Foreign Policy Lawfare
Don’t Trust China’s Opening of Its Financial Sector
Inviting foreign investors into a closed economy is a lot easier said than done.
BY ANDREW COLLIER
| DECEMBER 8, 2017, 7:53 AM
Chinese 100 yuan notes and one U.S. dollar on Jan. 6, 2017. (Fred Dufour/AFP/Getty Images)
Two days after President Trump left China as part of his recent Asian tour, Beijing announced a radical policy to open its financial sector to foreign firms. The Nov.10 announcement took the world by surprise as there had been no advance talks and no leaks suggesting a change. Given China’s weak adherence to earlier World Trade Organization (WTO) rules on the financial sector, however, the question is: How serious will China be about the new policy?
Whether China takes this financial opening seriously will have a significant impact on its relations with the United States. The gradual opening of China’s financial system could integrate China more closely to global trade and financial flows, and thus advance the long-standing Western dream of a China that functions closer to a Western model — a
model that assumes the ground rules of capitalism, including larger financial markets and an openly traded currency.
But American skeptics say China has not lived up to its previous promises in the WTO to allow foreign access to its financial markets. Foreign commercial banks comprised
about 2 percent of China’s market share in 2006, when China adopted new rules five years after its WTO accession; that share has since fallen to a relatively insignificant 1.3 percent. Among brokerages, JPMorgan First Capital ranked 120th out of China’s 125 brokerage firms by net income in 2015, according to the Securities Association of China. UBS Securities ranked 95th, pretty far down the scale. In the past few years, several foreign securities firms have abandoned or lowered their stakes in Chinese joint ventures. There are also growing security concerns in the Trump administration, and among private companies, about financial technology that could be abused by China, including cloud computing, which is integral to modern banking systems. One recent example
is Amazon’s sale of its stake in its cloud-computing partnership in China due to China’s desire to control cloud data.
What exactly does China’s new policy do? As reported by the Financial Times:
- Foreign firms will be allowed to own stakes of up to 51 percent in securities
ventures, increased from 49 previously; China will scrap foreign ownership limits
for securities companies three years after the new rules are effective.
- China will lift the foreign ownership cap to 51 percent for life insurance
companies after three years and remove the limit after five years.
- Limits on ownership of fund management companies will be raised to 51 percent,
then completely removed in three years.
- Banks and so-called asset-management companies will have their ownership
Foreign firms quickly expressed enthusiasm for the new policy. JPMorgan Chase, Morgan Stanley, and Swiss bank UBS all said they are eager to take advantage of the new rules and increase their investments in China.
Others are skeptical. The European Chamber of Commerce in Beijing called the new policy an “encouraging step towards the opening of China’s financial system overall.” But the chamber clearly believes the policy may not remove a host of existing barriers to entry. The chamber said the regulations come at a “late stage,” making it difficult for foreign firms to penetrate existing markets. Applicants may “be asked to apply for additional licenses or will face other restrictions.”
Generally, given past experience, there are a number of roadblocks in the way of foreign entry, including institutional, financial and cultural issues.
First, it’s not clear how far or how quickly China will lower the barriers to entry. Several years ago, the Shanghai Free Trade Zone was touted as a quick way for entry into China until applicants discovered they needed local Shanghai government approval — not just from Beijing — to register their companies and move money offshore. Under the new
financial policy, the central government through the people’s Bank of China and the China Banking Regulatory Commission are likely to expeditiously issue permits for foreign firms, but there could easily be registration requirements from other institutions lower down the hierarchy, including provincial governments and local regulators. Second, the biggest market — commercial lending — is the most difficult for foreign firms to crack. Most Chinese banks are at least partly owned by state entities that will be reluctant to sell stakes to outside investors beyond insignificant minority holdings. Weak, financially strapped local banks may be willing to sell but they offer myriad financial and compliance risks.
The most likely entrants will come in the insurance and securities industries. “Securities and insurance will be first,” said a research analyst for China’s State Council-affiliated think tank who I interviewed in Beijing on Nov. 15. He called the policy “good for reform” in China and noted that researchers analyzed the risks to China’s financial system in a report two years ago, suggesting this has been on the minds of the leadership for some time.
Foreign securities firms, in particular, offer a degree of global experience and technology that would be attractive to Chinese corporations. Also, there is far less balance-sheet risk for securities firms that take a fee for transactions, compared with a commercial bank making a long-term loan that remains on its balance sheet. In addition, China is increasingly seeking to raise capital abroad, both to avoid capital controls and due to tighter liquidity conditions domestically.
However, Chinese insurance and securities firms have been generally quite profitable and may be reluctant to sell majority stakes. Only the weaker ones would be willing to dispose of majority equity interests. Foreign firms also may be reluctant to import their most valuable trading technology and algorithms into a country with weak protection of intellectual property. Trading algorithms take years to develop. Also, many countries will be unwilling to allow Chinese access to important financial data such as the size of gold reserves or financial flows. China has its own view of national security that tends to be more protectionist than that of the West.
In addition, Chinese insurance and securities brokers have dipped heavily into the opaque shadow banking market, acting as if these loans are not their responsibility — a questionable assumption given China’s state-led financial system. This would raise red compliance flags among foreign firms.
Further complicating implementation of the new policy is an expected change in the leadership of the country’s central bank. Zhou Xiaochuan, the governor of the People’s Bank of China (PBC), is seen to be retiring in 2018. The two likely candidates to replace him, Jiang Chaoliang and Guo Shuqing, have differing views on financial liberalization. Guo, the former chairman of China Construction Bank, is considered more globally sophisticated and open to financial reform. He studied at Oxford for a year and later was in charge of China’s foreign exchange policies. In contrast, Jiang is more of a banker’s “insider,” having spent most of his career in the domestic Chinese banking industry. The
appointment will be important due to the PBC’s rising power. In July 2017, during a financial meeting held every five years, the PBC was anointed the chief financial regulator for the country, so this appointment will be key to any radical changes.
Expect a flurry of high-profile deal announcements from the securities industry — but little actual new capital. American firms dominate global finance and are likely to be the first movers. The real progress will come in 2018 when the foreign financial institutions, especially U.S. firms, have had time to digest the news and test the willingness of domestic regulators to allow significant foreign access. The new financial openness will encourage overseas banks to favor China’s foreign policy mandates due to their interest in expanding revenue. This would be good for China’s rising global influence.
However, there could be opposition among domestic groups in the United States concerned about American capital contributing to China’s economic improvement. The Trump administration is showing growing signs of launching trade policies against Chinese imports. While U.S. banks will be wary of waving the flag in China, senior Trump administration officials may be less reluctant to take action against Chinese institutions such as foreign branches of Chinese banks if they feel that China is taking advantage of American capital.
Andrew Collier is an independent macroeconomic researcher based in Hong Kong. He holds a master’s degree in international relations from Yale University, and is the former president of the Bank of China International USA, the BOC’s U.S. investment bank.