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Hong Kong's national security law: What does it mean for legal teams?

Legility 07 / 07 / 20

In the midst of a world reeling from COVID-19, China bypassed Hong Kong legislature to pass a new national security law essentially making it illegal to speak out against the Chinese government - removing the right to free speech previously enjoyed in Hong Kong and criminalizing the ongoing peaceful protests. Before understanding what this means for Hong Kong’s future, as the third-most important banking center in the world – after New York and London – and the conduit between China and Western economies, it’s important to first understand what makes Hong Kong so important.

Hong Kong as connector

Consider Legos: There is a connector Lego that allows you to connect one structure to another. That is a good analogy for Hong Kong. It takes two vastly different banking systems (China and the US/Europe) and allows them to seamlessly connect. There are two primary reasons why Hong Kong has been able to maintain such importance in the global financial landscape:

  • The Hong Kong Monetary Authority (HKMA) requires similar controls to that of the US and Europe – namely transparency, proper accounting, and timely reporting. This assurance against things such as fraud and money laundering provide Hong Kong unfettered access to Western financial institutions in a way that China cannot.
  • Since 1983, the Hong Kong Dollar has been pegged to the US Dollar, and Hong Kong sits on reserves of $440 billion, twice the value of all money in circulation in Hong Kong. The ability to seamlessly transact in US Dollars means Hong Kong can easily create banking instruments denominated in US dollars, which equaled $4 trillion last year. As seamless as the creation of US dollar denominated banking instruments, Hong Kong also connects directly to New York financial hubs through proprietary technology, which passed through payments of $10.4 trillion last year.

What does the national security law mean for Hong Kong's role in the economy?

Since the passage of the new national security law last month, there have been many questions about what that will mean for Hong Kong’s position as this connector between China and the US/Europe. Remarks from the US White House include threats to remove the Hong Kong special position and impose sanctions. These threats have been responded to with similar threats by China. In my view, there are three scenarios to watch for here – best case, moderate and nuclear.

With the clock ticking on the 2021 sun-setting of LIBOR and the implementation of SOFR, financial institutions must be able to efficiently assess their exposure and risk with a consistent, quality driven process. The expediency of the review, capture and abstraction process not only gives these clients more time to communicate and negotiate with their clients, but reduces the drain on internal resources and provides an accessible database that displays key provisions for ongoing and future needs.

Best-case: Hong Kong risk score

In a best-case scenario, Hong Kong might receive a higher risk score. It is rational to worry that Hong Kong’s institutions, including the courts and central bank, might no longer remain independent. It is also rational to worry that corporate governance and transparency might dissolve – will an auditor note about possible fraud on a Chinese state-owned entity account equal sedition? This worry might erode the perception of Hong Kong as a global banking hub and safe place to conduct business.

Moderate outcome: Banking shifts away from Hong Kong

A moderate outcome might mean the gradual erosion of Hong Kong as a banking hub, leading to a shift of banking activities to somewhere less controversial. Particularly, the portion of business that has no ties to China, which currently makes up two-thirds of currency trades and one-half of fund assets in Hong Kong. There is still no better place to do business with China than Hong Kong, so this business would remain. This loss of non-China business could be material for Hong Kong. However, this could be partially replaced by increasing funds from China looking to invest globally.

Extreme outcome: International sanctions affect Hong Kong

The most extreme outcome is that the US could impose sanctions which would create penalties for conducting business with individuals, firms, or banks operating in Hong Kong. The US could also impose additional administrative barriers which would clog the currently seamless banking function between the US and Hong Kong. These measures could destabilize Hong Kong as a financial hub and represent a major escalation by the US. In turn, that could cause China to retaliate against Western multinationals operating in China, and possibly encourage them to push harder at making the Yuan a global currency by incentivizing the use of payment systems built on Chinese technology and attracting foreign businesses that accept the Chinese way of doing business.

Much remains to be seen in Hong Kong

It is most likely that we will fall somewhere between best case and moderate, as cooler heads prevail and political focus moves elsewhere. Both HSBC and Standard Chartered have voiced support for the new national security law and expressed hope that this will create a more cohesive business landscape and ease the increasing protests. Time will tell, but for now this is not the end of Hong Kong, it is not even the beginning of the end.

About the author

Legility
Legility

Legility, a leading provider of technology-enabled legal services, provides consulting, technology, managed solutions, and flexible legal talent to corporations and law firms. The company has more than 1,000 lawyers, engineers, consultants, technology and data specialists, and operational experts serving more than one-third of the Fortune 100 and one-quarter of the Am Law 200. Legility helps its clients improve operational efficiency. By combining people, processes, and technology, Legility offers innovative and bundled solutions that align with how the legal market is increasingly looking to engage. www.legility.com

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