Shanghai is designated by China’s central government to become a top-tier international financial centre (IFC) by 2020. Last year, China’s State Council, the cabinet, formally approved Shanghai’s plans to become an IFC, directing the country’s ministries and regulators to open the way for the transformation. While Shanghai will gain in importance, it is facing many challenges in achieving the goal of becoming an IFC.
The first obstacle is the inflexible regulatory structure in China. China has a clear regulatory division across different sections of the financial market. Bond issuance, for instance, falls under the authority of the PBOC, the China Securities Regulatory Commission, the National Development and Reform Commission, and in some cases, the China Banking Regulatory Commission, the State-owned Assets Supervision and Administration Commission or the China Insurance Regulatory Commission.
So far Shanghai has not been granted the authority to enact legislation concerning the financial industry, the lack of which is a constraint to the development of Shanghai as a financial center. The scale and roles of Beijing and Shanghai mean that getting coordination right is quite difficult. By comparison, Hong Kong and Singapore, with their highly centralised regulatory overseers, are considered more transparent and investor friendly.
The second obstacle is the issue of full convertibility of the RMB and the relaxation of controls allowing the free flow of currencies in and out of China. Without a global currency, the talk of building an international financial centre makes limited sense.
For now the Chinese government has allowed a limited amount of foreign investment in local markets through its Qualified Domestic Institutional Investor programme and has permitted external flows through its Qualified Foreign Institutional Investor programme. The restrictions have limited the number of international financial institutions choosing to locate in Shanghai. By the end of 2009, Shanghai had only 17 foreign banks, about one eighth of the number in Hong Kong.
The capital market in China is relatively immature and Shanghai has a number of important gaps compared with global and regional norms. For example, compared to the equity market, the fixed-income market in China is underdeveloped. The size of China’s RMB bond market as of March 2010 was US$2.65 trillion, only around three per cent of global issuance.
Financial innovation in China is hampered by the government’s measured and conservative approach to financial reform. Many products that are common in other financial centers are lacking or underdeveloped in Shanghai. For example, China has been slow in introducing stock index futures, which are a common hedging product in most markets. Shanghai's CSI 300 equity index was launched in April 2010 after a three-year pilot program. The Singapore exchange, in contrast, has allowed trading of contracts on the FTSE/Xinhua A50 China index since 2000, allowing indirect access to the A-share market for offshore investors.
Finally, the lack of top financial professionals with international experience might become a problem for Shanghai. Making Shanghai an attractive city for international financial experts to live and work in is a big challenge. For example, taxation on individual income can be up to 45 per cent in Shanghai - in contrast, income tax in Hong Kong is capped at 15 per cent. To address this, Shanghai officials floated the idea last year of tax breaks and incentives for financial professionals. However, because central government recently made the reduction of income inequality a priority, the idea of providing tax breaks to wealthy bankers has, unsurprisingly, not gained much traction at cabinet level.
However, the picture is far from doom and gloom overall. Despite the obstacles to be overcome, the financial markets in Shanghai have made impressive progress, largely as a result of the strong growth in China’s economy. At the end of 2009 the Shanghai Stock Exchange was the world’s third-largest exchange by turnover (US$5.1 trillion) and the sixth largest by market capitalisation (US$2.7 trillion). The turnover value of China’s futures markets (including Shanghai, Dailan and Zhenzhou) in 2009 was more than RMB 100 trillion. The Shanghai futures market is now ranked 10th in terms of volume traded on global exchanges, while it was ranked only 29th in 2000; that is a significant leap in only a decade.
Furthermore, China remains one of the most attractive destinations for foreign direct investment. The continual inflow of international capital brings into China advanced financial concepts, techniques and talents, making the financial markets in China more international. More progress in Shanghai is expected, particularly if China’s economy keeps growing as it has been.
In the 1930s, Shanghai was the famous financial hub in Asia. It had the region’s largest stock exchange and largest concentration of international banks (27 international banks in 1936). The history of being an important financial centre in Asia serves as a positive reinforcing factor in Shanghai's current bid to return to its former glory.
In sum, China will continue to open its financial markets gradually and with great care. Other financial centres in Asia, such as Hong Kong and Singapore, will have to continue to move forward on financial innovation and product offerings as they compete with Shanghai. Shanghai’s future depends on the pace of financial reform, particularly the liberalisation of China’s foreign exchange regime, and how well it can attract international talent. Based on developments in recent years, it seems a return to Shanghai’s former reputation as a leading financial centre cannot be far away.
Sonny Gao, Director, Business Development, ATC, Shanghai