Hong Kong is boosting its links to Chinese banks — but there are risks involved

Hong Kong’s burgeoning financial links with China hold enormous opportunities — but they carry risks for its banking sector as well.

Compared to Hong Kong’s, mainland China’s financial regulatory regime can be less transparent. So, as financial institutions from the mainland increasingly operate in the semi-autonomous financial hub, potential business partners need to be aware of such differences and enhance their own adherence to the city’s rules.

That issue was demonstrated by the Hong Kong Monetary Authority’s recent reprimand and fine of a mainland Chinese bank over money-laundering enforcement concerns, according to Fitch Ratings.

“(The incident) highlights the potential financial crime and compliance risks faced by Hong Kong banks as a result of the territory’s role as an international financial hub and its integration with the Chinese financial system,” Fitch said in a release dated Aug 23.

The regulator announced on Aug. 17 that it ordered Shanghai Commercial Bank to institute changes and pay a fine of 5 million Hong Kong dollars ($637,000) for laxity in monitoring business relationships with nearly three dozen customers.

“The HKMA’s challenge in maintaining oversight standards and upholding anti-money laundering regulations should also be viewed in the context of Hong Kong’s increasing economic and financial linkages with China, where corporate governance and transparency tend to be weaker than in Hong Kong,” the ratings agency added.

Fitch said the regulator’s action against Shanghai Commercial Bank displays the regulator’s resolve in fighting money laundering and will likely further strengthen compliance in Hong Kong’s banking sector.

Regulators worldwide are under growing pressure from the United States to take a tougher stance on money laundering and to block terrorist financing. A key element of compliance is to carefully monitor customers to root out potentially suspicious transactions, which can be extremely complex.

In deciding on the punishment, the financial regulator in a statement cited “the need to send a clear deterrent message to the industry about the importance of effective internal anti-money laundering-counter-terrorist financing controls and procedures.”

Hong Kong, a former British colony, became a semi-autonomous special region of China in 1997, but maintained its currency, legal system and financial regulations.

Despite systemic differences, economic ties with the mainland have become much closer over the past two decades. Many Chinese companies and financial institutions have moved into Hong Kong, where they are subject to local laws and regulations.

Shanghai Commercial Bank responded to the HKMA’s punishment by saying it had fully cooperated and accepted the results.

“The bank will continue to review and enhance its internal policies and procedures, where necessary, to deter any financial crimes,” it said in an Aug. 17 statement.

Frank Tsui, who manages $6 billion worth of Greater China equities, including bank stocks, at Hong Kong-based Value Partners, said that, in China, where banks are mostly state owned, a similar situation would likely be handled differently.

“These things tend to be settled internally,” Tsui told CNBC on Wednesday, adding that standards differences between Hong Kong and China are likely to remain for some time.

“They may not be able to suddenly change everything in the blink of an eye,” he said of the situation in China. “It will take time.”

Examples of increasing financial cooperation and integration include efforts in recent years to foster mutual stock and bond investing between Hong Kong and mainland markets, which remain highly controlled.

And while China’s efforts to become more open financially have been lauded, there are also worries that they should not be seen as a given.

“One gets the sense that these attempts at openness could be reversed, depending on political, domestic exigencies,” John Woods, chief investment officer for Asia Pacific at Credit Suisse, said on Tuesday.