China: Backtracking on reforms not an option
The opening up of the Chinese financial sector to majority foreign ownership is an important and strategic move, but the guidelines curtailing banking sector liberalization make it look like one step forward, two steps back.
By Noah Sin
After years of waiting, Wall Street bagged a victory in China in early November 2017 when the government announced that foreign firms would be allowed to own majority stakes in a range of local financial sector players, from local banks to securities joint ventures.
The timing of the announcement – right after Donald Trump’s first visit to China as US president – was important. For the White House, this was perhaps the biggest win of the trip, dwarfing the $250 billion of deals signed in Beijing.
The announcement on foreign majority
China may have had ulterior motives. Alongside being a nice gift to the US administration, the removal of ownership caps could also be seen as a strategic manoeuvre by Beijing to bring US-China trade back into balance, as some analysts have pointed out.
Foreign participation in the Chinese financial sector will help widen the US services surplus with China, which amounted to $37.4 billion in 2016, according to the Office of the US Trade Representative. This, in turn, will go towards offsetting the deficit in goods, which stood at a considerably larger $347 billion in the same year.
China’s decision comes at a particularly opportune time given that politicians in Washington and Europe are growing increasingly unhappy with Chinese dealmakers.
According to a report in September by the Committee on Foreign Investment in the United States, 29 of the 143 transactions under review for national security concerns in 2015 were acquisitions involving companies from China, more than any other country on the list.
The announcement is, then, a mark of real progress. But China quickly followed up one set of liberalization measures with an odd step.
On November 16, just six days after the reform was announced, the China Banking Regulatory Commission (CBRC) published draft rules that will require shareholders planning to own more than 5% of a Chinese bank to register with it for approval.
Furthermore, the rules will forbid any entity from holding more than a 15% stake in any bank through investment pools such as funds and insurance plans.
These rules certainly make sense in the domestic context. They skew towards rural banks that are transforming into commercial banks. The proposed changes could help diversify the investor base in these banks and improve the quality of capital, and are therefore credit positive for Chinese financial institutions overall, according to Moody’s.
But from the perspective of potential investors in those institutions, the announcement tells a different story, namely of China opening up the financial sector on the one hand, while simultaneously demanding a final say over who gets to own a Chinese bank on the other. Perhaps the touted big bang is not so explosive after all.
Not that the CBRC’s new veto power has taken foreign banks by surprise. Initial responses to the liberalization were lukewarm at best, and China has a long history of slipping caveats (explicitly or otherwise) into its reform measures.
So, while caution can be justified domestically, where policymakers have expressed the desire to contain financial risks at all costs, China should also be aware that steps like the CBRC draft rules do little to bolster the confidence of foreign financial institutions in its intention to truly liberalize its market.
A more desirable approach would be for China’s leadership to swing the door wide open and champion globalization in an increasingly closed world, a vision president Xi Jinping outlined in his Davos speech last January.
If China really wants to show its commitment to globalization at a time of rising protectionist pressures, one way would be, for example, by exempting foreign financial institutions from the CBRC draft rules.
Xi’s new era begs for a new approach. The financial sector would be a good place to start.