How to trade China’s tightening grip on Hong Kong
China is introducing new laws that could impact Hong Kong’s role as a financial hub and bridge between the mainland and the rest of the world. We look at what it means for markets and what the opportunity is for traders.
The Hong Kong success story
Hong Kong was returned to China on 1 July 1997, after 156 years as a British colony. Under the deal that was negotiated for over a decade, Britain agreed to return Hong Kong so long as China promised to give it a high level of autonomy. The agreement said that, while it would be aligned on issues like foreign relations and defence, Hong Kong would maintain the culture it had developed for at least 50 years (2047). This included independent courts, free press and a more open economy than what was being experienced on the mainland.
This gave birth to the ‘one country, two systems’ rule. While tensions over China’s governance over Hong Kong have been tested on multiple occasions in the past, Hong Kong has enjoyed autonomy and freedoms that most people in China can only dream of experiencing. Still, this has been fruitful for both Hong Kong and China.
Hong Kong is the sixth largest financial hub in the world. Although centres in Shanghai, Beijing and Shenzhen have grown in recent years, Hong Kong remains a key centre for international trade and acts as a bridge between the mainland and the rest of the world. For example, capital restrictions on the mainland means many Chinese businesses use Hong Kong’s open economy to tap into international financial market. Similarly, foreign firms that want to break into China often use Hong Kong as a springboard.
China tightens grip on Hong Kong
However, Hong Kong’s special status is under threat after the Chinese government passed new laws that many fear will curb its freedoms. Details are vague, but they are expected to criminalise acts of secession, subversion, terrorism and the interference of foreign entities. In layman’s terms, this could make the idea of an independent Hong Kong illegal, bring an end to free speech, crackdown on protestors and tighten controls over the thousands of foreign businesses.
The new laws are currently expected to be introduced by September, although the ramifications of them are not yet clear. It has sparked a fresh wave of protests, building on the ones held last year, when China attempted to implement a new law that would allow people in police custody to be sent and trialled on the mainland under China’s rules, rather than in Hong Kong courts.
Although the world has much bigger and more pressing problems on the agenda, the move has drawn widespread criticism from the international community, including the UK, the EU, Australia, Canada and the US, but they have been warned by China not to interfere in what it sees as a domestic issue.
How will China’s new laws impact Hong Kong’s role as a financial hub?
There are major implications for Hong Kong’s financial hub. The first issue is the disruption of protests and the impact that is having on everyday business in Hong Kong itself. Protests have become common practice as dissidents fight back against China’s attempts to end Hong Kong’s autonomy and bring it in line with the mainland.
The second and much bigger problem is how the new laws will affect Hong Kong’s status in the world. If Hong Kong loses its economic freedoms, then it may also lose its appeal to foreign firms that use it as a springboard into the mainland as well as Chinese firms that use it to access international financial markets.
It is already threatening the unique status that Hong Kong holds in the world. For example, Hong Kong has been exempt from the tariffs and sanctions that US President Donald Trump has slapped on China in recent years because the country has recognised its special status. But the US has already warned that its privileges could be revoked following China’s move. Trump held off taking any immediate action and instead Hong Kong has become the latest pawn in the trade war between the two countries. The US Senate has already voted to restrict the ability for Chinese firms to list on US exchanges, and if that includes those listed in Hong Kong, then many companies could find themselves in the firing line.
This is not the first time that China has tried to strengthen its hold over Hong Kong, but the concern at the moment is that it could be the last. Although China has backed down before, the country looks more adamant than ever that it can exert its power over Hong Kong – especially while the coronavirus and global economic fallout keeps everyone distracted.
What does it mean for markets and how can you trade it?
Hong Kong is understandably in the spotlight right now. China’s decision and the protests it has prompted have injected severe volatility into Hong Kong’s stock market, which presents opportunity for traders.
Below, we look at several ways to trade the current volatility on offer:
- Indices: Hang Seng index
- Currencies: Hong Kong dollar
- Hong Kong exchange traded funds (ETFs)
- UK-listed stocks
How to trade Hong Kong with IG
With IG, you can trade on the best trading platform and back whether you think an index, currency pair, ETF or stock will rise or fall in value. Go long (buy) if you think they will increase in value, or go short (sell) if you think they will decrease in value.
To take a position, follow these simple steps:
Indices: Hang Seng index
One way to trade the volatility is through the Hang Seng index, which acts as a benchmark for the largest stocks listed on the Hong Kong Stock Exchange (HKSE). It tracks 50 of the largest and most liquid stocks listed in Hong Kong and a few sectors dominate the index: financials, property and construction, consumer staples and discretionary, as well as handfuls of energy, utility and healthcare companies.
The volatility of the Hang Seng index increased significantly in March as protests erupted and the coronavirus outbreak worsened. In fact, the Hang Seng volatility index, which tracks the volatility of the index, spiked to 64.80 on 15 March – its highest level for over five years – and although it has reduced significantly since then it remains well above the average levels seen in recent years. As of 4 June, 55% of IG client accounts with open positions on the index are short.
Below is a list of the companies that make up the Hang Seng index, including their weighting. You can choose to trade the stocks individually, or you can trade the index itself. Trading a stock means you take a position on whether it will rise or fall in value, but the index is the benchmark metric used to measure the health of the HKSE as a whole.
Hang Seng index: who are the constituents and how is it weighted?
|Code||Industry||Hang Seng index weighting|
|China Construction Bank (CBC)||0939.HK||Financials||8.40%|
|Industrial & Commercial Bank of China (ICBC)||1398.HK||Financials||4.78%|
|Hong Kong Exchanges and Clearing (HKEX)||0388.HK||Financials||3.71%|
|Bank of China||3988.HK||Financials||2.90%|
|CK Hutchison Holdings||0001.HK||Conglomerates||1.90%|
|Link REIT||0823.HK||Properties and construction||1.78%|
|Hong Kong & China Gas||0003.HK||Utilities||1.73%|
|CK Asset||1113.HK||Properties and construction||1.56%|
|Sun Hung Kai Properties (SHK PPT)||0016.HK||Properties and construction||1.52%|
|Galaxy Entertainment||0027.HK||Consumer discretionary||1.34%|
|China Overseas Land & Investment||0688.HK||Properties and construction||1.34%|
|Hang Seng Bank||0011.HK||Financials||1.28%|
|China Resources Land||1109.HK||Properties and construction||1.25%|
|Sands China||1928.HK||Consumer discretionary||1.11%|
|BOC Hong Kong||2388.HK||Financials||1.08%|
|Techtronic Industries||0669.HK||Consumer discretionary||1.06%|
|Sunny Optical Technology Group||2382.HK||Industrials||0.96%|
|Country Garden||2007.HK||Properties and construction||0.94%|
|Mengniu Dairy||2319.HK||Consumer staples||0.94%|
|Shenzhou International Group||2313.HK||Consumer discretionary||0.92%|
|Geely Automobile||0175.HK||Consumer discretionary||0.82%|
|MTR Corp||0066.HK||Consumer discretionary||0.81%|
|WH Group||0288.HK||Consumer staples||0.81%|
|New World Development||0017.HK||Properties and construction||0.69%|
|Hengan International||1044.HK||Consumer staples||0.61%|
|China Shenhua Energy||1088.HK||Energy||0.58%|
|Henderson Land Development||0012.HK||Properties and construction||0.57%|
|Bank of Communications (Bankcomm)||3328.HK||Financials||0.53%|
|Cheung Kong Infrastructure (CKI Holdings)||1038.HK||Utilities||0.45%|
|Wharf REIT||1997.HK||Properties and construction||0.43%|
|Sino Land||0083.HK||Properties and construction||0.42%|
|Hang Lung Properties||0101.HK||Properties and construction||0.41%|
|Want Want China||0151.HK||Consumer staples||0.38%|
|China Unicom Hong Kong||0762.HK||Telecoms||0.38%|
Currencies: Hong Kong dollar
Hong Kong also boasts its own currency, the Hong Kong dollar (HKD), and central bank, the Hong Kong Monetary Authority (HKMA). HKD is one of the most-widely traded currencies in the world.
The most important thing to understand about the currency is that HKD is pegged to the US dollar, which means it trades within a very narrow range against the greenback, which is the world’s reserve currency and most widely used. HKD has traded between HKD7.75 to HKD7.85 per $1. The peg means the key currency pair to watch is USD/HKD. Although HKD can be moved by the performance of the Hong Kong and, to a degree, the Chinese economy (like all other currencies), the peg also means that the dollar is actually the key driver.
The peg means HKD has limited appeal to traders, but volumes have still increased over recent years as volatility caused by the disruptive political situation has presented more opportunities to traders. 4% of all turnover from over-the-counter (OTC) foreign exchange instruments was denominated in HKD in 2019, up from 2% in 2016 and 1% in 2013, according to the Bank for International Settlements.
Hong Kong ETFs
You can also speculate on the situation in Hong Kong using ETFs. ETFs allow you to take a position on basket of assets and there are many that offer exposure to Hong Kong.
You can find more ETFs using the IG ETF Screener, which allows you to search for ETFs using a number of criteria, including asset class, geography and performance.
Tracker Fund of Hong Kong (2800.HK)
The Tracker Fund of Hong Kong is one of the largest ETFs in terms of net assets that can provide exposure to Hong Kong. It tries to replicate the performance of the Hang Seng index, so this is another way to trade it.
iShares MSCI Hong Kong ETF (EWH.P)
The iShares MSCI Hong Kong ETF is one of the most popular Hong Kong-focused ETFs among traders, partly down to the fact it trades in dollars rather than HKD. It tracks the performance of the MSCI Hong Kong Index, which follows 43 constituents that represents 85% of all freely floated stocks (by market cap) listed in Hong Kong. This means it provides exposure to many of the stocks in the Hang Seng index and the Tracker Fund of Hong Kong, but it offers significantly different weightings. Below is a list of the top 10 holdings of the ETF, which collectively make up 64% of the weighting:
|Hong Kong Exchanges and Clearing (HKEX)||0388.HK||Financials||8.52%|
|Sun Hung Kai Properties||0016.HK||Properties and construction||4.79%|
|Link REIT||0823.HK||Properties and construction||4.12%|
|Hong Kong & China Gas||0003.HK||Utilities||3.97%|
|CK Asset Holdings||1113.HK||Properties and construction||3.58%|
|Galaxy Entertainment||0027.HK||Consumer discretionary||3.08%|
|Hang Seng Bank||0011.HK||Financials||2.95%|
UK stocks to watch
HSBC Holdings (HSBA.L)
HSBC was founded in Hong Kong in 1865 in order to finance trade between Asia and Europe. The bank is listed in London, Hong Kong, New York, Paris and Bermuda, but Asia is where it makes over two-thirds of its profits and that predominantly comes from Hong Kong and mainland China. HSBC and Standard Chartered were both among the targets of protestors last year and their share prices have taken hits when disruption intensified and tensions rose in Hong Kong. HSBC has warned in the past that there is ‘potential for any associated economic slowdown to impact our expected credit losses in Hong Kong and mainland China’. That is even more significant considering HSBC is providing HKD30 billion in relief to businesses in Hong Kong, although, so far, expected credit losses have remained steady in the region but soared in wider Asia.
Like most businesses, HSBC has tried to stay clear of the grapple between Hong Kong and the mainland, but it has now publicly supported the Chinese government’s new laws. It was reported that the bank released on Chinese social media stating it ‘respects and supports all laws that stabilise Hong Kong's social order’ but stressing that the ‘one country, two systems’ setup was key to the areas future success. Although the bank has been criticised for the move, threatening to cause anger among Hong Kong staff, analysts believe this is the bank’s way of minimising disruption that could be caused by the Chinese government if it didn’t provide its support.
Standard Chartered (STAN.L)
Standard Chartered is another bank that is listed in London with major exposure to Hong Kong. The bank is also listed in Hong Kong and India. Hong Kong is by far its largest market – accounting for 41% of the bank’s underlying profit before tax in 2019, with the rest of Asia contributing a similar amount. It has already warned that a ‘softer Hong Kong economy’ will be one of the reasons why it won’t grow profits by as much as it had hoped in 2020, alongside with the coronavirus and the global economic slowdown.
Standard Chartered has also been impacted by protests and the disruption in the past, and has followed HSBC in backing the new laws. ‘We believe the national security law can help maintain the long-term economic and social stability of Hong Kong,’ but it too stressed it believes in the ‘one country, two systems’ rule.
Prudential is an ‘Asian-led’ insurer listed in London, Hong Kong, Singapore and New York. The insurer has intensified its ties to Hong Kong in recent years after it spun off its UK business and made the Hong Kong Insurance Authority its primary regulator, having previously been under the scope of the UK’s regulator.
Hong Kong is its largest individual market, but it has also been the underperformer of late. While sales and profits grew at double-digit rates in China, Indonesia and many of its other Asian markets, Hong Kong sales were down 11% while profits declined 12% last year.
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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