Shanghai free-trade zone

Regulation delay puts foreign banks in a spot in Shanghai free-trade zone

Lured by the mainland's first free-trade zone in Shanghai, overseas lenders are left with little to do pending more details of government reforms

PUBLISHED : Tuesday, 14 January, 2014, 8:51am
UPDATED : Wednesday, 15 January, 2014, 5:39am

Foreign banks lobbied to set up in the mainland's first free-trade zone in Shanghai are grappling with a dilemma - what can they really do in the ambitious zone?

Last week, Bank of East Asia and DBS became the first two foreign banks to be officially approved to open their branches in the zone for business.

Both banks were among the first batch of global financial institutions that were encouraged by the banking regulator to apply in September last year to open branches there.

More foreign banks were expected to be approved soon, government sources said.

After about three months of waiting and preparation, many foreign banks were left with very little to do in their new offices since most regulations were being worked out, said lawyers and accountants.

"The free-trade zone is still in its infancy. Although the government has announced a series of changes, details are yet to be confirmed. Until then, we shall not see any actual impact," said Jack Chan, a managing partner of financial services for the Greater China region at Ernst & Young, one of the world's Big Four accounting firms.

For any bank, opening a branch is just the beginning of the business. The next and key question is where to find clients and determine the type of business and products that will most readily attract those clients.

Early last month, the People's Bank of China announced a so-called reform guidance to support the free-trade zone. The central bank proposed to run some pilot steps in key areas of financial reforms, such as interest rate liberalisation, free convertibility of funds and foreign exchange management among others.

However, analysts found the six-page blueprint that included 30 key points were too general for Shanghai to quickly implement.

"The general directives ring hollow. That is a helpful guidance but detailed implementation regulations are needed. We view it as a goodwill gesture by PBOC to assuage concerns of the lack of clarity on the regulatory scheme, but it is not enough," said Shanghai-based Joseph Chan, a partner with law firm Sidley Austin who has been active in advising foreign businesses in the zone since its launch in October.

"Note that important 'breakthroughs' contemplated in the blueprint, like capital account convertibility, carries no definite time line for implementation.

"The vast majority of new companies are set up by domestic investors, with only a handful by foreign investors, and with very low average registered capital. It is clear that foreign investors have adopted a wait-and-see attitude."

At a news conference in November, Ai Baojun, the Shanghai vice-mayor who is heading the free-trade zone's administrative committee, said about 1,400 companies had registered in the zone. However, only 38 were foreign firms.

"For the zone, the only change so far appears to be that companies allowed to invest in it will not have to go through an approval process. As for the negative list, while there's a possibility that Shanghai will ease the limitations, for the moment the list very much matches the categories for restricted and prohibited projects in the government's fifth catalogue of industries for guiding foreign investment," said McKinsey Asia chairman Gordon Orr in a research report this month.

The so-called negative list has a number of restricted and prohibited projects and sectors for international investors. It includes those that Beijing said would threaten national security, so foreign investors can forget about those sectors.

"This ambiguous situation gives the authorities, as usual, full freedom to maintain the status quo or to pursue bolder liberalisation in the [free-trade zone this year] if they see a need for a stimulus of some kind. On balance, I'd say this is relatively unlikely to happen," Orr said.

On Monday, Shanghai vice-mayor Tu Guangshao said at the Asian Financial Forum that the central bank would issue more detailed policies in the coming months, with the focus on the long-awaited "free trade account" system which will be a test of China liberalising its financial market.

Besides more detailed rules about capital flow, foreign firms that had set up in the Shanghai zone would also have to wait for more details about how to handle their tax and other regulatory issues before they could see "real business" in the free-trade area, Jack Chan said.

Although foreign banks may have enough patience for Shanghai, there may not be much time left for the city to enjoy its free-trade status, according to government sources.

The central government might only offer Shanghai one year of "privilege" before it approved other provinces and cities to set up their own free-trade zones, the sources said.

Joseph Chan said: "Reconciliation of different priorities and vested interests of the various agencies is paramount. Success or failure of the free-trade zone hinges on that."