If you think it's only Hong Kong's asset markets that are increasingly turning Chinese, you haven't been paying attention to the city's banking industry.
The 86 percent first-day gain in shares of Tencent Holdings Ltd.-backed China Literature Ltd. last Wednesday was reminiscent of the typical "China pop."
While investor-connect programs between the mainland and Hong Kong are undoubtedly changing the character of the local market, evidence of a larger financial system swamping a smaller one is more pronounced in banking.
Fitch Ratings Ltd.'s Hong Kong bank analyst Sabine Bauer has scrutinized 28 of the city's largest lenders to get a handle on their mainland book, which she says is approaching $1 trillion. That tops the high reached in 2014, when sustained expectations of an appreciating yuan prompted Chinese residents to max out on dollar borrowings from Hong Kong, Singapore and Taipei.
The yuan "carry trade" went south in 2015 after China devalued its currency and made it a two-way bet. The cross-border lending that has since resumed is different from the previous cycle in at least two major aspects, according to the research that Bauer conducted with Grace Wu, who covers Chinese lenders at Fitch.
For one, a smaller chunk of it is interbank exposure. Hong Kong lenders are getting their hands dirty, going directly to corporate customers on the mainland, rather than to other financial firms.
The other difference is more fundamental. The identity of lenders is changing. Three years ago, London-headquartered HSBC Holdings Plc and Standard Chartered Plc controlled 25 percent of Hong Kong's China exposure between them. Local city banks accounted for another 8 percent. That combined one-third share has shrunk to a quarter. Even Chinese banks' Hong Kong subsidiaries -- such as ICBC Asia and CCB Asia -- have lost ground.
Who has the loan book? Chinese lenders' Hong Kong branches now account for 37 percent of the city's mainland exposure, up from 22 percent in 2014.
This shift will continue, and it will have a significant impact both on how investors think about Hong Kong banks' solidity, and how the Hong Kong Monetary Authority manages the accumulation of default risks up north on banking books down south.
The first line of defense in fortifying any banking system is obviously more capital. But that shield is unavailable since a growing share of China risk now sits in the branches of mainland banks, and those branches don't have their own cushioning. Thus Hong Kong becomes reliant both on mainland lenders' risk-management abilities and Beijing's resolve to backstop its own financial institutions globally.
That these branches can't accept public deposits in Hong Kong is some consolation, but not a whole lot. Should Beijing demur, or even delay, in taking care of what a troubled Chinese bank owes a Hong Kong subsidiary of HSBC, StanChart, or any other mainland lender for that matter, a liquidity shock could spread through Hong Kong's financial system via its interbank market.
Yet the former British colony has its hands tied. The HKMA has taken many steps to curb banks' enthusiasm for lending to homebuyers in the city's frothy property market. There, it doesn't have to worry about annoying Beijing. But to have macro-prudential measures that require more capital on China-related lending isn't a route HKMA is ready to go down.
Taiwan has set such limits, but not Hong Kong. Authorities highlight the diverse nature of banks' China activities and their preference to supervise risk management. Yet, the fact that almost two-thirds of the China-related exposure is held by mainland lenders also plays a role, according to Fitch. A way of tightening regulations without sending an anti-China signal could be for Hong Kong to use its stress tests on Hong Kong-incorporated banks to prescribe "Pillar 2 add-on capital requirements" for banks with outsize China exposure, Bauer says.
While more politically correct, such an approach still doesn't take care of the branches of Chinese banks in Hong Kong, only the subsidiaries. For the former, the city can only hope that Ma Kai, China's newly appointed super regulator, will also be thinking of Hong Kong when wielding his macro-prudential stick.
That pop in banking isn't from the uncorking of champagne when an IPO closes 86 percent higher. Rather, it's the unpleasant sound of a credit bubble bursting. Anybody who thinks Hong Kong's AA+ rating is secure ought to keep an eye on the lending landscape.
It's still 30 years until the end of the city's constitutionally guaranteed exceptionalism, but as far banks are concerned, Hong Kong is rapidly turning Chinese. With all the rewards and risks that come with it, too.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.