financial services liberalisation in the china (shanghai) pilot … · 2016-07-12 · shanghai...
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Financial Services Liberalisation in the China (Shanghai) Pilot Free
Trade Zone: Reflections on Regulations and Regulators
Kim VAN DER BORGHT WANG Qian ZHANG Ji1
Abstract:With the foundation of China (Shanghai) Free Trade Zone, China’s reform
also enters a new stage. Under the era of global financial crisis, strong
and efficient financial services supervision is in urgent need. Through
analyzing the supervision situation in Shanghai FTZ, also the global
financial supervision model reform since financial crisis, financial
regulation in Shanghai free trade zone should be based on protecting the
interests of the investors and the public. Supervision should consider the
balance of cost and effect, and its target should not be too complicated.
Then the following recommendations are concluded: ○1 Financial
regulatory legislation system in Shanghai FTZ should be improved, also
macro-prudential regulation should be strengthened. ○2Offshore financial
business regulation in Shanghai FTZ should be improved; ○3 In
ShanghaiFTZ,measures should be taken to improve interest rate
marketizationsupervision; ○4 Regulation to capital account open should
be improved.
Keywords:China (Shanghai) Pilot Free Trade Zone, Financial Supervision, Policy
Suggestion
1.Introduction
The reform process of the financial sector started with the decision of the 16th
Chinese
Communist Party National Meeting in 2002, where the direction was given to start the
process and to allow privately owned business to become part of the financial sector,
this included allowing foreign-owned companies into the sector, albeit gingerly as
minority shareholders in existing (state-owned) banks.2 It has been a process of
steady but cautious reform to reposition the Chinese financial sector into a more
1 Kim Van der Borght is Visiting Professor, School for WTO Research & Education, Shanghai University of International Business & Economics; Professor of International Economic Law, Vrije Universiteit Brussel; Reader in Law, University of Westminster. WANG Qian is Associate Professor, School of WTO Research and Education Shanghai University of International Business and Economics. ZHANG Ji is Graduate, School of International Trade and Economics, Shanghai University of International Business and Economics. Corresponding author: WANG Qian ([email protected]). 2 Insert reference
market-oriented logic and revise the role of the state of the regulator and the facilitator
of this process.3
The second major push in the reform process has followed about a decade later. On 17
August 2013, the establishment of the China (Shanghai) Pilot Free Trade Zone
(CSPFTZ) was approved by the State Council.4
This second push aims to
internationalise the Chinese financial sector, position Shanghai as a first tier
international financial centre and to lay the foundations for the internationalisation of
the renminbi and the eventual acceptance of the Chinese currency as a reserve
currency.
The CSPFTZ was inaugurated on 29 September 2013.5 The CSPFTZ has jurisdiction
over four customs zones: the Waigaoquiao Free Trade Zone, the Waigaoquiao
Bonded Logistics Park, Yangshan Free Trade Port Area, and the Pudong Airport Free
Trade Zone.6 The creation of the CSPFTZ has united these four customs zones that
previously operated as separate bonded areas into a single free trade zone. This
process started in 1990 when bonded areas were created and when Shanghai was also
chosen as the location to pilot this system with the inauguration of the Waigaoquiao
Free Trade Zone in 1990. This was followed in 2003 by the Waigaoquiao Bonded
Logistics Park. The first free trade port in China was the Yangshan Free Trade Port
Area (2005). In 2009 the Pudong Airport Free Trade Zone was decided and the
expansion of the zone was realised in 2012. The total area of the CSPFTZ is now 28
square km.7
The CSPFTZ is a national project that dovetails with the development plans of the
Shanghai Municipal Government. In 2006, the Eleventh Five Year Plan of Shanghai
put forward the construction of the “four centres” of Shanghai, that is making
Shanghai an international economic centre, an international financial centre, an
international trade centre and international centre.8. The CSPFTZ is part of the
implementation of this “four centres” plan.
While several cities ‘clamoured’ to be chosen for this pilot, the Shanghai Municipal
Government prevailed in its bid to host the pilot project.9 The Shanghai Municipal
Government was strongly motivated as it faced rising manufacturing costs that result
3 See Wei Ping He, Banking regulation in China: what, why, and how?, 20(4) Journal of Financial Regulation and Compliance 367 (2012). 4 Insert reference 5 WTO, Trade Policy Review China – Report by the Secretariat (WT/TPR/S/300) (27 May 2014), at 51. 6 Circular of the State Council on Printing and Distributing the Overall Plan for China (Shanghai) Pilot Free Trade Zone (GuoFa [2013] No.38) 7 Insert reference to official decisions of the state council for all these events. Also see, WTO, Trade Policy Review China – Report by the Secretariat (WT/TPR/S/300) (27 May 2014), at 51. 8 See for “Outline of the Eleventh Five-Year Plan for National Economic and Social Development in Shanghai” MORE INFO NEEDED AND REFERENCES. WHAT IS THE DIFFERENCE BETWEEN A TRADE CENTRE AND AN ECONOMIC CENTRE?the relationship among the “four centres” is “3+1”,once the trade centre, financial centre and logistics centres are established, the economic centre is naturally formed. 9 See X, Planning key to free-trade zones (editorial), South China Morning Post (11 June 2014).
from exchange rate appreciation and increased labour costs, weak external demand
owing to the slow recovery from the global financial crisis, the increasing trade
frictions and the complicated customs regulatory processes that continue to turn away
foreign capital and discourage domestic investment.10
The development of the CSPFTZ builds on Shanghai’s strengths such as its excellent
geographical location in terms of shipping and access to a vast and dynamic
hinterland.11
The choice for Shanghai as the location for China’s push to host one of
the world’s premier tier financial centres also reflects the current reality of Shanghai
as the de facto capital of finance of China.12
Shanghai hosts the headquarters of the
Bank of Communications and the Pudong Development Bank. The financial
operations and the back office operations of respectively the China Industrial Bank
and the China Ping’an Insurance Company are based in Shanghai. It is home to the
Shanghai Stock Exchange, the Shanghai Futures Exchange, the Shanghai Gold
Exchange, China Union Pay, the Foreign Exchange Trade System and the Interbank
Market. It is then not surprising that it is the leading city in terms of the number of
foreign financial institutions seeking a base in China.13
At the Third Plenary Session of the 18th Central Committee of the Communist Party
of China (2013), a ‘National Leading Group for Comprehensive Deepening Reform’
was established. Among the responsibilities of this Group is the development of the
CSPFTZ.14
The Group is headed by President Xi Jinping and will take responsibility
for the national policy design, inter-departmental and regional coordination and the
implementation and supervision of major reform across sectors in furthering China's
reform process.15
The WTO Trade Policy Review Report lists the initial achievements of the CSPFTZ
as reported by the Chinese authorities. It reveals that in the period from September
2013 until mid-February 2014, 434 foreign-invested enterprises were established
representing a total investment of US$1.8 billion. It was reported that these investors
come from 40 different countries. The investments have been strongly attracted to
services, including 89 financial companies were set up and 34 financial leasing
10 Foreign companies have gradually moved their bases from the eastern coastal area to regions and countries that have low manufacturing costs(Beresford et al.,2012) (Yang et al., 2010), 11 See Yizhi Wang, Hiroyuki Shibusawa, Edward Leman, Yoshiro Higano & Gouping Mao, A Study of Shanghai’s Development Strategy to 2020, 5(2) Regional Science Policy & Practice 183 (2013). 12 See Anindya K. Bhattacharya, The Feasibility of Establishing an International Financial Center in Shanghai, 12 Journal of Asia-Pacific Business 123-124 (2011). 13 See Yizhi Wang, Hiroyuki Shibusawa, Edward Leman, Yoshiro Higano & Gouping Mao, A Study of Shanghai’s Development Strategy to 2020, 5(2) Regional Science Policy & Practice 186 (2013). 14 See WTO, Trade Policy Review China – Report by the Secretariat (WT/TPR/S/300) (27 May 2014), at 10; X, China's reform leading group holds first meeting (China Daily, 23 January 2014) 15 See Third Plenary Session of the 18th CPC Central Committee, The Decision on Major Issues Concerning
Comprehensively Deepening Reforms (12 November 2013) (abridged translation). Is there any public information
available about this Group? How many members? Who? Any public information on their activities? Reports?
Statements?
companies. The Zone currently represents 27% of Shanghai's total trade (exports and
imports).16
As the title of the free trade zone indicates, this is a pilot project. Shanghai was
chosen as the location for the pilot project as in previous cases with bonded zones and
free trade ports. The pilot project has an initial period of two to three years to test
further trade and investment liberalization with a focus on services, including testing
new modes of services and new forms of supervision.17
The experience gained
through this pilot project is to serve nationwide as a model for new ideas, new
approaches and further reform.18
It is a strategic plan to ensure a more effective and
efficient domestic financial sector (‘serving the nation’) and to further the
internationalization of China’s financial sector (‘going to the world’).19
The pilot
project allows experimentation ‘step by step with risks under control’.20
To date,
more than 20 cities have a declared interest in being next in line when the results of
this pilot are rolled out further, including Shenzhen, Tianjin, Qingdao, Chongqing and
Xi’an. However, these new applications have been stopped by the Central government
since they are still waiting for CSPETZ to show a ‘duplicable and replicable
experiences’ and real impact.21
This article aims to review the regulatory aspect aspects of the financial reforms in the
CSPFTZ and the arrangement for regulatory oversight. The first section reviews the
regulatory framework and concludes that it does not yet meet international standards
in terms of legal certainty, legal clarity and transparency and meaningful stakeholder
involvement.22
No detail – the detail is to follow – most likely in a responsive mode: as problems or
questions occur, the question is pushed up the chain to receive a response.
2. CSPFTZ Financial Services Liberalisation: Law and Institutions
2.1 Law and Institutions
16 WTO, Trade Policy Review China – Report by the Secretariat (WT/TPR/S/300) (27 May 2014), at 51. 17 See Article 2 (Overall Objectives), Decision of the State Council, Framework Plan for the China (Shanghai) Pilot Free Trade Zone (27 September 2013). 18 See Article 2 (Overall Objectives), Decision of the State Council, Framework Plan for the China (Shanghai) Pilot Free Trade Zone (27 September 2013). 19 See chapeau of Title 2, Decision of the State Council, Framework Plan for the China (Shanghai) Pilot Free Trade Zone (27 September 2013). 20 See chapeau of Title 2, Decision of the State Council, Framework Plan for the China (Shanghai) Pilot Free Trade Zone (27 September 2013). 21News of the Xinhua net(Chinese version) http://news.xinhuanet.com/politics/2014-06/03/c_126575983.htm Actually, this FTZ fever in China was originated from a formulation in the “Decision” of the Third Plenary Session of the 18th CPC Central Committee, that is “Based on practices in the China (Shanghai) Pilot Free Trade Zone, a number of qualified areas will be built into FTAs.”(Article 24). However, some local governments are pursuing merely the preferential policies. It goes counter to the original intention of the central government which focuses on system innovation, deepen reform and further open up. 22
See also X, Planning key to free-trade zones (editorial), South China Morning Post (11 June 2014). The editorial summarises the problems cogently: ‘The special measures outlined to attract foreign investors are short on detail. A "negative list" of areas and activities off-limits to investors runs to more than 1,000 items, leaving much red tape and a commercial legal framework and freedoms to do business that fall far short of international standards.’
The policy framework for the liberalisation of financial services is the decision of the
Third Plenary Session of the 18th
Central Committee of the Communist Party of
China.23
As part of the reform into a socialist market economy, a direction is charted
to a modern market system with open, fair and transparent rules and markets-based
prices.24
Even though there are some exceptions to this development, financial
services fall squarely within the policy and have been targeted for reform.25
These
reforms include allowing qualified private capital to set up financial institutions under
enhanced supervision with a deposit insurance system and a market-based exit system,
improve the market-based exchange rate formation mechanisms for the RMB and
accelerate interest rate liberalisation.26
Whereas the policy direction is given by the Central Committee, the legal basis for the
establishment of the CSPFTZ is provided by the 2013 decision of the State Council in
pursuance of the afore-mentioned policy by issuing the Framework Plan for the China
(Shanghai) Pilot Free Trade Zone.27
The Guiding Principles of the Framework Plan
provide that the CSPFTZ ‘will create a regulatory environment on cross-border
investment and trading that is in line with international practices, enhance China's
economic position globally, and contribute to achieving the revival of the Chinese
People's China Dream’.28
The fourth ‘major tasks and measures’ of the Framework
Plan deal specifically with strengthening innovation and further liberalization of
financial services.29
This strategy is focused on positioning Shanghai as a full-service
international financial centre and internationalizing the RMB by opening up the
CSPFTZ for private investors and foreign-invested and Sino-foreign financial
institutions and by allowing financial innovations (including new areas of financial
activities for China such as commodity futures trading, equity escrow, and
cross-border RMB reinsurance).30
The Circular on the Framework Plan delegates the responsibility for the
implementation of the Framework Plan to the Shanghai Municipal People's
Government. 31
23
Insert reference 24
Insert reference 25
Insert reference which exceptions? 26 See Third Plenary Session of the 18th CPC Central Committee, The Decision on Major Issues Concerning
Comprehensively Deepening Reforms (12 Nov 2013) (abridged translation), para. 18. 27 See Decision of the State Council, Framework Plan for the China (Shanghai) Pilot Free Trade Zone (27
September 2013). 28 Insert reference. Why revival? 29 The other three are: (1) Accelerate the functional transformation of government; (2) Opening up of investment
sectors; (3) Promote the transformation of trade development approach; and (5) Improve regulatory supporting
systems 30 Decision of the State Council, Framework Plan for the China (Shanghai) Pilot Free Trade Zone (27 September
2013). 31 See Circular of the State Council on the Framework Plan for the China (Shanghai) Pilot Free Trade Zone (18
September 2013).
Whereas the delegation to the Shanghai Municipal People’s Government is explicitly
stated in the Framework Circular, there is also some informal delegation of powers for
the development of rules to the relevant agencies and bodies, in particular the People’s
Bank of China and to the three regulatory bodies of the financial sectors, the China
Banking Regulatory Commission, the China Securities Regulatory Commission and
the China Insurance Regulatory Commission. These bodies develop regulations on
financial services liberalisation by issuing circulars and ‘policies and measures’.
These documents are quasi-legal in nature but they are in practice the applicable legal
rules in the absence of being overruled.32
However, these documents merely
represent a further layer in the regulation in that they provide further implementation
of the strategy but do not provide detailed rules. Examples include multiple references
to ‘qualified foreign-invested banks’ or ‘conditioned banks’ but the conditions for
qualification are left to decided.
A further level of details is to be developed by the municipal government of
Shanghai, Shanghai Head Office of the PBC, China(Shanghai) Pilot Free Trade Zone
Administration, others can develop detailed rules and procedures.
Insert paragraph on the institutions responsible for the implementation and
functioning
2.2 The Opinion of the People’s Bank of China (PBC Opinion)
The People’s Bank of China is the highest level of implementation of the CPC Central
Committee and State Council Decisions. It provides the three general principles that
underpin the financial reforms33
:
1. The principle of the financial sector serving the real economy will be followed
to further facilitate trade and investment, promote the opening of the financial
sector and to facilitate the FTZ to compete internationally on a higher platform.
2. The principle of continuing reform and innovation, and leading the way in pilot
will be followed to promote the cross-border use of RMB, the move towards
capital account convertibility, market-based interest rate reform and
foreign exchange administration reform.
3. The principle of keeping risks within controllable ranges and making steady
progress will be followed to organize experiments in an orderly manner whenever
the conditions for an experiment are mature.
32 See Peter Howard Corne, Creation and Application of Law in the PRC, 50 American Journal of Comparative
Law 372 (2002). See generally Robert Guillaumond, Lu Jianping & Li Bin, Droit chinois des affaires 51-121
(Brussels : Larcier, 2013) 33 Opinions of the PBC on Financial Measures to Support the China (Shanghai) Pilot Free Trade Zone
(unofficial translation, edited)
The principles reflect the two main concerns. The first concern is to learn the lessons
from the 2008 financial crisis by developing a cautious approach to financial
liberalisation and to develop rules and regulations that aim to avoid speculative
financial transactions by emphasising the linkage with the ‘real economy’ and by
avoiding the pitfalls of the too-big-to-fail experiences in US and EU markets.34
The
second is to strengthen the market-reform and the internationalisation of China’s
financial sector, including the internationalisation of the RMB and the integration of
the Chinese financial sector into the international markets.
The principles reveal important elements of the strategy. The reform and innovation
process will be a gradual process. The objective is to keep the process under control
and the steer its course. The purpose is to bring financial sector out of the state
protective umbrella. This liberalisation is to support a reform of the Chinese financial
sector and to facilitate its development into a sector that can sustain international
competition. The facilitation of the CSPFTZ to compete internationally on a higher
platform should be interpreted as a strategy of knowledge and know-how transfer and
acquisition. By allowing foreign financial institutions to operate in the CSPFTZ and
allowing them to enter into joint ventures, the Chinese financial institutions are forced
to meet these increasingly higher benchmarks and become competitive at the
international level as part of the efforts to make Shanghai a premier international
financial centre built on Chinese financial institutions.
The second key element in the strategy is to position the renminbi as an international
currency. This requires that the exchange of the renminbi is gradually released from
strict controls and that the interest-rates are brought in line with the expectations of
the market. The liberalisation of the usage of the renminbi includes the promotion of
its cross-border use beyond simple trade payments. The most recent policy statement
of the Shanghai Head Office of the PBOC was released on 21 February 2014 in the
form of a ‘Notice on the support of China (Shanghai) free trade zone to expand
cross-border RMB test used’.35
The Notice ….
The third key element concerns oversight and risk-management. It forestalls a
wholesale review of the regulatory system. This issue will be discussed in the second
part of this article.
2.3 The Circular of the China Banking Regulatory Commission (Banking
Circular)
Banks operating in the CSPFTZ are not subject to the restrictions that are in force in
China generally. The China Banking Regulatory Commission explains the effect of
these changes for Chinese-funded banks and for qualified foreign-invested banks.36
34
Insert reference.to academic literature on ‘real economy’ link and financial crisis 35
http://shanghai.pbc.gov.cn/publish/fzh_shanghai/2974/2014/20140221174612080116226/20140221174612080116226_.html 36 Circular of the China Banking Regulatory Commission on Issues Concerning Banking Supervision in China
National Chinese-funded commercial banks, policy banks and banks in Shanghai can
benefit from this new regulatory environment by setting up new branches or special
institutions in the CSPFTZ, or by upgrading their existing presence to a branch or
sub-branch.37
Qualified foreign-invested banks are similarly allowed to set up subsidiaries, branches
or special institutions or to upgrade existing sub-branches to branches. Qualified
foreign-invested banks can also set up Sino-foreign equity joint-venture banks.38
As
for Qualified foreign-invested banks, strict regulation applies in terms of the
time-periods required to set up a branch by the representative office of a foreign bank
in the CSPFTZ and to be allowed to carry out RMB business. The Circular indicated
that a shortening of the time-periods will be studied. For setting up sub-branches the
pre-approval procedure will be replaced by a reporting requirement for the
qualifications of the branch office, the senior management and certain business
permission.39
“A "green channel" will be set up to grant the market access for
banking industry in the FTZ to enhance the administration efficiency by setting
time limits for certain items.” According to the WTO TPR, the Chinese authorities
have explained that "Green Channel" means “streamlining the market access
procedures for financial institutions by optimizing the supervision mechanism, so as
to promote opening and competition among banks and financial institutions within the
CSPFTZ”.40
The Banking Circular clarifies that qualified private investors can enter the banking
sector in the CSPFTZ. They can set up banks, finance leasing companies, consumer
finance companies and other finance institutions but they shall assume their own
risk.41
They can also participate in setting up Sino-foreign equity joint-venture banks
with other Chinese or foreign financial institution investors.42
As was shown for private investors, the Banking Circular is not limited to banking but
encompasses financial services in a wider sense and particular when it concerns
cross-border investment and financing services. The activities of banking financial
institutions supported by the China Banking Regulatory Commission include
(Shanghai) Free Trade Zone, Yin Jian Fa [2013] No. 40, of 28 September 2013 (English translation – Chinese original version prevails) [hereinafter Banking Circular], 37 Article 1 Banking Circular. Policy Banks were established by the Decision of the State Council on Reform of the Financial System (25 December 1993) carrying out the decision of the Third Plenary Session of the Fourteenth Central Committee. The policy banks were established to separate policy finance from commercial finance. They are guided and supervised by the PBOC. There are 3 policy banks in China: China Development Bank, The Export-Import Bank of China, Agricultural Development Bank of China. 38 Article 3 Banking Circular. 39 Article 7 Banking Circular 40 WTO, Trade Policy Review China – Report by the Secretariat (WT/TPR/S/300) (27 May 2014), footnote 63. 41 As a corollary to this, a deposit insurance guarantee is envisaged. See Third Plenary Session of the 18th CPC Central Committee, The Decision on Major Issues Concerning Comprehensively Deepening Reforms (date) (abridged translation), para. 18. 42 Article 4 Banking Circular.
cross-border financing business, including but not limited to commodity trade finance,
whole supply chain finance, offshore vessel finance, financial support to modern
service sectors, onshore loans against offshore guarantees and commercial
instruments. This list in the Banking Circular is not a closed list. Furthermore,
banking financial institutions are supported to promote finance services for
cross-border investments, including but not limited to cross-border M&A loans and
project loans, guaranty for offshore loans, cross-border assets management and wealth
management business and real estate investment trust. Again this list is not
limitative.43
Beyond banking and financial institutions, the Banking Circular also contains rules on
the operations of qualified large enterprise groups in the CSPFTZ that are allowed to
establish group finance companies and that qualified investors can set up auto finance
companies and consumer finance companies in the CSPFTZ.44
Finally the Banking Circular provides that trust companies established in Shanghai
are permitted to relocate into the CSPFTZ; that national financial asset management
companies may establish branches in the CSPFTZ and that finance leasing companies
may establish specialised subsidiaries.45
2.4 The Policies and Measures on the Capital Market of the China Securities
Regulatory Commission (Policies and Measures).
The objectives of Commission as explained in this document are to deepen the capital
market reform, further promote the opening-up and support the CSPFTZ. The
Commission indicates that this process will require further research and refinement of
the Policies and Measures. But it stresses the need for speedy implementation.
The Policies and Measures allow the Shanghai Futures Exchange to establish a
Shanghai International Energy Trading Center Co., Ltd. in the CSPFTZ. This Energy
Trading Center will set up a trading platform for international crude oil futures. This
trading platform will also be open to foreign investors.
Most of the Policies and Measures give a cautious direction for reform rather than a
set of rules. The areas opened up are encapsulated in caveats and conditionalities
making it difficult to achieve the speedy implementation referred to in the document.
The Policies and Measures invariably include the ‘qualified’ and reference to
‘relevant regulation’ without either being defined, leaving uncertainty is to the
implementation of these reforms.
Further specific reforms include the possibility for qualified investors (companies and
individuals) to make investments in foreign and domestic securities and futures
43 Article 5 Banking Circular. 44 Article 2 Banking Circular. 45 Article 3 Banking Circular.
markets; the possibility of foreign parents of enterprises in the CSPFTZ to issue RMB
bonds in domestic markets (in accordance with relevant regulations); the possibility
for securities and futures institutions to register and set up specialized subsidiaries in
the CSPFTZ; and the possibility for securities and futures institutions in the CSPFTZ
to carry out over-the-counter transactions of commodities and financial derivatives for
domestic clients.
2.5 The Opinion by the China Insurance Regulatory Commission to Support
the China (Shanghai) Pilot Free Trade Zone (Insurance Opinion)
The Insurance Opinion comes in the form of a reply to undisclosed questions from its
Shanghai Bureau. It lists eight areas where the China Insurance Regulatory
Commission (CIRC) will support reform. The CIRC will support the establishment of
foreign-invested specialised health insurance institutions in the CSPFTZ; it will
support the establishment of branches of insurance companies; it will support an
outbound investment pilot for CSPFTZ insurance institutions; it will support the
development of reinsurance business in the CSPFTZ by world-known specialized
insurance intermediaries as well as social organizations or individuals and it will
support the development of cross-border RMB-denominated reinsurance business in
the CSPFTZ; it will support the development of shipping insurance business in
Shanghai, including development of shipping insurance institutions and shipping
insurance brokers; and development of the Association of Shanghai Shipping
Insurance;
In more general terms, the CISC will support innovation in insurance products by
insurance companies and the continuous expansion of the service scope of liability
insurance business. It will strive to improve the insurance market system in Shanghai
and to promote the establishment of functional insurance institutions such as shipping
insurance pricing centre, reinsurance centre, insurance fund management centre, etc.
The overall objective of the reforms in the insurance market is to establish a
mechanism linking the financial reform and innovation in the CSPFTZ with the
building up of Shanghai International Financial Centre.
With controlling financial system risks, there would be no longer QFII, RQFII.
Enterprises in Shanghai FTZ would invest in securities and futures. Individuals could
directly invest in overseas securities market without QDII constraints. The institutions,
which provide financial services to entities in Shanghai FTZ, is not limited in the zone,
but in Shanghai46
. Financial opening is one of important contents in China (Shanghai)
Pilot Free Trade Zone. Under the premise of risk control, by implementing the
“central bank 30” and other polices, the financial services sector should be further
46 People's Bank of China. Opinions of the People's Bank of China on Financial Supporting China (Shanghai) Pilot
Free Trade Zone. December 2, 2013. More Details :http://zbw.sh.gov.cn/WebViewPublic/item_page.aspx?newsid=635215802017535000&coltype=8
opened up in Shanghai FTZ, to accelerate the financial innovation, strengthen the
service function of finance, and support of the Shanghai trade zone at high platform to
participate in international competition.
Meanwhile, financial opening would also lead to inter-kingdom protoplast fusion
between banking, security, insurance and other financial businesses. Nowadays,
financial holding corporations in integrated operation become the general trend,
which calls for new requirements for the current financial supervision system.
Therefore, it is in urgent need for in-depth study on financial opening and integrated
supervision innovation in Shanghai FTZ. Besides, as the global continuous reflections
from the financial crisis, constructing proper financial supervision system in Shanghai
FTA is particularly important. It is foreseeable that financial institutions in the region
would have more degrees of freedom. With the deepening open up in financial
services industry, it will greatly increase the financial risk and affect the stability of
the financial market. State Council and the central bank emphasize that the financial
opening should be under controllable risk, especially the systematic risk. It means that
it needs to establish a supervision and management system to adapt to open of the
financial market. Therefore, it is necessary to perfect the regional financial
supervision legislation system, strengthen the macro prudential supervision, and
establish a suitable supervision institution. For these specific financial opening areas,
it has to explore appropriate supervision framework on offshore financial business,
interest rate marketization, and capital account liberalization. On the other hand, only
with a strong and effective supervision system, could better and deeper opening be
achieved. Otherwise, struggle for opening financial services sector in Shanghai FTA
would be in vain.
3. Financial Supervision in China and CSPFTZ
3.1 Financial Supervision in China
The People’s Bank of China was established in 1948 as a merger between of three
existing commercial banks, Huabei Bank, the Beihai Bank and the Xibei Farmer
Bank.47
From 1950 until 1979, the PBOC was the sole bank in China functioning
both as a central bank and as a commercial bank.48
In 1980, the commercial banking
activities were split off from the PBOC and transferred to four state-owned
commercial banks: the Bank of China (BOC), the China Construction Bank (CCB),
the Agricultural Bank of China (ABC) and the Industrial and Commercial Bank of
China (ICBC).49
The role of the PBOC was redefined with a dual function. The first
was to develop monetary policy. The second was the regulation and supervision of the
banking sector, including banking, insurance and securities.50
However, owing to
the mixed operations in the financial sector and the rapid development of the
47 Insert ref 48 Insert ref 49 Insert ref 50
banking and trust industries, a certain amount of chaos ensued. In 1992, the
China Securities Regulatory Commission (CSRC) was established and in 1998, the
China Insurance Regulatory Commission (CIRC).51
The current system of financial supervision in China was established in 2003 when
the Tenth National People’s Congress Standing Committee approved a proposal of the
State Council to separate banking regulation and supervision from the People’s Bank
of China and entrust it to a new body, the China Banking Regulatory Commission
(CBRC).52
The CBRC is the principal regulatory and supervisory body for the
banking sector and is directly accountable to the State Council.53
It is not subordinate
to the PBOC that maintained its role of the guardian of monetary policy but stands on
an equal footing with it; each has its distinct function and role in the supervisory
system.54
The separation was aimed at providing greater independence to the PBOC
in terms of developing monetary policy as it would no longer have to deal with
conflicts of interests between monetary policy and its role as a banking regulator.55
Additionally, the PBOC has delegated its task to regulate and supervise the foreign
exchange market to the State Administration of Foreign Exchanges (SAFE) that it
oversees.56
Further of relevance to supervision in the banking sector and especially in
relation to the operations of foreign banks are the Ministry of Finance, the National
Development and Reform Commission (NDRC) and the State-owned Assets
Supervision and Administration Commission (SASAC)57
Some authors have indicated as a weakness that the role of local regulatory and
administrative bodies is unclear and that this could be confusing to foreign
institutions.58
The fact that the main regulatory bodies are based in Beijing might
further diminish the regulatory power of Shanghai and risks allowing for a divergence
between the Shanghai realities on the ground and the policy perceptions and
formulations in Beijing.59
This means that China has not followed the dominant model that had spread to most
51 See Charles C.C. Chau, The new watchdog for the banking and financial industry in China: the China Banking Regulatory Commission, 8(?) Journal of International Banking Law and Regulation 335 (2003). 52 Wei Ping He, Banking regulation in China: what, why, and how?, 20(4) Journal of Financial Regulation and Compliance 368 (2012). 53 Wei Ping He, Banking regulation in China: what, why, and how?, 20(4) Journal of Financial Regulation and Compliance 368 (2012). 54 Article 2, Law of the People's Republic of China People's Bank of China 1995. 55 It has been suggested that the PBOC set interests rates with the interests of major banks in mind rather than inflation targets for the country. See Charles C.C. Chau, The new watchdog for the banking and financial industry in China: the China Banking Regulatory Commission, 8(?) Journal of International Banking Law and Regulation 337 (2003). 56 57 See Wei Ping He, Banking regulation in China: what, why, and how?, 20(4) Journal of Financial Regulation and Compliance 369 (2012). 58 Yizhi Wang, Hiroyuki Shibusawa, Edward Leman, Yoshiro Higano & Gouping Mao, A Study of Shanghai’s Development Strategy to 2020, 5(2) Regional Science Policy & Practice 192 (2013). 59 Yizhi Wang, Hiroyuki Shibusawa, Edward Leman, Yoshiro Higano & Gouping Mao, A Study of Shanghai’s Development Strategy to 2020, 5(2) Regional Science Policy & Practice 192 (2013).
jurisdictions namely a single regulator or a twin peaks model.
Due to the specific situation of China, the systemic risks are assessed in a different
framework as the execution of the planned developments can receive a higher priority
over systemic risks as long as these systemic risks can be covered by the central
government. This has led to a higher level of non-performing debt and of inefficient
banks as would be tolerable in different circumstances. As the planning provides for a
marketization of the financial sector, these risks have to be brought in line with
international practice.
The CSPFTZ is the pilot project where this process of bringing the financial sector in
line with international standards is being tested. This process has two elements. The
first is the development of suitable regulations as discussed above. The second is the
monitoring and enforcement of these regulations.
3.2 Brief Overview of Regulators in Other Financial Centres
The CSPFTZ is a strategy to position Shanghai is a premier international financial
centre. It is therefore relevant to briefly review the supervisory arrangements at the
international financial centres with whom it enters into competition, in particular
London, New York and Tokyo. To a lesser extent, also Hong Kong and Singapore are
relevant in this discussion.
The supervision of the financial sector can be organized in a variety of ways. There
are jurisdictions that favoured a single regulator, like the Financial Services Authority
(FSA) (UK).60
Some jurisdictions prefer multiple specialized regulators, like the US
with supervisory roles given to the Federal Reserve (central bank), the Securities and
Exchange Commission and the Commodity Futures Trading Commission. However,
these supervisory mechanisms proved flawed in the light of the 2009 financial crisis.
Despite the FSA being followed as a model of best practice, the UK abolished the
organization and brought the regulatory supervision task under the Bank of England
(central bank).61
Add Tokyo, HK and Singapore
Hong Kong
• Banking
Hong Kong’s banking sector comprises three tiers of authorized institutions(AIs):
licensed banks, restricted licence banks and deposit-taking companies. The Hong
Kong Monetary Authority(HKMA) ensures general stability and effective working of
the banking system through the regulation of banking and deposit-taking business and
the supervision of AIs. The HKMA has responsibility to promote proper standards of
60 The Financial Services Authority was established in 1997 and discontinued in 2010. 61 Insert ref
conduct, encourage sound and prudent business practices, and to help prevent illegal,
dishonourable or improper practices in the banking industry. The HKMA derives its
regulatory powers from the Banking Ordinance. The HKMA has a general discretion
under the Banking Ordinance to grant or refuse an application for authorization to
operate a banking business or the business of taking deposits in Hong Kong.
As to the supervision methods, the HKMA adopts a “continuous supervision” policy
to supervise banks, and its main objective is to detect and address a problem at an
early stage. This involves monitoring the businesses of the AIs through a variety of
techniques, including: on-site examinations; off-site reviews; prudential meetings;
meetings with the board of directors; co-operation with external auditors; sharing
information with other supervisors. Furthermore, the HKMA adopts a risk-based
approach to banking supervision to ensure that AIs have the necessary risk
management systems to identify, measure, monitor and control risks inherent in their
business operations, and address any problem at an early stage. The HKMA has
identified eight major types of inherent risk: credit risk, interest rate risk, market risk,
liquidity risk, operational risk, legal risk, reputation risk and strategic risk.
• Securities
Under the present regulatory framework, the Securities and Futures Commission
(SFC), which is the “lead regulator” for the securities industry, sets out the principles
and regulatory requirements for all intermediaries to follow. An AI wishing to engage
in securities intermediary activities must register with the SFC. When an AI applies to
be registered, the HKMA will advise the SFC whether the AI is fit and proper for this
purpose. Being the “frontline regulator” of AIs’ securities business, the HKMA is
responsible for supervising the securities business conducted by the AIs, and where
necessary, issuing circulars to AIs to supplement the SFC’s regulatory requirements
on the basis of the HKMA’s supervisory experience and the nature of operations of the
AIs.
To facilitate co-operation on supervising AIs’ securities business, the HKMA and the
SFC have entered into a Memorandum of Understanding setting out their roles and
responsibilities.
Singapore62
-Single Regulator
• Monetary Authority of Singapore
As Singapore's central bank, the Monetary Authority of Singapore (MAS) is an
integrated supervisor overseeing all financial institutions in Singapore -- banks,
insurers, capital market intermediaries, financial advisors, and the stock exchange. It
conducts integrated supervision of financial services and financial stability
surveillance. With its mandate to foster a sound and progressive financial services
sector in Singapore, MAS also helps shape Singapore's financial industry by
promoting a strong corporate governance framework and close adherence to
62
See the official website of Monetary Authority of Singapore, http://www.mas.gov.sg/
international accounting standards. As to the specific financial regulation of different
institution, there are particular departments inside the MAS supervising the
businesses.
• Banking and Insurance
Banking Departments I, II and III
The three Banking Departments collectively supervise licensed and regulated banks,
merchant banks, finance companies, money changers and remittance agents in
Singapore. They foster the stability and strength of Singapore's financial system by
monitoring the safety and soundness of the financial institutions that they supervise,
and promoting the adoption of international best practices in corporate governance
and risk management. Broadly, Banking Department I supervises the local banking
groups on a consolidated basis, and certain foreign banks. Banking Department II
supervises a mix of retail and wholesale banks, finance companies, money changers
and remittance agents. It also houses the Supervisory, Methodologies, Transactions
and Analytics Division. Banking Department III generally supervises banks active in
treasury and private banking businesses.
Insurance Department
The Insurance Department supervises and regulates insurance companies and has as
its primary objective the protection of policyholders' interests. The department adopts
a risk-focused approach in the prudential and market conduct supervision of insurance
companies. In its standards setting role, the department works closely with industry
associations to promote the adoption of best practices by the industry.
• Capital Markets
Capital Markets Intermediaries Department
The Capital Markets Intermediaries Department has responsibility for the admission
and supervision of capital markets intermediaries, including securities dealers and
futures brokers, fund managers, corporate finance advisers, and financial advisers. It
administers the licensing and business conduct rules for these intermediaries under the
Securities and Futures Act, and Financial Advisers Act. The department is also
responsible for regulating insurance brokers under Part IIB of the Insurance Act.
Investment Intermediaries Department
The Investment Intermediaries Department has responsibility for the admission and
supervision of investment intermediaries, including fund managers, Real Estate
Investment Trusts managers and trust companies; and credit rating agencies. It
administers the licensing and business conduct rules for these intermediaries under the
Securities and Futures Act and Trust Companies Act.
Market Conduct Department
The Market Conduct Department has supervisory responsibility for capital markets
through the administration of the Securities and Futures Act, the Business Trusts Act
and the Singapore Code on Take-overs and Mergers. It regulates (i) the offering of
securities, business trusts, Real Estate Investment Trusts and collective investment
schemes; (ii) the conduct of takeover and merger transactions; and (iii) SGX as a
listed entity. It also enforces the civil penalty regime for market misconduct.
Markets Policy & Infrastructure Department
The Markets Policy and Infrastructure Department has supervisory responsibility for
markets and infrastructures including central counterparties and trade repositories.
The department formulates and implements policies in relation to markets and
infrastructures, as well as market and business conduct policies to achieve fair
outcomes for depositors, investors and policyholders. It is also responsible for
formulating MAS' positions on competition issues and corporate governance
standards.
• Policy, Risk and Surveillance
Prudential Policy Department
The Prudential Policy Department formulates capital and prudential policies for banks,
insurance companies and securities firms to promote a sound and dynamic financial
sector in Singapore. The department develops capital standards for the financial sector,
including MAS’ approach on the implementation of Basel III. It also formulates MAS’
policies on housing loans and unsecured credit, concentration limits, and the deposit
insurance and policy owners’ protection schemes. It reviews MAS’ policy on banking
structures and strengthens the regulatory frameworks for banks, merchant banks,
finance companies, and financial holding companies.
Specialist Risk Department
The Specialist Risk Department provides risk expertise for the effective prudential
supervision of Singapore's financial sector. The department monitors and assesses the
risk management processes and controls of individual financial institutions and
designated payment systems. It also keeps track of systemic macroprudential risks of
the financial industry and formulates efficient approaches to deal with the risks
identified. Areas of focus include (i) financial risks comprising credit, market,
liquidity and operational risks; (ii) technology risk including IT systems and security
controls, (iii) business continuity management; and (iv) payment systems and
infrastructure.
Macroeconomic Surveillance Department
The Macroeconomic Surveillance Department conducts surveillance of the financial
system to identify emerging trends and potential vulnerabilities, and closely monitors
and evaluates developments in G-3 and regional economies, as well as international
financial markets. The department undertakes in-depth policy-relevant studies on
macro-financial linkages, systemic risk and other financial stability issues. It works
closely with MAS' supervisory departments to ensure that both macro and
micro-prudential perspectives are brought to bear on financial stability issues.
London——from single regulation to “twin peak” regulation
In order to adapt to the mixed operation in financial industry, the England government
reformed the financial supervision system in 1997, unifying the supervision
authorities of 9 financial institutions including bank of England into a single
institution. In Oct 1997, Financial Service Authority (FSA) was set up, who is
responsible for the regulation and prudential supervision of banking, building
societies, credit unions, insurers and major investment firms.
After the financial crisis of 2008, a new regulatory framework for the United
Kingdom’s financial sector came into effect in April 2013. Since 2013, the FSA has
become two separate regulatory authorities: the Financial Conduct Authority (FCA)
and the Prudential Regulation Authority (PRA). The PRA works alongside the
Financial Conduct Authority (FCA) creating a “twin peaks” regulatory structure in the
UK. The PRA will co-operate closely with the FCA. The key principle underlying this
co-operation will be that each authority should focus on the key risks to its own
objectives, while being aware of the potential for concerns of the other. Separate
mandates of the PRA and FCA for prudential and for conduct regulation will allow
both regulators to apply more focus to their respective areas than has previously been
the case. 63
The FCA regulates the financial service industry in the UK. The FCA is a separate
institution and not part of the Bank of England. The FCA is responsible for promoting
effective competition, ensuring that relevant markets function well, and for the
conduct regulation of all financial services firms. This includes acting to prevent
market abuse and ensuring that consumers get a fair deal from financial firms. The
FCA operates the prudential regulation of those financial services firms not
supervised by the PRA, such as asset managers and independent financial advisers.64
The PRA was created by the Financial Services Act (2012) and is a part of the Bank
of England and responsible for the prudential regulation and supervision of banks,
building societies, credit unions, insurers and major investment firms. It aims
through its supervision to develop a rounded, robust and comprehensive view of these
firms, to judge whether they are being run in a safe and sound manner, and whether
insurers are protecting policyholders appropriately. It sets standards and supervised
financial institutions at the level of the individual firm. The PRA’s most significant
supervisory decisions are taken by its Board – comprising the Governor of the Bank
of England, the Deputy Governor for Financial Stability, the Chief Executive Officer
of the PRA (and Deputy Governor for Prudential Regulation), and independent
non-executive members. The Board is accountable to Parliament. 65
63
See Andrew Bailey, Sarah Breeden and Gregory Stevens, Bank of England Quarterly Bulletin 2012 Q4. 64
See the official website of FCA: http://www.fca.org.uk/ 65
See the official website of PRA: http://www.bankofengland.co.uk/Pages/home.aspx
3.3 Financial Supervision in the CSPFTZ
However, this is due to the specific structure of China’s financial system, and the
main source of financial market risk is not systemic risk. In addition, the difference
between financial institutions will continue to exist in the future for a long period,
which decides that the separated supervision suits to China. Based on the actual
supervision effect, segregate supervision system promotes the development of
financial industry. ○1 Improves the professionalism and independence of financial
regulators, and clears the regulating responsibility of different regulators; ○2
Improves the professionalism of China's financial institutions. From the actual
regulatory effect, under the guide of regulators, financial institutions carried out the
market-oriented reform, improved the corporate governance system, and the further
developed the main business. The financial sector is under increasing development;
○3 Isolates the financial risks effectively, and maintains the stability of the financial
system.
Although it suits the general need of the development of China's financial system, and
also plays a huge role, the segregate supervision system may not meet the actual
needs of Shanghai FTZ. If the segregate supervision system was applied in Shanghai
FTZ, the inherent disadvantages would be amplified. ○1 Segregate regulation may
lead to higher financial regulatory costs and lower efficiency. Thus segregate
supervision could hardly master the comprehensive financial status in Shanghai FTZ,
take timely measures, and effectively response to systemic financial risk; ○2 Because
of the deepening financial liberalization, mixed financial products and groups will
continue to appear, segregate regulation would lead to lack of supervision or over
regulation; ○3 It is easy to accumulate systemic risk under segregate regulation, due
the lack of macro prudential supervision.
3.1.2. the Overall Financial Supervision in Shanghai FTZ
Although the financial supervision and legal rules haven’t been all issued in Shanghai
FTZ, financial supervision should focus on the protection of public investors and
eliminating the negative externalities of the financial crisis. Regulators shall be
authorized clearly to be responsible for financial supervision in Shanghai FTZ.
Therefore, in the reform practice in Shanghai FTZ, an inevitable requirement is to
implement macro and micro prudential and effective supervision on financial services
industry. Financial supervision mode in Shanghai FTZ shall not copy the western
financial supervision mode or continue the existing regulatory system. The financial
supervision mode shall be compatible with the actual situation of financial
development in Shanghai FTZ.
Single regulator pattern refers to the entire financial system is regulated by a single
regulatory authority, and it would be in charge of protecting public investors. For
Shanghai FTZ, a relatively small financial market, a single regulator could supervise
more comprehensively. Appling a single regulator in Shanghai FTZ has the many
advantages. ○1 A unified regulatory system can be established to form supervision
economical scale and avoid regulatory loopholes or regulatory overlap; ○2 Regional
financial institutions could be under more comprehensive regulation. A single
regulator could comprehensively review and assessment the compliance and potential
risk of regional financial institutions, which helps in reducing the management cost
and forming economical scale of supervision; ○3 Compared to segregate regulation,
a single regulator allocates the supervision resources better. However, as a coin has
two sides, there are disadvantages of a single regulator: ○1 A single regulator lacks
the mechanisms to inspect supervision loopholes. A single regulator would neglect
certain financial risks or some systemic important financial institutions’ risk status.
Without effective supervision make up, it may lead to serious consequences; ○2
There could be internal communication disorders in the single regulator. In Shanghai
FTZ, to facilitate management, a single regulator still would be divided into many
functional departments to be in charge of different financial areas. That would
contribute to obstacles in information communication; ○3 The power of single
regulator is too concentrated and lacks restraint, which may lead to decrease the
supervision efficiency. Through the above analysis, applying a single regulator in
Shanghai FTZ is the better choice. To overcome its disadvantages, macro prudential
supervision, better inside communication and more restrains shall be applied.
3.2. Supervision on Offshore Financial Business
China’s offshore financial market starts late, and its development is also gone through
twists and turns. In May, 1989, the People's Bank of China allowed China Merchants
Bank to run offshore banking business in Shenzhen. Subsequently, a number of banks
got approval, such as Shenzhen Development Bank, Guangdong Development Bank
Shenzhen branch, ICBC Shenzhen branch and Agricultural Bank of China Shenzhen
branch. Qualified banks got approval in Shanghai to begin offshore financial business.
Due to the Southeast Asia financial crisis in the beginning of 1999, the People's Bank
of China and the State Administration of Foreign Exchange had suspended all
offshore financial business of domestic banks. Until June, 2002, China Merchants
Bank and Shenzhen Development Bank were approved by the People's Bank of China
to start offering offshore business in Shenzhen, and Bank of Communications and
Shanghai Pudong Development Bank were allowed to run offshore financial business
in Shanghai. At present, limited offshore financial business is allowed, and the scale
of offshore financial business lags behind of that of western countries.
3.2.1. Current Status and limits of Offshore Banking Business in China
So far, regulatory on China’s offshore financial market still has obvious flaw, and has
not formed a complete supervision system. Firstly, the supervision legislation is still at
a lower level. The relevant regulations or administrative measures are as following,
Regulations of Offshore Banking Business, Detailed Rules for the Implementation of
Regulation of Offshore Banking Business, Measures of China Banking Regulatory
Commission for the Implementation of Administrative Licensing Matters Concerning
Chinese-funded Commercial Banks, Measures of China Banking Regulatory
Commission for the Implementation of Administrative Licensing Matters Concerning
Cooperative Financial Institutions, Procedures on the Administration of Borrowing of
International Commercial Loans by Institutions within Chinese Territory, Regulation
of the People's Republic of China on the Administration of Foreign-funded Banks.
However, the framework of offshore banking business is initially established.
Secondly, the regulating function of the authority is limited. Even, there are
contradictions between the supervision policies. The jurisdiction on offshore banking
business is distributed in the above regulations or administrative measures. State
Administration of Exchange Control is authorized by Regulations of Offshore
Banking Business to regulate the offshore banking business. However, its jurisdiction
is limited in regulating foreign exchange business, which means that Administration
of Exchange Control can’t regulate the offshore banking business effectively.
3.2.2. Offshore Banking Business Supervision in Shanghai FTZ
In order to establish offshore financial market, Shanghai FTZ firstly needs to
determine the specific offshore banking business model. In comparison, and the
internal and external separation offshore financial model is more suitable for
Shanghai FTZ. This kind of offshore banking business is derived by the government,
and established specifically for non-residents. The internal and external separation
offshore financial model is in accordance with the orderly conduct of offshore
financial business in Shanghai FTZ under the guidance of the government. Secondly,
one of the important reasons for choosing the internal and external separation offshore
financial model is the issue of hot money. In view of foreign offshore financial centers’
experience, suddenly turning of short-term capital flows is one of the important
causes of the crisis in financial markets. Due to the freedom of trade in Shanghai FTZ,
it is easy for hot money to find spaces; in addition to the unsound financial
supervision, there are many blanks, which could be used by hot money. It is
foreseeable that hot money would try best to maximize their profit. How to prevent
hot money banging the market, and affecting the normal economic order becomes the
focus of offshore financial supervision in Shanghai FTZ. One the most important
advantages of the internal and external separation offshore financial model is that it
separates the internal and external market, which helps in effectively stabling the
exchange and the financial market. Besides, the internal and external separation
offshore financial model has low requirements in financial liberalization and financial
supervision system, and its impact on the domestic economy can be controlled in a
limited range. Taking the current status of China’s financial supervision into
consideration, internal and external separation model suits the Shanghai FTZ. If the
permeability model was implemented in Shanghai FTZ, because of the high amount
of foreign exchange reserve and the increasing appreciation pressure on RMB, it
would bring huge risks for real economy. Therefore, the internal and external
separation model suits Shanghai FTZ most.
As to the offshore financial market access supervision, it can be generally divided into
market access supervision subject and scope. About the market access standards,
national treatment should be strictly carried out in Shanghai FTZ, according to WTO/
GATS requirements. It is not only the demand of developing offshore banking
business, but also the common practice for most countries; as to market access scope,
for better attracting investment, more wide standards should be drawn up in Shanghai
FTZ, to allow the entrance of banks and non-bank financial institutions. Supervision
of offshore banking business can be divided into capital supervision, business scope
supervision and transaction currency supervision. According to the common practice,
capital supervision always takes the method of indirect control; as for the scope
regulation, there are three situations, namely limited in traditional banking business,
extended to the bonds and notes business and traditional banking and other
comprehensive financial services business (Luo, 2008). One of the aims to establish
Shanghai FTA offshore market is to raise sufficient capital for development, but it also
needs to pay attention to the prevention of financial risks. Therefore, in the scope of
business regulation, regulation on business scope should include traditional bank
business and securities business; for the transaction currency, under the background of
financial reform in Shanghai FTZ, it should gradually promote the convertibility of
RMB capital account. The prosperity of offshore market could be hardly achieved
without RMB’s prosperity trading. For the offshore financial tax system in Shanghai
FTZ, preferential tax system is generally choice of offshore financial center. However,
the actual choice of preferential tax system should be in accord with the Shanghai
FTA. For instance, as the main purpose of the offshore center of America is for dollar
reflux, it determines that US doesn’t provide many tax preferential. In order to
strengthen the competitiveness and raise funds sufficiently, preferential tax is essential.
But in the current stage, only rely on the super national treatment preferential taxation
can't attract enough capital, but better integrated environment. Therefore, it is
appropriate to implement moderate tax in Shanghai FTZ.
3.3. Regulation on Interest Rate Marketization
The real interest rate marketization is to let the market mechanism play a decisive role
in forming capital price, thus guiding the rational flow of funds and improving the
efficiency of capital allocation. However, the interest rate marketization is not equal to
be without supervision, on the contrary, the stability of interest rate market in
Shanghai FTZ depends on the effective financial supervision. Experience abroad
show that the effective supervision mechanism could ease the short term impact
brought by market-oriented reform of interest rate, and ensure the normal
development of the market-oriented reform.
3.3.1. Current Status and limits of Interest Rate Marketization In China
At present, measures of financial regulation in China is relatively single, mainly
depend on the regularity supervision, namely through a system of laws and
regulations to regulate related financial activities in the market. And so is the interest
rate regulation. Under the separate supervision system, people's bank of China, China
banking regulatory commission, China securities regulatory commission and China
insurance regulatory commission are established to be in charge of the financial
regulation. However, it lacks of macro prudential regulation and pays less attention on
systematic risks66
. This is decided by the specific structure and developing stage of
China’s financial sector. Also the main source of financial risk is not systemic risk.
However, as the financial supervision practice during the interest rate marketization
process shows, western countries are more and more depent on the integrated
application of administrative, legal, economic and other measures. While, under the
current regualtion mode, complicance supervision is mainly adopted, which brings
more administrative interference, causing casualness in actual fiancial suoervision,
which leads to lacking bound, lacking risk supervision and ineffective supervision.
Under the interest rate marketization process in Shanghai FTZ, simple compliance
supervision can hardly meet the demands of Shanghai FTZ. ○1 As it depends on
strict financial regulations, compliance supervision doesn't have enough consideration
of new situations during reform, which could damage financial innovation and
banking effieciency in Shaghai FTZ. ○2 The formulation and implementation of
financial laws and regulations often lags behind the actual situation, lacks market
sensitivity and can’t reflect the risk situation that commercial banks face. ○3
Compliance supervision focuses on disposing afterwards, which couldn’t play the role
as risk early warning.
66Zhang Xiaopu, Lu Zhao. Choice of financial supervision system: international comparison, well principles and reference [J]. Studies of International Finance, 2012 (9): 79-87.
3.3.2. Supervision on Interest Rate Marketization in Shanghai FTZ
In view of the reform task of Shanghai FTA, the marketization of interest rate must go
ahead, and has already stepped into the most crucial phase. As practice has proved,
because of improper operation in the deep-water district, many countries’ interest
rates marketization eventually fail, even leading to a serious banking crisis. The
interest rate marketization process would not be always smooth. Only proper
supervision could ensure the smooth progress of interest rate marketization. For
example, interest rate marketization reform of Japan is derived by the government,
and also is gradual reform. However, when facing a banking crisis in the later reform,
more mergers, assistance and full faith and credit are applied to save the banking
sector, leading the Japanese economy into a long-term downturn in a certain extent.
For the reason that there are great differences between China and the western,
supervision on interest rate marketization has to be explored to be in line with the
actual situation of Shanghai FTZ.
First of all, sound and effective supervision system needs to be established in
Shanghai FTZ, completing both micro and macro prudential supervision, regulation
on interest rate related risks, and regulatory mechanism reform. A sound framework of
macro prudential management shall be established to strengthen the supervision
coordination between agencies. Also, contra-cyclical measures should be utilized to
maintain financial stability in Shanghai FTZ. Regional banking monitoring and
management system should be established to focuses on symmetric risk and
systemically important financial institutions.
Secondly, supervisory work in Shnaghai FTZ should focus on the establishment of
deposit insurance system, guarding against and defusing systemic risk caused by the
failure of single banking institution, enhancing the ability against systemic risks, and
solving the problem of "too big to fail". Interest rate marketization in Shanghai FTZ
would weak the bank profitability, leading capital to risky assets, coupled with the
interest rate risk, systemic risk is easy to be accumulated, causing banking industry
crisis. From the practical experience of many countries, the deposit insurance system
could guard against systemic risk effectively. It can not only restrain moral hazard
problem of the banking industry, but also help stabilize the financial system and
prevent risk splice after failure of financial institutions. In the process of the interest
rate liberalization, developed countries all established deposit insurance system. For
example, during the second interset rate liberalization process in 1996, South Korea
set up the deposit insurance system, and successfully reduced banking moral hazard,
easing the impact of economic marketization, guaranteeing the success of interest rate
marketization reform. However, how to build deposit insurance system, how to
establish the insurance institution in Shanghai FTZ has yet be determined. It still
needs to be explored in practice.
Finally, but not least, the existing investigation on site shall be improved to monitor
the banking interest rate volatility. More sepecificly, regular monitoring system on
banking interest rate fluctuation should be established. Also, supervision system on
liquidity risks needs to be eatablished, namely the liquidity risksupervision indexes
system, which cores are Liquidity Coverage Ratio and Net Stable Funding Ratio.
Adhere to regulate capital adequacy ratio of commercial banks inShanghai FTZ,
strictly regulate the liability composition, maintain high liquidity ratio, supervision on
interest sensitive assets and interest rate sensitive liabilities. These two above
indicators, Liquidity Coverage Ratio and Net Stable Funding Ratio, are to supervise
commercial banks to deal with the velocity shockliquidity. Liquidity coverage ratio is
to ensure that banks maintain adequate quality assets to response to short-term (30
days) the major risk impact, while net stable funding ratio is to deal with long-term
risk flow for banks, encouraging banks to adjust the structure of assets and liabilities
to reduce short-term financing maturity mismatch, and promote their assets and
liabilities structure reasonable67
.
3.4. Supervision on Capital Account Liberalization
In the process of internationalization of the RMB, capital account liberalization is
indispensable. For China, without proper supervision, it is hard to imagine effective
capital account open. In practice, because of capital account open, many countries
suffer a lot from the crisis caused by improper capital account liberalization. In the
process of capital account open of Shanghai FTZ, appropriate monitoring mechanism
needs to be established to ensure secure and stable operation of the economy.
3.4.1. Current Status of Supervision on Capital Account Liberalization
In accordance with the IMF’s "Annual Report on Exchange Arrangements and
Exchange Restrictions 2011", capital account control can be divided into capital and
money market instruments transaction control, derivatives and other tools transaction
control, credit instruments transaction control, investment control, direct investment
control, estate transactions and personal capital transaction control. According to this
standard, there are 22 items of part convertible account, 14 items of basic convertible
account and 4 items of inconvertibility account. Details are as table 3.1 below.
Table 3.1 statistical table of capital account control items
item total
inconvertibilit
y
part
convertible
basic
convertible
capital and money market
instruments transaction
control 16 2 10 4
derivatives and other 4 2 2
67 Ba Shusong, Zhu Yuanqian. A review of the Basel Capital Accord Ⅲ [M]. China Financial Publishing House. 2011..
tools transaction control
credit instruments
transaction control 6
1 5
investment control 2
1 1
direct investment control 1
1
real estate transactions
control 3
2 1
personal capital
transaction control 8
6 2
total 40 4 22 14
Source:People’s Bank of China. Speed up opening capital account in China [J].
China Finance, 2012, (5).
As to securities investing, China implements the qualified foreign institutional
investor (QFII) system and the qualified domestic institutional investor (QDII) system.
The QFII system allows foreign investors through the strictly regulated special
account to invest Chinese securities market. Under QFII, its capital, capital gains,
dividends could be remitted after approval. The QDII system, reverse system of QFII,
allows qualified domestic institutions under regulatory approval, in the certain extent,
to invest in foreign securities markets through special account68
.
3.4.2. Supervision on Capital Account Liberalization in Shanghai FTZ
According to Opinions of the People's Bank of China on Financial Supporting China
(Shanghai) Pilot Free Trade Zone, there would be no longer QFII, RQFII. Enterprises
in Shanghai FTZ would invest in securities and futures. Individuals could directly
invest in overseas securities market without QDII constraints. The institutions, which
provide financial services to entities in Shanghai FTZ, is not limited in the zone, but
in Shanghai. With deepening financial openness, effective financial supervision
system in Shanghai FTZ is in urgent need, to prevent risks from capital account
liberalization.
Firstly, statistical monitoring system shall be established and perfected, and makes
early warning on abnormal capital flow. The macro prudential supervision framework
shall be established and perfected, utilizing the macro prudential tools to compensate
the limitations of other macroeconomic policies. These macro prudential tools include
capital adequacy ratio, provisioning rate, leverage and liquidity indicators. However,
due to the different situation from that of western, how to utilize these indicators in
practice still needs to be continuously explored.
Secondly, information disclosure system should be strengthened to stable investor
68 Capital account management , People’s Bank of China, Tianjin Branch. More Details :
http://tianjin.pbc.gov.cn/publish/fzh_tianjin/2909/2011/20110830145932274439248/20110830145932274439248_.html
confidence. To a certain extent, investor confidence contributes to the volatility of the
market fluctuation. At present, China's information disclosure system is fragmented,
scattered in the "Interim Measures for the Information Disclosure of Commercial
Banks", " Accounting Law of the People's Republic of China", " Measures for the
Management of Capital Adequacy Ratios of Commercial Banks" and other laws and
regulations. A unified information disclosure system should be established as soon as
possible, to strengthen the transparency of the market.
Thirdly, it is necessary to strengthen the capital flow management measures (CFMS),
and impose temporary capital controls in case of emergency. For instance, financial
trading tax could be flexibly imposed, to constrain on the scale and period of capital
inflow. Even it could ban abnormal capital into a certain field, to ease the volatility of
short-term capital flow. Financial transaction tax, based on specific purpose, imposes
on transactions of specific financial products, such as stock, bonds, derivatives and
foreign exchange tool69
. The main role is to alleviate the short-term volatility caused
by large-scale flow of capital. According to the Brazil’s successful capital account
openness experience, it could impose different tax rates based on the period of foreign
loans. The shorter period, the higher tax rates are, however it would impose tax on
foreign loans more a certain period of time (such as 5 years). During a crisis, when
capital outflow happens, it could gradually reduced tax rate until the abolition of taxes
on financial transactions; while facing a large number of short-term fund inflow, it
could be gradually raised tax rate on all kinds of financial transaction, such as FDI,
various types of securities and funds, foreign loans, and derivative product
transactions, to prevent capital from avoiding controls.
4. Conclusions and Recommendations
Market economy is legal economy, and financial regulation in Shanghai FTA needs to
follow the rules of market economy. On one hand, the demand of legality is decided
by the nature of the market economy. Without regulatory, the effective operation of
the financial market in Shanghai FTA is unimaginable. On the other hand, the
development and perfection of financial supervision also depends on the development
of financial market. The strict enforcement of the law is the key to realize the
effective supervision in Shanghai FTZ. The legislation of the financial supervision is
particularly important in the financial supervision in Shanghai FTA, properly handling
the relationship between financial supervision and the market is by financial
supervision has important meaning. However, in fact, the choice of the supervision
model should also consider the influence of interest groups, and reflect the need of
financial legislation of virtual economy.
4.1. Improve Financial Supervision System, Strengthen Macro Prudential
Supervision
69 He Ziqiang. Financial trading tax under post financial crisis: debate, practice and reference [J]. Shanghai Finance, 2011,10: 007.
At present, financial supervision legislation in Shanghai FTZ still has many blanks,
and unified financial legal system has not yet formed. Therefore, it is necessary to
formulate a unified financial supervision system, which would lay a solid foundation
for further development Shanghai FTZ and also provide valuable experience for latter
financial reform in China. On constructing process of FTZ, financial supervision
legislation also need to constantly adapt to the needs of the development of virtual
economy.
Macro prudential regulation should be base of supervision in Shanghai FTZ, to
prevent systemic financial risk. A single supervisory mechanism under the
comprehensive supervision meets the actual needs of Shanghai FTZ. Through
legislation to clear a single authority’s regulating scope and responsibility, give
regulator enough to rights to take preventive or remedial measures, improving the
effectiveness of financial supervision. Single regulation can reduce the regulation cost;
achieve economies of scale; adapt to the trend of integration in the financial
institutions; avoid the supervision vacuum and other issues, and better coordinate
financial supervision and the development of financial services in Shanghai FTZ.
4.2. Improve the Supervision on Offshore Financial Business
Offshore financial market in Shanghai FTA should be internal and external separation
model, independent of the current account management system and monitoring capital
flows of all accounts. First of all, internal and external separation model is suitable for
the offshore financial markets, which are driven by the nation. Secondly, because of
the issue of hot money, huge foreign exchange reserves, permeability model may
bring huge risk to China. Upon the market access supervision, according to the rules
of WTO/GATS, national treatment should be carried out, allowing banks and
non-bank institutions into the offshore market. As to the regulation of business types,
indirect control is more suitable. Based on to the actual requirements of international
financing and risk prevention, traditional banking and securities business shall be
permit in Shanghai FTZ. As for the offshore financial supervision, effective macro
prudential supervision framework should be adopted in Shanghai FTZ, including
capital adequacy, credit risk, liquidity risk, internal control system and other risk
index.
4.3. Improve Regulation During the Marketization of Interest Rate
Superimposed on the interest rate market is the supervision of risks of the
marketization of interest rates and risk. In the process of interest rate marketization, a
sound and effective supervision system must be established in Shanghai FTZ,
including the micro prudential and macro prudential measures, focusing on regulation
of liquidity risk. To solve too big to fail, deposit insurance system also shall be
constructed in the banking sector, focusing on systemically important financial
institutions, to prevent and resolve the systemic risk caused by failure of single
banking institution. Secondly, the regular monitoring system shall be improved to
regulate banking interest rate fluctuations, mainly by the liquidity coverage ratio and
net stable funding ratio. Adhering to keep high bank capital adequacy, regulate the
structure of assets and liabilities and maintain high liquidity ratio would keep the
banking sector in Shanghai FTZ stable.
4.4. Improve Capital Account Regulation in Shanghai FTZ
First of all, to cope with the new financial risks along with the opening of the capital
account, macro prudential regulatory framework, including statistical capital adequacy,
provisioning rate, leverage and liquidity indicators, monitoring abnormal capital flow,
shall be established in Shanghai FTZ. Secondly, establishing and improving the
information disclosure system. Thirdly, in emergencies, capital flow management
measures (CFMS) should be adopted, such as the financial transactions tax, limiting
the capital flows to alleviate the volatility of short-term capital caused by mass flow.