Key Points:

  • Shanghai’s economic structure to be reformed
  • Shanghai, Shenzhen, Zhuhai, Guangzhou and Dongguan approved to use RMB as settlement currency in international trade on a trial basis  

On March 25, China’s State Council issued an Opinion to Support Shanghai Becoming an International Financial Center and Shipping Center by 2020 (“Two Center Opinion”). The Two Center Opinion reinforces the status of Shanghai as the only potential international financial center and shipping center in mainland China and distinguishes Shanghai from other regional financial centers in Beijing, Tianjin and Shenzhen.  

Although the Two Center Opinion does not specify the detailed measures or actions to be taken for Shanghai to accomplish the goal by 2020, it is believed that the Two Center Opinion will be the starting point for reform of Shanghai’s economic structure. It also presents a good opportunity for outside investors to participate in the reform process. By identifying itself as an “international” center, Shanghai is expected to provide investors outside the country with more access to various sectors of its and China’s economy, especially in the areas of finance, logistics and services.

Shanghai is drafting a number of rules and regulations toward its goal of implementing the Two Center Opinion. Subject to the State Council’s approval, these new regulations may include the following measures:  

1. Financial Center Related Measures

  1. Becoming an international RMB settlement center;  
  2. Providing tax benefits for private equity funds;  
  3. Allowing transactions at the Shanghai Exchange of funds based on Hong Kong stocks;  
  4. Developing over-the-counter markets for unlisted companies;  
  5. Allowing enterprises from outside China to issue renminbi (RMB)-denominated bonds in China; and  
  6. Allowing qualified companies from outside China to issue RMB-denominated shares.  

2. Shipping Center Related Measures

  1. Providing tax benefits to vessel leasing companies;  
  2. Providing tax benefits to shipping companies at Yangshan Port;  
  3. Providing tax breaks on shipping-related insurance revenue for insurance companies registered in Shanghai; and  
  4. Encouraging the establishment of a Shanghai-based luxury cruise business, including permitting a cruise company from outside China to form a wholly foreign owned enterprise in Shanghai.  

RMB Settlement in International Trade Permitted in Five Cities

Among the above proposals, the approval of Shanghai as an RMB settlement center for international trade has already been achieved. Shanghai, together with four cities in Guangdong (Shenzhen, Zhuhai, Guangzhou and Dongguan), has been approved to use RMB as a settlement currency in international trade on a trial basis as of 8 April 2009, which means companies in these five cities may use RMB as the settlement currency for import and export, instead of US dollars, euros or other non-China currency, to avoid the risk of currency exchange rate fluctuation.

While this new policy is exciting news for banks and export companies, the implementation rules – currently in draft form – to be provided by the People’s Bank will provide a greater understanding of the policy and clarify numerous details and issues. One of the major problems posed by the policy is that the RMB is not a freely convertible currency. Given the strict foreign exchange control regulations of China, this problem raises the question of how to conduct RMB settlement in actual practice. Answering that question requires determining:  

  1. a means by which a company outside China may open an RMB bank account overseas, most likely either at a China-based bank branch located outside China or through an agency arrangement between a China-based bank and a bank outside China;  
  2. whether a company outside China receiving RMB may own the physical RMB (in cash) or merely a credit;  
  3. how a China-based bank may settle RMB with a bank outside China;  
  4. when a company outside China that owns RMB overseas uses those RMB to make a payment to a China-based company, how such a payment can be deemed as export income in order to comply with existing import and export verification regulations; and  
  5. whether an RMB investment made in China by a foreign invested company located in China (e.g., a wholly foreign owned enterprise) would be considered a foreign investment.  

It is believed that at the trial stage, only a few China-based banks will be licensed to conduct a business in RMB settlement. The implementation rules to be published by the People’s Bank will outline the requirements and procedures for applying for such a license. It is also believed that Hong Kong is most likely to become the first region to begin RMB settlement. Because Hong Kong has the closest business relationship with mainland China, Hong Kong companies have significant need of RMB, as evidenced by the enormous amount of RMB currently flowing between Hong Kong and mainland China via the black market. Also, Hong Kong has experience in doing individual RMB business, and RMB settlement would provide considerable support to Hong Kong’s economy from its central government during the worldwide financial crisis