Huabin Wang

Assistant General Manager

Bank of China Limited, London Branch

September 23, 2014

CHINA (SHANGHAI) FREE TRADE ZONE

—Implications and Considerations

Table of Contents

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3

CHINA (SHANGHAI) FREE TRADE ZONE

2 INTERPRETATION OF FTZ FINANCIAL POLICIES

DEBATES AND OUTLOOK

2

Officially launched on

29 Sep 2013 Keywords: China’s

Pilot

Scope of implementation: 29 kilometers, including 4 existing

zones: Waigaoqiao Free

Trade Zone;

Waigaoqiao Free

Trade Logistics Park;

Pudong Airport

Comprehensive Free

Trade Zone; and

Yangshan Free Trade

Port Area.

China’s (Shanghai) Free Trade Zone

3

issues in infrastructure/system, relationship between the government and the market

use Shanghai FTZ as a pilot zone

Duplicable mode

Progress in a controlled manner

Why?

How?

Position of Shanghai – RMB home market

In theory, Shanghai should have played more important role in RMB internationalisation.

Why Shanghai FTZ – at the right time

4

China Today – Special Stage

Economic growth

slowdown

Throes of the economic restructure

Digestion of the 4trillion Yuan economic

stimulus

FORCEFUL REFORM

Financial reform

RMB internationali

sation

breakthrough

RMB free convertible Capital account control

Capital account open is a MUST for a currency’s internationalisation

Traditional Currency Internationalisation

Innovative RMB Internationalisation Separate

from

Let RMB circulate under the capital account but keep the control of its

convertibility to protect domestic macro economy.

Special path of RMB internationalisation

5

Circulation first, convertibility follows

when time comes

Cannot do -> can do (negative list management)

National treatment before admittance

A challenge of the traditional philosophy

Promote reform by opening up

Accelerate economic restructuring by opening service trade

Strive for higher-standard opening by the pilot free trade zone

Significance to China’s Reform

Shanghai FTZ Vs Reform

6

Functional transformation of

government

Simplify the approval process, strengthen the supervision function, and complete the review process

Custom “Frontier opening, second-tier effective and efficient control”

Changes in polices re tax, forex, custom and commerce.

Open up investment sectors

Opening up of financial, shipping, commercial, cultural, social and professional services

pre-national treatment, and negative list

To build a system to promote overseas investment

Open up Financial services

Innovative financial policies

To establish financial transaction platform

Opening up of FIs and services

Promote the development of financial services

Transformation of Trade development

approach

To encourage the establishment of the Asia-pacific headquarter, operational centre, and international settlement centre

To establish international commodities trading and resources allocation platform

Promote Shanghai as a shipping centre and business such as finance lease, cross-border e-commerce etc.

Shanghai FTZ Policy Framework

Shanghai FTZ Policy Framework

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Foreign

Companies

12%

Chinese

Companies

88%

Business registration

Services

20%

Investment

19%

Others

3%

Trade

58%

Industries

By the end of June 2014, there are 10,445 companies registered in the FTZ, of which 1,245 are foreign funded.

By the end of July, 84 licensed FIs and 2878 financial service firms registered in the FTZ.

Snapshot of entities in the FTZ

Type No.

Foreign Banks 23

Transaction Clearing Institutions 17

FI reinvestment projects subject to CSRC

approval 15

Chinese Banks 14

Insurance companies 11

Commodities trading platform 2

Non-banking FIs subject to CBRC approval 2

Type No.

Financial leasing companies, private equities 595

Financial info providers 267

Investment and asset management

companies 2101

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Table of Contents

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3

CHINA (SHANGHAI) FREE TRADE ZONE

INTERPRETATION OF FTZ FINANCIAL POLICIES

DEBATES AND OUTLOOK

9

Interpretation of FTZ financial policies

OBJECTIVES: Deepen innovation and opening up of financial services

Accelerate the innovation of financial system. Under proper risk control, the China

(Shanghai) Pilot FTZ will pilot RMB capital account convertibility, interest rate liberalisation

and the cross-border use of RMB.

POLICIES ANNOUNCED IN:

RMB internationalisation

Interest rate liberalisation

Foreign exchange rate liberalisation

Opening up of the capital accounts

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1. Foreign direct investment shall be subject to approval and overseas investment are also restricted

2. Chinese residents shall not have foreign debts, and foreign debts are subject to scale management.

3. China’s capital market shall not be open to foreign capital, which may participate in the market by

special channels, such as QFII.

CAPITAL ACCOUNTS OPENING: Based on the capital account definition of IMF, there are 43

capital accounts, most of which have been liberalized in China. At present, there are only three capital accounts subject to control in China

FTZ financial policies — RMB internationalisation

1 Cross-Border Two-Way RMB Cash Pooling

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Account of

enterprise in the

FTZ

Subsidiary A

Subsidiary B

Subsidiary C

Subsidiary A

Subsidiary C

RMB cash pooling

Remove previous restriction on quota.

Free Fund transfer between offshore and onshore, cash flows generated in

production, operation and industrial investment activities.

No cash flows from financing activities at moment

Subsidiary B

Loan costs Other costs Loan-to-deposit ratio &

amount limitations

Enterprises registered in

HK

Around 4.2%-4.4% Financing guarantee

issuance fee >1%

None

Enterprises registered in

the FTZ

Around 5.2% None None

Onshore

enterprises(outside the

FTZ)

≧6% None Strict limitations apply

tight liquidity in the market

Case Study: Cost comparison on three scenarios for a 1-year RMB loan

FTZ financial policies — RMB internationalisation

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2 Overseas RMB Loan for Enterprises in the FTZ

Benefits to Clients

More access to offshore capital/finance market

Lower financing costs

Receipt and Payment under the traditional supply chain Onshore (outside FTZ)

40 60

50

100

30

A

B

C

Overseas company

Receipt and Payment under the FTZ mode

60

20

20

20

A

B

C

Overseas company

Special RMB deposit account

in a bank located in Shanghai

Offshore

Onshore (outside FTZ) FTZ Offshore

FTZ financial policies — RMB internationalisation

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3 Centralised RMB Cross-border Current Account Receipt and Payment

Benefits to Clients Netting payments

Efficient payments

Less position management costs

4 Cross-border E-Commerce RMB Payment

Co

mm

erc

ial O

pp

ort

un

itie

s

Provide opportunities for E-commerce firms get into the vast Chinese market

i.e. 2013, the total transaction volume in China E-commerce market was 9.9trillion Yuan (around US$1.57trillion)

Co

st w

ise

Lower cost, saving forex conversion cost

Op

era

tio

n

Enhance the efficiency of fund settlement with upstream and downstream enterprises

FTZ financial policies — RMB internationalisation

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Enhance pricing supervision mechanism during the IR liberalisation

Issuance of transferable CDs

Remove the upper limit of IR under current accounts in the FTZ(small

amount, foreign currency)

FTZ financial policies — Interest rate liberalisation

Principles towards IR liberalisation:

“foreign currency goes first, RMB follows large amount goes first, small amount follows; Loan goes first, deposit follows”

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FTZ financial policies — Forex management reform

Benefits to Clients: Manage the foreign debt and lending quotas of all its members on a centralised basis

Enhance the efficiency of cross-border capital use.

Reduce financial cost.

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Cross-border foreign currency cash pooling

Domestic foreign currency main

account of firm in the FTZ

Current

Account

Foreign

debt

account

Settlement

Account

（Overseas

subsidiaries）

Other overseas

subsidiaries

International foreign currency

main account of firm in the

FTZ

Net out-going transfer cannot exceed

50% of owner’s equity of the group.

Capital, Assets

Realisation &

reinvestment

account

Domestic cash pool

Cross-border

Overseas cash pool

Net in-coming transfer cannot exceed

combined foreign debt limit of all members

• FREE TRADE UNIT FTU

• FREE TRADE ENTITY FTE

• FREE TRADE NON-RESIDENT FTN

• FREE TRADE INDIVIDUAL FTI

• FREE TRADE FOREIGNER FTF

The split accounting system in the FTZ enables an enterprise to open both traditional account (second-tier account) and FTA (first-tier account) at the same time.

FTZ financial policies — Opening of capital accounts

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Split accounting system by introducing Free Trade Account

FTE

Free Trade

Entity

account

Offshore accounts

NRA outside

FTZ (OSA/NRA)

Other

settlement

accounts

under the

same entity

Other FTEs

FTN

None residents

free trade

account

Other

settlement

account

Frontier prudent management Tier-two limited access +Strict control

Offshore Onshore (outside the FTZ) In the FTZ

Treated as

cross-border

Current

account,

direct

investment

Conditional

circulation

FTZ financial policies — Opening of capital accounts

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Split accounting system by introducing Free Trade Account

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CHINA (SHANGHAI) FREE TRADE ZONE

INTERPRETATION OF FTZ FINANCIAL POLICIES

DEBATES AND OUTLOOK

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2

3 4 5

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HOWEVER, the RMB internationalisation is a fact and the journey is irreversible. The only question is the pace of travel not the direction.

Creating Shanghai FTZ is a crucial move for China in executing its proactive opening-up strategy to explore best practices in financial management that are replicable nationwide.

The opening-up policies being implemented in Shanghai FTZ will largely shape the future landscape of China’s financial services industry.

HESITATE, WAIT AND SEE?

Debates and Outlook

… if Shanghai Free Trade Zone goes well, it is expected to achieve “ (RMB) circulate first and free convertibility follows” in three years (2017)….

-Dr. CAO YuanZheng (Group Chief Economist, Bank of China) said on September 20, 2014

Debates and Outlook

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…there is a big future for Shanghai Free Trade Zone, there is

a big future for Shanghai …

- said Premier LI Keqiang during his visit to Shanghai

FTZ on September 18, 2014

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