Over the past few weeks, the Shanghai Free Trade Zone (FTZ) has captured business headlines here in China and abroad as discussion continues about the impact that the zone will have on reform in China. As of October 30th, 208 companies have registered in
the zone in just under one month, notably 36 in the asset management sector.
One of the early announcements was the commitment from Citibank and DBS to enter the zone. When we initially heard that these banks were so committed, we were a bit skeptical. Often foreign companies in China support government programs to better their relationship
with the government. However, in the past couple of weeks, we have changed our view.
The FTZ itself, although the future reforms are somewhat unclear, will open up a number of immediate near-term opportunities for banks in the zone. These opportunities primarily revolve around non-reform related products and services:
Chinese Yuan / RMB fungibility – One of the key aspects of the zone will be what happens to Chinese Yuan (also known as RMB) fungibility or the ability to exchange RMB freely for other foreign currencies. Although it is a bit unclear exactly
what exchange will be possible, the feeling is that some reforms to help open up convertibility will happen. At a minimum, a RMB system somewhat similar to the Hong Kong CNH where the RMB currency is held offshore and is essentially treated as a completely
separate currency – although still limited by exchange restrictions.
Trade – Interestingly, although this is a fairly obvious one, as the Shanghai Pilot FTZ is currently setup somewhat like a mini-HK or offshore port, trade services for companies setup in the FTZ will either need to come from banks within
the FTZ or overseas banks. So if you think about this, currently, if you are a manufacturer in China, you would likely either be using a domestic bank or the domestic branch of a foreign bank for LCs, Loans, Bank Guarantees, etc.. If you are a manufacturer
in the free trade zone however, you will need to have a bank either also in the free trade zone or overseas as the FTZ is essentially an offshore market.
Interest rate exposure – As a few industry experts have pointed out, interest rates in the FTZ do not have to necessarily be the same as those outside of the zone. While this may bring some somewhat challenging issues for corporates who
are setting up in the zone to manage interest rate risk both in the zone and outside, it does offer banks an opportunity to provide interest rate related services and risk management tools to the corporates they serve in the zone. It will take some time before
we can really determine what these might be, but certainly will be an opportunity.
Experience with reforms – Finally, by being in the zone, banks will learn through first hand experience how any reforms will change their industry. Although there is some debate as to how lined up the Chinese government is behind real reform,
especially with the November plenary on the near horizon, but certainly any of the near-term reform will happen in the Shanghai FTZ at least as a test and then for further roll-out through-out the country. Banks that are there now will be able to test and
Good relations and good opportunities
So overall, it would be remiss to say that banks and companies like Microsoft, Citi and DBS are not entering the zone to better their relationships with the government, there certainly is some of that involved in their decision-making process. It is also
clear that first movers will likely have better advantages in the long-term. What the examples above do show as well is that there are additional product and service opportunities for banks in what will be a relatively open and uncompetitive market – at least
in the short term.