Can Hong Kong Survive as a Centre for International Litigation and Arbitration?

As Beijing continues to flex its political and cultural muscles, Hong Kong’s legal systems and processes are seemingly being drawn ever closer to those of mainland China. This is starting to trigger concerns about whether Hong Kong remains the right jurisdiction when it comes to international arbitration.

Elicius Intelligence analysts have been speaking to key legal and business figures working in the region to evaluate what this shift might mean for the future of litigation and arbitration in the territory.

Hong Kong as a Centre for Arbitration

For most of the 20th Century, Hong Kong was a geographical and cultural anomaly. This was a core part of its appeal, making it a highly attractive location for businesses needing a base in the region, particularly in the financial services sector.

Its location, confidence in the robustness of its legal systems and processes, and a mutual enforcement agreement with mainland China made Hong Kong a popular option when it came to contractual clauses specifying how disputes between parties would be handled and resolved. In fact, until recently, Hong Kong was the third most popular option when specifying a seat for arbitration in international cross-border contracts.

However, the increasing alignment of Hong Kong’s legislative systems and processes with those of mainland China is beginning to cause ripples of concern with Western firms, leading a growing number to question whether those systems can be trusted when it comes to international arbitration.

A Managing Partner with an American business advisory group told Elicius that this shift is accelerating, “With China enacting the national security law last year and increasingly tightening its grip on Hong Kong,” he says, “overseas companies will continue to question whether Hong Kong should remain the jurisdiction for arbitration especially when companies are negotiating longer-term contracts.”

It is a view increasingly shared by many legal and financial firms operating in the region. The extension of China’s National Security law into the territory and the growing influence of Beijing in Hong Kong affairs, has signalled to many companies that Hong Kong may no longer offer the legal stability and security that it once did.

“Hong Kong used to play the role of West Berlin,” a regional expert observes. “If the US and China are in a new Cold War [..] with the National Security Law, it has become East Berlin.”

The CEO of a private equity fund based in Asia, who Elicius spoke with, supported that view, and predicted an inevitable long-term decline for business in Hong Kong. “Hong Kong’s inevitable sunset as a major financial hub and centre for wealth management is less directly due to the protests and COVID-19” he told us, “and more due to the China central government’s effective takeover of the administration”.

The Ambiguity of (Data) Law

Recent data protection laws introduced by Beijing may further complicate the context for effective arbitration/litigation of disputes where the legal proceedings involve a mainland Chinese entity/individual. And uncertainty over how the far-reaching privacy laws will be implemented is causing considerable anxiety among executives from various industries whom we spoke to.

On 10 June 2021, the Standing Committee of the National People’s Congress passed the Data Security Law (DSL), which came into effect on 1 September 2021. Importantly, DSL has certain extraterritorial reach that governs not only data processing activities within China, but also those carried out outside China that harm “the national security, public interests, or lawful rights and interests of citizens and organisations in China”. The DSL, together with the Cybersecurity Law and the Personal Information Protection Law (PIPL) (which was approved by China’s legislature in August 2021 and became effective on 1 November 2021), will enable China to constrict the sharing of broad swaths of personal and corporate data outside its borders, including the transfer of data from mainland China to Hong Kong.

Both statutes would require companies to obtain approval before providing data to non-Chinese judicial or law enforcement entities. The sanctions for failure to obtain prior approval from the mainland are clear – an entity may be fined up to 1,000,000 CNY (approximately $156,000), as well as additional fines for responsible individuals. However there remain scant details regarding either the approval process itself or the identities of competent Chinese authorities.

The Rule of Law

At the heart of many concerns is an erosion of confidence in the legal infrastructure that Hong Kong provides. The businesses that we consulted with when developing this analysis frequently expressed specific unease about the stability of, and confidence in, the legal and financial structures that all businesses need when it comes to litigation and arbitration.

We spoke with the CEO of a major bank active in the region, who shared his own private concerns about the impact of reduced confidence in the legal system. “Why should we increase our investment in an increasingly unstable territory?” he asks. “Business disputes were previously taken to impartial courts. Why would international businesses invest in Hong Kong without the security of the legal process?”

An American CEO who we spoke with shared this analysis, seeing an inevitability in firms moving away from Hong Kong as an arbitration centre. “The near-universal consensus is that Hong Kong as a reliable global arbitration centre will evaporate,” he told our analysts. “Arbiters, judges, and advocate positions have already been replaced with mainland China appointees.”

Fundamentally, what we are witnessing at the moment is the slow collapsing of trust in the reliability and independence of the legal systems and processes that are in place. Existing contracts may not be drastically affected, but new contracts, particularly for long-term infrastructure projects, are increasingly identifying other jurisdictions as the location for arbitration services.

One major legal firm operating in the region told Elicius that they are increasingly recommending to their clients that contracts specify Singapore rather than Hong Kong as an “arbitration friendly seat” in terms of cost and procedure.

Impact

It is important to remember, that a decline in confidence around arbitration is part of a much wider perception that the erosion of impartiality in the legal system is creating an unstable operating environment for Western firms.

This is leading to concerns that Hong Kong could ultimately adopt other policies seen on the mainland, such as the imposition of strict rules about capital leaving the country. To mitigate against this risk, several businesses that we have spoken to have already taken steps to begin to diversify their assets out of Hong Kong.

This fall in confidence is already starting to have an impact on the strength and shape of the Hong Kong economy as a whole. A combination of political instability and COVID-19 caused the Hong Kong economy to shrink by 1.2% in 2019 and 7.5% in 2020, respectively and has triggered big falls in the value of the HANG SENG.

The American Chamber of Commerce in Hong Kong surveyed members in July 2020 – showing that 5.43% are considering leaving in the short term, with 30.05% considering leaving in the long term.

All of the data is pointing toward a contracting economy, an exodus of western firms, and a Hong Kong that from a legal and business perspective increasingly looks and feels like mainland China.

New Opportunities

However, it is also important to recognise that although the shifting status of Hong Kong creates risks that businesses will need to manage, it also opens up new opportunities which they may seek to exploit.

The increasing integration of the territory with the mainland, particularly in terms of infrastructure and logistics, means that there are likely to be new opportunities for Western companies who want to work with Chinese partners, particularly in sectors such as healthcare, financial services and education.

Additionally, Hong Kong is increasingly the gateway by which money leaves mainland China, and remains the only clearing house for RMB. These factors alone mean that, despite growing risk, many firms will continue to seek out new opportunities in the territory.

Reasons such as these have led some analysts to conclude that it may not be the right moment for Western firms to abandon Hong Kong entirely. One major American firm we spoke to argued that for some businesses the benefits of demonstrating that they remain committed to the territory continue to outweigh the risks. “If companies want to do business with China and maintain good relations with China,” they tell us, “they should not be quick to abandon Hong Kong.”

How Elicius Intelligence Can Help

The closer ties to Beijing mean that businesses will increasingly need to ensure that they are confident in the legal processes that provide oversight and regulation for their major contracts. For some, this may signal a move away from Hong Kong as a centre for dispute resolution. However, for others, either with existing long-term contracts already in place, or with a strong strategic imperative to maintain good relations with China, Hong Kong may remain a viable option, albeit one with a set of increased risks that need to be managed.

Elicius Intelligence can help businesses manage those risks, providing timely and accurate advice, and helping to navigate local systems and processes.

To learn more about how Elicius Intelligence can support your business around contract negotiations and enforcement in fluid political environments, get in touch for a confidential discussion.

 

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