Shanghai launched its FTZ last year, but rumours of it knocking over Hong Kong as the business gateway to China may be premature.
By Alan Warboys
In September last year, China began one of its most daring economic experiments of the past 35 years.
Premier Li Keqiang inaugurated the Shanghai Free Trade Zone (FTZ), a 29sq km district in the city which will be a testing ground for reforms that may later be implemented across the country.
Regulations were swept away, along with currency controls and stringent rules on the flow of capital. They were replaced by tariff-free zones and a variety of tax and policy breaks for foreign companies.
The FTZ was vaunted as a hub of innovation, offering benefits for both Chinese and overseas firms.
The fanfare that surrounded the pilot project caused many business leaders in Hong Kong to start fretting over its future as China’s pre-eminent financial centre.
The former British colony has served as the gateway to the mainland for investors for decades and, more recently, has facilitated the flow of money out.
Many in Hong Kong felt Shanghai, home to one of mainland China’s two stock markets and dozens of glitzy skyscrapers, was being groomed by leaders in Beijing to take the number one spot.
A year on, such fears have so far proven unfounded. Some analysts have even criticised the Shanghai FTZ as being a flop, with little progress made.
Hong Kong, meanwhile, has continued to leverage its advantages as a special administrative region to keep up its role as a conduit for money flowing in and out of China.
“You can’t be anything but disappointed,” says Fraser Howie, the co-author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.
“Nothing much has been experimented with to push along the reform agenda. The best you can say is that we’re a year closer to something happening.”
Others are more sanguine. “It’s still early days to assess the market impact on Hong Kong,” says Clement Chan, managing director of assurance at BDO Ltd in Hong Kong and president of the Hong Kong Institute of Certified Public Accountants.
“The concept raised a few eyebrows and a few expectations,” says Chan, also a board member of the Australian Chamber of Commerce.
“They are still very much evolving the concept. It’s not the finished article, they’re refining along the way.”
"The Shanghai Free Trade Area is a bridgehead for the globalisation of Chinese companies. We give more choice to clients who used to invest overseas through Hong Kong." – Weng Wei, Shanghai FTZ managing director
Chan, who has joined two business group trips to the FTZ from Hong Kong to meet with its promoters and organisers, says the foreign investors he’s met are embracing the spirit of the zone.
“There’s a lot of adventurism; thinking outside the box. People from Hong Kong and other parts of China are going there to learn about it for their own specific interests.”
China’s economic miracle started slowly when Deng Xiaoping began opening up its markets in the late 1970s.
But it was special economic zones established in the 1980s that boosted trade liberalisation and marked the rise of China’s export dominance.
The zones were vaunted as opening the door to Chinese capital and its domestic market to foreign companies.
China now makes up 12 per cent of the world’s economy, and that’s expected to rise to 20 per cent in the next decade or so.
The Shanghai FTZ is the first of its kind in mainland China. By the end of August 2013, it had attracted registrations from more than 10,000 businesses, including more than 1600 foreign companies, says Li Jun, the zone’s deputy secretary-general.
They include powerhouses such as Citibank and e-commerce giant Amazon. While registrations are now slowing, the initial frenzy shows outsiders aren’t willing to miss out.
The FTZ is intended to show what life could be like without the many restrictions that remain across other areas of China.
Gone are the kerbs on capital flows in and out of the country, and restrictions on foreign companies competing in certain industries or converting the yuan into other currencies.
Yet much of what was proposed remains on the drawing board, including plans to start crude oil futures, gold contracts and an international board for overseas-listed firms.
While there’s been some deregulation for media and video gaming companies, Howie observes: “The fact companies can set up an office to promote films isn’t the game changer people were looking for. You can dip your feet in, wade up to your waist, but until you can let go of the side you don’t know if you can swim or not.”
Howie doesn’t see Shanghai’s FTZ experiment posing a threat to Hong Kong. “Hong Kong is a place where things happen,” he says.
“You can get off a plane on a Monday morning, meet someone at the airport and have a meeting that night. Papers are signed by Tuesday. There’s an ability to get people together and do things that there isn’t in China.”
The design of the Shanghai FTZ suggests that the zone is primarily set up to promote trade and capture inbound investment, notes William Lin, senior investment manager with the Australian Trade Commission.
He says Shanghai isn’t set up to support Chinese outbound investment, unlike Hong Kong.
Combined Chinese and Hong Kong overseas deals totalled
US$154 billion in the first six months of 2014
“Hong Kong has long served as a bridge between China and the world, but in recent years, its investment role has started to transfer from gateway-in to gateway-out,” says Lin.
More than 3000 Chinese investment companies have set up in Hong Kong that can do deals without the cumbersome approval processes they face on the mainland.
With its strong rule of law, free capital flows, transparency and minimal government interference, Hong Kong will continue to benefit as outbound merger and acquisition activity grows.
Combined Chinese and Hong Kong overseas deals totalled US$154 billion in the first six months of this year, up 39 per cent from the second half of 2013, according to industry news watcher Mergermarket.
“Due to significant political and cultural differences, Chinese companies face challenges at every stage of outbound investment,” says Lin, citing due diligence and human capital as two examples.
“For many Australian businesses, Hong Kong should continue to be a natural and complementary part of their China strategy.”
But Weng Wei, Shanghai FTZ’s managing director, sees things differently. “The Shanghai Free Trade Area is a bridgehead for the globalisation of Chinese companies. We give more choice to clients who used to invest overseas through Hong Kong,” he says.
The South China Morning Post has reported that Weng expects more than 100 mainland China companies to have invested up to US$4 billion overseas by the end of this year.
And there are signs that things are starting to happen. Overseas parent companies of units registered in Shanghai may be allowed to issue so-called Panda bonds in China, and the Shanghai Gold Exchange may start bullion trading there this year.
As well, a trial program that allowed Shanghai and Hong Kong investors to buy stocks on the other exchange was heralded as a success.
And despite a recent slew of anti-monopoly probes into foreign businesses operating in China, lawyers have welcomed legal changes in Shanghai to boost arbitration and allow injunctions and restraining orders in business disputes.
Weng has acknowledged that Hong Kong isn’t about to be usurped by Shanghai. He sees both cities working as gateways for Chinese companies going out into the world. “They can work together,” he says.
Alexis Garatti, an analyst for Hong Kong-based equity research service Haitong International Research, says the zone will raise the role of Shanghai, but it’s “almost certain that Hong Kong will keep on as the window on the capital markets in China”.
More Chinese investors are demanding to invest in overseas assets to diversify their portfolios, says Garatti. “In recent years Chinese stocks have underperformed. That’s why there has been increasing demand for diversification.”
Garatti insists that Hong Kong will remain a key route for capital outflows, provided it remains politically stable.
Protests in Hong Kong over China’s planned system of election for the city’s next leader may yet impact the city’s relationship with the government in Beijing.
A warning shot was fired when mainland Chinese media covered a report saying that as a centre for commerce and finance, Hong Kong could be overshadowed by a host of inland Chinese cities as soon as 2022.
The report – by Trigger Trend, a Chinese research firm based in the neighbouring city of Guangzhou – noted Hong Kong’s annual GDP growth already lagged behind Shanghai and dawdles at about 2 per cent, compared with China’s more than 7 per cent.
But Hong Kong’s position is built on other factors, including its appeal as a place to live.
The centre of China’s export industry for the past 35 years, Guangdong is now seeking to move up the value chain.
While it may have worsening air pollution and high property prices, it also has a thriving international culture, world-class schools and is an easy place to do business.
China’s government, too, values Hong Kong’s role as a conduit, allowing yuan to be drawn from the city’s automatic teller machines and Chinese companies to tap investment by listing on the city’s stock market.
Hong Kong may get another opportunity to piggy-back on market reforms as more free trade zones are set up in China.
BDO’s Chan believes as many as 12 municipalities and provinces have the tacit nod from China’s central government to prepare their own zones.
And inside information says the southern province of Guangdong, adjacent to Hong Kong, may be the next zone to be declared.
The centre of China’s export industry for the past 35 years, Guangdong is now seeking to move up the value chain. And Hong Kong has the financial infrastructure and expertise to capitalise on having a free trade area on its doorstep.
That means new career opportunities for bankers, businesses, lawyers and accountants will be a commute away rather than requiring a relocation north to Shanghai.
“There will be a lot of collaboration between Hong Kong and Guangdong to really package it as an alternative to Shanghai,” predicts Chan.
This article is from the November 2014 issue of INTHEBLACK.