Finance:Bringing the Offshore,Onshore

Much of the 15 square-kilometer Qianhai area in the southern boom town of Shenzhen is barren, newly-reclaimed scrub land. But on August 2, 2012, Qianhai’s urban planners received their first bank loan of US$3.2 million, earmarked for infrastructure construction.

Like most locals, Zheng Hongjie didn’t know where Qianhai was, but that didn’t stop him from being appointed the head of the newly-created Qianhai Administration in 2010. His task to create “China’s Manhattan,” or, to use the clunky language of central economic planners in Beijing, a “Shenzhen-Hong Kong cooperative zone in the field of modern service industries.”

Creating Wealth

According to a blueprint approved by the State Council, China’s cabinet, every one of Qianhai’s 15 square kilometers will generate US$1.6 billion of GDP by 2020, giving the area 20 times the GDP of Shenzhen and twice that of Hong Kong.

Early signs are good. Multi-billion-dollar deals have already been signed with nearly 40 foreign investors. On June 29, 2012, Zhang Xiaoqiang, vice minister of the National Development and Reform Commission(NDRC), China’s top macroeconomic planning agency, announced a list of key sectors that will be encouraged in the program during a press conference in Hong Kong. Unsurprisingly, financial services topped the list.

Since its return to mainland sovereignty in 1997, Hong Kong has done more than help propel the Chinese yuan to international status. Its openness to foreign investment and a comprehensive legal framework governing the financial industry has served as an example to Beijing.

Same Dream

Still a fishing village in the late 1970s, Shenzhen, China’s first Special Economic Zone (SEZ), has mushroomed into the fourth richest city in China in terms of net GDP . However, the preferential treatment afforded to the country’s SEZs has been gradually eroded by economic development throughout the rest of China, weakening the city’s competitive edge. In the first quarter of 2012, for example, net GDP in the cities of Tianjin, Suzhou and Chongqing had already outpaced that of Shenzhen.

With 92 percent of its GDP generated by the financial sector, Hong Kong enjoys an international status among financiers equal to those of London and New York. With coffers housing the world’s largest offshore deposits in Chinese yuan, Hong Kong is poised to be the world’s biggest hub for yuan-based international transactions. Hot on its heels are Singapore, Shanghai, Seoul and London.

More than 70 percent of the overseas investment that has underwritten Shenzhen’s economic boom originated in Hong Kong. Shenzhen holds the second or third largest financial assets in the Chinese mainland, and is the “mainland’s second stock market, while there is no third,” said Xiao Zhijia, deputy director of the Shenzhen Municipal Financial Affairs Office, during an online dialog with local business owners.

Shenzhen’s proximity to Hong Kong, in many ways the city’s spiritual home, has whetted its appetite for becoming an international financial center in its own right. Many hope the two will deepen their relationship, not least their respective governments. Qianhai could be where this long-awaited match is finally made.

Xu Qin, mayor of Shenzhen, described Qianhai as a “springboard, which will propel Shenzhen into the international market and Hong Kong into the mainland market.” In an article in Shanghai Securities News in early January 2012, Charles Li, chief executive director of Hong Kong Exchanges and Clearing (HKEx), noted that Hong Kong could improve its core competitiveness as an international financial hub by serving as the “first overseas home” of the “next international currency,” the Chinese yuan.

Kindergarten

Policy is already one step ahead of practice. Qianhai will be the first region authorized to broker cross-border yuan-denominated loan agreements between Hong Kong and the mainland. As Qianhai has no banks yet, and the cost of borrowing in Hong Kong is lower than on the mainland, this means that enterprises in Qianhai will soon have access to Hong Kong’s immense yuan pool.

Lenders in Hong Kong are reportedly champing at the bit. According to data from the Hong Kong Monetary Authority(HKMA), yuan deposits with the 134 authorized institutions engaged in yuan business in Hong Kong stood at about US$88 billion by the end of May 2012 - 36 percent of the total non-dollar foreign currency deposits in the territory. Currently, the biggest market for any yuan-denominated business is, unsurprisingly, the Chinese mainland.

In the same article, Charles Li of HKEx described Hong Kong’s role as “a kindergarten” from where the yuan, now “in its infancy,” will be able to mature before going international in the future.

“Offshore yuan has to be invested back in the mainland market from their overseas“kindergarten,” he wrote in the article.

However, capital controls on the mainland remain an obstruction to cross-border loans and direct investment. A draconian approval process means only a trickle of capital makes its way legitimately into China’s mainland economy. Qianhai will be the first place on the Chinese mainland to benefit from the liberalization of these controls. Outside of borrowing from Hong Kong banks and bond issuance, the new Qianhai authorities are also being encouraged to explore any and all ways to tap Hong Kong’s yuan-denominated capital, with policies already in place to cope with a back-flow of yuan to the mainland.

In this regard, Hong Kong has another attractive ace up its sleeve. The rules governing the Qianhai operation state that Hong Kong’s experience should be drawn upon whenever the Qianhai Administration formulates regulatory framework for market operations. In short, Qianhai will, in some ways, work from Hong Kong’s rulebook, not Beijing’s.

The administration itself is a semi-independent institution established in accordance with specific ordinances (the so-called Qianhai Rules), making it arguably a “statutory body” in Hong Kong or UK law, and an “independent agency” in the US. The Qianhai Administration can recruit its officials from Hong Kong or anywhere it deems appropriate. The Hong Kong government itself is part of the Inter-ministerial Committee for Qianhai Affairs set up by the central government.

Controversies have arisen over these unprecedented steps toward financial openness and regulation. Some have warned that it is extremely difficult to control fluid offshore capital once it returns to shore. Professor Zhang Ming at the Chinese Academy of Social Sciences believes that lax regulation in Qianhai could invalidate all China’s national capital controls, destabilizing the money supply.

Others have suggested that the liberalizations don’t go far enough, and urge a wholesale adoption of Hong Kong’s financial regulatory framework in Qianhai. While this has been rejected by Beijing’s economic planners, giving greater leeway to international financial practices is a goal of the Qianhai experiement.

“Qianhai has to explore innovative mechanisms for public management in a fully open environment,” Wang Jingxia, a senior official with the Qianhai Administration, told NewsChina.