China's financial industry ponders reform and innovation amid reorganisation of global trade and supply chains

• Reorganisation of global trade and supply chains to increase efficiency and reduce reliance on physical presence
• Change in financing structure goes hand-in-hand with transformation of Chinese financial institutions
• Growing use of fintech may amplify market volatility and risk through herd behaviour. Innovation needs to be slowed down if regulation cannot keep up

A new decade of reform, challenges and opportunities was the theme of The Asian Banker’s Finance China 2020 conference and provided an occasion to discuss how financial institutions can turn the crisis into an opportunity, as well as accelerate industry development through further opening up measures as well as the wider and deeper application of disruptive and innovative technologies.

This year’s conference included both physical and virtual participation from international guests. Keynote speakers included Li Wenhong, Director, China Banking and Insurance Regulatory Commission Shenzhen Office; Robert Koopman, Chief Economist and Director, World Trade Organization; Edmond Lau, Senior Executive Director, Hong Kong Monetary Authority; He Jie Director, Shenzhen Municipal Local Financial Regulatory Bureau and Tu Guangshao, Former Vice Mayor of Shanghai.

In the keynote speeches and subsequent panel discussion they shared insights on the comprehensive reform of the financial sector for an open global economy and financial measures and toolkits to further revitalise China's development.

Reorganisation of global trade and supply to increase efficiency and reduce reliance on physical presence

In his keynote speech, Robert Koopman, Chief Economist and Director, World Trade Organization, said that although the WTO’s latest trade forecast in June was more positive than in April, even the most optimistic forecast sees trade declining by 12.9%, and GDP by -2.5% in 2020 as confidence declined producing weak investment growth.

The recovery in 2021 will be aligned to a more pessimistic scenario, he added, where trade will not recover to its previous trend. The gauge in the trade momentum analysis had to be expanded after it recorded its lowest ever score of 84.5%, well below trend, dragged down by weak export orders, air freight and container shipping. However, Koopman noted “signs of a nascent recovery.”

In terms of global trade and supply chains, he also added that there will likely be a reorganisation of globalisation, specifically in how they will evolve. Efficiency consideration will be key to maintain and increase trade flows, such as a reduction of “just in time” manufacturing, a geographic diversification of supply chains and an increase in stockpiles and automation.

In terms of financial services and trade, he noted that developing country providers and exporters including those in China, have been strongly focused on physical presence abroad, but digitalisation is reshaping the business model at an increasing rate.

Change in financing structure goes hand-in-hand with the transformation of Chinese financial institutions

China needs to accelerate its opening-up and allow foreign companies to have initial public offerings in China in order to increase the magnitude of foreign investment, stated Tu Guangshao, Executive Director, of the Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University.

“A lot of industries are in demand of long-term financing and the financial institutions are the ones that determine how the money is channelled. This change in financing structure (from banks to financial markets) goes hand-in-hand with the transformation of financial institutions.” Tu said.

He urged Chinese financial markets to reform to the new business models and emerging business industries which will be very important for future economic growth.

“We should take note of the changing asset forms of enterprises. The new technology companies have vast intangible assets ranging from a high of 90%, and a low of 71% observed from our studies of American and Chinese listed technology companies,” he commented.

Growing use of fintech may amplify market volatility and risk through herd behaviour

The growing use of fintech may lower the risk threshold for partner banks and introduce more risky customers cautioned Li Wenhong, Director, China Banking and Insurance Regulatory Commission Shenzhen Office. “The risk models are not fully tested by the economic cycles and are yet to be proven.”

He also warned that growing fintech use may aggravate the difficulties in protecting the rights of consumers because at a systematic level, fintech will deepen the relations between financial institutions and infrastructure, operators and regulators giving rise to increasing complexity. “When the financial services efficiency has been improved the velocity of risk transmission will also increase through the herd effect.” Li explained.

“Financial institutions are making use of smart tools to provide advisory or consultancy services to investors, and as they increase the number of clients it may increase the risk of buying and selling at the same time - thus aggravating market volatility.”

“This pandemic is a stress test of our capabilities,” Li said, adding that, “regulators must monitor fintech by first determining what is its ‘essence’. We see from financial and non-financial institutions increasing types of financial products and non-financial products which are blurring the distinction. It is worth noting that with the help of fintech, some of the financial services have developed new names and forms but their essence remains the same.”

It will challenge the professional capabilities of regulators Li shared, and they will need to be fully equipped with the latest knowledge, skills and literacy to ensure the effectiveness of financial regulation.

“The decentralisation will allow more unregulated enterprises to enter the industry and many transactions will be out of the settlement system of the PBOC - there will be regulatory arbitrage,” he warned.

Innovation needs to be slowed down if regulation cannot keep up

In the wider dialogue covering the outlook for the new decade, He Jie, Director of the, Shenzhen Municipal Local Financial Regulatory Bureau warned that while financial openness translates to cross-border innovation; “there has been good and bad innovation so we must be aware of the risks.” He questioned the innovation related to peer-to-peer (P2P) platforms for example and asked if they can really achieve efficiency.

He stressed the need to factor in ethics of innovation in such platforms when they do not create value but destroy it instead. “If some of the equities are worth nothing after three years, that kind of innovation is worth nothing.” A lot of innovations were in essence P2P platforms he said, “that have actually triggered the evil in humans.” He concluded that innovation needs to be slowed down if the regulation cannot keep up, with investors intending to focus more on know your customer (KYC).

Commenting on the internalisation of the renminbi and development of central bank digital currency by  (CBDC) by the People’s Bank of China (PBOC), Patrick Hess, Finance Professor at Goethe University and Principal Supervisor at European Central Bank – Single Supervisory Mechanism, said that growing geopolitical frictions and uncertainties have led to increased use of the euro and the Chinese currency, especially in the energy market. He also observed that European countries are more far away from a CBDC than China.

“The PBOC is trying to manage expectations and say this is not something that will happen next year. My guess is we will see the first CBDC issued in China in the next three years - building on China’s already quite advanced infrastructure such as Alipay and WeChat Pay.”

Hong Kong remains resilient and its banks are performing above international standards

Edmond Lau, Senior Executive Director of Hong Kong Monetary Authority shared in a video message how Hong Kong has moved on amid its challenges and exhibited resilience as it had in all previous financial crises: “Our banks are in very good shape on all measures of global banking standards, which are all above international standards.”

He emphasised that there have not been significant fund outflows from either the HKD or the banking system, with the total amount of banking deposits rising in both last year and this year and then turned to the capital market commenting that the stock market remains one of the most active markets in the world in both primary and secondary market activities, in terms of the growing number of listed companies and the continuous inflow into the stock market through the Stock Connect.

“For example, the Stock Connect scheme now accounts for 68% of all A-shares trading by overseas investors and over 50% of the Chinese bonds in the CIBM market are acquired through the Bond Connect,” Lau shared.

To strengthen Hong Kong’s key function as the gateway to Mainland China, Edmond Lau mentioned that such functions will be further enhanced by the Greater Bay Area (GBA) initiative, along with the government’s endeavour to enhance the competitiveness of Hong Kong’s private equity (PE) platform on the tax front.

“No discussion of new initiatives would be complete without mentioning green finance initiatives” Edmond supplemented in his closing and added his confidence that Hong Kong will overcome challenges and emerge as a more vibrant international financial centre.