SHANGHAI'S FUTURE AS LEADING FINANCIAL CENTER

C O N F I D E N T I A L SECTION 01 OF 03 SHANGHAI 000211

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STATE FOR EAP/CM, EB AND E
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SF FRB
FOR CURRAN/LUNG; NY FRB FOR CLARK/CRYSTAL/MOSELEY
TREASURY FOR ADAMS, AND OASIA - DOHNER, HAARSAGER, CUSHMAN
USDOC FOR ITA KASOFF, MELCHER, MCQUEEN
NSC FOR HUBBARD AND TONG

E.O. 12958: DECL: 4/11/2032
TAGS: EFIN ECON CH
SUBJECT: SHANGHAI'S FUTURE AS LEADING FINANCIAL CENTER

REF: A. SHANGHAI 159

B. SHANGHAI 174

C. SHANGHAI 133

CLASSIFIED BY: Kenneth Jarrett, Consul General, U.S. Consulate
General Shanghai, Department of State.
REASON: 1.4 (b),(d)




1. (C) Summary: During a March 23 meeting with the Consul
General and Econoff, Shanghai Futures Exchange (SHFE) CEO Yang
Maijun and Shanghai Office for Financial Services Deputy
Director-General Fang Xinghai said Shanghai's role as China's
leading financial center was secure; Hong Kong and Tianjin were
not threats; and the May or June launch of the China Financial
Futures Exchange (CFFE) should further solidify Shanghai's
position. Fang was not optimistic about short-term prospects
for reforms he had advocated in a March 6 Asia Wall Street
Journal op-ed, including liberalization of China's Qualified
Foreign Institutional Investor (QFII) and Qualified Domestic
Institutional Investor (QDII) programs, and an ability to
arbitrage the price difference on stocks listed on Mainland
China and Hong Kong markets. He hoped that at least margin
trading and the ability to take long and short positions would
be allowed soon. Yang and Fang said Secretary Paulson's March 8
speech at SHFE (Ref A) was generally well-received by its
audience of mostly Chinese financial sector officials and
leaders of Chinese financial service companies because it
identified the right course of action. However, it provoked a
defensive nationalistic response by some who did not appreciate
a foreign official telling China what it needed to do -- even if
that official was right and it was in China's own interests.
Fang said that to persuade China to undertake reforms at the
upcoming Strategic Economic Dialogue (SED) meetings in May, the
USG needed to be prepared to make concessions. He raised the
licensing of PRC banks in the U.S. as one example. End summary.

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Shanghai vs. Hong Kong: Not a Zero-Sum Game
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2. (SBU) During a March 23 meeting with the CG and Econoff, Fang
Xinghai , Deputy Director-General at Shanghai's Financial
Services Office (and a former Executive VP at the Shanghai Stock
Exchange) said that Shanghai did not face competition from Hong
Kong, Beijing or even Tianjin, as China's financial center.
Shanghai's role was well-established and secure given its
infrastructure and human-resources capital. Fang said that a
key part of his job was "developing Shanghai into a leading
financial center;" the other key role was managing the Shanghai
Government's investments in financial sector companies.


3. (C) According to Fang, Hong Kong and Shanghai's relationship
should not be viewed as a zero-sum game. Just because Shanghai
grew 10 percent did not mean that Hong Kong lost 10 percent.
Tianjin was not a real contender as a financial center and "was
only a player due to the mayor's background in financial
circles." Beijing, despite having the regulators and major
policy banks, was not a true threat to Shanghai in international
terms. To support this argument, Fang pointed to the fact that
despite heavy lobbying by Beijing's municipal government, only
two foreign banks had opted to incorporate with Beijing as their
headquarters.

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Shanghai Futures and China Financial Futures Exchanges
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4. (U) Shanghai Futures Exchange CEO Yang Maijun said that the
SHFE was the biggest of China's three commodity futures
exchanges and traded copper, aluminum, rubber and fuel oil. It
had just launched trading of zinc that week since China was the
world's top consumer. Yang said the SHFE had plans to list steel
rods, gold, nickel and oil in the near future.


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5. (SBU) Yang said that the China Financial Futures Exchange
(CFFE),co-located with SHFE, should launch its first product in
May or June. He believed that the development of CFFE had been
fairly rapid since it was announced last August. He said that
CFFE had clear political support, but that launching of trading
had been delayed by technical issues and the development of
trading processes. He reiterated that CFFE had worked very
quickly to implement something as complicated as creating an
entire market for trading financial futures.

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Need Long-Term View for Reforming China's Capital Markets
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6. (C) Fang was rather pessimistic about short-term prospects
for reforms he had called for in a March 6 Op-Ed piece in the
Asia Wall Street Journal (AWSJ) entitled "Taking Stock in
China," including increasing QFII quotas, loosening QDII
investment restrictions to increase demand, and devising a
system to allow Chinese investors to arbitrage the differences
in value of Chinese companies listed both in Hong Kong and
Shanghai. (Note: Shanghai "A" shares sell at a P/E premium,
compared to shares of the same company listed on the Hong Kong
market, "H" shares. End note.) Fang was skeptical of his
chances of influencing the policy debate in China, saying that
he did not think that most Chinese decision makers read the
English-language AWSJ. As a Chinese with extensive
international experience (see bio note paragraph 12),Fang said
one always needed to take the "long term view" to changes in
China. He said that it often took several years for a policy
proposal to become law. It was "good to talk about new ideas,
but don't have any expectations of accomplishing anything
quickly."


7. (C) Fang said that reforms the Shanghai Stock Exchange was
planning (Ref B),such as changing the 10 percent daily limits
on stock price movements and changing the settlement dates for
stock purchases, were cosmetic and not necessary or important.
What was needed, in addition to the more structural reforms he
had discussed in the AWSJ article, was the development of margin
trading and mechanisms for investors to take both long and short
positions on stocks.


8. (C) SHFE's Yang discounted rumors (Ref C) that average
Chinese investors were mortgaging real estate holdings to fund
stock purchases. Yang said that Chinese culturally found a
great deal of security in owning a house and any attempt to try
to borrow money against it to play the market was unlikely for
the average investor. For "rich people," who owned more than
one house, on the other hand, both Yang and Fang said that they
knew of people who had mortgaged a second or third property to
play the market. Fang reiterated that one of the problems with
the market was that it was made up of too many retail investors,
noting that increased QFII quotas would allow institutional
investors to play a greater role in China's stock markets,
thereby increasing stability.

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A Nationalist Reaction By Some to Paulson's Speech
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9. (C) Both Fang and Yang agreed with the fundamentals of
Secretary Paulson's March 8 speech in identifying the right

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course of action and said Chinese financial leaders did as well.
According to Fang, however, some Chinese officials questioned
the tone of Secretary Paulson's remarks, noting that he had
spoken "very directly" and "was telling us what to do." Yang
and Fang agreed that Secretary Paulson had the credentials to
give such a speech, but it had caused some in the audience to
react in a "nationalistic" or defensive manner. Fang also
critiqued the Secretary's assertion that he had "never seen a
successful joint-venture securities firm" despite having been
the head of the Goldman Sachs investment firm when it formed
such a joint venture in China. (Note: Fang was referring to the
Goldman Sachs-Gaohua joint venture. End note.) Fang said that

SHANGHAI 00000211 003 OF 003


this critique was a "direct attack" on the Chinese model that
had only allowed foreign securities firms to invest in China as
joint ventures and would have been noted as such by Chinese
financial leaders.

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SED: Just Because We Should Doesn't Mean We Will
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10. (C) Fang said that the U.S.-China Strategic Economic
Dialogue (SED) was a useful forum for senior-level discussions.
Regarding increased financial sector liberalization in China, he
said that just because what the United States has asked China to
do what was in China's own long-term interests did not mean that
China would do it without concessions. The Chinese government
had institutional issues it needed to overcome and domestic
interest groups that were resistant to the reforms called for in
the Secretary's speech. Furthermore, due to China's political
calendar, Chinese officials would be unwilling to undertake any
risky or controversial reforms until after the Party Congress in
the fall.


11. (C) Fang added that the Chinese side would expect to receive
concessions from the U.S. side for any concessions it made. He
pointed out that at the same time the United States was pushing
China for access to its market, no Chinese bank had been
licensed to open in the United States and, after such deals as
CNOOC had been blocked, China was feeling that its access to
U.S. markets was increasingly fragile and certain parts had been
closed off to Chinese investors and goods.

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Bio Notes
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12. (U) Fang Xinghai has a PhD in Economics from Stanford
University (1993) and a BS in engineering from Tsinghua
University (1986). In 1993 he joined the World Bank's Young
Professional Program as an economist/investment officer in
Washington, DC. In 1998, he returned to China and worked at the
China Construction Bank, China Galaxy Securities Company, and
was Deputy Chief Executive Officer of the Shanghai Stock
Exchange from 2001-2005. He became Deputy Director-General of
the Shanghai Office for Financial Services in December 2005. He
is married and speaks fluent English.


13. (U) Yang Maijun was born in 1955 in Dali, Yunnan Province.
In the early 1970s, he worked on a farm in Yunnan Province for
two years and then at a factory for three years. He was one of
the successful applicants in the first round of college entrance
examinations at the end of the Cultural Revolution. He was
appointed General Manager and CEO of the Shanghai Futures
Exchange in August 2006. Prior to joining SHFE, Dr. Yang was
Director of the Futures Supervision Department at the China
Securities Regulatory Commission. He is married. He
understands more English than he speaks and is able to
communicate on financial issues in English at a 3 level.
JARRETT