Hong Kong’s Private Wealth Bankers Should Be Anxious

(Bloomberg Opinion) — Shortly after Hong Kong narrowly surpassed Switzerland as the world’s largest offshore asset management center, the sustainability of the business is already being called into question.

This seismic event is China’s recent crackdown on cross-border stock trading. Hefty fines aside, Beijing has asked three online brokers, the largest of which is based in Hong Kong, to liquidate all existing mainland Chinese accounts within two years. In a simultaneous move, the city’s securities watchdog issued a statement warning against inadequate due diligence in client onboarding and calling for close monitoring of dormant accounts.

For now, Beijing’s ire is directed at Futu Holdings Ltd., Up Fintech Holding Ltd.’s Tiger Brokers and Longbridge Securities Ltd., three retail online securities firms. But the bigger question is whether Hong Kong’s valuable private banking business will also be affected. The move is interpreted as China tightening controls on capital flight from the mainland, fearing that uncontrolled outflows would weaken the yuan and destabilize its financial system.

Some institutions are already being cautious. The Shanghai branch of Hong Kong-based Bank of East Asia Ltd. has suspended offshore account openings for its high-net-worth clients, South China Morning Post reported. UBS Group AG is postponing its mid-year wealth outlook event in China, while HSBC Holdings Plc is recommending that Hong Kong-based private bankers avoid non-essential travel to the mainland.

Managing money is very profitable for wealthy individuals. At HSBC, the business could generate a 35% return on equity, according to estimates from Goldman Sachs Group Inc.; This rate is well above the company average of 17%. Last year, Hong Kong’s cross-border wealth rose 10.7% to $2.9 trillion, according to Boston Consulting Group Inc.; flows from the mainland represented 59% of assets under management.

This easy money can disappear overnight. I see at least three major obstacles.

First, China claimed that online securities firms were breaking the law because they were not licensed to solicit mainland clients for cross-border stock trading. Publicly, Futu said he would fully cooperate with the government and had the right to present a defense and request a hearing.

In the past, Hong Kong-based asset managers for global banks would travel to the mainland to socialize and deepen relationships with their clients. But account openings or discussions about specific investment products would not occur until their clients visited the financial center themselves. Will China allow this practice to continue?

Second, can mainland clients invest abroad while onshore? As part of the crackdown on online brokerage, there is an understanding that Chinese investors will not be allowed to trade on their apps if they are physically located on the mainland. The government can ensure compliance by asking brokers to track a user’s IP address and through the global positioning system, or GPS, on his phone.

If this strict interpretation were applied to global banks, there would be little incentive for a wealthy person living in Shanghai, for example, to maintain offshore accounts at these banks. Hong Kong banks are being pressured by the city’s securities watchdog to close dormant accounts.

Third, how backward-looking will China be? Futu and Tiger are asked to liquidate all mainland Chinese accounts; This differs from an understanding developed three years ago of an earlier regulatory crackdown that brokers could continue to serve existing mainland customers but were prohibited from seeking new users.

Hong Kong’s monetary authority has instructed banks to require customers to declare that funds used in investment accounts come from outside mainland China. At Standard Chartered Plc, 30 percent of the net new money the bank generates comes from “global Chinese customers,” with money already sitting overseas, according to management.

If Beijing decides to go one step further, a simple declaration form will not be enough. Local institutions will need to conduct detailed due diligence themselves. This would be a time-consuming, labor-intensive compliance nightmare that would inevitably reduce the operating efficiency of wealth divisions.

Hong Kong likes to portray itself as a global financial centre, but Beijing’s latest crackdown is a real stress test for that image. We will learn in the coming months whether China’s reach will extend from brokers to bankers. The city’s luxury private wealth managers should be worried.