Hong Kong is one of two special administrative regions run by the Chinese Government under the ‘one country, two systems’ policy (the other being Macau). Hong Kong Special Administrative Region (SAR) is largely self-governing with its own currency and its own legal system.
In January 2009 Hong Kong SAR applied to join the Islamic Financial Services Board (IFSB). The news was revealed at a seminar on Islamic finance being promoted jointly by the IFSB and the Hong Kong Monetary Authority (HKMA), which operates as the SAR’s central bank. A second conference, the 2009 Asia Sukuk Summit, also took place in Hong Kong a month later, in February.
It is clear that the financial authorities in Hong Kong have woken up to the potential Islamic finance offers, both in terms of prospective inward investment and of boosting the territory’s international trading role. In 2007 Hong Kong Chief Executive Donald Tsang visited the Middle East, hoping to drum up interest among borrowers and investors to issue Islamic bonds in Hong Kong. In 2007 the Arab Chamber of Commerce and Industry helped establish a five-member Shari’ah advisory council for the SAR.
All talk, little action?
There was much talk throughout 2008 that the Hong Kong Airport Authority (HKAA) would issue the SAR’s maiden quasi-sovereign Sukuk. While Sam Kwok, Treasurer of the HKAA has confirmed that such an issue is under discussion, talk is all that appears to be happening so far.
Steps towards creating Islamic products in the SAR have been limited. In November 2007 Hang Seng Bank launched the first Shari’ah-compliant fund authorised by Hong Kong’s Securities and Futures Commission – the Hang Seng Islamic China Index Fund. The fund invests primarily in the constituent stocks of the Dow Jones Islamic Market China/Hong Kong Titans Index. The index comprises the 30 largest Shariah-compliant stocks of companies whose primary operations are on the Mainland and in Hong Kong and are traded on the Stock Exchange of Hong Kong.
In July 2008 Mayfair Pacific Financial Group unveiled plans to launch a $300 million Shari’ah-compliant mutual fund; created, according Cristina Tung, the Managing Director of Mayfair Pacific, in response to demand from investors in the United Arab Emirates (UAE) and Pakistan. It is the first Islamic mutual fund to focus on the Greater China region, covering mainland China, Hong Kong and Taiwan. Tung believes that there are interesting opportunities for Islamic finance not only in and out of Hong Kong to mainland China, but also further afield in Taiwan, Macau and the Kowloon Peninsula.
Just a month later, the first full service Islamic finance banking window was opened in Hong Kong in August 2008 by Hong Leong Bank (Malaysia).
Committed to Islamic instruments
Speaking at the IFSB/HKMA sponsored conference in January, Joseph Yam, Chief Executive of the HKMA commented, “The importance of Islamic finance is rising in the global financial market. As an international financial centre, Hong Kong is stepping up its efforts to promote its financial services to major Islamic countries and regions, and developing an Islamic bond market.”
However, Hong Kong has yet to resolve a key tax problem. The SAR taxes profits arising locally but not interest – interest income is tax-exempt. This creates an immediate problem whereby many Islamic instruments would face tax charges while conventional investments would not. The territory is now considering ways to modify its tax laws to attract Islamic finance.
It is possible that the SAR Government could waive tax on income on profits from Islamic bonds. This is a mechanism that is already used on government bonds and exchange fund debt papers. Such a move would also impact on mainland China, giving mainland debt issuers access to Shari’ah-compliant financial instruments, offering overseas Islamic capital the opportunity to invest in areas of China that have a high Muslim population, such as Xinjiang, Gansu and Ningxia.
In February, while noting in passing the start of the Year of the Ox in the Chinese calendar (the ox being a symbol of strength, resilience and bullishness), Eddie Yue, Deputy Chief Executive of the HKMA told the Asian Sukuk Summit, “Shari’ah law, prohibits excessive leverage, risk-taking and uncertainty, and promotes ethical practices. These are indeed universal principles in all markets – or at least they should be: one of the lessons of the present financial crisis is that too little attention has been paid to them. This is not to suggest that Islamic finance is without risk – indeed many of the risks inherent in Islamic finance are similar to those of conventional finance, and, in fact, Islamic financial institutions may be subject to other unique risks from the liquidity and operational perspectives. But Islamic finance introduces an alternative form of financing, and one that offers many opportunities particularly when financial market conditions start to improve.
“A key part of the Government’s strategy for developing Hong Kong as an international financial centre is a focus on Islamic finance. In support of this initiative, the HKMA, in collaboration with the Treasury Markets Association (TMA), has devoted considerable time and resources into establishing an appropriate infrastructure framework and developing an education and awareness programme both locally and worldwide. Although we are still in the infant stages of development, we have accumulated some experience.
“Islamic finance, at least for jurisdictions like Hong Kong, means change – a change in perception, a change in skills, a change in structures and techniques, in contracts, standards, and so on.
“One of the most daunting of the changes required for policymakers and regulators is the change in regulations and taxation rules to provide an equitable environment for the operation of Islamic finance within the overall financial market framework. Within Hong Kong, with the wealth of expertise drawn from members of the TMA, recommendations were put up and analysed by the Government as a priority in its comprehensive tax review. The Government has concluded that the legal system in Hong Kong is flexible enough to meet the demands of Islamic finance transactions.
The rule of law
“This is because, with our robust rule of law and our simple tax structure free of capital or interest gains tax, there have only been a minimal number of taxation issues that have to be dealt with. The legislation on tax also gives power to the Government to grant tax exemptions where necessary to those who apply for it. The legal architecture in Hong Kong therefore lends itself well to Islamic finance. There is therefore little time to spare, in the run up to a revival of the Sukuk market and the lead time it takes to promulgate tax exemption rules for Islamic finance transactions; financial market players in Hong Kong must gear themselves up to embrace the change.
“While the recognition of Islamic finance as a viable fund-raising and investment alternative is gradually making its way to the corporate sector in Hong Kong, the pace of development is still rather slow. Furthermore, this market awareness should also be promoted beyond banks and other types of financial institutions to all related service industries, such as investment managers, asset managers, securities and brokerage houses, exchanges and commodity firms, pension funds, insurance agencies, solicitors, accountants, and trustees. Not only will this require a much wider network of collaboration among the trade associations in Hong Kong, it will also require the financial institutions themselves to play a role in educating their customers and stimulating the potential supply and demand of Islamic financial products in Hong Kong.
“I believe that there is endless potential for us [Hong Kong] to innovate in the area of Islamic finance, especially in deploying our special strengths – our close affinity to China, our experience as an international fund raising centre and asset management hub, and our role as a testing ground for the Mainland’s financial liberalisation. There is, for example, no obstacle to Hong Kong’s becoming a centre for Islamic IPOs, given our distinct record as a leading IPO centre in the region.”
Professor K.C. Chan, Secretary for Financial Services and the Treasury, Hong Kong SAR, confirmed that the Government “is putting in place tax neutrality measures to facilitate the development of Islamic finance. These measures seek to address disadvantageous treatments on the issuance and transactions of Sukuk vis-‡-vis conventional bonds. They will enhance the commercial viability of Sukuk in our market… We continue to enhance our market infrastructure and raise our profile as an Islamic finance platform. Market response to our effort has been encouraging.”
However, Chan predicted that the Government’s “commitment and confidence in developing Islamic finance remain strong... While economic cycles will have a bearing on the pace and intensity of Islamic finance development, prospects for the Islamic finance industry in 2009 and beyond would remain positive, given the strong fundamentals underlying the development.”