Via Financial Times

Hong Kong’s stock market tumbled after the Chinese government said it planned to impose a national security law on the city in a move that blindsided traders and prompted concerns over the Asian financial hub’s future.

The Hang Seng skidded as much as 5.7 per cent on Friday, putting the index on track for its worst one-day performance in nearly five years on investor concerns that Beijing’s show of legal force could reignite mass protests in Hong Kong and further worsen relations between the US and China.

The jolt to the market came hours ahead of the opening of the National People’s Congress, China’s annual meeting of lawmakers, on Friday. Beijing used the gathering to announce that it would abandon setting a gross domestic product target for the first time, as the country faces its most severe economic downturn in four decades.

Beijing’s move to assert its authority over Hong Kong, which is governed under the “one country, two systems” model that affords the territory a high degree of legal autonomy, comes as small protests have resumed in recent weeks after coronavirus restrictions were eased.

The planned changes would target subversion, terrorism and foreign influence and would be imposed through Hong Kong’s mini-constitution, the Basic Law. China’s national security agencies would set up operations directly in Hong Kong.

“When needed, relevant national security organs of the Central People’s Government will set up agencies in [Hong Kong] to fulfill relevant duties to safeguard national security,” reported Xinhua, China’s state-owned news agency.

The Communist party’s decision earned a sharp rebuke from Washington, with President Donald Trump saying the US would “address that issue very strongly”.

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One question is the special economic and trading status the US extends to Hong Kong but not mainland China as a whole. If Washington deems that the “one country, two systems” arrangement is fraying, the president can revoke certain privileges.

Traders in Hong Kong said they had been caught off-guard by the late-night announcement. Some were concerned it could lead to the end of the territory’s special trading status with the US.

“The key is whether the national security law will affect US-China relations,” said Kenny Wen, a Hong Kong-based strategist at brokerage Everbright Sun Hung Kai. Mr Wen added that further falls were likely for Hong Kong stocks if protests erupted over the weekend.

Louis Tse, managing director at VC Asset Management in Hong Kong, said traders were surprised by the move, but added that Beijing had strong incentives not to upend Hong Kong’s financial system. The city provides Chinese companies with a vital platform for raising funds offshore.

“Hong Kong is just like an ATM, you key in the password and you get the money,” Mr Tse said. “China will have to contemplate quite a few things before they actually stamp their authority on Hong Kong by passing this law.”

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MTR Corp, the company that runs Hong Kong’s metro system and was targeted by protesters during the unrest last year, fell 10.4 per cent, making it one of the worst performing Hang Seng members.

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Another equity trader based in the city pointed out that investors had not taken positions in the market that reflected any previous fears of a crackdown. “I don’t think anyone really thought they would do this at this time,” he said. “The short [selling] activity doesn’t reflect it.”

The security law’s impact was also felt in trading of the Hong Kong dollar. The currency, which is permitted to trade in a narrow band versus its US counterpart, weakened on Thursday evening immediately following the announcement before stabilising on Friday.

Line chart of HK$/US$ showing Security law hits Hong Kong's dollar

In China, the CSI 300 index of Shanghai and Shenzhen-listed stocks fell 2.2 per cent as the NPC — Beijing’s rubber stamp parliament — declined to set a GDP target for the first time. The country faces its most severe economic downturn since the 1970s because of the coronavirus pandemic.

Tai Hui, Asia-Pacific markets strategist at JPMorgan Asset Management, said dropping the economic growth target was “realistic”. “There are just too many variables. You’ve got the outbreak, [and] you’ve got the escalation in US-China trade tensions,” he said.

Additional reporting by Daniel Shane in Hong Kong