Shanghai’s Free Trade Zone – empty gestures or meaningful reforms?

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The China (Shanghai) Free Trade Pilot Zone (FTZ), approved by the State Council at the beginning of July 2013, was launched with much fanfare at the end of September. The launch and the publicity surrounding it gave rise to much excitement and expectations of reform in key areas such as foreign exchange control and the regulation of foreign investment. However, the initial euphoria over the FTZ and what it promised has been largely replaced by a sense of cautious scepticism. Is it fair already, as many people have done, to write off the zone as a publicity stunt? This article takes a hard look at the zone; its significance in the context of the reforms that were announced at the 13th Party Plenum last November; what it has delivered to date; and what it can realistically be expected to deliver in the not-too-far-distant future.

The FTZ occupies 28 square kilometres in Pudong, Shanghai, currently made up of the Waigaoqiao Bonded Zone and the bonded zones surrounding the airport and the deep water port. Despite being an hour’s drive from downtown Shanghai, real estate prices in the zone have rocketed in expectation of future growth. Organisations such as Shanghai International Arbitration Centre (SHIAC) have responded, with SHIAC setting up a special branch in the zone to hear zone-related disputes.

The General Plan for the Shanghai Free Trade Zone that was released alongside six sets of administrative measures at the zone’s inauguration promised a series of reforms that mainly related to the following broad areas:

  • administrative reform by way of flipping the regime of foreign investment regulation from an “approval first” regime to a “register first and monitor later” regime;
  • the introduction of a “Negative List” concept (addressed in detail below);
  • liberalization of capitalization requirements for the setting up of companies in the FTZ;
  • possible future liberalization of certain areas of foreign investment activity; and
  • liberalization of cross-border financing and the pulling back of foreign exchange controls on the capital account.

Media reported that the FTZ had become a personal project of China’s premier, Li Keqiang – a national initiative to deregulate business and push reform and liberalization in the country’s financial sector. In those three hot months of summer, expectations of what the zone would permit and achieve reached boiling point. But enthusiasm started to cool as questions about the actual details of the reforms remained unanswered. Excitement was replaced by a view that the FTZ was perhaps nothing more than a desperate grab for attention by a metropolis that since Expo in 2010 had receded from the limelight.

The “Negative List” concept arose out of China’s negotiations with the United States over a proposed Bilateral Investment Treaty. The list sets out those types of projects that are still subject to foreign investment pre-approval and those projects still subject to percentage caps on foreign investment. The issuance of the Negative List was the first blow to expectations, as it by and large, with some minor exceptions, merely set out those areas which were subject to restrictions in the existing and long-standing Foreign Investment Guidelines. Sceptics took this as a sign that the Shanghai government could not deliver because of central government opposition.

Understandably, businesspeople want to see concrete measures that lead to meaningful new opportunities. However, the significance of the change from an approval-based to a registration-based system cannot be overstated in a country which has always put a premium on the control of foreign investment. That such a change has been piloted at all is remarkable – it requires the adoption of an entirely different mindset on the part of government officials. As underlined by the inclusion of the FTZ in the 13th Plenum Party Document, the zone is now enshrined as a testing ground for the freeing up of the economy from official control. Following the pattern set up by the successful reforms piloted in the Special Economic Zones in the early 1980s, the whole nation could end up as an easier place to do business because of the FTZ.

The fact that the first version of the Negative List contained little by way of substantial liberalization was merely because it was rushed. Shanghai leaders chose to issue the first version of the list before they could negotiate and secure support for industry-specific liberalization. Their justification – that they would issue further versions with progressive reforms – fell on disbelieving ears. But recently, true to their word, we have seen meaningful change to the Negative List. Liberalization in what is considered by many the toughest industry nuts to crack – the telecoms and IT industries – has been announced, with media reporting in early January foreign investors for the first time being allowed to take majority control over online data and transaction processing businesses, call centres, internet access, and multi-side voice and video communications services. All such businesses based in the FTZ, with the exception of the internet access businesses, will reportedly be able to offer services nationwide.

So what about the least well-developed but most ambitious of the zone’s goals – financial reform? Major financial institutions such as HSBC and Citibank have already taken up residence in the zone in anticipation of such reforms. But how long will they have to wait? Within a raft of mainly hortative measures by the PBOC in an Opinion on 2 December, pre-approval requirements were scrapped for companies in the zone to conduct cross-border settlement and exchange deals; ‘qualified’ foreigners working in the zone can trade equities; and ‘qualified’ residents in the zone can invest in the foreign securities market. Such measures illustrate the trend towards allowing easier access to offshore finance, creating the conditions for companies to put in place cross-border regional treasury functions, and permitting domestic companies freely to invest overseas. However, the PBOC has deliberately refrained from committing to a specific timetable for rolling out the more exciting of the financial reforms such as the lifting of interest rate controls, the issuance of negotiable instruments of deposit, and more wide-ranging capital account liberalization.

Which China specialist would ever have imagined securing a business licence for a WFOE in just four days, with payment of minimal registered capital, in a time frame dictated purely by the company’s documents of incorporation? This is what has started happening in the FTZ. For a while, until a lack of resources in the zone under the weight of demand slowed down the issuance of business licences, the process of setting up a company in the FTZ began to resemble that in Hong Kong. The FTZ represents progress. There will be hiccups along the way as so much by way of negotiation is needed with a multiplicity of government departments for new reforms to be piloted. But the facts that the FTZ exists at all and that the reforms to date have been achieved represent enormous efforts over a very short period of time by a small number of determined reformers within the Chinese governmental and political infrastructure.

Topics:  China, Foreign Exchanges, Free Trade Zone, Trade Policy

Published In: General Business Updates, International Trade Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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