China's Financial Liberalization, Post-Shanghai FTZ Edition

Shanghai FTZ: More than vaporware, actually.

Earlier on, I doubted the utility of the Shanghai Free Trade Zone (FTZ) as a viable endeavor given its emphasis on financial services instead of traditional goods processing. Liberalization of financial services for MNCs has long been a sticking point for them operating in China. While controlling "hot money" has been an official priority, it has also resulted in limitations for MNCs in funding PRC-based operations. That is, it is not so easy to borrow, lend, and otherwise use capital for day to day operations in a faraway land.

As it turns out, the Shanghai FTZ may turn out to be quite useful to multinationals. This is according to a firm that should know a thing or two about challenges faced by MNCs operating in the PRC--JP Morgan. It is quite sanguine about the prospects for MNCs in facilitating financial operations that were previously harder to conduct in China as Shanghai FTZ's more liberal regime is being spread China-wide:

The existing Shanghai FTZ rules have since brought China significantly closer to regions such as the United States and Europe in terms of ease of cross-border liquidity management. The extension of the RMB cross-border liquidity management rules to nationwide, now further close remaining gaps. The new rules largely permit MNCs to conduct RMB cross-border sweeping from anywhere in China, though there are some eligibility and operational criteria of which to be aware. Day-to-day operations of RMB cross-border sweeping under the nationwide rules must comply with a number of requirements, which include:

• Minimum prior year annual revenues of RMB 5 billion and RMB 1 billion, respectively, for both onshore and offshore participants
• A quota on borrowing by onshore entities from offshore counterparts (there is no quota limit for lending from onshore to offshore)
• Some additional restrictions (over and above those already applicable to the Shanghai FTZ scheme) on what offshore borrowing may not be used for, including investments in derivatives and use for wealth management products or entrustment loans to non-participants
• Both onshore and offshore participants must have been in operation for more than three years

While these requirements may preclude some MNCs from participating in the nationwide scheme, the limitations for many larger entities are not seen as major obstacles. For instance, one of the perennial issues for MNCs that established operations in China was that once they became profitable, they faced a challenge in repatriating retained earnings. Therefore, the inbound quota is likely to be seen as much less of an obstacle than the opportunity of no quota for outbound flows.

I believe that the Shanghai FTZ is another example of China's small-scale experimentation with liberalization. Insofar as the Shanghai FTZ experiment was judged a success by metrics PRC officials hold--don't ask me what they are, exactly--loosened restrictions are now being implemented PRC-wide. In the process, the PRC will more and more resemble other countries where capital flows more or less freely. This development is certainly in line with the PRC's wishes to make the yuan an international currency. That is, you cannot establish your currency as a medium of exchange when there are several restrictions to using it onshore and offshore as required by trading necessities.