SHANGHAI DEFINING ITS ROLE AS AN INTERNATIONAL FINANCIAL

UNCLAS SECTION 01 OF 05 SHANGHAI 000410 SENSITIVE SIPDIS DEPT FOR EAP/CM NSC FOR MEDEIROS AND LOI STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI, MAC/OCEA TREASURY FOR OASIA/INA -- DOHNER/WINSHIP/YANG TREASURY FOR SED -- LOEVINGER/OWENS/VAN HEUVELEN TREASURY FOR IMFP -- SOBEL/CUSHMAN STATE PASS CEA FOR BLOCK STATE PASS CFTC FOR OIA/GORLICK MANILA FOR ADB USED E.O. 12958: N/A TAGS: ECON EFIN EINV PGOV PREL CH SUBJECT: SHANGHAI DEFINING ITS ROLE AS AN INTERNATIONAL FINANCIAL CENTER REF: A. A) SHANGHAI 187 ¶B. B) SHANGHAI 191 ¶C. C) HONG KONG 1163 SHANGHAI 00000410 001.2 OF 005 ¶1. (SBU) Summary: Shanghai received a large rhetorical boost this past spring in its quest to build a modern financial sector that might eventually rival New York and London. The State Council, after months of delay, issued an endorsement of Shanghai's goal to become China's international financial center by 2020. However, Shanghai continues to struggle with regulatory barriers that will limit the ability of Shanghai officials to use the State Council document to implement far-reaching financial reforms. End Summary. ========== Background ========== ¶2. (SBU) EconOff in recent weeks met with a variety of contacts on Shanghai's plan to become an international financial center by 2020, the outlines of which were announced in April 2009 following a late-March State Council meeting (Refs A and B). According to a top official with the Pudong Financial Services Bureau, the plan had been strongly supported by the late Huang Ju, who was Mayor and then Party Secretary of Shanghai before moving to the Politburo Standing Committee in 2002. However, the State Council's April announcement embraced only part of earlier formulations, calling for Shanghai to become an international financial center and an international shipping center, while dropping mention of Shanghai becoming an economic and trade center. (Note: Shanghai officials, including Party Secretary Yu Zhengsheng and Mayor Han Zheng as of late September continue to promote development of "four centers" in Shanghai. See septel. End note.) ¶3. (SBU) The "two center" plan was endorsed with great fanfare at this May's second annual Lujiazui Forum, held in the heart of Shanghai's financial district. (Note: Pudong is an eastern district of the Shanghai metropolitan area, largely built up over the last twenty years. Lujiazui is that portion of Pudong directly across the Huangpu River from Shanghai's historic Bund and old city neighborhoods, and is home to the national or regional headquarters of a number of Chinese and foreign banks, as well as home to China's largest stock exchange, the Shanghai Stock Exchange. End note.) Top financial officials opened the Lujiazui Forum with lengthy speeches supporting the goal, including People's Bank of China Chairman Zhou Xiaochuan, China Banking Regulatory Commission Chairman Liu Mingkang, China Securities Regulatory Commission (CSRC) Chairman Shang Fulin, and China Insurance Regulatory Commission Chairman Wu Dingfu, as well as Shanghai Party Secretary Yu. The plan will take another eleven years to implement, according to Shi Haining, Director-General of the Pudong Financial Services Bureau: it took five years (2001-2005) to build the foundation, will take until 2010 to set up, and then until 2020 to complete. ========================================== The International Market Will Decide . . . ========================================== ¶4. (SBU) Much of the debate over Shanghai's plan to establish itself as China's international financial center focuses on Shanghai's ability to outcompete other Chinese cities -- including Hong Kong, which is acknowledged to have a substantial lead (Refs A and C),Beijing, Tianjin, and Shenzhen -- and to eventually hold its own against the acknowledged international centers in New York and London. SHANGHAI 00000410 002.2 OF 005 ¶5. (SBU) Officials closely tied with Shanghai's financial center plan say that Shanghai's best chance to compete for international status is to develop its comparative advantages and "allow the market to decide." Fang Xinghai, Director-General of the Shanghai Financial Services Office, and Jeffery Chen, Deputy Director-General of the Pudong Financial Services Bureau, both said that Shanghai's strongest card relative to its domestic rivals is its proximity to financial markets. They pointed out: - Shanghai is the base for China's largest stock market, largest commodities futures exchange, the world's largest gold exchange, China's only bond market, and China's only financial futures exchange. Fang Xinghai further claimed that all these markets are rated in the world's top five or ten. - Fifty percent of China's asset management companies are headquartered in Shanghai, in order to be close to these markets, said Chen. Private equity and venture capital firms are strongly attracted to Shanghai for the same reason. ¶6. (SBU) In turn, the confluence of domestic markets and players in Shanghai has already brought in international financial firms looking for a foothold in the China market. Fang noted that Shanghai has more foreign-invested bank headquarters than any other Chinese city, as well as being home to the most international insurance companies and foreign-invested mutual funds. ¶7. (SBU) By contrast, both interlocutors acknowledged that Beijing has the lead in terms of headquarters of major state-controlled banks and domestic insurance companies. Under these conditions, an executive at a foreign-invested bank explained to EconOff, China could have more than one financial center, although in her view, Beijing would no longer challenge Shanghai for overall preeminence. (Note: Of China's Big Five (state-owned commercial) banks, Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China are all headquartered in Beijing, close to the regulators; only Bank of Communications calls Shanghai home. Shanghai is headquarters to only three of China's top ten insurance companies as ranked by 2008 premium income, accounting for approximately 14 percent of total national premium income. End note.) ¶8. (SBU) Comment: Shanghai's argument that competition among domestic localities should be decided by the market -- rather than a diktat from the Central Government -- appears to reflect confidence that it already has nudged aside its domestic rivals on the international stage, while also acquiescing that it cannot gain a monopoly in the domestic market. End comment. ============================================= = . . . With A Little Help From Local Incentives ============================================= = ¶9. (SBU) Shanghai is offering some incentives to financial companies establishing local offices to level the playing field with rivals. As described by Shi, these include the following: - Individual income tax reimbursement. This is a "big challenge," said Shi, because Shanghai must compete for talent with Hong Kong and Singapore, where taxes are low, but given China's current fiscal revenue situation in which revenue growth has slowed considerably over the last two years it is not a propitious time to convince leaders to lower taxes for high-income persons. In addition, local governments are SHANGHAI 00000410 003.2 OF 005 forbidden to reduce income taxes. Instead, Shanghai is offering reimbursements: 40 percent for the top executive, and 20 percent for mid-level management personnel. - One-time bonuses from the Pudong government to new employees in financial institutions. - Fiscal subsidies, including for hiring college-educated interns. In total, through spring 2009, Shanghai had provided RMB20 million in subsidies to financial firms. (Note: Approximately US$2.9 million. End note.) - Assistance cutting bureaucratic red tape. For instance, accelerating transfer of residency status (hukou),placing children of financial firms' employees at the head of the line for local schools, and helping to locate office space. ¶10. (SBU) Shanghai also provides indirect incentives, note the officials. For instance, Shanghai has one of China's best educational systems. Other cities -- such as Tianjin -- can offer educational preferences to employees' children, but they will not be as effective, since the schools are not as attractive. Pudong Financial Service Bureau's Chen also said that Shanghai has a more transparent regulatory environment, helping to control costs as a company sets up operations. Shanghai's goal is to reduce taxes and transaction fees, so that it becomes a place where international firms can grow. Shanghai does not want to be "a center for headquarters," he said, but "a center for capital." ========================================== Financial Center Bureaucrats Gaining Clout ========================================== ¶11. (SBU) Pudong District, home to Shanghai's tallest skyscrapers and the Lujiazui Finance and Trade Zone, is gaining bureaucratic clout as Shanghai pushes to build an international financial center. In May, for instance, the State Council approved bordering Nanhui District to merge into Pudong District, more than doubling Pudong's land area. According to Chen, this measure will open opportunities to develop Nanhui's largely rural land base, to gain economies of scale from combining administration of the large port facilities in each. In addition, the Pudong Financial Services Bureau was upgraded from its former status as an office and made independent of the Pudong Reform and Development Commission, said Chen. =========================== Pilot Projects . . . =========================== ¶12. (SBU) Chen said that Shanghai is lobbying the Central Government to allow pilot projects in Shanghai as a way to achieve financial sector liberalization. Shanghai has succeeded in lobbying for pilot projects by arguing that local firms and officials will not try to skirt the spirit of the law during implementation. For instance, Shanghai-based Hua'an Asset Management received CSRC licensing as the first Qualified Domestic Institutional Investor (QDII, a program under which China-based fund managers can invest in overseas assets),said Chen, because the Pudong Financial Services Bureau offered assurances to CSRC. Fang of the Shanghai Financial Services Office said that Shanghai used the same argument in order to set up the local pilot for using renminbi in trade settlement (Ref B). ¶13. (SBU) Shanghai officials and financial sector players also SHANGHAI 00000410 004.2 OF 005 mentioned the following measures currently under consideration that would liberalize the financial sector: - Exchange-traded funds (ETFs). Both the CSRC and the State Administration of Foreign Exchange would need to approve ETFs, which would allow domestic investors to purchase instruments on the Chinese stock markets that mimic the performance of an overseas investment, said Chen. A likely first ETF on the Shanghai market would be the New York Stock Exchange (NYSE) index, he said. Asset management companies are lobbying for this measure. - Listing by overseas firms on the domestic market. Peng Su, a representative of NYSE-Euronext in Beijing, told EconOff that the NYSE index ETF for now is not being emphasized as he works on smoothing regulations to allow overseas firms such as Coca-Cola to gain access to fundraising to through the Chinese market. One continuing sticking point is whether or not to permit U.S. Generally Accepted Accounting Principles to be used in the Chinese books of these overseas firms, said Peng. Some Chinese regulators want a quid pro quo with Chinese firms being allowed to use Chinese accounting standards when listing on the NYSE. - Real estate investment trusts (REITs). Shi said that the proposal to begin licensing REITs in Shanghai had been generated by his office, since there are experts on staff who research and propose financial liberalization measures. - Opening a "credit card park." China Construction Bank has established its credit card business in Shanghai, said Shi, and Bank of China has a payment and settlement center. There are plans to establish a Shanghai Financial Information Services Park as part of the Zhangjiang High-Technology Park in Pudong, which would build off these existing services in collaboration with China Union Pay, China's leading credit card payment system. ============================================= == . . . Cannot Always Overcome Regulator Log Jams ============================================= == ¶14. (SBU) The formal process for approving new financial products is unwieldy, say our interlocutors. For instance, noted Shi, asset management companies are currently allowed to introduce only two products per year. Fang -- formerly a top executive at the Shanghai Stock Exchange (SSE) -- said each time the SSE prepares to offer a new product, such as a simple option on stocks, it is blocked because the CSRC must approve it and then report it to the State Council. If one person believes that a product is not necessary, said Fang, then it can be blocked. Fang said that he hopes the Central Government can delineate a few areas where decisions can be made in Shanghai -- more like the system used by the NYSE, in which pre-approval is not needed. ¶15. (SBU) A recent episode involving pilot incentives for private equity (PE) firms in Shanghai, however, illustrates how quickly log jams can reappear after being broken up. In June, Chen said, Pudong extended to PE firms incentives -- such as income tax reimbursement -- that are available to other financial firms. Even though it was not clear that the Central Government would approve the move, Pudong was able to convince the well-known firm Blackstone to establish a PE fund. Other multinationals quickly followed in order not to cede the first-mover advantage to Blackstone. However, Chinese media reported in September that Central Government authorities are SHANGHAI 00000410 005.2 OF 005 now reviewing the policies. ¶16. (SBU) The lack of an arbiter to break deadlocks at the Central Government level will probably continue to slow Shanghai's financial liberalization pace, say financial sector professionals. One Shanghai financial official said that a key part of the State Council's Shanghai financial center plan was for a working group to be authorized to make timely approvals (Ref B). However, as of mid-August, the working group, which is to be headed by the National Development and Reform Commission, had not yet met, a Shanghai official told EconOff. ======= Comment ======= ¶17. (SBU) The biggest challenge remaining for Shanghai's aspirations to build an international financial center by 2020 is improving China's regulatory structure, as Shanghai's hands remain largely tied by overly cautious bureaucrats in Beijing. Shanghai Financial Service Office's Fang said that he lobbies at every opportunity to open markets to foreign financial firms, which he estimates will bring much-needed expertise to Shanghai's financial sector. He said a cause of the global financial crisis was too little regulation, whereas China continues to have too much. While there are voices in the Chinese government that are using the Shanghai international financial center plan to press for greater financial liberalization, there are also clearly groups in China lobbying to limit financial liberalization, in part to protect domestic financial players.CAMP