Testing the ground
The Shanghai Free Trade Zone has become a testing ground for China’s efforts to open its capital markets and to accelerate the transition towards a freely convertible currency.
Testing the ground
Although the pace of development in the Shanghai Free Trade Zone has underwhelmed international market participants, they remain convinced that the business district offers too much potential to ignore.
The 29-square-kilometre trade zone officially opened in September 2013. It is a key pillar in Premier Li Keqiang’s plans to reform China’s capital markets.
Chinese authorities have advertised the zone as a testing ground for reforms of currency, interest rate, trade and financial policies, such as relaxed ownership rules for foreign banks and credit rating agencies.
The best practices adopted in the zone are expected to be expanded and replicated throughout the world’s second-largest economy.
Foreign institutions now present in the zone expect to gain valuable on-the-ground experience and relationships in more open and, hopefully, profitable renminbi capital markets within the liberalised district. This should give them an advantage over competitors currently without presence in the district.
“If you are a believer that the leadership is committed to these financial and economic reforms, then getting into the Shanghai Free Trade Zone and participating in those opportunities will give you an edge over your competitors” said Andrew Whitford, head of Greater China at Westpac.
Westpac and other Aussie majors have been especially active in the Greater China market of late. All are trying their best to take advantage of the PRC’s status as Australia’s biggest trading partner.
“If you are a believer that the leadership is committed to these financial and economic reforms, then getting into the Shanghai Free Trade Zone and participating in those opportunities will give you an edge over your competitors”
Last year, China accounted for 31.6% of Australia’s exports and 18.8% of its imports, according to Australia’s Department of Foreign Affairs and Trade. That factor should make the renminbi’s expected emergence as an international currency even more beneficial for Aussie firms. The free-trade zone is one way to tap into that potential.
“We absolutely believe that rules and regulations will be relaxed in the free-trade zone to enable China to test these new policies,” Whitford said.
The new regulations include plans, announced in May, to allow companies and individuals, based in the district, to open special accounts for financial transactions that the zone sanctions, such as offshore investments.
Bankers view this as a critical, albeit small, first step for dealmakers keen to enjoy the more liberal business environment.
Now that the zone has been in operation for about 10 months, many Chinese and international banks have hired staff and opened up offices. Several thousands of businesses also have registered there, all of which are potential customers for the banks that could, in turn, also benefit from China’s gradual opening of its capital account.
However, most of those institutions are not yet doing business. They are, instead, waiting for some more clarity on new regulations from Chinese regulators. For many – especially financial institutions – the rate of liberalisation is uncomfortably slow.
“There has been some progress, but the financial-market progress is not as dramatic as many had been expecting from the very beginning,” said Haibin Zhu, chief China economist at JP Morgan.
What is more, some businesspeople are irritated that, while Chinese regulators are allowing them to set up branches in the zone, the same regulators are also introducing new market opportunities outside of the zone, such as Shanghai-Hong Kong Stock Connect.
The Stock Connect will allow foreign firms that have not applied for business licences in the zone to enjoy a more lenient Chinese regulatory regime without having to deal with the red tape of the Shanghai district.
“Financial reform is not only happening in the free-trade zone,” Zhu said. “It is also happening nationwide. So, the advantage to doing business within the free-trade zone is not as big as many would have thought.”
However, not everyone considers this a problem. It is just part of doing business in China. Many of the firms to open up in the zone, such as Westpac, also have offices outside of it. Offices throughout China will be able to work together more easily as international best practices spread beyond the zone and throughout the country.
“What you’ll find is that a lot of the technology and method of doing business developed in the zone get replicated across the country. So, if you aren’t in the FTZ when it does get replicated across the country and you don’t have all the systems in place, you’re going to be behind the eight ball,” Westpac’s Whitford said. “That’s the first-mover advantage.”
Negative or positive?
Chinese regulators have been making some progress. Market participants have praised the decision from the administrators of the zone to dictate foreign investment in the district through the use of a so-called negative list, which itemises industries where foreign investment is still banned or requires pre-approval. As long as its industry is not on this list, any foreign company can, in theory, compete on equal terms with local firms.
Regulators last month shortened the negative list from 190 sectors or subsectors to 139. While bankers and economists said that the bulk of the cuts were immaterial changes, the reduction had been hailed as a positive step.
“The good news is, first, that they are moving forward and, second, that they also mentioned that this is a continuous process,” JP Morgan’s Zhu said. “In 2015, there will be another revision – that’s the idea they want to give. That’s the positive side I look at, so it’s not the end of the game.”
Nonetheless, market participants are still urging local authorities to push for faster change.
The European Union Chamber of Commerce in China, for instance, has said that simply reducing the negative list is not enough.
“The full name of the zone is the China (Shanghai) Pilot Free Trade Zone,” said Stefan Sack, vice president of the European Chamber and chairman of its Shanghai Chapter, in a prepared statement this month.
“For me, the two most important words in this are ‘China’ and ‘Pilot’ as they show the intention of the zone as a testing ground for rollout nationally. China urgently needs reforms, so it is important that the CSPFTZ – as a pilot zone – not become a bottleneck to central-level implementation but instead help to accelerate reforms throughout China.”
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