Indonesia, Malaysia, the Czech Republic, Russia — for the past two months K.C. Chan has maintained a rigorous schedule, traveling from place to place, raising awareness in the marketplace of Hong Kong's unique role on the global financial frontier.

The footprints along his path, and the road not yet traveled, help to shed some light on Chan's convictions and his mission.

"For me, Hong Kong's strength is definitely international connectivity. We must make sure we build on that strength," the city's secretary for financial services and the treasury told China Daily in an exclusive interview.

Time magazine, in an issue published in 2008, coined the term "Ny-lon-kong" for a cover story on globalization. The story declared that cities such as New York, London and Hong Kong are "linked by a shared economic culture", making them "exemplars of globalization".

"At that time, I said Time magazine had been so kind to Hong Kong and that it saw the potential for Hong Kong. New York is serving the US economy, London half of Europe. At that time, Hong Kong was the very distant third in terms of financial market size and importance," Chan said.

In terms of the economic hinterlands the three regional hubs and global icons serve, Chan's perception was not about being humble, but being realistic.

"These days I think Hong Kong is still trailing behind New York and London, but in 10 years, our vision is that 'Kong' should be equal with 'Ny' and 'Lon' thanks to China's rise, because we serve the world's second largest economy," said Chan, adding that it is not just Chinese investors, but a lot of international investors who come to Asia trying to raise funds through Hong Kong, which has made the city flourish.

In the 12th Five-Year Plan, a chapter is dedicated to Hong Kong, promising support for Hong Kong being an international financial center and, specifically, a testing ground for the yuan to go global.

Assuming a central role in the internationalization of the yuan, Hong Kong is developing an offshore yuan market at an impressive pace within a short period of time. Since July 2010, the signing of the revised clearing agreement for renminbi business in Hong Kong has helped to build steam for the development of an offshore yuan market. Yuan deposits in the local banking system surged sixfold, accounting for about 9 percent of the city's total deposits. Eighty-six percent of China's cross-border yuan trade settlement is done through Hong Kong. Yuan-denominated bonds, nicknamed "dim sum bonds", have grown virtually from zero to around 55 billion yuan in the past year.

"The reason that Hong Kong is a good offshore market is that we are quite sensitive to the national policy and we understand the role gradualism plays in mainland policy making," said Chan.

"From day one when we talked with the mainland about what Hong Kong can do on yuan internationalization, we expressed that we share the concerns about financial security. Now we think the risk can be managed and I believe this view is shared by many mainland policy-makers," said Chan.

Though the market is growing, there are groans about a developing bottleneck — Yuan funds raised in Hong Kong have yet to find a routine channel for repatriation to the mainland, where the higher returns await.

Some bankers expect a yuan foreign direct investment (FDI) rule to be the next major step towards yuan internationalization, rather than the current case-by-case approval that currently holds. That will facilitate Hong Kong's offshore market by stoking demand for yuan lending, yuan bonds and yuan initial public offerings.

Chan sees yuan FDI as an important task in the coming months, but "whether we have a systemized guideline of regulation will not bring a fundamental change".

"I don't think there is any fundamental policy hurdle at this point. I am looking at everything to work together, like a machine," said Chan, adding that it is also very important to get foreigners to switch to yuan in trade settlements.

In the first quarter of 2011, around 7 percent of China's cross-border trade was settled in yuan, a majority of which was done through Hong Kong banks.

"We need to increase the percentage of trade settlement in yuan," said Chan, who carried this theme in his recent overseas trips.

"When I met with people on the mainland, I tried to emphasize Hong Kong's international connections and give them our vision that Hong Kong is not only for Chinese investors and institutions, but also attracts a lot of international players as they can invest in the mainland market," said Chan.

"We are not only doing business in offshore yuan. That is not what we are after. What we are after is to improve Hong Kong and make Hong Kong more competitive, so that we can serve what we see China in 10 years," said Chan.

Credibility is the key issue

The heat of summer features a simmering tussle between investors and mainland concept stocks in North America. The credibility of mainland companies listed overseas has been strained by short-sellers, who have chilled the once frenzied Chinese market, by leveling charges that inaccurate information is being spread. Amid skepticism fueled by reports of huge losses by prominent fund managers, robust denials by companies tagged as losers, questions inevitably emerged, what is the situation in Hong Kong, where mainland companies account for half of its market capitalization?

"Hong Kong has very tough regulations. Some of the cases you saw in the US market wouldn't happen here, because they wouldn't meet our listing standards," said K.C. Chan.

Mainland companies went public in the US through "reverse mergers", in which a private company buys a listed shell company and retains the US listing. This roundabout practice saves firms from some of the scrutiny applied to an ordinary IPO.

These stocks, from Longtop Financial Technologies Ltd to Sino-Forest Corp, are suffering from share price slumps, as short-sellers insisted the companies supplied investors with false information. Sino-Forest plunged 75 percent in Canadian trading two days after Carson Block of Muddy Waters LLC said the company overstated its timber holdings.

"No market has a perfect record. Otherwise there is no risk. And risk is part of the picture. The question in the market is, have we tried a lot in terms of providing good regulation? Have we tried to put in place the safeguards?" said Chan.

To list in Hong Kong, the fund-raising venue that topped the world in the past two years, a company is required to show three years of profit, then survive reviews by the listing division of the local stock exchange, an independent listing committee, and Securities and Futures Commission (SFC) under a dual filing system.

Chan recalled that when he assumed his role in 2007, many people came to him saying that it is too difficult for companies to obtain listings in Hong Kong, and that the bourse should follow other market practices.

"I said: 'No, we are not going to follow other markets. I think quality is important.' We don't try to lower our quality in order to win business," said Chan.

"However, it is naive to think that your quality is so high that no one will fail," he said, "In the past, we had cases of some enterprises running into troubles, their accounting statements are not accurate. We have our own problems. But the point is, we recognize it, and we don't try to win businesses by undercutting regulation."

An IPO trouble that is still pending settlement involves Hontex International Holdings, whose stock was suspended March 2010. The High Court froze HK$997.4 million of the Fujian fabric maker raised through its IPO as SFC investigated allegations that the company overstated earnings in its listing prospectus.

In March, the city's watchdog chided investment banks and other sponsors for failing to perform adequate due diligence in their works on IPOs.

The regulator's departing head, Martin Wheatley, said on June 8 that the commission would issue a consultation paper in the third quarter to collect views on tougher penalties for IPO sponsors. The effort to reform laws means listing sponsors in dubious IPOs may face jail terms.

Yuan still not a sure bet

Hong Kong's development into an offshore yuan center has made great leaps in the past year but each done deal and each under consideration must be viewed against the backdrop of the expectation that the Chinese currency is to appreciate.

The desire to hold something that you believe will gain value in future is certainly rational in a market-driven economy like Hong Kong.

According to official figures, yuan deposits rose fivefold in the preceding 12 months to May, reaching 544.8 billion yuan by the end of that month.

"Right now we see a lot of accumulation of yuan overseas, because overseas investors want to hold it, even though the interest rate is so low. That helps to some extent. But clearly that is not sustainable," said K.C. Chan.

The doubts about sustainability and their far-flung impact on Hong Kong are valid.

At a China Daily Asia Leadership Roundtable held in early June, Professor Fan Gang, former member of the Monetary Policy Committee of the People's Bank of China, warned that the yuan's upward momentum may be exhausted in 2 to 3 years, posing the risk of inverse capital flow when investors shy away from the currency.

For Hong Kong, does the yuan's projected path, which is rising to a plateau, indicate a fleeting boon or does it foreshadow strong headwinds?

Chan said though the expectation of yuan appreciation facilitates growth of the offshore yuan liquidity pool, some who might use yuan to settle their trade will not do so because they think yuan will cost more.

The logic is that such expectation has made traders more willing to accept the currency to settle exports, but reluctant to borrow the yuan to settle imports, leading to an imbalance in cross-border trade settlement.

"So the expectation is not totally beneficial to our development. Now we want a much more balanced situation where people do not have one-sided view on the exchange rate. So the people are more likely to switch to yuan for trade," said Chan, "and that is important, because the whole policy of yuan internationalization is to encourage import and export to be denominated in yuan."

If the yuan appreciation expectation moderated, "we got more trade, more people to borrow yuan, issue paper, so it may not be that bad," Chan said.

Bio

K.C. Chan has been the secretary for financial services and the treasury of the government since 2007. Prior to assuming the post, he was dean of business and management of the Hong Kong University of Science and Technology.

Chan received his bachelor's degree in economics from Wesleyan University and both his MBA and PhD in finance from the University of Chicago.

Before joining the government, Chan held a number of public service positions including chairman of the Consumer Council and director of the Hong Kong Futures Exchange.