China opens new trade zone in Shanghai, reform plans unveiled

By Gabriel Wildau and Pete Sweeney SHANGHAI (Reuters) - China opened a new free trade zone in Shanghai on Sunday in what has been hailed as potentially the boldest reform in decades, and gave fresh details on plans to liberalize regulations governing finance, investment and trade in the area. Officials gave no details on when specific initiatives will be implemented but the government has said most will be introduced in the next three years. The Shanghai FTZ, which covers an area of nearly 29 sq km on the eastern outskirts of the commercial hub, was approved by China's State Council, or cabinet, in July. State-run Xinhua news agency quoted Commerce Minister Gao Hucheng as saying that the creation of the FTZ was a crucial decision for China's next wave of reform and opening-up. "It follows the trend of global economic developments and reflects a more active strategy of opening-up," Gao said at the launch ceremony. The State Council said on Friday it would open up its largely sheltered services sector to foreign competition in the zone and use it as a test bed for bold financial reforms, including a convertible yuan and liberalized interest rates. Economists consider both areas key levers for restructuring the world's second-largest economy and putting it on a more sustainable growth path. Some Chinese and foreign firms are already setting up subsidiaries in the zone. A total of 25 companies so far have been approved to start operations in a variety of sectors, alongside 11 financial institutions, most of which are domestic banks but including the mainland subsidiaries of Citibank and DBS. Ralph Haupter, corporate vice president of Microsoft Corp, speaking on the sidelines of the opening ceremony, said Microsoft was excited about the zone's potential. "Details and sizes of business are hard to predict at this stage. But business is continuously growing and the entertainment business is very important for us at Microsoft." A Xinhua report quoted a document from China's Ministry of Culture saying the ministry would remove a 13-year old ban on video game console manufacture and sale for companies registered in the zone, provided the products were approved. "Foreign game machine manufacturers will be eligible to sell their products in China, merely via their entities registered in the zone," the report said. HIGH HOPES, OR NOT? Some have compared the FTZ, which integrates three existing zones, to Deng Xiaoping's creation of a similar zone in Shenzhen in 1978 which was crucial to China's economy opening up to foreign trade and investment. Optimism among mainland investors that the zone will trigger fresh investment and infrastructure spending has sent property prices and FTZ-related stocks soaring in recent weeks. Skeptics point to a similar scheme launched last year near Shenzhen, in Qianhai, that so far has failed to meet expectations. But analysts and economists say that the Shanghai plan is more ambitious and specific, such as in regulations on how foreign and Chinese individuals can invest across borders. Foreign and Chinese investors have only been allowed to invest cross-border by buying into funds regulated through either the Qualified Foreign Institutional Investor (QFII) program or the Qualified Domestic Institutional Investor (QDII) program, both of which are restricted by quotas. But Dai Haibo, deputy director of the zone administrative committee, said on Sunday foreigners and Chinese in the zone would be allowed to invest funds directly for the first time. He did not say whether they would also be subject to a quota. He also said that foreign banks in the zone would be allowed to issue bonds in the domestic market. Officials said China would develop an international oil futures trading platform in the zone and encourage foreign participation, part of attempts to upgrade commodities markets and hedge risk in the world's largest energy consumer. The insurance regulator added on Sunday that it would support allowing foreign health insurance providers to operate in the zone and would also back the development of yuan-denominated cross-border reinsurance, among other reforms. REGULATORY REQUIREMENTS FOR FOREIGN BANKS Regulations of Chinese and foreign banks will also be eased, said Liao Min, head of the Shanghai branch of the China Banking Regulatory Commission (CBRC), adding the CBRC will adjust loan-to-deposit ratios and other regulatory requirements related to cross-border financing for banks in the zone. Cross-border financing could potentially drastically reduce funding costs for Chinese firms and expose domestic banks to more foreign competition, but would also provide Chinese banks an outlet to find new clients overseas. Liao said that the government would consider easing regulatory requirements for foreign banks when they apply to upgrade representative offices to full-fledged branches in the zone, and it would accelerate the application process for foreign banks applying for yuan settlement licenses. Both functions are key for foreign banks seeking to do business in China, and the slow pace of approval has been a subject of frequent complaints from foreign bankers. Given the mixed history of other capital account reform projects and the current speculative environment, regulators have been signaling caution in recent weeks. The project is widely considered to be a pet program of Premier Li Keqiang but he did not attend the opening ceremony. The heads of the central bank and the foreign exchange regulator were also absent. The highest ranking official from the central government was Commerce Minister Gao. State media have run commentaries warning against undue property speculation, and have said that the most dramatic reforms were unlikely to be enacted this year. "All reforms to interest rate and exchange rate systems will be based on the premise of risk control," Zhang Xin, head of the Shanghai branch of the People's Bank of China, told a press conference on Sunday. Experts also doubt Beijing will be able to implement major changes in the zone without them spilling over into the rest of the country. Numerous high profile academics and officials have argued publicly against introducing them in this way. There have also been reports of bureaucratic turf wars over which agency will drive financial reform. Liao Qun, China chief economist at Citic Bank International, said the tone of the master planning document remains cautious given the challenges. "Liberalization may not be realized all at once." Foreign investors continue to await the publication of a "negative list" of banned investment targets and industries. In the past foreign investors were put off by vague explanations of what industries could be invested in and what remained off limits. The negative list concept would allow free foreign investment in any industry not specifically on the list. Shanghai government officials told Reuters the list would be published at some point on Sunday. Reuters was unable to find such a list on any major government website at time of reporting. (Additional reporting by Jiang Xihao and David Lin in SHANGHAI and Michelle Chen in HONG KONG; Editing by Jeremy Laurence and David Cowell)