Editorial: Why Opening Up China’s Financial Markets Won’t Guarantee Growth
China recently took a much-awaited step to widen foreign investors’ access to its financial industry.
On the day U.S. President Donald Trump wrapped up his state visit, the Chinese government announced a sweeping proposal that allows foreign investors to hold substantially higher stakes in securities and futures brokerages, fund management companies, banks and insurers. Ultimately, domestic and foreign investors will be treated equally.
Hopefully, this hard-won breakthrough will inject new momentum into China’s economy and financial development process. It’s not known when the policies will actually be rolled out, or their impact. Opening the market can accelerate reforms, but first the industry must have already achieved a certain level of change. Therefore, financial reform should be proactive and precede market liberalization.
The plan for opening-up covers the entire financial market. Foreign investors will be allowed to own up to 51% of shares in joint ventures in securities, funds or futures, and this cap will be removed after three years. The 20% cap on a single foreign investor holding shares of a Chinese bank or financial asset manager will be eased; so will be the 25% cap on several foreign investors holding such stakes. After three years, foreign investors will be allowed to own up to 51% of shares in joint ventures in life insurance and this cap will be removed after five years. Such measures aim to create a level playing field for Chinese and foreign institutional investors that want to enter China, in terms of the ratio of shareholding, the form of new joint ventures, the qualification of shareholders, the scope of business and the number of licenses. The measures are a sign of China’s self-confidence, and can improve the country’s financial market so that it appeals more to foreign investors.
At first glance, it may seem China’s move to lower entry barriers to its tightly-guarded financial market took some by surprise. But China had already shown signs of preparing to take such a step. In January, President Xi Jinping reiterated his commitment to opening China’s markets in his keynote speech during the Davos forum. The China-U.S. Economic Cooperation 100-Day Plan that was agreed upon during Xi’s visit to the U.S. in April also mentioned opening China’s financial market. In August, the State Council, China’s cabinet, released a series of measures aiming to promote foreign investment in China, accelerating the opening-up process of the country’s banking, securities and insurance sectors. There is also a timeline and detailed plan to push ahead with increasing foreign investment in China. During the 19th National Party Congress, authorities stressed the significance of expanding foreign investors’ access to China, in an attempt to improve efficiency by enhancing competition. These measures all point to the ultimate goal of further opening China’s financial sector.
Allowing foreign investors greater access to China’s financial markets will help bring in advanced ideas on business management, rules and regulatory measures that are deemed more mature, but it will also increase competition in the domestic market so that financial resources can be allocated more efficiently. It can also stabilize the financial market, and improve financial institutions’ ability to serve the so called “real economy”—the sector that produces actual goods and services. In the past few years, China’s financial market has been fraught with risky operations, as a result of being overly suppressed. So, by opening up this market, authorities can kill two birds with one stone.
Excitement aside, we should keep a level head when considering several questions. When will the policy become effective? Will there be more foreign investors after the removal of the restrictions on shareholding? Several market observers have raised doubts, saying “will people come in after we open the door?” During the two decades after China joined the World Trade Organization, the country has made on-and-off efforts to open its financial services sector, but with few concrete results.
China is among a few countries in the world that maintain a cap on foreign investors’ shares in fund managers, brokerages, and futures companies. As overseas investors are unable to become controlling stakeholders, they have less of a say and are unable to grow their businesses in China. Compared to the total value of the financial assets in China, those held by foreign investors are only a drop in the ocean. Some of them have already voted with their feet, selling their stakes in joint ventures in China.
There are uncertainties regarding whether the new policy will eventually draw in more overseas investment. While foreign investors attach great importance to the level of control they are allowed, market prospects matter to them even more, and that makes improving China’s overall business environment a critical factor to lure them in. Such an improvement hinges on China’s overall political situation, regulatory standards, legal environment and transaction costs. The liberalization of China’s financial industry must be thorough. Simply lowering the barriers for entry isn’t enough and it requires more preparatory work to be done in addition to opening-up itself.
Speeding up reforms by opening up markets has been in the DNA of China’s economic development for the last 40 years. However, it doesn’t mean that opening up guarantees successful reforms; a certain level of reform is a prerequisite to a fruitful liberalization. If, several years later, foreign and domestic financial institutions are really on a level playing field, the key question will then be how Chinese companies are to remain competitive.
In recent years, financial reforms have deepened and these changes have been led by interest-rate liberalization. The size, depth and variety of tools used in China’s financial market are so much more sophisticated than before. This deepening has substantially boosted the competitiveness of the financial industry.
However, in recent years, we’ve also seen stock-market routs, a bond market meltdown, implicit government guarantees and other corruption scandals in financial markets. They all suggest that there is still more room to improve the level of corporate governance and operational management. And that is intertwined with the broader, higher-level changes, because reforming the financial sector alone is going to have a limited impact. For instance, the banking sector has been affected by astronomical amounts of credit flowing to local government fundraising platforms and state-owned enterprises, which are very likely to sour and become bad loans one day. Although China has adopted Basel III, which has increased capital adequacy requirements for banks, the country’s vast, unregulated shadow banking sector poses a risk to the overall financial system. These fundamental flaws could seriously hinder the competitiveness of Chinese banks in future.
For now, the global economy has gained momentum, and all major economies are showing solid signs of a stable recovery. In order to foster long-term development, these economies are deepening their structural reforms and adjusting monetary policies to attract more foreign investment. The oncoming tide is strong and China cannot ignore it. In fact, as the Chinese economy improves steadily, we should seize this golden window of opportunity to speed up financial reform and opening-up. If that’s the case, the “heart” of China’s economy will beat more strongly. We hope the central economic work conference that will convene at the end of the year will come up with more specific strategies.
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