Since the handover, the rivalry between Shanghai and Hong Kong (HK) to become the New York of Asia has shown no signs of letting up. Much to the frustration of Shanghai, HK remains one of the most vibrant international financial centers in the world. HK's banking industry is famous for its global network and sophistication. Of the world's top 100 banks ranked by assets, 80 have a presence in HK (1). Additionally, HK's stock market has cultivated a worldwide reputation for its fundraising capability. Since 2004, it has overtaken Tokyo as the leading equity fundraising market in Asia (2). HK's high degree of economic freedom (3), world-class regulatory framework (4), rule of law and rich pool of financial professionals are all strengths that have made this city a haven for internationally mobile investors. Shanghai, on the other hand, is not an international financial center. Unlike HK, it has failed to attract foreign portfolio investment (FPI) on a massive scale. In the following paragraphs, I will discuss the contrasting performance between HK and Shanghai in embracing FPI.

At present, HK still has a huge lead over Shanghai as an international financial center. This development gap has attracted the attention of many scholars. According to Y. W. Sung, Shanghai's development as a financial center has been hampered by the weakness of China's banks and the lack of convertibility of the Renminbi (RMB). China's banks are burdened by huge bad debts, and cleaning up such debts will take a long time. Unless China's banks are financially sound, opening China's capital account will risk inviting speculative attacks on the RMB. (5) Susanne Soederberg also reminds us that free cross-border flows of private capital, particularly in the form of FPI, has led to two problems for developing countries. 'First, there appears to be a greater vulnerability of the economy to risk, financial volatility and crisis. Second, there is a growing imposition of restrictions on policy autonomy, which may result in increased economic problems and higher levels of political repression in the South.'(6) In contradistinction to Shanghai, HK has a fully convertible currency. The free flow of capital in and out of HK is seen within the financial industry as a critical source of competitive advantage. (7)

The banking sectors in HK and Shanghai also exhibit great difference. It is an unassailable fact that the former is an international banking center, while the latter is just a Chinese banking center. Although many foreign banks are eager to expand their retail operation in Shanghai,(8) they still believe that HK's banking services are well-developed and of high quality. Unlike Shanghai, HK offers a very hospitable environment for foreign banks. As an international banking center, HK performs three main functions: financial intermediation, clearing and maturity transformation. (9) In the post-handover period, local banks have displayed assertiveness in developing financial intermediation services outside their territory boundary. HK has the potential to become the major center of loan syndication and project financing for Mainland enterprises. The abundant funding in the local banking system is an advantage in this respect. (10) Recently, Henry Tang also discussed a proposal to establish an RMB debt issuance mechanism in HK.(11) The fate of HK as an international banking center, to a certain extent, depends on its ability to seize the day and build up its RMB businesses.

In terms of human capital, HK's financial services industry (FSI) has benefited from the fact that the local pool of appropriately skilled staff is generally seen to be deeper than anywhere else in Asia. (12) Unlike Shanghai, HK has a corps of senior finance managers with 15-20 years' experience who understand Asian markets and are trusted by their home offices to make decisions for the Asia-Pacific region. (13) Although Shanghai has tried its best to upgrades the quality of its financial workers, it is harder there to find top-notch people with credit analysis, administrative and other skills important to financial service companies. (14)

In addition to the above-mentioned advantages, HK's financial and legal institutions provide sources of advantage for the FSI. They include: a sound regulatory regime on a par with international standards, an efficient and transparent market, and, perhaps most importantly, a well-enforced legal system based on British tradition. According to Michael Enright, 'HK's legal system has been one of the major reasons for its success.'(15) In Shanghai, preserving the power of the state and protecting social stability often take precedence over international standards when sensitive legal cases are involved. (16) Besides, Shanghai does not have a sound regulatory regime. As a result of these institutional hurdles, Shanghai lags behind HK in developing its financial markets. In response to this, the Chinese government lists most of the country's biggest companies in HK rather than Shanghai. The turnover of shares of Mainland enterprises in HK is far higher than in any other international financial center. (17) Furthermore, Nasdaq Stock Exchange and the New York Stock Exchange have ambitious plans to establish links with the HK Exchanges and Clearing.

Though Shanghai has made great progress in developing its financial sectors in recent years, there are still many obstacles to Shanghai's development as an international financial center. HK, on the other hand, is an international financial center that provides intermediation services for people within the Asia-Pacific region and also for people outside this region. (19)

The End
March 2006

Notes
1. Lui Yu-hon, 'Banking, monetary affairs and developments of financial markets,' in Joseph Y.S. Cheng and S.H. Ho (eds.) From colony to SAR: Hong Kong's challenges ahead (HK: The Chinese University Press, 1995), p.153.
2. The 2006-07 Budget (HKSAR government, February 2006), p. 9.
3. A recent study of 102 countries from 1975 to 1995 finds HK first in overall economic freedom (D.K. Ghosh and M. Ariff (eds.) Global financial markets: Issues and strategies (Westport: Praeger Publishers, 2004), p. 30.
4. Although HK has high-quality regulatory framework, many local listed companies are criticized for their bad corporate governance. According to a study conducted by Governance-Metrics International in 2004, HK got below-average ratings for corporate governance (Hong Kong Standard, 9/9/2004).
5. Sung Yun-wing, 'Hong Kong economy in crisis,' in Lau Siu-kai (ed.) The first Tung Chee-hwa administration (HK: The Chinese University Press, 2002), p. 131.
6. Susanne Soederberg, The politics of the new international financial architecture (London: Zed Books, 2004), p. 15.
7. According to Li Deshui, RMB's free conversion would not take place in the next five years. If RMB could be traded freely, Mainland financial centers such as Shanghai would jump from national financial centers to international ones (Hong Kong Economic Times, 26/7/2005). Apart from China, many developing countries place major restrictions on conversions of their currency (Charles Hill, Global business today (Boston: Irwin/McGraw-Hill, 1998), p.284.
8. South China Morning Post, 22/2/2006.
9. Richard Ho, 'Hong Kong as an international financial centre,' in Richard Ho, Robert Haney Scott and Kie Ann Wong (eds.) The Hong Kong financial system (Hong Kong: Oxford University Press, 1994), p. 395.
10. Hang Seng Economic Monthly, September 2005.
11. The 2006-07 Budget, op.cit., p. 10.
12. Michael Enright, et.al., The Hong Kong advantage (HK; Oxford University Press, 1997), p. 149.
13. P. Yatsko, New Shanghai (Singapore: John Wiley & Sons (Asia) Pte Ltd., 2003), p. 85.
14. Ibid.
15. Michael Enright, op.cit., p.108.
16. South Chins Morning Post, 7/2/2006.
17. P. Yatsko, op.cit., p.85.
18. Ghosh and Ariff, op.cit., p.50.
19. Richard Ho, op.cit., p.383