I have been reading a thought provoking paper by Sue Lyn Stubbs on the future of Hong Kong as an IFC, but which is also highly relevant to Shanghai. She suggests the planned creation of “The China Network” IFC (which would include Shanghai) rather than any one city dominating the East Asia region and time zone (as London and New York dominate theirs). Stubbs is optimistic about the future of Hong Kong as an IFC. She puts up a good argument, but I think she is WRONG! In my view, Hong Kong does NOT have a great future. Moreover, China will seek to reduce the role of the English language and English based common-law in the international financial system.

The Stubbs paper, entitled “The Future of Hong Kong as a Global Financial Center — Embracing Hard-Power and Soft-Power” is a Huntsman Program Honors Senior Thesis at The Wharton School. She considers the future of Hong Kong right out until 2047 and after!

Stubbs says that “there is a window of opportunity for China to leverage the relative strengths of each of its current and emerging IFC’s to create the “China Network” Financial Center. By combining the strengths of the centers in Beijing (banking), Shanghai (domestic funds and bonds), Shenzhen (growth enterprises and IPOs) and Hong Kong (international financial center), China could create a networked center that would have the potential to compete on a par with the top-tier IFCs in London and New York”.

Each of these four locations would perform “distinctive and complementary roles within the region”. It would, she says, “create a seamless trading scheme that could allow global products to be traded, cleared and settled at the lowest transaction costs and lowest trading and settlement risks across the region”.

Appealing as this idea is, I think that the Stubbs argument has a fundamental flaw (which also may be relevant to the threats of HSBC to move its headquarters from London. See post “HSBC headquarters” in right hand column). However, the flaw in her argument could, ironically, make a different version of her “China Network” a reality!

Stubbs’s “China Netwok” argument is built on the idea of each of the four cities bringing something unique to the table. In Hong Kong’s case this is ultimately about its English based common-law system and international acceptance of this (ie one of its “soft powers”). China could do lots of things in an attempt to make Shanghai the pre-eminent IFC in the East Asia region (and I spoke about these at the 30 May SIIFC Forum), but one of these will NOT be a change in its legal system or the use of English as a default language in case of dispute. That is, Shanghai will not emulate Dubai.

Stubbs says that June 30th, 2047, the 50 year period for the “One Country, Two Systems” policy, “could potentially be an end to Hong Kongs’s capitalist way of life”, but then goes on to say that “most experts would agree that maintaining the status quo is the most likely scenario for Hong Kong’s future”. This, of course, is 32 years away, but Stubb’s paper is really about using that benign assumption about the future of Kong Kong to plan and create “The China Network” in the intervening period.

I really do doubt that China will be happy to see a prolonged continuation of the status quo for Hong Kong. This is not to say that there would not be benefits, but Chinese nationalism, pride and ambition will, in my view, eventually make it unacceptable. China clearly wants tighter control over its future, and a “Western-oriented” enclave would seem to be inconsistent with that. If I am right on this, then Hong Kong’s uniqueness and contribution to the “China Network” will be substantially eroded.

Stubbs concedes that the “legal, institutional, political and cultural barriers between the cities are somewhat large” but optimistically argues that “they are not insurmountable particularly if there is a common will”.

Where I differ with Stubbs is that I do not think that there will ultimately be such “will” by China in regard to integrating a “One Country, Two Systems” Hong Kong.

Rather, I think that the Hong Kong that would be part of her “China Network” would be a Hong Kong that is part of a “One Country, One System” — and thus, in my view and somewhat ironically, more likely to actually occur! In my view, Stubbs has got the end result at least partly right but on the wrong premise! Her “China Network” will be somewhat different from the one that she envisages.

Stubbs quotes Hong Kong based Dr. Simon Xiaobin Zhao as saying: “The Global consolidation of International Financial Centers (IFCs) like Europe and London, the Americas and New York do not apply to Asia and other parts of the world due to the fact that their systems, institutions, and markets are so diversified and fragmented”. I think that Stubbs is right when she says that it is “unlikely that a single center in Asia will play such a dominant role as New York does for the Americas, or that London does for Europe and Africa”.

In my view, what is often missed in the London story is the enormous benefit it received from having the US replace Britain (and Empire) as the world largest economy. The new “Empire” had the same language and, essentially, the same legal system.

Would Paris now be the dominant IFC in Europe if the US has been colonized from France and French speakers? And what would have happened if it had been China rather than the US which was the successor to the UK (and Empire) — would there have been no dominant IFC in Europe, but instead a number of cities such as London, Paris, Frankfurt etc sharing the role?

While there are very significant advantages of “agglomeration”, as Stubbs puts it, even her “China Network” IFC (in whatever form) might not dominate the East Asian region and time zone.

There is also another possible issue here for the world financial system. Just as China is not happy with present institutional arrangements in the world of finance (witness the existing arrangements with the IBRD and the IMF, the new China proposed AIIB  and BRICS Bank etc), it may ultimately not be happy with the dominant role of the English language and common-law in that system.

I think China will work to change the situation.

Reaching out to London (to help promote the RMB as an internationally used currency etc) is presently quite useful for China (just as working with Hong Kong is now useful), but at some stage the focus may switch to continental Europe IFCs in the hope that this will erode, at least to some degree, the present pre-eminent role of London as an IFC in that region and time zone.

New York will be quite safe in its position as a top-ranked IFC as its importance is in large part due to the size of the US economy. In the East Asian region, Singapore is likely benefit in relative terms from the decline of Hong Kong and become the dominant non-Chinese IFC.

Thirty-two years from now (the Stubbs time-frame) the world of finance will, in my view, look substantially different. And, I would not go betting on greater integration! Fragmentation, based on two blocks (one China centered, and one US centered) is more likely. Moreover, way before 2047 the new world of finance should be abundantly clear.