor who’s chairman of Li & Fung Ltd., a supplier of Chinese-made goods to retailers such as WalMart Stores Inc. and Target Corp. “Looking back, we were going through a bubble in 1997,” Fung, 62, says. “Now we are on very solid ground. We are much more important as a financial center.”
Although mainland China has two stock markets of its own, in Shanghai and Shenzhen, Hong Kong remains the No. 1 source of capital for the world’s fastest- growing major economy. Hong Kong IPOs raised $43 billion in 2006 compared with $10 billion in 1997. That total included $16 billion of the $22 billion raised last October by Industrial & Commercial Bank of China in the world’s biggest-ever share sale (the other $6 billion was raised in Shanghai). Shares in ICBC, as the bank is known, have since increased by 41 percent to 4.33 Hong Kong dollars on April 11, making China’s biggest lender the world’s ninth-biggest company by market value.
In terms of personal wealth, Hong Kong is home to the most U.S.–dollar billionaires per capita, says Kathryn Shih, Hong Kong–based Asia-Pacific head of wealth management at UBS AG. That’s 29 in a population of 7 million. One in every 50 residents is a millionaire, Merrill Lynch & Co. and Capgemini SA reported in a 2006 world wealth survey. Total funds under management in Hong Kong are $579 billion, three times as much as in 2000, according to the Hong Kong Securities and Futures Commission.
To win a share of Hong Kong’s boom- ing investment banking and wealth management markets, foreign banks have been boosting their presence. UBS, which last year topped the league tables for arranging Hong Kong and Chinese over- seas share sales, according to Bloomberg data, has doubled its Hong Kong staff to 2,000 in the past three years, Shih says. UBS arranged $7.4 billion worth of Chinese share sales last year, including part of the $11.2 billion IPO of Bank of China Ltd., the country’s No. 2 lender.
“There’s no opportunity I have seen anywhere in the world that compares with what we have before us here today in Hong Kong,” says Steven Barg, 45, UBS’s head of equity capital markets for Asia. Barg previously headed teams in Europe aAnd the U.S.
At Goldman Sachs, profits from Asia exceeded those from Europe since 2005 and last year more than doubled to $4.02
billion compared with $3.01 billion in Europe. Goldman now has 1,300 em- ployees in Hong Kong, up from 800 in 2003, and has also added 200 to its staff in Beijing in the past year. “In the 10 years since the handover, Goldman Sachs in Asia has gone from being marginal to a genuine third leg of the global business,” Freshwater, the Asia vice chairman, says. Goldman was the No. 2 underwriter of China IPOs last year, arranging $7 billion, including the Bank of China sale. The U.S. bank has a paper profit of $8.75 billion on the $2.6 billion investment it made in ICBC last year before the share sale. “No one would have dreamed the amounts of equity raised through listings here could have been done in that period of time,” says Freshwater, a Briton who has spent 30 of the past 40 years in Hong Kong and who, as president of the city’s law society in 1984, witnessed Thatcher and Deng sign the joint agreement.
Hong Kong is now so good at raising capital that IPOs no longer need to be dual-listed in New York, says KL Wong, 57, Hong Kong–based chairman of Asia Origination at Merrill Lynch, which helped arrange the record ICBC share sale. “Last year, the largest IPO in human history was just a Hong Kong listing,” he says. “Our regulatory regime, governance and secondary market liquidity are now all acceptable.”
China’s big, newly listed lenders are also transforming Hong Kong’s banking landscape, says David Li, the Cambridge University–educated chairman of Hong Kong–based Bank of East Asia Ltd. “I’m very much an underdog,” says Li, 68, who advised Beijing on the handover and also holds a British knighthood. “During colonial days, I was under the threat of the big British banks here. I’m under the threat of different big banks now.”
Some underdog. Last year, Bank of East Asia’s net profit soared 25 percent to 3.43 billion Hong Kong dollars ($439 million) from HK$2.78 billion as the bank expanded into China. In the year ended on April 11, the bank’s share price rose 57 percent to HK$48.55—more than double that of the Hang Seng Index and four times that of the Hang Seng finance sub-index. Because of Li’s mainland connections, the bank now has 31 outlets on the mainland—nearly twice as many as Citigroup Inc.
Hong Kong’s wealthy domestic mar- ket is still fertile pickings for the two London banks that have operated there for almost 150 years. HSBC and Standard Chartered Plc are issuing banks for Hong Kong’s currency. Standard Chartered makes 26 percent of its profits there. HSBC makes 23.5 percent. “It’s re- markable that Hong Kong, with 7 mil- lion people, can be the biggest contributor to group profits,” says Peter Sullivan, 59, Standard Chartered’s Hong Kong CEO.
Banks aren’t the only ones profiting from Hong Kong’s prosperity. At Sam’s Tailor, open since 1957, owner Manu Melwani says business jumps every year at bonus time as his clientele has changed from British army officers to bankers, lawyers and accountants.
Chief Executive Tsang, who was re- elected in March, says one of his priori- ties in his second five-year term is to make sure Hong Kong doesn’t lose its edge to Tokyo, Singapore or China’s domestic financial center, Shanghai. Tsang, 62, a policeman’s son who picked up a British knighthood before the hand- over, ticks off Hong Kong’s advantages for foreign investors: a well-regulated market, the British-based legal system, free media and minimal corruption.
Hong Kong ranks 15th cleanest—high- er than the U.S., Japan and Germany—out of 163 countries in the 2006 corruption perception index compiled by Transparency International, a Berlin-based advocacy group. China is 70th. “We are part of the Chinese nation, but we are a unique jewel,” Tsang says. “There are certain things that we represent that are lacking in the main- land.” Hong Kong will even share in Beijing’s Olympic glory in 2008. As the only place in China apart from Macau where horse racing is legal, it will host the equestrian events for the 2008 games.
Casting a shadow over Tsang’s vision is mainland China’s commercial capital, Shanghai. Shanghai’s stock market trades in so-called A Shares that are reserved mostly for Chinese investors using yuan. Increasingly, Chinese companies listing in Hong Kong are getting a second listing for their shares in Shanghai. Last year, 71 percent of the $62 billion of funds raised on Chinese stock markets was in Hong Kong, according to PricewaterhouseCoopers LLP. This year, 64 percent of an estimated $58 billion will be raised in Shanghai and Shenzhen as companies already listed in Hong Kong sell more shares domestically, the New York–based accounting firm says. “If you are complacent, you risk being overtaken one day,” says Fred Ma, Tsang’s secretary for financial services. The momentum may already be moving away from Hong Kong, says Simon Murray, Hong Kong–based founder and chairman of General Enterprise Management Services, a $750 million private equity fund. “Hong Kong’s such a great stock market because foreigners can’t invest in A Shares,” says Murray, 67, a former Asia chairman of Deutsche Bank AG and CEO of Hutchison Whampoa, Hong Kong’s biggest conglomerate. Eventually, China will make its yuan convertible to the dollar and other currencies. “When that changes, we will all be up in Shanghai. If you want to catch fish in China, you have to be up there. From Hong Kong, you need a very long rod.”
Murray, a marathon runner, says another factor that will drive investors away from Hong Kong is its pollution. “To be a successful financial center, you need to be not just transparent in your systems but also in the air you breathe,” he says. In the 1980s and ’90s, Hong Kong moved its manufacturing industry across the border to Guangdong province, where labor is cheaper. Now, the pollution from 60,000 Hong Kong–owned factories wafts back across the border, adding to the city’s homegrown haze. In November, Merrill Lynch cut its ratings on three Hong Kong property developers over concerns that Hong Kong’s pollution problems could cause a brain drain. “The air quality in Hong Kong is now regularly so poor that the long-term competitiveness of this city-state is, in our minds, in some doubt,” former Hong Kong–based Merrill analyst Spencer White told clients in a note. By comparison, rival Singapore has the best air quality of any major city in Asia, says ECA International, a London-based human resources consulting firm. Even Shanghai’s is less polluted, ECA says.
In October, Tsang’s government un- veiled plans to enforce emission caps on power companies and give tax breaks for cleaner vehicles. He says he’s also talking to his counterparts in Guangdong. “We will certainly do all we can in Hong Kong, but that will not be half enough,” he says. “It will take hard work and continuous monitoring for the next five years.”
Tsang says he’s committed to narrowing the wealth gap by boosting spending on public works and investing more in education. Though unemployment has fallen to 4.3 percent from 8.6 percent in 2003, the proportion of families with monthly incomes of less than HK$6,000 has grown to 22 percent from 13 percent since the handover, he says.
Philip Ng, 70, is one of those who missed out on the boom. He operates a ciga- rette and soft drink stall in the shadow of HSBC’S Nor- man Foster–designed downtown head- quarters. Working seven days a week, Ng clears HK$2,700 a month, which leaves him nothing after he’s paid for food and HK$1,600 to rent a 120-square-foot HONG KONG 2007 (11-square-meter) room in a 600-square- foot flat he shares with three other single men. “If you are a property developer or in finance, of course this is the best time,” Ng says. “But people like us at the bottom of society see none of these benefits. We don’t have savings to invest. It’s difficult and getting more difficult.”
As important as economic issues, Tsang says, is winning approval from both Hong Kongers and leaders in Beijing for a plan to introduce a democratic system of government. Although China is a one- party state, it has promised that the peo- ple of Hong Kong will one day be able to choose their own chief executive. Currently, the 60-member legislature has just 30 directly elected members. The chief exec- utive is elected by 800 people, mostly Beijing loyalists.
Tsang says his goal is to set a timetable for introducing universal suffrage for the ter- ritory before he leaves office in 2012. To get approval for the necessary reforms, Bloomberg Markets 117 June 2007 Tsang—who won 649 votes after being challenged by a pro-democracy candidate, barrister Alan Leong—has to win approval from Beijing plus two-thirds of Hong Kong legislators. Pro-democracy legislators, including Leong, 49, want universal suffrage to happen in time for the next election. Beijing’s leaders are more cautious, Tsang says. “I will try and maneuver and find something that is ac- ceptable at the end of the day,” he says.
While Hong Kong may lack democracy, it doesn’t censor the media or ban freedom of speech, according to the 2006 U.S. State Department report on human rights prac- tices in Hong Kong. Before the handover, the leading democracy activist of the time, legislator Martin Lee, was nicknamed Martyr Lee by people who believed he would be imprisoned or worse once the British left. Today, the British-trained bar- rister, 69, still sits in the legislature, prac- tices law and attacks both the Beijing and Hong Kong governments for what he claims are breaches of the constitution.
He says that while the handover declaration promises Hong Kong will be governed by its people, Tsang and his Hong Kong–born government team are really mouthpieces for Zeng Qinghong, the Chinese vice president with overall responsibility for Hong Kong affairs. The big promises have been broken,” he says. “Hong Kong people are no longer ruling Hong Kong, and democracy has been delayed.”
Although he’s escaped martyrdom, Lee has only been allowed to visit the mainland once—for 1 1⁄2 days—in the past 18 years after he led demonstrations in Hong Kong against the Tiananmen crackdown. “I can visit every country in the world except my own,” says Lee, whose father was a Nationalist general.
That hasn’t stopped Hong Kong’s people from demonstrating. In 2003, when former Chief Executive Tung Cheehwa tried to introduce an anti- sedition law, 500,000 people, including Bank of East Asia Chairman Li, took to the streets in protest. This year, the government was confronted by an angry mob when it demolished the downtown pier for the Star Ferry, which has shuttled between Hong Kong island and Kowloon for 100 years.
Is Tsang confident he can deliver on his democracy pledge? “That’s not the right word, but I am determined,” he says. Tsang has shown resolve in the past, says Goldman Sachs’s Freshwater. In 1998, at the height of the financial crisis, the Hong Kong dollar came under attack from hedge funds that had profited from the collapse of the Thai, Indonesian and South Korean currencies. Tsang, then financial secretary, fought back, spending $15 billion to buy up blue-chip Hong Kong stocks and shore up the market.
Tsang,who stands 5 feet 6 inches tall and wears a bow tie to work every day, says he didn’t in- form Beijing until 30 minutes after he entered the market. “Someone in Beijing said I must have swallowed a tiger’s gall bladder,” says Tsang, referring to a Chinese expression for someone who shows unexpected strength.
“It was a very gutsy call,” Freshwater says. “Some people say it was a tougher decision than it would have been in 1996 because under a British governor, that decision would have been made by the Bank of England in London.”
Tsang hasn’t won all his battles. An attempt to introduce a goods and services tax was blocked in the legislature. In a city where the maximum income tax rate is 15 percent and the top corporate tax is 17.5 percent, Tsang says, Hong Kong still urgently needs to broaden its tax base.
Still, he says one thing he doesn’t have to worry about is the PLA. He says the Chinese soldiers are more disci- plined than their British predecessors, who were famous for rowdy nights in the bar district of Wanchai. “We have never had any incident—not even a speeding ticket,” Tsang says. “These people behave impeccably.”
Even with their bird’s-eye view intothe PLA compound, Freshwater and his Goldman Sachs colleagues say they never see signs of military activity. If so, the barracks may be the only place in to- day’s Hong Kong where nothing much is happening.