Shanghai not yet an international financial centre, but on the right track
In 2009, China’s State Council set the goal for Shanghai to become an international financial centre by 2020. Achieving such an ambitious objective would elevate China’s economic capital to the ranks of cities like London and New York.
Ten years later, the European Union Chamber of Commerce in China surveyed European banking executives in the city to see if Shanghai had met its goal. The results are clear: Shanghai is not there yet, and even if the goal is extended to the end of 2020, it is all but impossible to meet. Despite some notable improvements, the financial ecosystem still faces too many hurdles to overcome to earn the label of an international financial centre.
While a series of equity caps on foreign investment in financial services have been removed in recent years, European banks continue to face de facto barriers that greatly complicate their participation. Regulatory obstacles limit business expansion for 85 per cent of respondents. Factors like forthcoming limits on intragroup exposure and the overnight treatment of long-term borrowing from overseas banks make it extremely difficult for foreign entities in China to receive sufficient funding from their headquarters. Meanwhile, branches of foreign banks cannot issue renminbi (RMB) bonds onshore, precluding them from raising funds for operations locally.
To evaluate Shanghai’s progress thus far, one can compare it to the centres it has tried to emulate: London and New York. 88 per cent of the executives surveyed believe that Shanghai is over-regulated compared to these cities. As important is that the majority of respondents believe that the enforcement of regulations in Shanghai is less specific, transparent, and consistent.
Transparency and reliability form the foundation of a stable international financial centre. The lack thereof in Shanghai, compounded by arbitrary government interventions in the market, have eroded trust in the financial system. Not a single respondent believes that stocks are priced accurately in the Chinese market, and only 12 per cent have faith in the pricing of corporate credit. This past year’s opening to foreign rating agencies is as step forward to improve the quality of China’s financial system, as is the recent overhaul of the bankruptcy law, but they come far too late to reach the 2020 goal.
Regulatory reform will also depend on increased communication between the various regulators responsible for China’s financial system. Fortunately, respondents have seen improvement in coordination among regulators in the past five years, but are split on whether or not coordination has improved between regulators’ headquarters and provincial branches.
73 percent of respondents find the licencing process to be more difficult in Shanghai than in London or New York. Licencing proves particularly cumbersome, as the second most common obstacle for executives to expand their business in China. The various operational practices permitted in Europe by one licence would require several licences in China, and the case-by-case awarding of licences raises suspicions of political expediency in the application process.
The financial ecosystem will also have to be revamped to reach the level of internationalisation required by China’s plan. The majority of respondents believe that the foreign market share of China’s banking system should reach at least 5 per cent, compared to the most recent figures of 1.29 per cent. Although Shanghai may be more advanced in this regard to constitute as the financial centre of mainland China, in order to be competitive globally, China will need to nearly quadruple this metric to meet the expectations of European banking executives.
An expansion of European banks’ footprint will require the recruitment and maintenance of high-level executive talent. This issue is relevant to all sectors in China but especially the financial services sector, as an arena in which foreign talent can play a major part in bringing knowledge and experience, but the ability to attract foreign assignees will be hampered by recent revisions to the individual income tax law, under which tax-free benefits such as relocation support and children’s education will expire at the beginning of 2022. If such increased costs are to be borne by the employer or the employee, talent will leave and it will be difficult to bring more in.
Overall, the banking executives in this survey are split about their short to long-term views, with 42 per cent indicating that while Shanghai will miss the 2020 target, it will still become an international financial centre in the near future. However, large bloc remains pessimistic or uncertain, and for good reason, not least of all due to matters of currency. Internationalisation of the RMB will ultimately determine if a Chinese city can become an international financial centre. Over the past decade, China has strived to boost the strength of its currency compared to the US dollar, but overseas use (excluding Hong Kong) remains low.
Survey respondents believe that capital controls and inconvertibility of the RMB will preclude Shanghai from becoming an international financial centre. Yet these problems are not easy fixes. Although necessary in the long-run, the immediate removal of capital controls and full RMB convertibility may lead to mass outflows that could have negative repercussions for the global economy as a whole. The solution is an incremental, phased and well-planned approach to easing these barriers.
In the meantime, a focus on regulatory reform and further internationalisation of the financial ecosystem in Shanghai will go a long way to moving the city towards its goal. Shanghai is not yet an international financial centre, but with the right steps over time, there is no reason to doubt that it will eventually succeed.