The week that Cathay Pacific surrendered to China

One of the world’s top airlines has discovered just how dangerous Hong Kong’s pro-democracy protests are becoming for companies based in the city and doing business with mainland China.

The stunning resignations late Friday of Cathay Pacific’s CEO and chief commercial officer came at the end of a tumultuous couple of weeks for the airline. No company has become more emblematic of just how thin a line businesses are having to walk as largely peaceful protests by huge crowds escalate into violent clashes between smaller groups of protesters and police.

China is furious at the challenge to its authority and has threatened a crackdown if the situation deteriorates further. More demonstrations are planned for this weekend.

Li Ka-shing, chairman of CK Hutchison Holdings Ltd. and CK Asset Holdings Ltd., listens during an exclusive interview with Caixin Media at Cheung Kong Center on March 12, 2018 in Hong Kong, China.

Related article Hong Kong's richest man appeals for calm ahead of more protests

Cathay’s (CPCAY) crisis intensified a week ago. First it had to accept restrictions from Chinese authorities on who could fly its planes over the country. Then it threatened staff with dismissal if they took part in the protests.

None of that was enough to save two of the company’s highest ranking executives, and news of their departures broke first on Chinese state media.

“International businesses have to face a new reality here,” said Ronald Wan, chief executive of Partners Capital International in Hong Kong.

For more than 20 years, the former British colony has operated under a rule known as “One Country, Two Systems,” which affords the city political and legal freedoms that are not available on the Chinese mainland. That has helped protect Hong Kong’s status as a formidable financial hub, and reassured foreign companies that the city is a safe and stable place to operate.

But the Cathay crisis indicates a shift in how China views the city — and how it expects companies to operate there.

“Beijing is increasingly hard-lined about sovereignty and territorial integrity issues,” Wan added. “Hong Kong is no longer a shelter. It’s not ‘Hong Kong, China.’ It’s China.”

A tumultuous two weeks

The political turmoil started months ago when Hong Kong residents began protesting a controversial bill that would have allowed extradition to mainland China. The bill was eventually shelved, but the demonstrations have evolved into a broader call for greater democracy and an inquiry into alleged police brutality.

Cathay’s central role came into focus much more recently. More than a thousand of its employees took part in a strike last week that forced the airline to cancel over 150 flights. Days later, China said it would not allow Cathay flights crewed by people who have taken part in “illegal demonstrations, protests and violent attacks” to use its airspace. It forced the airline to provide crew IDs.

Cathay Pacific lost hundreds of flights this week when protesters targeted Hong Kong airport.

The airline had little choice but to comply with the order, since Cathay not only flies in and out of mainland China but also through its airspace to reach Europe and the United States.

“The threat by Chinese civil aviation authorities to essentially ban aircrew taking part in Hong Kong protests from operating China flights is impossible to ignore, touching on half of the carrier’s revenue,” said David Bandurski, co-director of the China Media Project. “I think we can expect to see many more examples like this going forward, of China using its economic leverage to push its political agenda.”

But Cathay’s capitulation didn’t end there.

On Monday, the company hardened its language and warned that it could fire employees who take part in illegal protests. Chinese aviation authorities met with Merlin Swire — the billionaire head of Cathay’s biggest shareholder, Swire Pacific (SWRAY) — that same day.

The Swire Pacific Ltd. logo is seen atop a tower in the TaiKoo Hui Cultural Plaza in the Tianhe district of Guangzhou, Guangdong province, China, on Monday, Nov. 25, 2013. China is proposing the largest package of economic reforms since the 1990s to stoke growth in the worlds biggest emerging market. Photographer: Brent Lewin/Bloomberg via Getty Images

Related article Hong Kong's billionaires are calling for order to be restored

Then on Wednesday, Cathay said that it had terminated two pilots, without giving a reason. A well-placed source within the company told CNN the pilots were fired in association with activities related to the protests.

All the while, Cathay was grappling with threats to its bottom line. Hundreds more flights were canceled earlier this week as protesters overran the airport, and bookings are being affected. Its stock has plummeted more than 12% within the last month.

By Friday, the company would announce that CEO Rupert Hogg and Chief Commercial Officer Paul Loo were out.

The ‘sins’ of Cathay Pacific

China Central Television, the mainland outlet that broke the news that Hogg was out, later published a long post Friday night on Chinese social network Weibo that characterized Cathay’s actions as “sins.”

“No zuo no die!” the state-owned media wrote, using slang that translates to: “If you don’t do stupid things, they won’t come back and bite you in the a–.”

CCTV pointed out that Cathay “said some employees’ behavior doesn’t represent the position of the company” only after the Chinese aviation authority acted. It accused the airline of having “flawed” professional ethics.

Cathay did not give specific reasons for the management changes. But Chairman John Slosar said in a statement that “recent events have called into question Cathay Pacific’s commitment to flight safety and security and put our reputation and brand under pressure.”

Hogg, meanwhile, told employees in a memo to staff that it was a “grave and critical time” for the airline.

“There is no doubt that our reputation and brand are under immense pressure and this pressure has been building for some weeks, particularly in the all-important market of mainland China,” Hogg wrote in the memo, which the airline shared with CNN Business. “Could we have managed things differently? In hindsight, ‘yes’.”

Greg Waldron, the Asia managing editor for the aviation news source FlightGlobal Group, said he didn’t want to speculate about the reasons for the departure. But he said the episode highlights the challenge for the airline.

“It’s unprecedented,” Waldron said. “Clearly it doesn’t want to upset Beijing.?It wants to avoid politics and stay focused on its business.”

Part of a trend

What happened to Cathay this week likely won’t be an anomaly, said William Reinsch, the Scholl chair for international business at the Center for Strategic and International Studies in Washington.

He said that the Chinese government is already increasing its efforts to control companies and pressure them to conform to the party line.

“In [President] Xi Jinping’s administration, priority number one is maintaining party control,” Reinsch added. “That’s self preservation, and that’s more important than anything else.”

Businesses in Hong Kong could feel a chilling effect. The financial sector depends on stability, he added. Without that in the city, some businesses might feel the need to uproot and move to other places in the region, like Singapore.

“It creates enormous uncertainty about the government’s intentions,” Reinsch added. “And what people tend to do when there’s uncertainty is they either do nothing and wait, or if they foresee the situation continuing, they move.”

Wan, the Partners Capital International executive, said there will likely be wide-reaching consequences for other firms.

“I’m afraid Cathay is not the only one that has to make a compromise,” he said. For western businesses like HSBC (HBCYF) or the Jardines conglomerate, “if you can’t move your businesses out of Hong Kong, you have to compromise, too.”

– CNN Business’ Laura He and Michelle Toh contributed to this report.