Interview with Hong Kong magazine Gafencu Men - June 2011 (they spelt my name wrong!)

posted Jun 17, 2014, 3:19 AM by Steve Donoughue   [ updated Jun 17, 2014, 3:19 AM ]

The Jockey Horror Show

Hong Kong tax bills will soar if the Jockey Club’s revenues continue to fall as it fails to fight off burgeoning unlicensed online competition

Since 1885, the Hong Kong Jockey Club (HKJC) has stood as a proud local institution, synonymous with both entertainment and philanthropy. Yet the club, which rakes in more cash per race than any similar organisation worldwide, is now facing its biggest ever challenge, one that many see it as being woefully unprepared for: online gambling.
It is estimated that a third of all bets now placed on the city’s thoroughbreds circumvent the club’s monopoly and end up in the hands of unauthorised internet gaming websites.

Addressing this new reality, Winfried Engelbrecht-Bresges, the club’s CEO, says: “Competition is just a mouse-click away. Our competitiveness is at risk.”

With the club still reeling from the arrests in November last year, which saw a number of individuals accused of abusing their position within the body for personal gain, the organisation has notoriously brought the shutters down on media comment. Its refusal to spell out its plans for meeting the challenges of the digital age, however, have only fuelled speculation that the body is hugely worried by the changes in the marketplace.

The Hong Kong government has even more reason to be perturbed. The HKJC is the SAR’s sole horseracing, lottery, and football betting operator and, as a result, its single largest taxpaying entity—contributing a whopping seven per cent of total tax revenues to the city’s coffers every year. Last year, the figure was HK$12.8bn. It is this hefty contribution that, many believe, keeps personal income tax rates in Hong Kong at some of the lowest levels in the developed world.

The HKJC is also the SAR’s largest charitable contributor, donating HK$1.5bn for the year ending June 2010. Beneficiaries of the club’s munificence range from art archives to hospices for single mothers.

According to the club, approximately HK$105m is wagered on every race. That is 50 times the average bet per race at American tracks last year. After the winning bets and prizes are paid out, the SAR government walks away with about 72.5 per cent of what’s left in taxes, as opposed to 25 per cent paid to the Singaporean government by the city-state’s own gambling institutions.

Steve Donaghue is a London-based gambling consultant and believes the HKJC may have a real problem on its hands. He says: “Take out rates from pools, if too high, make returns for winners less than if they’d gambled elsewhere. Since the HKJC is operating in effectively a free market—as people can use the internet—it will have to become more competitive to survive in the long run.”

With unauthorised internet gaming websites obviously free from the shackles imposed on the HKJC, potential winnings are considerably higher—increasing their attractiveness to punters. The sites aren’t paying gambling royalties or gambling taxes to the track, meaning they can offer far greater jackpots.

Gambling activities in Hong Kong are regulated by the Gambling Ordinance (Cap 148, Laws of Hong Kong). In particular, section 7(1A) and section 8 prescribe illegal gambling activities with overseas bookmakers.

According to Lawrence Li, spokesman for the Hong Kong Police Force, the enforcement officers are well aware of the problem of overseas online-gambling sites. He says: “The Technology Crime Division of the Commercial Crime Bureau has the professional capability to give technical support to operational units engaged in the investigation of illegal online gambling.”

To combat online gambling, the police currently gather intelligence from several sources, including, most obviously, the internet. He says: “The police also exchange intelligence and mount joint operations with overseas law-enforcement agencies.”

According to Donaghue, the problem of revenues being siphoned off by online conduits is not restricted to Hong Kong. He says: “This is the question facing a lot of countries in Europe at the moment, many of whom are considering how best to regulate internet gambling. Italy would appear to have hit on the model which, while not perfect, does seem the most capable of keeping unwanted operators out of the country.

“To target Italy you first need a licence. Your servers need to link into the regulators system so they can inspect all the transactions, if they need to, and then calculate the relevant taxes. Those who don’t get licences are put on a blocked list and ISPs are expected to block them.

“If we look elsewhere, the UIGEA [Unlawful Internet Gaming Enforcement Act] in the US set-up a system which bans financial institutions from taking gambling bets. It is thought that a mixture of ISP blocking and financial blocking will stop most foreign transgressors—however, the issue is how to make the ISPs and banks responsible for the policing. This was seen as too much in the UK and so the proposed new system of national licensing doesn’t actually have any teeth. Foreign operators who target the UK illegally will basically just get away with it, unless a system of agreements between licensing jurisdictions can be implemented. This would mean that those acting illegally in one country would have their licences suspended in the jurisdiction they are licensed in—which is a nice idea but yet to be proven to work.”
Many argue that online gambling will inevitably diminish the ability of racing tracks to earn reasonable returns. There are a number of initiatives aimed at trying to combat such “free-riding” by online bookmakers through linking-up with overseas racecourses to accept bets on each other’s races. This process, known as “commingling”, broadens the gambling pool for racing organisers, allowing them to offer improved odds to punters.

The Singapore Turf Club, for instance, has a deal with Tabcorp Holdings, ensuring a number of Australian bets on Singaporean races are pooled. Similarly, French tracks have commingling arrangements with the US, UK, Spain, Italy, Spain, and Switzerland.

The issue for the HKJC today, as well as the online challenge, is the rapid development of the global gambling industry in terms of both distribution and product range. Land-based gambling options for Hong Kongers have multiplied with the growth of Macau, the introduction of Singaporean gambling, and the plans for more casino resorts around the region. At the same time, online now provides every form of gambling directly into the home or onto the mobile phone.

This is the main problem for the HKJC. Prior to the development of the internet it had a localised monopoly in the gambling market. Now, Hong Kongers can either jump on a hydrofoil if they want live gaming or, more temptingly, they can just log on to foreign websites and gamble from their sofas. The HKJC is in direct competition with the rest of the world online and with the best of the world’s land-based operators in their local region. In order to compete, it has to provide the same range and quality of products, and the question is: are they “nimble” enough as a monolithic, quasi-state monopoly to deliver this?

Unfortunately for the club, the SAR’s laws prohibit commingling deals as Hong Kong doesn’t make allowances for double taxation. This means that the HKJC’s foreign receipts would be taxed twice—firstly locally, but also in the jurisdiction where the bet was placed, thus killing any profit incentive.

The government has now indicated that it is willing to review tax rules for inbound commingling. The club estimates annual revenues for illegal bookmakers from local horse races to be equal to between one-third and 100 per cent of receipts. Theoretically, that’s HK$2.6bn the Inland Revenue Department (IRD) doesn’t collect each year, based on the HK$7.9bn in racing taxes the operator paid in the year ending March 2010.

Donaghue says: “Illegal activity is always incredibly difficult to quantify by its very nature. Policy makers need to realise that gambling is a normal, natural urge found in all civilisations and throughout history. Prohibition has been proven to only push gamblers into the hands of organised crime. Thus if there is such a large illegal-gambling market in Hong Kong, the HKJC needs to address this—either by growing their scope of operations to attract these gamblers away from illegal operators, or to open up the market and legalise the illegal bookmakers.

“Prior to 1960, the UK was awash with illegal bookmakers, largely because off-course betting was illegal. It was, in fact, the police who were the main lobbyists for liberalisation because it was their officers who were being corrupted by the illegal bookmakers. Liberalise, regulate, and tax is usually the best method.”
Growth in the HKJC’s racing revenues has failed to keep pace with global internet gambling. The city’s gross racing revenue grew a measly 3.6 per cent to HK$11.7bn for the year ending June, compared to online gaming which rose 10.4 per cent to HK$92.5bn, according to GBGC gambling consultants. It might, therefore, be only prudent for the club to become an internet operator in its own right.

The organisation has some experience in the area, with some 30 per cent of its revenues coming from online soccer betting. The club now wants the SAR government to legalise its expansion into other sports. This would enable the HKJC to compete with established online companies, such as the London-listed Betfair Group, which accepts bets on everything from internet poker to betting on the Kentucky Derby.

Ultimately, in line with market reality, it’s going to get tougher for the club to retain its monopoly and continue to make the massive profits of old. The myriad options for consumers—both legally permitted and illicit—ensure that it must learn to operate in a whole new world and by a whole new set of rules.

Donaghue, though, believes that moving to a free market may cause more problems than it solves. He says: “The question is more: should local gambling benefit? There is much that is very good about the HKJC. It takes its winnings and uses them for good causes and has a decent problem-gambling programme. Under a free market, where profits go to shareholders, how much of the profits would be used for the public good? It’s always been said that if the HKJC closed, then the taxes in Hong Kong would have to go up 5 per cent just to cover its charitable donations.

“Free markets are very good at providing consumer choices, but not very good at clearing up their messes. So you could only really consider a free-market solution if you had a system of national licensing—so everyone offering gambling either on- or offline had to be licensed—or local taxation, at a rate that covered the social costs of gambling at the very least, and the means to inspect and enforce the rules. All eminently feasible, but the question is: would Hong Kong society be better off? Whether a gambler has more options to gamble is a less-important consideration.”

Donaghue suggests the future of the HKJC may lie in splitting into both a regulator and an operator. This would see it, as a regulator, allowing free competition based on strict licensing, taxation, and the adoption of a problem-gambling policy. As an operator, it would maintain its dominant position through its skill, brand, and reach, thus continuing to successfully generate revenue.

This does not, though, address concerns that many gaming sites are situated in dubious, lawless locales, such as Curacao or Vanatu, where authorities are impotent and regulation is lax. According to Louis Romanet, chairman of the International Federation of Horseracing Authorities, such operators do not share revenue with race operators or pay racing levies, and can, therefore, pay out at better odds. He believes such websites will always return better money than legitimate organisations, such as racing bodies, as the latter must contribute toward racing logistics and pay taxes.

The club, though, is resilient if anything, largely owing to the huge cushion of cash it sits on. During the recent global financial crisis, a number of members supposedly transferred a total of HK$2bn into their betting accounts—since the operator does not provide credit—from their bank accounts. This was because, apparently, they had more faith in the club’s longevity than the Hong Kong banking system. It is such a world-class reputation that may yet rescue the club and smooth its passage into online betting. The familiar branding and stature of the HKJC would offer huge reassurance for online punters. Ideally, they would continue to use their existing brand and platform for both horseracing and all other forms of gambling.

The prospect of an expanded mainland Chinese market may also bolster the club, especially as horseracing remains illegal north of the border. To attract China’s nouveau riche with cash to burn, the HKJC spent HK$100m in constructing its Beijing clubhouse, where it currently has 1,000 non-betting memberships. The general consensus is that, within a decade, horseracing will be permitted on the mainland—a move that the club is ideally positioned to capitalise on.

Ultimately, the club needs to recognise that it has to establish its brand in cyberspace and in China. To that end, it is incumbent on the powers that be in LegCo and the IRD to make legal provisions for commingling and allowances for double taxation as the bare minimum required to ensure those tax dollars keep tumbling in. As to whether the club will still be with us 20 years down the line—well that’s a pretty safe bet, as safe as any in the rapidly changing gambling industry.