China’s financial liberalisation: Fact or fiction?

• In an effort to attract more foreign investors and, improve China’s economic standing, the country has laid out plans to open up its economy
• The country would focus on significantly expanding the business scope of foreign banks and opening up trust, financial leasing, auto finance, money brokerage and consumer finance sectors to foreign investment
• China, however, has made several promises before of easing certain trade regulations, but did not follow through, something that makes everyone wonder whether China will push through with its plans this time

Since the Boao Forum in April, China seems to have embarked on a new heightened pace of opening up its economy. Unlike previous vague commitments, the newly-appointed People’s Bank of China Governor Yi Gang laid out clear plans and deadlines on a dozen or so measures in his speech in Hainan.

Yi said that in the near term, the country would remove the foreign equity investment limit on banks and financial asset management firms and that banks would be able to set up subsidiaries and branches. Other rules include abolishing the requirement where at least one domestic shareholder of joint venture securities brokers needs to be a security broker.

Although many of the measures were mostly incremental and are repetitions of previous pledges, the speed at which China is enacting some of these measures into rules could be a hint that they mean business this time.

For example, the China Securities Regulatory Commission lifted the foreign ownership limit on securities companies to51% at the end of April, just weeks after the central bank governor mentioned it at the forum. The change from 49% previously is notable as it would allow foreign entities to take a controlling stake in joint ventures.

Furthermore, China quadrupled the daily northbound investment quotas into Shanghai and Shenzhen to RMB52 billion($8.2 billion) from RMB13 billion ($2.1billion) and southbound into Hong Kongto RMB 42 billion ($6.6 billion) from RMB10.5 billion ($1.7 billion) from May 1st.

“This time the follow-up has been swift. Regulators were mentally and technically ready for the that they were committing to,” said Julia Wang, Greater China economist at HSBC. “It was not always the case that regulators are ready to immediately act.

And banks’ responses to the new rules have been just as rapid with Nomura reportedly seeking a 51% stake in a new China-based brokerage business and UBS applying for a 51% stake in its Chinese joint venture UBS Securities.

Personal assurance

Even more elucidating to China’s new found commitment to liberalisation was the attitude and approach of the Chinese at the Boao Forum, in particular President Xi Jinping’s opening speech.

“We’ve seen signals of opening uplong before Boao, what I found interesting was the tone and the way President Xi spoke,’’ said Tjun Tang, senior partner at Boston Consulting Group. ‘’Especially how he gave his personal assurance about translating all these reforms into a reality sooner rather than later.’’

This compares to Xi’s speech three years ago when he said rather starkly that “China will stick to its basic state policy of opening up”. Even Christine Lagarde, International Monetary Fund chief praised President Xi in her speech at Boao this year for “the openness” that he advocated.

In the long term, governor Yi spoke about significantly expanding the business scope of foreign banks and opening up trust, financial leasing, auto finance, money brokerage and consumer finance sectors to foreign investment.

The government will also not set foreign ownership limits for investment in wealth management companies set up by commercial banks by the end of 2018 and will launch the Shanghai-London Stock Connect program within two years.

But for some, these promises are met with a certain degree of scepticism as China has repeatedly pledged to open up certain sectors but not followed through.

‘’It was a slick and sophisticated speech by Xi, who was offering a flower of peace to Trump. But at the end of the day, I don’t think the bureaucracy are going to make moves against their own interests,’’ said

Andrew Collier, managing director of OrientCapital Research in Hong Kong. ‘’China would always welcome foreign capital but the truth is they are very unwilling to give up control.’’

Heightened pressure

China’s pledges to open up its financial sector come at a time of heightened pressure on China from the United States overtrade tariffs with the threat of a tit-for-tat trade war looming in the background.

“There is an element of the Chinese using the Boao Forum to diffuse tension with the US. But this is still a secondary consideration,” said HSBC’s Wang. “For the last two years, the country was facing capital outflows and pressures on its currency. But this year, these external factors have dissipated and China is on a stronger footing. Mostly, China works along its own schedule.”

“The truth is that China needs foreign players because it doesn’t have a very developed institutional market,” said BCG’s Tang.

“In order to liberalise foreign exchange and open up capital controls, the country needs a well-functioning capital market where participants hedge risk,” he said. “I believe the government is trying to bring in capabilities and talent to help with that transformation.”

There can be no doubt that China’s path to financial liberalisation from one where the state subsidises growth is fraught with pitfalls.

“The challenge for China is control,” said Erlend Ek, director of policy studies at Beijing-based advisory firm China Policy. “There are bubbles in the economy and if you open up too fast you might lose control of managing these bubbles.”

Managing risks

While foreign ownership and investment in the financial sector will improve the competitiveness of the domestic financial sector, drive more efficient financial resource allocation and bring better financial services, according to Linan Liu, Deutsche Bank’s Greater China fixed income and currency/Asia rates strategist.

“The key challenges are how to manage financial risks with rising foreign participation and the negative impact on domestic financial institutions, such as losing market share and negative earnings outlooks,” she said.

In the near term, no one expects to see many palpable changes as implementation by any new entrants will be slow-moving. Finding and hiring the right people and setting up office, all take time. But domestically, China has already seen some significant change after the biggest government shake-up in years took place in March.

The revamp included merging its banking and insurance regulators, which will report directly to the State Council and the function of making new laws will be transferred to the PBOC. While this over haul puts Xi squarely at the heart of policy it was also done to resolve existing problems such as unclear responsibilities and cross-regulation.

Still, it remains to be seen about how many of Yi’s pledges at Boao will actually be translated into regulations. Domestically, the country seems to be embracing change and China’s economy is in a better place with capital outflow and currency concerns gone. Plus, the Chinese have the risk of a looming trade war with the US, adding impetus to further liberalisation. At the risk of sounding naïve, perhaps this time the Chinese are for real.

“The window of opportunity is now,” said BCG’s Tang. “And foreign players should get prepared.”