China’s financial system has undergone a significant transformation over the past decade (and has grown exponentially during that time). However, as is the case with all financial systems, there is still room for further development and improvement.
Much of China’s 13th Five Year Plan for financial services focusses on further financial reforms. Areas covered include:
- Further opening-up of China’s financial markets to foreign issuers and investors
- Steadily moving forward with RMB internationalisation
- Increasing the proportion of direct financing (ie financing provided by the capital markets as opposed to banks) while reducing leverage (by promoting equity financing)
- Creating the conditions for implementing a registration-based IPO regime (there is still much uncertainty and anticipation regarding the timing and manner in which this regime will be introduced)
- Promoting hybrid instruments, high-yield bonds, derivatives and other innovative financial instruments
- Establishing a green financial system consisting of green loans, green bonds, a green development fund and other innovative green financial products
- Improving market access for financial services and encouraging more private sector investment (China’s financial services sector is dominated by state-owned enterprises. For example, in the banking sector, there are currently only a handful of privately owned banks.)
- Enhancing the macro prudential regulatory framework and consumer financial protection
- Further regulating the development of internet-based finance, including peer-to-peer lending.
Many of the elements of the government’s plan for financial services complement its plans for the real economy. For example, the Plan emphasises the need for financial services to support, among other things, innovation and Internet Plus, green development, demographic changes and China’s “go global” strategy. More broadly, financial services are to also support China’s transition towards a more balanced economy where services and consumption play a greater role in driving growth.
However, while the government remains committed to financial reforms, it is equally (if not more so) concerned about financial stability and the prevention of systemic risks (such as the development of widespread credit, market volatility and liquidity risks), particularly where they may spread to the real economy and result in economic and social instability. The nature, extent and pace of implementation of the reforms could well be linked to the level of risk within the financial markets and broader economy, both domestically and internationally.
Unlike some areas of reform, the Plan does not expressly set quantitative objectives for the financial services sector. This is likely due to the qualitative nature of the financial reforms. In addition, financial markets are uncertain, unpredictable and increasingly driven by factors outside of the government’s control.
The land of opportunity?
Opportunities for international businesses in China
Effective implementation of the Plan is likely to make it easier for overseas financial institutions to set up or expand operations in China, obtain local or cross-border financing for those operations, and offer a broader range of products and services to a wider array of local and international clients.
Harnessing their experience in more mature financial markets, we expect to see some overseas financial institutions establishing in China’s growing internet finance, green finance, fintech, derivatives, hybrids and structured products markets. In addition, overseas companies may find that an increasing number of financial services providers “at home” are willing and able to follow them to China, providing them with integrated products and services from a cross-border platform.
At the same time, overseas financial institutions may face greater competition from Chinese competitors growing their global networks and expertise. They may also find that as China’s economic and financial influence continues to grow, China will become more confident in setting and policing financial regulations that are tailored to China’s economic and social situation, even if they differ from those in other financial markets.
Opportunities for local businesses in China
As China’s financial system and broader economy continues to open up to foreign investors and issuers, there will be greater demand for the financial products, services and market know-how offered by Chinese financial institutions. These institutions also have an opportunity to take the lead in green finance, fintech and other areas of financial innovation that receive strong government support.
RMB’s increasing importance as a global currency, along with Chinese companies’ increasing influence on the world stage, may also provide Chinese financial institutions with a competitive edge in the provision of transactional and advisory financial services. At the same time, Chinese financial institutions also face a number of challenges, including economic headwinds as well as higher levels of leverage in the economy.
From planning to implementation
The government’s high-level recommendations for setting the Plan were published in late October 2015, while the Plan itself was published in March 2016. In the months since the recommendations were published, Chinese financial regulators have already taken a number of specific steps to further the Plan’s objectives, including:
- Currency-related reforms that led to RMB’s inclusion in the International Monetary Fund’s Special Drawing Rights basket of currencies, marking an important milestone for the internationalisation of RMB
- Further opening-up of China’s domestic bond markets to foreign issuers (by allowing them to issue panda bonds – read more about this important development) and foreign institutional investors
- Policies on the issue of green bonds by financial institutions and non-financial enterprises, marking a key step in establishing China’s green bond market and green financial system
- Separate guidelines on how China’s financial services sector can support domestic consumption, the development of aged care services and the alleviation of poverty – all key focusses of the Plan.
A number of key statutes are also in the process of being amended, including the Securities Law.
In light of recent events in the stock and currency markets, the government is now placing greater emphasis on preventing and managing systemic risks. Over the next five years, pursuing the twin goals of advancing financial reform and maintaining financial stability may well pull policymakers and regulators in different directions.