The formal launch of the Shanghai Free Trade Zone (SFTZ) on September 29, 2013 could be a watershed moment for ushering in key financial and economic reform in China and propelling Shanghai into the ranks of the world’s leading financial centers such as Hong Kong, London and New York. The SFTZ, which will commence on a trial basis, is expected to cover 28 square kilometers and combine four existing bonded trade zones, namely the Yangshan Bonded Port, the Waigaoqiao Bonded Zone, the Waigaoqiao Bonded Logistics Park, and the Pudong Airport Comprehensive Bonded Zone. Most observers agree that the planned SFTZ will act initially as a test site for the liberalization of the services and financial services sectors, including initiatives covering 18 different industries and reforms concerning interest-rate deregulation, foreign direct investment (FDI), and convertibility of the Chinese currency among others.

Events surrounding the establishment of the SFTZ have moved quickly. The Ministry of Commerce (MOFCOM) declared the State Council’s formal approval to establish the SFTZ on August 22, 2013. Then in an unprecedented move on August 30, 2013, the National People’s Congress (NPC) authorized the State Council to suspend temporarily for three years certain laws and regulations1 governing foreign investment, foreign capital enterprises, and Chinese/foreign equity joint ventures to facilitate the establishment of the SFTZ and boost foreign capital inflow. Nearly one month later on September 25, 2013, numerous press sources noted that the Chinese government reportedly agreed to allow access to “sensitive and blocked” websites (e.g., Twitter, Facebook, etc.) and may solicit bids for licenses from foreign telecommunications companies to provide Internet services in the SFTZ.

Some Expected New Policies

  • As a customs supervised area, the SFTZ will not only enjoy preferential policies granted by the central government, but also formulate its own preferential policies by seeking approval from relevant authorities, e.g., seeking approval from the Ministry of Finance (MOF) with respect to financial policies or from the General Administration of Customs (GAC) on customs policies. If the relevant authorities need to coordinate on such approval or seek review from a higher level, they will submit a request to the State Council.
  • The Chinese government is expected to relax foreign investment thresholds in the SFTZ. As a first step, it may revoke the necessity for recognition of qualifications, equity ratios for foreigners, and business scope restrictions for foreign investment in the areas of finance, shipping, commerce and trade, culture, and social services.
  • Investment in the SFTZ will be subject to a “negative list” approach whereby only a list of prohibited or restricted investment areas will be published. This approach marks a first for China and signals a departure from traditional foreign investment catalogues that classify investments into encouraged, allowed, restricted, or prohibited categories.
  • According to the draft SFTZ blueprint, the Chinese government will accelerate financial institution innovation in the SFTZ, including through the convertibility and internationalization of the Chinese currency as well as promote cross-border financial liberalization. Reportedly, the government has authorized the Shanghai Equity Trust Trade Center to set up a financial trade platform through a Corporate Stock Transfer System (CSTS). Initially, domestic enterprises located in the SFTZ may be able to obtain overseas investment directly through the CSTS. While foreign enterprises located therein will not be eligible at first, the government may relax the CSTS requirements down the road.

Implications and Outlook

The SFTZ is an ambitious idea coming from the highest levels of the Chinese bureaucracy. Premier Li Keqiang is reportedly leading the strategy behind the establishment of the SFTZ, aiming to usher in a second round of openness and reform in China. Supported by the Political Bureau of the Central Committee of the Chinese Communist Party, Premier Li overcame numerous challenges and hurdles in promoting the planned SFTZ during the past several months. Currently, the Chinese government is accelerating the procedures of formulating new policy and regulations for the SFTZ, with seven2 key competent ministries tasked with formulating detailed regulations.

Should the SFTZ prove a success following the pilot period, it will ikely serve as a model for institutional innovation and replicated in other major cities across the country. Already other municipalities and cities, including Tianjin, Xiamen, Chongqing, and Guangdong- Hong Kong-Macau are applying to establish free trade zones (FTZ) within their own districts.

Yet, despite the hype surrounding the SFTZ, details surrounding its implementation are scant and numerous questions remain. For instance, how will the Chinese government manage financial risk following liberalization, assess responsibility and liability in the event of mismanagement, reign in competing vested interests of different government ministries, and ultimately accept less control? Time will tell. In the short term, however, the SFTZ will need to build up evidence in support of transparent markets without the meddling of the old guard.