China Further Opens Its Financial Sector To Foreign Firms

TO ANYONE WHO has been paying attention, Friday’s announcement by Deputy Finance Minister Zhu Guangyao of foreign firms being allowed broader access to financial markets would not have come as a great surprise. The move has been steadily if quietly signalled for some months.

Among those not paying attention appears to have been US President Donald Trump. His administration’s published summary of his accomplishments on his state visit to Beijing this week makes no mention of it. This stands in contrast to the much trumpeted $250 billion package of already agreed exports and memoranda of understanding for future sales that may or may not materialise as hard orders for US manufacturers.

To this Bystander, the contrast is emblematic of a visit for which the US president left the China hawks in his cabinet at home in favour of the company of a US trade delegation, and during which he quite unpredictably blamed his predecessors for US trade deficits with China, not the predatory trade practices of his hosts that he had lambasted on the campaign trail last year.

Our equilibrium was only restored when Trump returned to his ‘America First’ trade bashing of China and its regional fellows at the APEC summit in Vietnam. When it comes to international trade, Trump is clearly more a goods than services sort of guy, but then he has to deliver industrial jobs to supporters who perceive themselves as the losers of liberalised global financial markets.

Perhaps the oversight was also because the financial market opening applies to all, not just US firms. Yet it is US firms that have been at the forefront for years in pushing for greater access to China’s financial markets.

Friday’s announcement means that US and other foreign financial firms will be allowed to own 51% stakes in certain financial joint ventures, lifting the proscription against foreigners holding controlling stakes in Chinese commercial banks, investment banks and securities firms, fund managers and insurers.

Ownership caps have made foreign firms marginal players, even though foreign investors have had growing access to China’s equity and bond markets. The likes of Citigroup, Goldman Sachs, Deutsche Bank, UBS and others have been so discouraged hitherto (or in some cases so cash-strapped) that over the past decade they have sold their minority stakes in the sector that were acquired from the mid-2000s onwards after the restructuring of China’s banks in 2004-05 and the opening of financial markets in 2006 in accordance with China joining the World Trade Organisation

HSBC is the only international bank to retain a significant stake — 19.9% of Bank of Communications acquired in 2004. In all, foreign banks held 2.9 trillion yuan ($436 billion) of assets in China at the end of 2016. That accounts for 1.3% of China’s total banking assets, the lowest share since 2003, according to the China Banking Regulatory Commission, and down from a peak of 2.4% in mid-2006.

These assets returned a relatively trifling 12.8 billion yuan last year, less than 1% of the profits at Chinese counterparts.

From such a small market share there is self-evidently room for growth. Commercial lending looks the least attractive area. State-owned banks dominate the financial system. Their close links to the state-owned companies that drive much of China’s economic activity will be difficult to break. Slowing economic growth and growing credit risks also cloud the outlook for commercial banking.

Instead, foreign firms will focus on increasing their presence in insurance, investment banking and fund management. All have better growth prospects.

The devil, however, is in the details. Regulators are still drafting detailed rules, which will be released soon, but three-year and five-year timelines have already been set out for the implementation of some of the changes.

For example, the foreign ownership cap for life insurance companies will be lifted to 51% after three years and scrapped altogether after five. The same two-stepped approach is being taken towards securities and fund management companies, though in their cases the caps will be gone within three years of the new rules becoming effective (itself still not a date certain).

The gradual timelines and broad official support for this phase of financial-market liberalisation should mean it goes relatively smoothly, and give local firms the time to sharpen their game.

That is a key official priority. Within the central bank, at least, there is a view that protection of local financial firms is a source of financial instability risk. Along parallel lines of thinking, a more professionally skilled industry should also help with the official efforts to deleverage and rein in the shadow banking system.

The changes will no doubt bring in more financial management expertise and global standards of governance, along with more foreign capital investment which will be needed as China continues to drive its economy up the value-added chain. The slowing rate of inward foreign direct investment is a concern.

In this regard, we shall also be watching to see if the Party seeks to exert its control over foreign financial firms in the same way it is doing with commercial ones, especially in the name of fighting corruption.

The new moves suggest, too, that the deadlock between various ministries that has held back financial market reforms has been broken. That may lead to some eventual progress on the far more controversial internationalisation of the currency, full convertibility of the exchange rate and opening of the capital account.

These all still await and will do for some time, probably until this phase of market opening is complete, though we may see draft timetables over the coming months stretching into the 2020s.

Li Holds Fast To Financial Reform

Prime Minister Li Keqiang gave a boosterish speech on the new leadership’s commitment to economic reform to the World Economic Forum meeting in Dalian. There wasn’t much if anything new to the broad-brush proposals or to the timetable — gradual. The weight of the speech was more in that he made it than in its detail, and in his declaration that “China is now at such a crucial stage that without structural transformation and upgrading, we will not be able to sustain economic growth.”

That is a message that he and President Xi Jinping will be carrying into the Party’s Third Plenum to be held in November though there it may be less universally well received than it was by the WEF audience. In Dalian, Li did, though, make clear that financial-sector reform was central to the progress. He also held out some hope that foreign financial firms would be allowed a bigger slice of ownership of Chinese firms.

China Takes Critical First Step To Liberalize Interest Rates

China’s long-awaited liberalization of its interest rates is a big deal. Initially it is a bigger deal symbolically than in reality; only the floor on the rates that banks charge for loans is being scrapped in this first move; the People’s Bank of China says it will proceed slowly with what it calls such a risky undertaking and the cap on deposit rates remains for now. A small portion of all loans will be affected immediately (only 11% of existing loans were made at a discount to the benchmark rate). But its importance lies in the fact that the first step has at last been taken in a critical leg of financial markets reform. It puts China firmly on the path to a fully convertible currency and floating exchange rates.

Paulson’s Flying Trip To Beijing Provides Little Cheer

U.S. Treasury Secretary Henry Paulson’s flying visit to Beijing to prepare for the next round of strategic economic dialogue due in June was a glummer than usual affair.

Squeezed in between Washington appearances on Monday to announce his plan to restructure America’s financial regulation and a Thursday U.S. Senate hearing on the Bear Stearns bailout, Paulson briefed Chinese leaders on the U.S. economy and the risks that the credit crisis posed to the real economy.

Not that Chinese leaders haven’t been paying attention. “There is no doubt that what’s happening in U.S. markets clearly has to give pause to the Chinese,” over its own financial markets liberalization, the FT quotes Paulson as saying. “They may be too polite to say it directly.”

Concern, too, over investment – where both countries have been complaining about growing protectionism against each other. “This is an area where there has been a loss of confidence on both sides. More work needs to be done,” Paulson said.

The recent accelerated appreciation of the yuan, which has risen against the U.S. dollar at an annualised rate of about 15%-20% so far this year, was a rare bright note.