By Saikat Chatterjee and Michelle Chen
HONG KONG (Reuters) - Peering down from their gleaming tower blocks at pro-democracy activists on the streets, Hong Kong's bankers and traders cannot help worrying that the financial community could pay a heavy price in the long term if the city loses Beijing's favour.
As China steadily opens up, Hong Kong lives with the threat that its crucial role as China’s biggest yuan hub could become diminished as business flows to the mainland's growing financial centres in Shanghai and Shenzhen.
The past week has seen the strongest protests yet in the former British colony against Beijing's control, prompting Hong Kong Financial Secretary John Tsang to warn that if the unrest goes on too long it could cause more "permanent" damage than a possible blip in the city's stock market.
"Hong Kong is at a critical juncture," Tsang said on Friday. "This is not the time to lay blame... this is the time that we have to come together to solve problems."
The idea that Hong Kong could become regarded as a hotbed of social discontent raises questions for bankers over how long the city can expect to receive special the treatment that has helped it generate enormous business from China’s strategy to internationalize the yuan.
"Hong Kong has served its purpose and maintained its lead because it is a Chinese city with Western characteristics," said the Asia-Pacific treasurer with a European company in Hong Kong who requested anonymity due to the political sensitivities.
"The city risks squandering away that advantage quickly if the political uncertainty continues," he said, with the protests showing no sign of ending.
Bankers elsewhere in Asia were more blunt.
"This hurts Hong Kong’s status as the biggest offshore yuan hub negatively in the long term because the political risk quotient has increased significantly,” said Sean Yokota, Singapore-based head of Asian strategy at Nordic investment bank Skandinaviska Enskilda Banken AB.
Since being returned to Chinese rule in 1997, the former British colony's free-wheeling capitalism has provided communist China with a gateway to the world as it makes its own transition to a more market-driven economy.
Nowhere is this more evident than in China’s drive to increase use of the yuan currency in global trade and commerce.
Hong Kong handles about 80 percent of China's global trade settled in yuan and has the world's biggest offshore yuan deposits of almost a trillion yuan ($160.9 billion).
That has been only possible thanks to Beijing’s blessings.
Hong Kong was one of the few cities short-listed in 2009 to promote yuan business but its status as China’s foremost yuan hub was cemented after a landmark agreement between China and Hong Kong’s central bank in July 2010.
Questioned about the potential ramifications of the pro-democracy movement back in July, a senior official in the Chinese central bank gave an acid response.
Hong Kong's offshore yuan business is an "ever-growing slice of cake... but if it doesn't want to eat it, that's its own problem", said Guo Jianwei, deputy director-general at the monetary policy department of the People's Bank of China.
In 2010, Hong Kong’s market share was more than 90 percent. It is now put at 53 percent - though the decline is mitigated by the massive growth in global offshore yuan transactions.
Less than 1 percent of China's total trade was transacted in yuan in 2009, but it is now more like one-fifth.
China rules Hong Kong under a "one country, two systems" formula that accords it some autonomy and freedoms not enjoyed in mainland China, with universal suffrage an eventual goal.
Hong Kong's separate legal system has given the financial community some sense of comfort, that has helped Beijing promote it as an offshore hub.
But given the scale of dissent, dealers in Hong Kong wonder whether China will give a renewed push to promote free-trade zones opened in the mainland during the past few months.
"Beijing has been buying more insurance for strengthening yuan business in other areas, such as the Shanghai free trade zone, for the long-term development of yuan internationalisation," said Wilson Chan, chairman of an education sub-committee at Treasury Market Association, an industry body.
As China gradually opens its capital account, and pursues the internationalisation of its currency, the need for having an offshore trading centre in the same time zone will become less compelling. But with most reforms still a work in progress, there is little chance of any sudden loss of business.
Indeed, while the Chinese government is allowing foreign investors more access to its onshore markets, it is also encouraging other financial centres, from Sydney to London, to put in place mechanisms for trade in offshore yuan.
China is considering raising quotas for foreign investors under a yuan program to allow more investments into onshore markets, while a scheme linking the Hong Kong and Shanghai stock markets is due to start this month.
Still, the reforms have not been quick enough to spark any sudden rush to relocate from Hong Kong to the mainland, but there could be more discussion in board rooms after events over the past week.
"These protests, if they continue, may force companies to have a serious rethink on that issue," said the head of yuan currency trading at a U.S. bank in Hong Kong.
(Editing by Simon Cameron-Moore)