CFA Institute Magazine 17 September 2018
The Shanghai Free Trade Zone Continues Its Growth
In this interview, two experts discuss the impact of the Shanghai Free Trade Zone and its future outlook.
- With more than 50,000 member companies, the Shanghai Free Trade Zone continues to have significant implications for how investment firms operate in China.
- In addition to Shanghai, there are 10 other Free Trade Zones in China, but Shanghai is the only one that offers the Free Trade account, which functions “like an RMB offshore account.”
- The planned Shanghai Free Trade Port will open the market further, providing more flexible currency flows and more opportunities for foreign investors.
Ni: The Shanghai Free Trade Zone is a significant measure to boost China’s reform. It’s our new way of opening for the international community and exploring administrative innovation to stimulate new trading and investment. This is a very broad picture. The Chinese government has said that it wants to set up four centers. The four centers are something like a trading center, financial center, commercial center, and transit center. We chose Shanghai to be the first location in order to benchmark a world standard for Free Trade Zones.
What are the new reforms?
Ni: There are quite a lot. For example, part of the Free Trade Zone concept is that we will be more open to foreign investors. Are you familiar with negative lists?
What are negative lists?
Ni: In the past, if we allowed foreigners to invest in industries in China, we would give out what we call positive lists. We would tell you where you could invest. If something was listed on a positive list, then that means you were allowed to invest. Now, we’re doing it the opposite way: We provide a negative list. If something is on the negative list, that means you cannot do it. But if it is not mentioned, that means you are allowed to do it.
For example, on the negative list we may say that foreigners cannot make investments in weapons. You can do anything except weapons. The negative list will make investors feel more comfortable. Investors need to know the boundary of the government and the administration: Don’t cross this boundary and you can do anything that you like. The negative list is a very key change compared with the past, before the Shanghai Free Trade Zone.
What can foreign investors expect in the Free Trade Zone?
Ni: More industries are opening for foreign capital, especially in service sectors. Industries such as social services, financing services, maritime services, cultural services, professional services, and merchant services have all been opened up in the Free Trade Zone, which welcomes the participation of foreign capital. Second, we facilitate the outbound direct investment (ODI) procedures for domestic companies. That means domestic companies can more easily invest outside of China.
Number three, foreign companies can more easily engage in the commodity, futures, and financial markets in China. Number four, a one-stop service platform will be set up to support companies in engaging in relevant business in China.
What’s the one-stop service platform?
Ni: The Shanghai Pilot Free Trade Zone is not a brand new invention. This kind of service platform is actually a consolidation of a different government system. In the past, if you wanted to achieve a certain goal of your investment, you would have to go through different government offices.
Twenty years ago, if you wanted to set up a company or file a tax, you had to go to different divisions of the government. You had to obtain different rare title papers. This is too complicated. The one-stop service platform is focused on how to consolidate these different government divisions. Investors can complete their application on one single system. This is an idea we borrowed from Singapore. Singapore, beginning in the 1980s, started to set up what they called a trade-net. The situation in China is far more complicated compared to Singapore, but finally, we have established it.
The one-stop service platform can support thousands of companies at the same time, and the application period is dramatically shortened.
Have you been surprised by SFTZ growth?
Ni: I am not so surprised. The growth of Shanghai and of China is something that could be predicted. Without the creation of the Free Trade Zone, I still believe the growth would be there. But with the strategic plan of the Free Trade Zone, the growth is more healthy. The growth has helped Shanghai to achieve more opportunities. So, this translates into something we are quite happy with, most of all because the Free Trade Zone is a state-wide, strategic plan. Some key hurdles, which used to be quite complicated to solve in the past, can now be solved a little bit more easily.
How many Free Trade Zones are there?
Ni: Currently there are 11 Free Trade Zones in China. Batch I was Shanghai. Batch II was Guangdong, Tianjing, and Fujian. Batch III was Liaoning, Zhejiang, Henan, Hubei, Chongqing, Sichuan, and Shanxi. These are all modeled after the Shanghai Free Trade Zone. We can say it’s kind of a duplication of the Shanghai model.
The numbers of Free Trade Zones will no doubt grow. We have a strategic plan for growth. Even before the Free Trade Zone, we were thinking ahead. The central government has indicated that the Free Trade Zone will also include a Free Trade port.
Of course, the first Free Trade port will be in Shanghai. The Shanghai government has been working on the general plan of the Free Trade port for many months. However, the central government still wants Shanghai to be more creative, more innovative. So the Free Trade port plan is currently still in the planning stage.
What services will the Free Trade port offer?
Ni: Offshore business. That means there will certainly be more opening of the market, more flexible currency flows, and more opportunity for foreign investors. Offshore means liquidity of cargo and liquidity of currency; it will be totally different from the current Free Trade Zone management. The current Free Trade Zone management is still focused on the transaction between two markets—the domestic market and the overseas market. The Free Trade Zone is like the channel connecting the two markets.
For the Free Trade port, the key word is “offshore.” That means it’s like a hub connecting the overseas markets. The domestic market will still play an important role, but the key responsibility of the Free Trade port is to connect different areas in the overseas market.
How do investment firms operate in the FTZ?
Ni: Vanguard, for example, set up a subsidiary in the Free Trade Zone (in 2014 or 2015), and currently its business is engaged in the domestic stock market. The Shanghai Free Trade Zone provides Vanguard and other investment firms a number of crucial benefits. One of the biggest is that we provide more flexible currency and liquidity solutions. The Free Trade Zone provides a totally different solution for currency liquidity management, so this is quite attractive to the investment management companies.
What is the Free Trade account?
Ni: The Free Trade account is a very special account. As I mentioned, there are 11 Free Trade Zones in China. All the Free Trade Zones share similar policies, except for the Free Trade account. Currently, the Free Trade account is executed only in Shanghai. This Free Trade account is a totally different management system, invented by the central bank in Shanghai.
The Free Trade account is like an RMB offshore account. This is an easy way for foreigners to understand it. Companies can use it just like an offshore account, but it is an RMB account. In this account, RMB and foreign currencies can be converted into each other without limitation.
How is Swiss Vanquest working with the Free Trade Zone?
Raebsamen: We signed an MOU in January 2018 with the Shanghai Free Trade Zone to provide them innovation services from abroad. Swiss Vanquest invests and works with companies in technology areas, such as fintech, blockchain, AI, biotech, medtech, and healthtech. These are industries that are of interest to the Free Trade Zone, in the sense that they want to promote these industries to their members and also to promote some of the collaboration in these areas between China and the outside world.
There is also an ODI platform. The original purpose of the Free Trade Zone was to help foreign companies to set up in China. Now, it’s the other way around. They also want to provide services to domestic members in the Free Trade Zone to make overseas investments.
How do you connect companies you know with the Free Trade Zone?
Raebsamen: We organize industry conferences. Fintech, for example, is a very hot topic for everyone at the moment, especially in China. They want to know more about the possibilities of nascent fintech technologies and how they disrupt current markets and businesses. We also introduce other technology companies to the Free Trade Zone and offer services to the companies or the members in the zone.
Through our close collaboration with Eric’s team, we aim to create an active forum for our technology companies and the members of the Shanghai Free Trade Zone to embrace investment and business development opportunities.
Such as conferences in Switzerland and China?
Raebsamen: Yes, our goal is to bring overseas technology and experts into the Free Trade Zone and provide an exchange of technology and also of people. We want to link up people in the industry—people looking for contacts in China or members of the Shanghai Free Trade Zone looking for overseas contacts. For example, with fintech, some members of the Free Trade Zone might be interested in a visit to Crypto Valley, which is located in Switzerland, where I am from. There is a big community called the Crypto Valley Association, which provides fertile ground for world-class startups and established companies in fintech to settle. This is one way we can build bridges between China and Europe, and we have plans to expand that globally.
Eric, can you say more about the ODI platform?
Ni: Before 2013, if a domestic investor wanted ODI approval, it would take approximately three months. You needed three months to go through the whole procedure—especially for the very giant companies in China. After the Free Trade Zone setup, the new procedure normally takes just three days. So three months became three days! We are happy to see that not only in Shanghai but in some other Free Trade Zones as well, the regional government has also achieved this kind of system. It has become quite convenient for the local companies. Both government companies and private domestic companies can achieve this goal. It’s not as complicated as before.
In 2017, there were a number of quite famous and brilliant investments made by Chinese companies to acquire valuable foreign enterprises in Europe and the Americas. The Free Trade Zone plays a very important role in these ODI sectors.
How many FTZ firms are domestic?
Ni: Currently, domestic companies grow quite fast in Free Trade Zones, especially Shanghai. Before 2013, there were about 10,000 companies, and 80% of them were foreign companies. Now, there are more than 50,000 companies registered in the same area, and the ratio of domestic companies and foreign companies is about 50/50. So the growth of the local companies in the Free Trade Zone has been very rapid.
Barriers to domestic companies are almost null. We don’t set up any hurdles for domestic firms, and at the same time, we don’t set up any hurdles for the foreigners either. In the Free Trade Zone, the treatment of foreign companies and domestic companies is the same. The requirements are very simple: three days for set up and you need to follow the laws of mainland China. That’s all.
What’s unique about the Shanghai Free Trade Zone?
Ni: Shanghai is the financial center. For ODI banking solutions, Shanghai’s banks are the most experienced and professional. Shanghai will no doubt be the ODI base for all the Chinese companies in mainland China. So ODI and the Free Trade account, I think, will be the two key things in the future for a long time.
The Shanghai FTZ is unique. As I mentioned, its ODI policy has been copied by all the other Free Trade Zones, so the procedure for the approval is quite the same in many other Free Trade Zones. But Shanghai is the main hub for Chinese companies to invest from. For around 88% of ODI investments, you need to arrange some loan solutions, so you have to borrow the money from the bank.
What will the FTZ look like in the future?
Ni: The Free Trade Zone will continue to evolve. For example, I believe the Free Trade account will create something we are not even not expecting. More products will be created relevant to the Free Trade account. The account is just like a house. It can host a lot of things.
Since the invention of the Free Trade account, we have witnessed different institutions trying to build on top of it. They attempt different products to put into this empty house. Some of these succeed, and some fail. The Free Trade account is like a new baby, created in the world less than four or five years go. It needs to wear something glamorous, but something that’s not too tightly fitted. In the future, we believe there will be new products, specifically designed for the Free Trade account and also accessible to the international market.
What products will be useful?
Ni: Derivatives and sub-derivatives. I am not sure that the products are relevant to commodities—perhaps insurance or something. A lot of experts currently in the Free Trade Zones are working on it. There will definitely be more products relevant to the Free Trade account that will appear in the next few years, but we don’t know when and we don’t know which specific products. It’s also subject to approval by our central bank.
How is the FTZ administrated?
Ni: For the Shanghai Free Trade Zone, we have two main administrations. One system is purely government servants, and the other is government companies. I’m not sure the total number of people, but there would be thousands of people.
I belong to one of the Free Trade Zone government companies. We smooth the hurdles and talk with governments to mitigate the potential risks. I can tell you that we are not the first model to provide such kinds of services to industries. This kind of model we also borrowed from Singapore. Singapore has quite a similar company called JTC Corporation.
JTC Corporation was set up in 96 days. It created a very successful industrial zone in Singapore. China established this kind of idea in 98 days. So the Free Trade Zone and JTC Corporation share a lot of experiences and some similarities. Government and company, as two legs, move together: The idea is quite similar. If anyone wants to understand more about how we work in the Free Trade Zone, the JTC Corporation case would be a simple one to study, because JTC Corporation business cases are studied in some business schools. I suppose it’s easier to comprehend. In China, I have never seen a business case about us. Maybe some time later, you can write one for us.
About the Author
Nathan Jaye, CFA, is a keynote speaker and member of CFA Society San Francisco.