China is Opening up its Financial Markets

This post has been written by Rick Steele, CEO 8IP.

I attended the Lujiazui Forum in Shanghai last week. The title of the Forum “A New Vision for Financial Reform and Opening Up” says it all. In his opening address the Mayor of Shanghai said that China is in a critical period of modernisation and reform and opening up will bring great momentum for the “China Dream” to become a reality.

Yes, Shanghai is at the pointy end of financial reform and speakers across industry and academia were unequivocally supportive of reform. And city bureaucrats were pushing the Shanghai barrow to be a regional financial centre. But there were also regulators in attendance who acknowledged the inevitably of it all and focused on the how and when. In my view, the genie is out of the bottle and there is no turning back.

The Forum is a large one with probably a 1,000 people in attendance. It is held annually and sponsored by the People’s Bank of China, China Regulatory Commission, China Securities Regulatory Commission, China Insurance Regulatory Commission and the Shanghai Municipal People’s Government.

It may be obvious of course, but the thing that struck me was that all the financial infrastructure is underdeveloped and has a long way to catch up to the developed world. For example, the insurance sector is small for the risks that need covering, the mutual fund market is tiny with savings dominated by bank deposits and property investments and superannuation savings are only 2% of GDP (90% of GDP in Australia). So the potential opportunities in financial services are enormous.

However, access to China for foreigners is difficult and may always be difficult. There are quotas in place for both outbound and inbound capital flows, a regulated interest rate market and a regulated exchange rate – all these called administrative controls. Reflecting the move to open up, quotas are tending to be eased and pilot programs offering different quotas are being established.

One of the strong themes of the conference was internationalisation of the RMB and the development of RMB centres in HK, Taipei, Singapore, London and possibly even Sydney. There has been some increase in settling trade flows in RMB and development of associated swap and other products, but nothing material yet. There was little acknowledgement of the linkages between pricing of RMB offshore and onshore, capital controls and interest rates, but clearly the international use of RMB will put pressure on administrative controls elsewhere and deregulation of interest rates will likely follow soon after.

A straw poll at one of the panel discussions suggested that if the RMB was freely floated today then it would fall from current levels.

The low caps on deposit rates is having the effect of driving growth in wealth management products outside the banking system as well as investment in property. Removing the low cap on deposits will help to normalise this situation.

I do not recall any discussion on the matter, but as administrative controls are lifted and financial markets de-regulated, then eventually China will be more fully reflected in relevant equity market indices thus increasing the demand for Chinese assets to meet higher benchmark weights.

Bottom line

China will continue to ease administrative controls on the financial system and will become more sensitive to market forces. In the process, China is likely to engage more with foreign financial services firms. It is inevitable China will become increasingly popular as an investable market.