Caught in US-China crossfire, should HSBC split its global businesses?

Holding HSBC shares has been a disaster for investors over the past year. Its share price has nearly halved as the bank was dragged into politics, pushed to take sides in the falling-out between the United States and China, and with its British headquarters told to "toe the line" by joining British banks in not paying investors dividends this year. That last point especially shakes the very core of Hong Kong investors' investment thesis for the beloved HSBC shares, leaving 0005.HK in a very weak position.

First, a little backstory on the sixth-biggest bank in the world by assets, and the largest one headquartered in London. It was founded on "sound Scottish banking principles" in British Hong Kong in 1865, and incorporated a year later as the Hongkong and Shanghai Banking Corporation. That year, it also opened a branch in Yokohama, and it quickly became the cornerstone of Hong Kong and Asian regional finance. It is one of only a handful of retail banks in the world that are trusted to print physical banknotes for circulation - there are two others in Hong Kong, two in Scotland and four in Northern Ireland.

In 1992, it bought Midland Bank in Britain, a high-profile high-street bank, in a move to become a household name. Midland Bank's golden griffin logo had gone completely seven years later, with HSBC and its prominent red hexagon in just about every high street in the UK.

With its reliable dividend it was a favourite for Hong Kong investors, for whom the "rule of thumb" has been that if the shares are below HK$60 (closing Friday at HK$33.10, -1.05 per cent on heavy volume), you buy them and give them to your children and grandchildren - safe as houses and good as gold. But over the past 20 years, the bank has been involved in a series of scandals that would have its founder, Scotsman Thomas Sutherland, turning in his grave.

The trouble started with its aggressive global expansion in 2001 into Europe through its acquisition of Credit Commercial de France, followed by Demirbank, a bankrupt Turkish bank. Looking across the pond a couple of years later, it bought Mexico's third-largest retail bank, Grupo Financiero Bital, and in the US it bought credit-card issuer and subprime lender Household Finance Corporation (HFC).

In 2012, US prosecutors brought to light how HSBC's Mexican business had laundered at least US$881 million for two drug cartels. The outcome was US$1.9 billion in fines five years later and a deferred prosecution. That was the cherry on top of a pile of messes following its early acquisitions; involvement in a Ponzi scheme in 2001, owning a dodgy subprime financing company which was defrauding customers in 2002, and an investigation into whether the bank had helped wealthy clients evade taxes. The laundry list went on and on. So HSBC was already firmly in the US government's bad books when its alleged involvement in easing trade between Hong Kong-based Skycom Tech and Iran came to light - illegal under US and European sanctions.

All this time, the US government could have effectively shut HSBC down by denying it access to US-dollar clearing, the basis for its international trade and banknote issuance in Hong Kong. But it kept giving HSBC more rope with which to entwine itself, and as the main witness in the case between the US and Skycom (allegedly Huawei in disguise), the US is keeping HSBC over a barrel for the time being. Meanwhile, HSBC's proud bronze lions - Stephen and Stitt - have kept watch at the entrance of the Hong Kong headquarters.

The HSBC headquarters in Central, Hong Kong. Photo: Felix Wong

In June, Sir Jon Cunliffe, Deputy Governor of the Bank of England for Financial Stability, wrote to London's financial institutions telling them to suspend dividend payments for the rest of the year as losses would be mounting rapidly during the Covid-19 crisis. With the Bank of England estimating that losses among the financial institutions may top £80 billion (US$106 billion) this current financial year, it was not a big surprise to City analysts that dividends would be suspended and HSBC shares had already been sold off. But the news was a tremendous shock for Hongkongers who relied on those payments. The share price continued its downward slog.

More recently, Chinese media has laid into HSBC with accusations that it colluded with the US, which had fabricated evidence against Huawei. Such an allegation could have serious consequences for the bank's business in China - potentially another huge hit to the share price. Only a week or so earlier, HSBC's top executive in Asia had aligned HSBC in Hong Kong with China on the imposition of the new national security law, breaking its political neutrality in the middle of the US-China-UK firestorm.

HSBC has let itself become a political football being kicked around by the UK, the US and China. Who suffers the most? Shareholders have certainly had a rough time of it. But Stephen and Stitt have also been through the ringer, being daubed with paint and set on fire by protesters.

An HSBC lion on fire outside the bank's Hong Kong headquarters, and how the lion appears on HSBC credit cards. Photo: AFP

Last year, HSBC reported that 48.8 per cent of its revenue was earned in Asia, 29 per cent in Europe, 10.6 per cent in North America, 6 per cent in the Middle East and North Africa and 5.6 per cent in Latin America. The global bank is bloated with staff, and has undertaken a rationalisation that involves assessing the viability of several businesses based in Europe. Through that process it may cease to become a truly global bank, in which case it may be time to change tack anyway.

I see three scenarios for HSBC, and would welcome feedback on them or other ideas for how HSBC can recover from the current mess it is in. With its share price down almost 50 per cent in the past year, any good news would have to be very good indeed to double the share price from here just to bring it back to where it was.

1. HSBC does nothing. It plans to weather the storm and will take governments telling it what to do on the chin. HSBC Chairman Noel Quinn did acknowledge that with the bank's footprint being what it is, it is caught smack in the middle of the US-China face-off - a "challenging" position. Throw into the mix the Covid-19 losses, low interest rates in its key markets and its "suspended dividend", and "challenging" sounds like an understatement. To my mind, its stock, even at current levels, is un-investible.

2. HSBC toughens up. It could tell the Bank of England that, "No, HSBC will pay a dividend for the sake of Hong Kong shareholders", but in so doing would risk its relationship with the Bank of England and other British banks. It would have a tough time against China, though. While Chinese media has backed off with its accusations against HSBC for now, perhaps realising that HSBC's branch penetration in China makes it a convenient source of US dollars for trade, the temperature can easily be turned back up. The US needs its witness against Huawei, so what happens if HSBC "pleads the fifth" and refuses to testify?

The HSBC lions in Hong Kong are currently boarded up. Photo: Neil Newman

3. HSBC splits. It opts to fight the battles it can win regionally by no longer being a global bank. If HSBC were to split into two separate listings, in Hong Kong and London, it might be able to fight off government pressure and win investors back. This would effectively break the bank in two, or possibly three if its US business was eventually sold off. HSBC-branded private wealth management and asset management divisions could also be spun off. The affiliation between the groups could remain, and the separated banking divisions may have service agreements, but it would be out of the collective global crossfire which is still mounting over Hong Kong.

I think some form of break-up of the bank could well take place, and the HSBC brand in Britain could vanish in favour of a return to its old British brand - Midland Bank. A clue to HSBC having started to ring-fence its British business may be its recent move to stop the issuance of demand drafts in Hong Kong, or in old-school banking terms, a prepaid cheque drawn on the bank's own account to be cashed in Britain - one of the remaining physical ways to move money if you don't have a bank account overseas.

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This article originally appeared on the South China Morning Post (SCMP).

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