China is opening up to the outside world, albeit slowly. Recently, Guo Shuqing, Chairman of the China Banking and Insurance Regulatory Commission, stated that the body will introduce twelve new policies regarding opening up, from lowering requirements for foreign banks to set up branches to permitting foreign insurance firms to help establish companies in China. The measures are designed to increase the amount of foreign capital in the Chinese financial system. It sounds like a lot of effort is being put toward making China's financial sector more accessible, but is it, really? How can we reconcile this long list of measures with the sense that China's financial system is still pretty hard to tap by foreigners?
Opening up measures
The list of opening measures is long- they include: canceling the upper limit of the shareholding ratio of a single Chinese-funded bank, cancelling total asset requirements for foreign banks to establish corporate banks and branches in China, canceling the total asset requirement for overseas financial institutions to invest in a trust company, relaxing restrictions on Chinese shareholders of Sino-foreign joint venture banks, encouraging overseas financial institutions to cooperate with banking insurance firms controlled by private capital, allowing foreign insurance groups to invest in the establishment of insurance firms, permitting foreign-invested insurance groups in China to establish insurance institutions, easing access for Chinese and foreign financial firms to invest in the establishment of consumer finance companies, allowing foreign funded banks to operate RMB business without necessary approval, and allowing foreign funded banks to participate in the agent collection and payment business.
Last year, 15 measures for opening up were announced in April, and this has had positive effects on the market. Overseas firms were permitted to apply for majority stakes in securities and mutual-fund management companies as of April 2018. In May, China lifted single-shareholder limits for banks and scrapped some asset requirements for foreign companies to operate onshore. So far, the response to this list of opening measures has been positive within China. These measures can be added to those that further open the bond market, deepen connectivity between domestic and foreign stock markets, and permit overseas investors to trade RMB denominated crude oil futures onshore, as well as allowance of foreign firms to participate in the credit investigation sector, credit rating sector, bankcard clearing and settlement, and nonbank payment sectors.
Opening up to foreign capital?
So, is China opening to foreign capital or isn’t it? The answer is, to some extent. One thing that should be kept in mind is that there is a difference (link in Chinese) between allowing foreign firms to participate in domestic finance and opening up the capital account to foreign financial flows. Foreign financial institutions have been permitted to increase ownership in local firms and gain access to areas of business in which they had formerly faced restrictions. However, this doesn't mean that they will be able to overcome existing limits on investment or repatriation of foreign funds. China’s capital account still remains relatively tight on capital outflows.
Not only did capital account liberalization slow starting in the mid-2010s due to economic deterioration, but additional capital controls were implemented in order to stem depreciatory forces. New capital controls included increased scrutiny over outbound mergers and acquisitions deals, closer scrutiny of individual foreign currency purchases, and restrictions on investing in particular sectors overseas. So, while the new opening measures will allow foreign players to compete in China, they won't be permitted to compete as truly global institutions.
Measures still have merit
That doesn't mean the measures are without merit in terms of promoting the health of China's financial system. Certainly, allowing greater foreign participation will increase competition in China's financial sector, which will promote the efficiency of the sector. Foreign firms will bring some best practices in management and operations that can filter over to Chinese domestic financial firms and force incremental efficiency gains. While foreign firms are unlikely to receive the lion's share of business due to their lack of implicit state guarantees, they offer an important point of comparison for domestic Chinese firms that are used to carrying out business in a more bureaucratic manner.
There is also the hope that foreign small and medium sized financial institutions will enter the market and promote inclusive finance. Chinese financial firms have long struggled to provide financial services to smaller firms, which are considered higher credit risks. In addition, Dong Xiwei, deputy dean of the Chongyang Finance Research Institute of Renmin University of China, states that removing the asset restrictions of foreign financial institutions into China's financial sector will help to introduce small and medium-sized foreign-funded financial institutions that can ultimately change the uneven development of domestic financial institutions and diversify the financial system.
Increased foreign presence in China's insurance industry will push forward development of this sector. Some experts believe that this will increase the types of insurance firms in China as well as improve the shareholding structure. This will result in the expansion of insurance coverage, which is at a relatively low base.
The upshot is that the measures are a step in the right direction, but they aren’t the steps toward opening that overseas investors have been waiting for. Sure, they allow foreign financial firms to get a piece of the pie in China, which is significant news. Still, due to the ongoing presence of capital controls, foreign firms will not be permitted to engage in large scale overseas arbitrage and investment, which would likely be more lucrative. Capital controls are likely to remain in place until China’s economy is back on the upswing. That could take years. Until then, we’ll do with the opening measures that have been granted. At least they’re a step in the right direction.