More than 9,000 foreign firms operate in Hong Kong, among them 1,300 from the United States. So when the Chinese legislature recently passed a new security law intended to prevent “secession, subversion, terrorism and foreign interference” in Hong Kong, many CEOs and top executives began wondering about the business implications. The U.S. State Department added to the uncertainty last month by declaring that Hong Kong is no longer autonomous enough to warrant special treatment.
Between us we have researched in and about China and Hong Kong for many years, and we know that there’s no single answer to this question. That’s in part because because the implications of these two developments for firms will depend in large part on why they are in Hong Kong in the first place. Most are there for one of three main reasons, so let’s consider each:
For Hong Kong
These firms want access to Hong Kong’s upstream resources and downstream opportunities. They tend to be relatively small service firms focused on specialized areas such as finance. (Hong Kong was recently ranked the #3 financial center in the world after New York and London.) Part of the reason companies in this category tend to be smaller is that Hong Kong is a relatively small economy, with a GDP in 2019 of just U.S. $352 billion, which ranks about 35th in the world. Most of these firms are in the service sector because that sector represents nearly 93% of Hong Kong’s GDP.
Because of the dominant role of services in Hong Kong’s economy, any movement up or down in GDP has a direct and significant effect on the revenues of this first category of foreign firms. As political tensions in Hong Kong increased in the second half of 2019, Hong Kong’s GDP dropped 1.2% for the year, and the country officially slipped into recession. More worrisome, foreign direct investment (FDI) into Hong Kong fell a staggering 47% in 2019 to $55 billion. In the process Hong Kong fell from the #3 destination globally, just behind China, to #5. It will take months and even years to learn how China’s new security law will affect Hong Kong, and how countries around the world will react, but it is hard to imagine the specifics helping GDP and FDI. First that are in Hong Kong for Hong Kong will feel the pain immediately and directly.
If this weren’t enough, brain drain could also hurt these firms. Countries such as the U.S., UK, and Canada have all indicated their willingness to adjust their immigration or citizenship rules to allow, as the U.S. Secretary of State Pompeo put it, “Hong Kong people…[to] bring their entrepreneurial creativity to our country.” Firms in Hong Kong for Hong Kong rely heavily on local talent, and a loss of the best and brightest to other countries could be devastating to them.
These firms—1,300 of them from the United States—are in Hong Kong largely for the access it provides them to China, though most of them are also there for Hong Kong. A quick review of a few key numbers will make it clear why these firms have decided that Hong Kong offers them good access.
In 2019, China was the second largest recipient of FDI in the world ($139 billion), behind only the United States. According to the National Bureau of Statistics of China, approximately two-thirds of all the FDI into China came via Hong Kong. In 2018 Hong Kong exported $25.3 billion to China, which was Hong Kong’s #1 destination and accounted for 20% of all of its exports. China exported $282 billion to Hong Kong, which was China’s #2 destination after the United States ($499 billion) and accounted for 10.9% of all of China’s exports. In 2018, U.S. $37 billion (8%) of Mainland China’s exports to the United States and roughly U.S. $10 billion of China’s imports from the United States were transshipped through Hong Kong. In terms of capital flows, over the last decade approximately 80% of the IPOs outside Mainland China have been issued in Hong Kong. In addition, Hong Kong has handled about 40% of Chinese firms’ U.S. dollar-bond issuances. Given all of this, and Hong Kong’s proximity to Mainland China, it’s no surprise that so many foreign firms are in Hong Kong.
If Hong Kong loses its special status for good, these firms could get hurt in two ways. First, if the United States does anything to curtail debt or equity transactions in Hong Kong by Chinese firms, foreign firms based in China that collect significant fees for facilitating these transactions would see their top line shrink. Second, if tariffs or export controls are created for China and extended to Hong Kong, this could affect $47 billion worth of annual transshipments and hit the revenues of foreign firms based in Hong Kong that are involved in numerous aspects of these transactions—everything from logistics and financing to legal and banking activities.
In effect, those firms that are in Hong Kong for China, and especially any of the 1,300 or so U.S. firms in this category, could easily find themselves caught in the crossfire between China and the United States. Ironically, in the past Hong Kong’s special status either largely protected these firms from being caught in the middle, or in some cases helped them benefit. For example, past trade tensions between the United States and China have caused transshipments to increase. Those firms that were in Hong Kong for China and that were involved in in these transshipments benefited from the increase. With the loss of special status, these benefits would disappear.
Another potential area of concern for firms that are in Hong Kong for China firms would be changes in visa requirements. Currently, many nations, including the United States, have agreements with Hong Kong that require no visas and allow temporary stays of up to three months. In contrast, China has cumbersome visa requirements with most of these same countries. The loss of Hong Kong’s special status regarding visas could mean that firms that are in Hong Kong for China would probably find it much more difficult for their employees to fly into Hong Kong to conduct business for China.
There are 1,541 foreign firms that have their regional headquarters in Hong Kong, including over 300 U.S. firms. These firms use Hong Kong as their base of operations for activities throughout Asia, from Japan in the north to Australia in the south, and from Indonesia in the east to India in the west. Obviously, Hong Kong and China fall within these boundaries.
Hong Kong’s global and regional standing in finance facilitates the coordination of capital requirements for the region. If the new particulars of the security law end up being strict enough, and reactions from the United States and United Kingdom are strong enough that Hong Kong’s standing in the financial markets shrinks significantly, Singapore could become an attractive alternative for regional headquarters. Many aspects of its financial market, from company listings to foreign currency exchange, already rival or surpasses Hong Kong. Its political security, efficient infrastructure, quality schools, and other features only add to its attractiveness as a base for regional headquarters. U.S. technology firms in fact already have twice as many regional headquarters in Singapore as in Hong Kong.
Expatriates typically play a critical role and constitute an important portion of senior managers and top executives in virtually all regional headquarters. The thought of Chinese secret police being embedded in Hong Kong might make it difficult, or at least more expensive, to entice key expatriates to take up regional positions in Hong Kong. Often expatriates are put in these slots not just to do the job but as a core part of their development as future global leaders, and therefore simply substituting locals for expatriates would not be a satisfying option for most firms. Any brain drain of local talent would only amplify this leadership shortfall.
What Should CEOs Do?
Despite all of the differences outlined above, there are three general actions that firms in all three categories should take:
- Secure Your People. The most important asset in all three categories is people. Given that services constitute 92% of Hong Kong’s economy, this is hardly surprising. What is surprising and worrisome, however, is data that have turned up in research conducted by Stewart Black, who surveyed some 5,000 executives. Although about 93% of these executives (1,300 of them in Hong Kong, and their responses reflect those of the whole group) said that people are their most important asset, more than 84% had no clear strategy for attracting and retaining the people they need, and more than 96% did not have clear metrics to hold executives accountable for their success or failure in winning the war for talent. We have also found that although competitive compensation is important, superior culture, leadership, and job enrichment matter even more. The bottom line is that firms in all three categories need to review and strengthen their employee value proposition to ensure that the people they want want them.
- Review Scenarios. It’s essential to come up with different scenarios and think contingencies out in advance. Scenario planning is not about trying to predict the future but laying out best- and worse-case scenarios, and then making explicit the factors and cause-and-effect relationships that would bring them about. Going through this process attunes executives to what they need to watch so they don’t get blindsided. It also lowers the likelihood that executives will respond with knee-jerk reactions in the heat of the moment.
- Create Options. The worst-case scenario for Hong Kong is severe enough that foreign firms operating there would be wise to create some options so that, if need be, they can move people and activities to alternative locations without having to scramble whenever the time comes. This recommendation is the most difficult for firms that are in Hong Kong for Asia, but it is potentially the most beneficial to them as well. Moving a regional headquarters is not easy, which is why a survey by the American Chamber of Commerce in Singapore found that the vast majority of firms with regional headquarters in Hong Kong do not plan to move them. However, having contingency plans or even moving select activities to an alternate regional location can often cost less than taking a wait-and-see approach.
It is hard to predict exactly how severe the new security law will be or how the United States and other nations will react. But no matter what happens, the firms that will hit the right balance between doing too little and too much are those that understand clearly why they are in Hong Kong; that know what factors will help or hurt them the most; and that take the basic steps outlined above. And at the end of the day, China is still very dependent on Hong Kong for trade, FDI, equity and debt capital, and foreign exchange—and that self-interest should keep its leaders from going too far with implementing the security law.
J. Stewart Black (email@example.com) is a professor at INSEAD.
Allen J. Morrison is a professor at Arizona State University’s Thunderbird School of Global Management.
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