Observers welcome moves toward liberalization

The opening-up of China's financial markets could be one of the next major global trends, according to experts.

It could result in an influx of trillions of dollars from foreign investors, shifting the balance of the global financial system.

Chinese authorities have taken an incremental approach to the opening-up process because of the risk of violent capital flows destabilizing the economy.

Policymakers have always wanted to avoid a repeat of the Asian financial crisis of the late 1990s and those that have affected other emerging markets, such as Russia and some Latin American countries.

Now, there are clear signs that China is stepping up momentum to open up its financial sector, with next year set to be a landmark.

On Jan 1, financial authorities will remove limits on foreign ownership of futures companies operating in the country. This will be followed by the removal of caps on foreign ownership of mutual fund companies on April 1 and on securities companies on Dec 1.

Jin Keyu, an associate professor of economics at the London School of Economics, believes China's financial opening-up could be hugely significant for the world.

"It is one of the last liberalizations that China needs to do, and given the size of the country, it will be important for the world because China will be integrated, not just through trade, but also through capital flows," Jin said.

In addition to the recent announcements, China has expanded the Connect programs linking the Hong Kong Stock Exchange with the markets in Shanghai and Shenzhen, Guangdong province. These programs allow investors to trade shares both in Hong Kong and on the Chinese mainland. In June, the Shanghai-London Stock Connect was also launched, further internationalizing Chinese stock markets.

Furthermore, a new Bond Connect was launched in July, allowing access to China's inter-bond market and mainland investors entry to international bond markets.

In September, the central government abolished limits on the Qualified Foreign Institutional Investor and RMB Qualified Foreign Institutional Investor programs, allowing much greater access to Chinese markets.

As a result of these moves MSCI, the global index provider, announced this month it had raised the weighting of Chinese stocks in its emerging market index from 2.55 to 4.1 percent.

Jing Ulrich, vice-chairman of global banking and Asia Pacific for investment bank JP Morgan Chase& Co, said China now has a clear strategy to open up its financial markets.

"These moves are important and we welcome the government's efforts to further open up its financial markets. We believe that they will have positive implications for both China and the international community. In the past, China's capital markets were not very accessible to foreign investors," she said.

George Magnus, an associate at the University of Oxford China Centre and former chief economist at investment bank UBS, said the various measures taken by the Chinese government in recent months will benefit the country.

"They have all raised capital inflows into China, and entailed foreign investors taking more and more China risk," he said.

"China's opening-up comes at a time when the country is looking increasingly to foreign capital inflows, especially US dollars, to alleviate balance of payments and other financing constraints. There is no apparent intent to remove or lower controls on capital outflows."

China has been subject to tight controls on capital outflows since 2015, when there was speculation against the yuan after an adjustment to the exchange rate mechanism.

Some observers argue that it is difficult to have an open financial system without a fully open capital account.

Zhu Ning, deputy dean and professor of finance at the Shanghai Advanced Institute of Finance, said this remains the main barrier to an open financial system.

"I am probably more pessimistic on this than I was three or four years ago. The short-term pent-up demand for outflow is getting stronger and stronger, which makes it harder to open the floodgates."

Jin, at the London School of Economics, believes it is possible to open up the financial sector without a fully open capital account.

"Opening up financial services inside China is different from the free movement of capital flow," she said.

Jin stressed that it is important not to be "absolutist" about what constitutes a fully open capital account.

"Capital account liberalization can take on many different shades and categories. It is possible to be very nuanced about the particular type of capital flows that can be controlled," she said.

Ulrich, at JP Morgan Chase, believes the authorities have been adept at doing this.

"The asymmetric capital account openness measures adopted in recent years－relaxing rules to encourage inflows from global institutional investors and tightened restrictions on domestic outflows－has led to balanced capital flow dynamics," she said.

One of the reasons for opening up the financial sector to foreign businesses is that local companies will benefit from the competition, and this could help modernize China's financial system.

Xu Bin, professor of economics and finance at the China Europe International Business School in Shanghai, believes this could be the case.

"The real question is to what degree this will be done. If China's financial sector is about private companies delivering products, then the positive influence of foreign institutions is going to be big. If it remains made up of mainly State-owned financial institutions, then the effect will be much less."

Jin said, "The banking and financial system needs more competition and there is none better than foreign competition, because financial institutions in the United States and Europe have a substantial advantage," he said.

Ulrich said such competition would not only impose discipline, but boost domestic consumer confidence.

"Foreign institutions' participation would improve market discipline and business practices in the banking, insurance and securities industries. A continuous openness policy is also important to bolster domestic confidence," she said.

Whether further financial opening-up will lead to Shanghai, or even Shenzhen, becoming global financial centers, like London and New York, remains open to question.

Magnus, the author ofRed Flags, which focuses on the risks in China's financial system, said a number of steps have to be taken for this to be achieved.

"You can't really have a global financial center, as commonly understood and attracting thousands of participants and global institutions, in which there are formal restrictions on capital movements and only a partially convertible currency. There is also an issue concerning the situation where you have a government that is conflicted between being a participant in, and the regulator and owner of, the financial system," he said.

Xu, at CEIBS, said trying to build Shanghai as an international financial center was not the main focus of opening up.

"This ambition to make Shanghai an international financial center is not at a high point. I don't want to say it is fading away. People are still talking about it, but it is not a priority."

One of the major debates about financial opening-up is whether a country can become the world's second-largest economy and remain closed off to the global financial system.

Zhu, from SAIF, said: "This is something the USSR achieved. It was the world's second-largest economy and was a fully closed economy. It also fared well in the 1970s when the Western world was suffering from stagnation. It was never a powerful economy, though, and never had the influence that China is enjoying right now."

For Zhu, such opening-up is an important stage in the development of the economy.

"Opening-up has the potential to transform China's financial system and deal with some of the structural issues that beset the Chinese economy, and help it navigate through the so-called middle-income trap."

Precisely when China will have an open financial system is often speculated on, with dates such as next year or 2025 being bandied about.

Jin said: "It will remain a step-by-step process. I would expect it to be in the next few years and not long into the future.

"I hope foreigners will have the confidence that their participation is very much welcome. I think the Chinese government will do everything to provide them with a level playing field, and so I think it is all very positive."