Monday 26th February 2018: S-RM’s latest Regional Bulletin for Asia Pacific is a SPECIAL EDITION focused on China’s Belt and Road Initiative (‘BRI’).
Over the coming months, S-RM will be sharing regular updates and commentary on the BRI, its progress, and the implications for businesses operating in, or looking to operate in, the territories it will affect across Asia Pacific, Russia & CIS, the Middle East, Sub-Saharan Africa and Europe. In this issue of our Asia Pacific bulletin we look at Hong Kong’s evolving role as the ‘bank of belt and road’, and China’s emerging position in establishing a framework for the resolution of cross-border disputes. We also highlight projects along the BRI where some of the potential risks are already becoming apparent.
Click below to read and download the full bulletin and to view the interactive map:
Hong Kong: the Bank of Belt and Road?
Since its inception as a British colony in the 1800s, Hong Kong has been viewed as China’s gateway to the world. Whilst no longer China’s preeminent port – that honour belongs to Shanghai – Hong Kong continues to hold a special place in China’s relationship with the outside. Under the ‘One Country, Two Systems’ framework, Hong Kong retains its own legal system and, crucially, control over its economic and financial affairs. As such, Hong Kong doesn’t have to abide by the capital controls that limit inbound and outbound investment in the rest of mainland China.
It’s not surprising, then, that the Chinese government has recently announced its intention to allow countries involved in the Belt and Road Initiative (‘BRI’) to raise funds via CNY-denominated IPOs in Hong Kong. On the surface, this seems like a real boon for the city – but what are the implications of such an initiative?
It’s all about the yuan
The crux of the proposal is that the funds will be raised in renminbi, rather than Hong Kong dollars. The internationalisation of the renminbi is a key driver of the BRI IPO initiative, and Beijing has been touting the notion that renminbi should become a global currency for some time. To date, there have been only two yuan listings in Hong Kong, neither of which has been particularly popular with investors – Li Kashing’s Hui Xian REIT is currently trading 40% below its 2011 yuan offer price, and Hopewell Highway, a toll road operator, hasn’t impressed investors either. As such, it’s unclear whether there’s much appetite for yuan listings among Hong Kong investors. Most notably, none of Hong Kong’s biggest companies – including Cheung Kong, Henderson Land or Sun Hung Kai – have expressed any enthusiasm at the news.
What about international investors? Due to tight capital controls, it remains difficult for foreign investors to fully trade in the Chinese stock markets, and only a handpicked group of institutional investors are allowed to trade Chinese A shares; foreign investors currently own just 1.5% of Chinese stocks. But it’s unclear whether there’s significant international demand: in 2017, inbound foreign investment fell for a second straight year, perhaps in response to China’s soaring debt and subsequent credit downgrading from Moody’s. In this light, perhaps the main reason why the Chinese government is considering the BRI IPO plan isn’t to provide funds for international infrastructure plans, but to increase much-needed foreign direct investment in China itself.
Boon or burden?
So what does this mean for Hong Kong? For starters, it would give the city a boost in international IPO rankings. Hong Kong has long been a global IPO powerhouse; however, the last two years has seen a slump. Hong Kong raised total IPO funds of HKD 263 billion (USD 30 billion) in 2015, compared to HKD 195 billion (USD 25 billion) in 2016, and HKD 127 billion (USD 16 billion) in 2017.
Crucially, whilst there has been a significant decrease in the amount of IPO funds raised in Hong Kong, the actual number of IPOs has increased, meaning that Hong Kong is missing out on bigger ticket listings to rival exchanges. This is likely a result of the Hong Kong Stock Exchange’s failure to modernise and offer an attractive regulatory regime for technology and new economy companies. In 2014, for example, Hong Kong famously missed out on Alibaba’s IPO due to the Stock Exchange’s refusal to list dual class shares, often used by technology firms so that visionary founders can retain control. Viewed in this light, then, BRI IPOs could be a blessing to Hong Kong. Indeed, the Hong Kong Stock Exchange has already lowered the entry barriers for infrastructure companies to list, in a bid to attract BRI companies.
The risks, however, are equally clear. The BRI spans many countries associated with corruption and instability, which could prove a headache for regulators and investors alike; investor protection is crucial where foreign infrastructure projects are concerned. In addition, should the Hong Kong Stock Exchange ease its restrictions further for infrastructure companies or become embroiled in a regulatory mishap as a result, the reputational damage could be critical – Hong Kong’s status as a safe haven for investors could be in jeopardy.
Perhaps the main downside is that the biggest winner in the BRI is China itself. According to Archie Preston, a consultant for CITIC Guoan Group, the ability to raise funds in Hong Kong may just be a “safety net” in case domestic capital dries up – effectively relegating Hong Kong to a supporting role. “Many of the benefits of the BRI are expected to fall into the hands of large SOEs and well-connected private Chinese companies”, he adds. Perhaps this explains the reticence of Hong Kong’s biggest players?
BRI and the rise of cross-border disputes: what role will China play?
Legal resolution for cross-border disputes has been a key issue in discussions surrounding the Belt and Road Initiative (‘BRI’). An increase in trade connectivity will likely lead to a rise in disputes between trading partners in BRI countries, in which cultural, linguistic and judicial norms vary. The complexity and multi-jurisdictional nature of BRI projects has prompted a review of existing dispute resolution processes by Chinese and international legal professionals, which has seen an emerging desire for less formal procedures, such as mediation and arbitration.
Given that the majority of BRI outbound investment is driven by state-owned Chinese companies, China has been keen to resolve BRI-related cross border disputes on its own terms. In the past two years, China has proposed or launched a number of China-based initiatives to provide resolution to BRI disputes. China’s attempt to set the rules in BRI disputes has been a relatively decentralized process: it has not been led by any single government agency, but has instead been driven by multiple organisations at a local and national level. China’s Supreme Court, the most authoritative in the country, has been instrumental in establishing BRI courts and setting out guidance for BRI arbitrations. However, government-affiliated Chinese arbitration institutions, such as the China International Economic and Trade Arbitration Commission (‘CIETAC’) and the Wuhan Arbitration Commission (‘WAC’), as well as private law firms, are also involved.
Chinese companies will continue to push to set terms in contracts requiring BRI-related disputes to be settled under Chinese jurisdiction, instead of in the jurisdictions where the disputes arise, where they are concerned that arbitration may be disadvantageous. But questions have also been raised abroad about whether a China-led dispute resolution system will be equitable. According to CNBC, a US business news outlet, international legal professionals doubt the impartiality of China-based international courts, which may reduce confidence in a China-led BRI legal framework.
However, China has also demonstrated willingness to embrace international arbitration in the context of BRI. In 2015, China’s Supreme Court published 18 model cases on its website, heard both within and outside China, to serve as guidance for lower courts on how to address future cross-border disputes, including recognizing and enforcing international arbitral awards in accordance with the New York Convention, one of the key instruments in international arbitration, of which China is a signatory. Hong Kong, with its sophisticated legal system, language expertise, and experience in dealing with legal disputes involving Chinese companies, is likely to be favored by Chinese companies seeking international arbitration.
And Hong Kong is eager to maximize opportunities arising from the BRI: in 2017, former Justice Secretary Rimsky Yuen said that Hong Kong has introduced two amendment bills to its Arbitration Ordinance to better serve disputes that may arise from BRI-related projects. Additionally, the judgements of the Hong Kong International Arbitration Centre (‘HKIAC’) are enforceable in the signatory countries of the New York Convention, which includes a majority of BRI countries. In 1999 Hong Kong and China also signed an agreement on the Mutual Recognition and Enforcement of the Arbitration Award, which allows awards made in Hong Kong to be enforceable in China.
It is still too early to determine whether these China-centered efforts will gain traction in BRI countries, particularly given that some countries are also developing their own frameworks for dispute resolution. For example, in Kazakhstan – where nearly 21 percent of China’s cross-border M&A investment took place between 2000 and 2016 – the government has introduced new legislation in an attempt to simplify domestic arbitration procedures. This signals Kazakhstan’s desire to improve its own commercial arbitration mechanisms, rather than simply allowing a China-led framework to evolve, and it may also epitomize sentiment along the Belt and Road. However, perhaps the greatest stumbling block for China, particularly in more developed countries along the BRI with more robust democracies, is a mistrust of the Chinese legal system itself. China will have to work hard to show the world that it is ready to begin setting legal standards on the international stage.