The Shanghai Free Trade Zone – A Springboard for Accessing the Pool of International Financial Centers

The Shanghai Free Trade Zone – A Springboard for Accessing the Pool of International Financial Centers

By Dr. Lee Chih-Jen

The fifth report on the Competitiveness Index (Xinhua-Dow Jones IFCD Index) was released in 2014, four years after the first was jointly released by Xinhua Press and Chicago Merchandise Exchange Group (CME). This index reflects the competitiveness of 45 cities around the world as international financial centers. The latest report revealed that Shanghai ranked fifth (from sixth in 2013, side-by-side with Hong Kong), competing with cities like New York and London, which were ranked first and second in previous years.

The report points out that Hong Kong is still among the highest-ranking cities in certain categories, including “financial market,” “industrial support” and “service level”, but the ranks of the categories “growth and development” and “national environment” have fallen substantially. (The former fell from second position last year down to sixth this year, whilst the latter fell out of the top ten.) This is due to a slowdown in economic growth and an unstable domestic environment. Shanghai has made significant progress according to the report, with a ranking of number one for the "growth and development" indicator for five consecutive years. Its ranking as a “financial market” and for “industrial support” have been relatively stable too. The development of infrastructure and social management has caused Shanghai’s “service level” rankings to jump to number six. This is one of the key factors in enabling Shanghai’s competitiveness to stand up to Hong Kong’s this year.

Many financial professionals point out that the perceived advantage of Shanghai’s financial reforms is an important factor in the jurisdiction’s continual rise, compared with other international financial centers. Since the establishment of Shanghai’s Free Trade Zone (FTZ), breakthroughs in financial reform have been a driving force in its increasing competitiveness as an international financial center. Shanghai’s FTZ has become an important springboard for accessing a pool of international financial centers.

Despite the fact that the United States’ financial centers are relatively stable within a global context – and that the U.S. is still among the most powerful economies – Asia’s financial centers are a powerful force which will change global financial patterns in the future. The Asia-Pacific region’s relatively complicated structure, the ability of individual member states to complement one another, along with the region’s economic potential, are all key reasons for developing Asia’s financial centers. Such fundamental elements drive financial centers across Asia to develop rapidly, and there is a general trend for international financial centers to be inclined towards Asia.

Evidence for such trends is provided in The Opinions of the State Council of the PRC on Promoting Shanghai to Accelerate Development of the Modern Service Industry and Advanced Manufacturing Industry to Build International Financial Centers and International Marine Transportation, released in 2009 by the State Council of the PRC.  Shanghai is striding along a path of “one core” – which refers to the establishment of financial markets – and “two focuses”, which refers to the financial reform and opening pilot, along with the creation of an environment conducive to financial development. The top-layer design was unrolled from the Overall Resolution of the Shanghai (China) Free Trade Zone, approved by the State Council of the PRC on September 27, 2013. Following this, the People’s Bank of China, China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC) and China Insurance Regulatory Commission (CIRC) publicized the relevant standards. The official implementation of the Free Trade Zone on September 29, 2013 enabled many financial institutions and enterprises to begin working together to achieve success.

Mainland China’s financial reform has gone in two distinct directions. Key reforms – such as those relating to interest and exchange rates, the bank deposit insurance system, or the exchangeability of capital – are mostly carried out via methods that can be categorized “top to bottom” methods. The second direction is best categorized “bottom to top”. It is an option that the market is free to choose, and Beijing encourages local governments to pilot them. The development of online and regional finance is among the initiatives that have been piloted. Regional reform that comprises “bottom to top” covers China’s developed coastal regions in the eastern, central and western parts of the country, the industrialization of central China, the less developed west, and the autonomous and border regions. These reforms involve financial liberalization, financial cooperation with Hong Kong and Macao, rural financial reform, and the broader development of local and cross-border financial cooperation. The establishment of Shanghai’s FTZ is an important step in regional reforms. In addition to establishing more accessible administrative procedures and re-shortening of negative list, the implementation of the Shanghai FTZ one year ago has so far achieved the following:

      1. The Shanghai FTZ has contributed to the growth of cross-border RMB settlement by supporting the city in its role as an RMB clearing center. By the             end of September 2014, cross-border RMB settlement in the FTZ amounted to over RMB 200 billion, an increase of more than 2.5 times year-on-year.           Over 19.1 billion in RMB was borrowed overseas, allowing the financing costs within the FTZ to be reduced by between 10% and 20%.

  1. A group of global financial trading markets have been domestically established. The Shanghai International Gold Trading Center opened in mid-September, and The Shanghai International Energy Trading Center was incorporated in the FTZ.
  2. To date, there have been ten China-funded banks connected to the Shanghai FTZ’s account monitoring management system. Over 5,000 free trading accounts have been opened.

Financial innovation and construction of offshore financial centers are the two principal axes of the Shanghai FTZ. Banks and other financial institutions provide offshore financial services to residents outside the jurisdiction. They include deposits and loans for non-resident clients who undertake the role of financial intermediary, as well as services such as fund management, insurance, tax planning, trust and asset protection. But will Shanghai’s FTZ become a springboard for offshore finance? China-funded banks and financial institutions have a responsibility to actively create conditions conducive to innovation and the formation of a trading center for RMB products within the Shanghai FTZ. Of course, to attain the goal of product innovation, these banks and institutions must have considerable knowledge of interest rates, exchange rates, foreign exchange management and other international conventions, so as to fully understand risk control, pricing techniques, and commodities portfolios, amongst others.

Over time, foreign-funded banks and other financial institutions will achieve seamless integration within the international financial service system, just as Shanghai’s FTZ will certainly become integrated within the international trading system. In the future, finding a way to make use of advantageous global networks and high-quality clients to provide globally integrated and comprehensive financial services will become foreign-funded institutions’ niche, along with equipping Shanghai and other regions to stride into international financial centers.

China is currently fast-tracking the amendment of the Trust Law. Once the legal trust system is in place, demand for trust management will encourage China to accelerate the growth of wealth management services within the PRC. While many offshore financial services will become tangible, integrated offshore services will be created too.

A report titled Examples of Innovation in the Shanghai Free Trade Pilot Zone, released on October 10, 2014, illustrates typical cases of innovation in enterprises, including various models and achievements from different fields and perspectives. In the future – with the accumulation of such cases and continued adjustment and implementation of financial regulatory measures – I personally believe that Shanghai’s development in conjunction with the Free Trade Zone will allow it to propel itself into a position among the world’s top international financial centers.

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