Huang Shaoyi/China Foto Press

Focus: Financial Services

Financial Services

Financial sector reform has proceeded steadily in recent years—but still has some way to go

by US-China Business Council staff

Modernizing the financial sector is the most important of China's unfinished economic reforms. A rational, sound, and competitive financial system lies at the heart of a market economy, channeling capital to its most efficient and productive uses. Consumers benefit from better savings, investment, and credit systems. Financial sector reforms are critical to China's sustained economic growth, which is important not only to China but also to the rest of the world.

China's leaders understand the importance of financial sector reform and have made much progress in a relatively short time. The PRC government has established financial laws and regulatory institutions where, in essence, none had existed before. PRC policymakers began this work in earnest in the late 1990s with the establishment of a host of new regulators and continued the transformation through China's World Trade Organization (WTO) entry agreement in 2001. Their efforts have affected all sectors of the financial services industry, including banking, securities, insurance, credit rating services, consumer finance, electronic payments (see Modernizing China's Electronic Payments System), asset and fund management, and leasing services. At the same time, regulations govern, or are under development for, an ever-increasing number of new or sophisticated financial instruments, including financial derivatives, securitizations, and other modern capital markets products.

Though the pace of China's financial reforms has not been as fast as many observers would like, China has recently taken notable steps in a number of areas.

Banking

China's top leadership and foreign industry participants alike consider banking a pivotal sector when addressing potential areas of macroeconomic instability such as capital misallocation and excessive investment. Banking sector reforms also address microeconomic challenges such as developing new credit and investing options, developing healthy businesses in rural areas, and aiding small and medium-sized enterprises.

Since its WTO entry in late 2001, China has gradually granted foreign banks somewhat greater powers and market access. Perhaps the most important example is the permission foreign banks gained in 2006, consistent with China's fifth-year WTO commitments, to set up operations across China to offer services to domestic consumers.

For the most part, the China Banking Regulatory Commission (CBRC) has been the principal authority for regulations related to banking. In some cases since 2006, however, elements of China's financial system development were beyond CBRC's scope. In 2007, for example, the National People's Congress passed the Enterprise Bankruptcy Law; the People's Bank of China (PBOC) sought to further develop China's credit information database, and the NPC pushed for a related privacy law; and PBOC, China Insurance Regulatory Commission (CIRC), China Securities Regulatory Commission (CSRC), and CBRC took further steps to authorize crossover shareholdings. Finally, the government recapitalized several Chinese banks, and some banks began to prepare for stock market listings.

Since 2006, CBRC has made several reforms in its own areas of responsibility. These include releasing new bankowned leasing company regulations, proposing a scheme for deposit insurance, and reviewing more than 100 city commercial banks and four large city-based banks for listing. CBRC has also reviewed branching regulations for city commercial banks, officially opened the individual consumer banking sector to foreign companies on December 11, 2006, produced local incorporation regulations for foreign banks as well as accompanying implementation details, and approved 12 foreign banks in the first step toward full registration in China to conduct renminbi (RMB) business with all individuals. Several have been fully approved (see China Data: Foreign-Invested Financial Institutions in China)

Though CBRC retains the lead role in implementing banking reforms, PBOC, SAFE, CSRC, and CIRC have some overlapping authority in this sector. China has floated the idea of a new super-regulator for the financial sector, but discussions have not yet yielded concrete plans. The creation of such a regulator could affect the division of work among ministry-level regulators. Though the clear demarcation of roles and jurisdictions would be a welcome development, any lack of transparency in a new chain of command for decisionmaking could pose challenges for market participants.

Overall, foreign banks have reported strong growth in revenue and expansion of their customer bases and business scopes, stemming largely from domestic economic growth, energetic marketing, and high-quality service offerings. Nevertheless, regulatory restrictions remain heavy: Foreign banks face high capital requirements, limitations on their business scopes, and burdensome branching requirements, and must incorporate in China (rather than rely on branches to conduct business on behalf of foreign headquarters) if they wish to provide the full array of banking services to domestic PRC customers. Only a small number of foreign banks have established a longterm presence in China, and these banks have set relatively modest near-term goals. Foreign banks could contribute substantially to China's economic and financial development, however, as they bring valuable skills and services to the market. Their presence also encourages an efficient, competitive banking environment that benefits corporate and individual Chinese customers alike.

Recommendations

The efficiency and depth of China's banking sector would improve greatly if PRC regulators were to:

Eliminate or relax foreign ownership restrictions in Chinese banks;
Reduce the lengthy approval process for opening new branches and offering new products and services;
Clarify regulator responsibilities as they apply to overlapping duties, multiple approvals, and other administrative jurisdictional issues; and
Harmonize capital requirements for foreign bank branches with those for domestic banks.

Regulators would also benefit the sector as a whole by allowing foreign banks greater access to China's debt and equity markets and allowing foreign banks to offer customers more products and services, such as online banking and credit and debit cards supported by brands of their choice.

Securities

China has made progress over the past several years in building its stock exchanges and gradually allowing greater domestic access to individual and institutional investors. In response, China's securities markets have expanded rapidly: the Shanghai Economic Composite index for the Shanghai Stock Exchange rose 67 percent between January and July 2007, and total market capitalization on the Shanghai and Shenzhen stock markets grew by 176 percent in 2006 and 123 percent in the first seven months of 2007 to surpass $2.7 trillion. Moreover, since June 2006, when CSRC lifted its moratorium on the listing of new domestic initial public offerings, 115 domestic companies have listed on the A-share market.

China has also increased investment opportunities for domestic investors in other areas, including corporate bonds, derivatives, and investment funds. CSRC, the State Administration of Foreign Exchange (SAFE), and CBRC introduced a joint effort to expand the qualified domestic institutional investor (QDII) and qualified foreign institutional investor (QFII) programs. Notable developments over the past year include PRC approval of foreign entities such as the International Finance Corp. and the Asian Development Bank to issue RMB-denominated bonds on the China market to finance development projects and regulations that lowered the threshold for participation in QFII—though not for commercial banks or securities firms—from $10 million of managed securities assets and 30 years of experience to $5 million and 5 years. QFII investors may also contract with up to three domestic brokerage firms and hold multiple brokerage accounts. In addition, CSRC approved 18 new QFIIs in 2006, bringing the total to 52.

PRC leaders also pledged to increase the number of corporate bond offerings and to transfer oversight of most types of corporate bonds from the National Development and Reform Commission to CSRC, thus bringing corporate bonds under the same regulatory umbrella as other securities offerings.

At the same time, China has taken small steps toward expanding the ownership roles and activities available to foreign firms in the domestic securities sector. At the second Strategic Economic Dialogue (SED) meeting in May 2007, China confirmed its intent to lift the moratorium on approving new foreign-invested securities firms and to resume licensing securities companies by the end of 2007. In addition, China agreed that before the third SED meeting in December 2007, it would permit foreign securities firms to conduct a broader range of activities in China, including brokerage services, proprietary trading, and fund management. CSRC and SAFE also agreed to increase the quota cap for QFIIs' investment from $10 billion to $30 billion by the third SED meeting. PRC officials at the second SED meeting also committed to allow the New York Stock Exchange and NASDAQ to set up offices in China and did so under regulations that were implemented on July 1.

QDII programs, which allow domestic institutional investors to access a variety of financial instruments and capital markets outside of mainland China, are an important step in China's liberalization of investment opportunities. Yet these programs have been, to date, small relative to the potential pool of Chinese funds that are now legally allowed to invest in these programs. The Financial Times reported in April 2007 that only 5 percent of China's $18.5 billion QDII quota had been invested abroad and the vast majority of that amount was in the form of Hong Kong-listed H shares. Since then, however, several sets of measures have been released to reform the QDII program to allow a greater number of domestic investors to invest in a broader range of overseas investment products.

Recommendations

As China's securities sector expands, the country's ability to manage this growth can be aided by:

Removing or raising the 33 percent cap on foreign ownership in joint-venture securities firms and the 49 percent cap on foreign ownership of asset management firms;
Eliminating ownership restrictions on foreign banks trading RMB and RMB-linked products;
Expanding the role of foreign institutions in investing in sophisticated financial products such as asset-backed securities and futures and allow foreign brokerages to participate in the derivatives market;
Lowering capital requirements for securities firm participation and for participation in the futures market;
Allowing foreign firms to sell and trade A shares; and
Increasing transparency and establishing a transparent road map, on an agreed timetable, to allow foreign securities firms to engage in a full range of securities activities.

Moreover, the activities foreign firms may conduct are limited. Foreign securities firms should be able to offer a full range of financial activities, including trading in and underwriting all tradable classes of securities, including A, B, and H shares. Foreign firms should also be allowed to participate on an equal footing in China's less-developed financial sectors, including futures and derivatives markets. Foreign expertise and capital have the potential to play a pivotal role in accelerating the development of these markets, and foreign players can also assist in creating new products and services while demonstrating the benefits of high corporate governance standards. This would benefit issuers, investors, and markets in China's economy, as well as provide competition that would strengthen domestic securities companies.

Insurance

Since the third quarter of 2006, CIRC has rolled out a series of regulations aimed at increasing guidance and monitoring of the domestic insurance industry. In June 2007, CIRC released a draft of the Provisional Measures for Insurance Fund Management for comment. Though CIRC allowed only one month for comment, the release was a step toward more transparency in the regulatory process. Insurers hope that the significant laws that are currently in the pipeline—namely the draft insurance and pension laws—will also be released for comment.

Since 2006, some of the most important regulations that CIRC has drafted strengthen oversight of the issuance of insurance licenses; bolster transparency and corporate governance in the insurance industry and define disclosure requirements; detail oversight procedures and requirements for the administration of life insurance products; and emphasize supervision and corporate governance. In February 2007, the Ministry of Labor and Social Security and PBOC announced that annuity funds from non-bank corporations would be allowed to invest in China's interbank bond market.

Observers are keeping a close eye on PRC authorities' moves to issue licenses for wholly foreign-owned insurance subsidiaries that offer nonlife insurance (including insurance for vehicle, enterprise property, cargo, casualty, liability, and other areas). China made this commitment as part of the 2003 Joint Commission on Commerce and Trade (JCCT) and 2007 SED insurance dialogues.

Recommendations

Several insurance-related concerns remain, including:

National treatment in approval processes including concurrent, rather than consecutive, issuance of branching licenses for both life and nonlife foreign insurers;
Fulfillment of 2003 JCCT and 2007 SED commitments to approve and issue licenses for wholly foreign-owned nonlife insurance subsidiaries; Permission for all qualified companies to provide political risk insurance for Chinese companies with exposure abroad; and
Release of draft regulations for comment.

Several important insurance sectors remain closed to foreign investment. These include the so-called "statutory insurance" sectors, such as mandatory third-party auto liability insurance. In light of the growing number of vehicles on the road, liberalization of this sector will ensure the inflow of expertise and quality products and services that will help forestall a rise in insurance claims and premium costs. Sudden increases of claims and premium could overwhelm the capital resources of Chinese insurance companies. In sum, further liberalization will ultimately benefit China's companies and society.

Futures and asset-backed securities

PRC regulators have also gradually begun to develop other investment and risk management markets. CSRC issued several draft measures in April 2007 designed to regulate the futures market. These measures included a risk warning index for futures companies, as well as high capital requirements for participation in the markets—¥15 million ($2 million) in net capital, ¥45 million ($6 million) for exchange settlement net capital, and ¥90 million ($12 million) for comprehensive settlement net capital. A revision of earlier rules governing certification and activities of brokers in the futures market was issued in July 2007.

Unfortunately, high capital thresholds and other regulations have deterred many investors. Stipulations that require comprehensive settlement net capital to exceed ¥90 million ($12 million) automatically exclude most futures companies from participating, considering that the average registered capital of such companies in China is about ¥30 million ($4 million).

Though China has seen a few high-profile issuances of asset-backed securities—including China Development Bank's 2005 issuance of ¥4.3 billion ($573.3 million) in securities backed by unsecured corporate loans—it limits the number of issues, range of issuers, and the variety of assets used to back securities.

Recommendations

PRC regulators should follow through on publicly stated intentions to liberalize and diversify their financial markets. CSRC, PBOC, SAFE, and other regulators should develop regulations that will promote the growth of the corporate bond, futures, asset-backed securities, and other derivatives sectors and encourage Chinese investors to invest in these new markets. The proliferation of investment and lending options for individuals and financial institutions will contribute to the more efficient allocation of capital and provide new market opportunities for Chinese and foreign firms.

Opening investment in financial derivatives and in a greater variety of bonds, including asset-backed securities, will expand investors' options and China's capacity to manage increasingly sophisticated financial instruments. Foreign firms with proven expertise in these areas can facilitate this process. Lifting capital requirements and raising ownership limits would allow this expertise to grow in China.

Rating agencies

CSRC promulgated measures in August 2007 that govern credit rating services in China. The measures, which took effect September 1, require agencies planning to apply for a securities rating license to meet certain requirements, such as possessing legal entity status and registered capital or net assets that exceed ¥20 million ($2.6 million).

These new regulations are an important step in establishing some ground rules for credit rating agencies (CRAs), though a number of issues remain. Foreign investors face a 49 percent cap in ownership in PRC CRAs. Moreover, the law imposes liabilities on CRAs for their opinions by requiring them to verify the accuracy of the information received from issuers. This requirement could have a marked effect on the willingness and ability of CRAs to issue ratings efficiently. In addition, a lack of regulatory clarity threatens to prevent open competition. Matters regarding foreign ownership requirements also remain unclear for acquisitions. Unless resolved, these concerns may make it impossible for US CRAs to issue ratings in China.

Recommendations

Despite PRC regulatory efforts to lay out a clear foundation for the operating landscape of CRAs in China, the process is incomplete. The flow of accurate financial information would be facilitated if authorities:

Lift the restriction on 49 percent foreign ownership of established credit rating institutions and clarify rules relating to foreign ownership requirements; and
Adjust or ease regulatory burdens and verification requirements for CRAs.

A new chapter begins

In concluding its WTO commitments roadmap, China has partially opened the door to foreign financial service providers. Yet several commitments remain unresolved and some broader, structural questions remain unanswered. To gain the full benefits that the presence of foreign financial companies can bring to China's economy, China must not only complete its WTO commitments but move beyond them. Such progress and market openings would benefit both China and its commercial partners.

Improving Transparency

Transparency is an important part of a robust financial sector. Though PRC regulators have attempted to increase transparency by involving industry in the review process for new regulations, draft regulations are often released for a week or two, or a month—insufficient time, given the complexity and detail of the regulations involved. Improved transparency will serve all sides by allowing regulators a more steady dialogue with affected industries, thus making it more likely that outcomes reflect established, international best practices. As authorities move toward financial stability facilitated by foreign cooperation, having a transparent road map and agreed-upon timetable to provide securities firms with the ability to engage in a full range of securities activities will be necessary for these authorities to make the most out of the openings they provide in good faith. Financial services-related laws and regulations that should be released for adequate public comment periods prior to finalization include the insurance and pension laws and pending bank card regulations. These are just three of the pending laws and regulations in many financial services sub-sectors that would benefit from improved transparency.

—USCBC staff

The US-China Business Council (USCBC), publisher of the CBR, is a nonprofit membership organization that has been serving US companies doing business in and with China since 1973. USCBC is headquartered in Washington, DC, with offices in Beijing and Shanghai. This article is adapted from a longer USCBC paper, Financial Services in China: An Overview and Assessment of Reforms and Market Openings with Recommendations for Further Progress.

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	Huang Shaoyi/China Foto Press E-Mail \| Print \| License Focus: Financial Services Financial Services Financial sector reform has proceeded steadily in recent years—but still has some way to go by US-China Business Council staff Modernizing the financial sector is the most important of China's unfinished economic reforms. A rational, sound, and competitive financial system lies at the heart of a market economy, channeling capital to its most efficient and productive uses. Consumers benefit from better savings, investment, and credit systems. Financial sector reforms are critical to China's sustained economic growth, which is important not only to China but also to the rest of the world. China's leaders understand the importance of financial sector reform and have made much progress in a relatively short time. The PRC government has established financial laws and regulatory institutions where, in essence, none had existed before. PRC policymakers began this work in earnest in the late 1990s with the establishment of a host of new regulators and continued the transformation through China's World Trade Organization (WTO) entry agreement in 2001. Their efforts have affected all sectors of the financial services industry, including banking, securities, insurance, credit rating services, consumer finance, electronic payments (see Modernizing China's Electronic Payments System), asset and fund management, and leasing services. At the same time, regulations govern, or are under development for, an ever-increasing number of new or sophisticated financial instruments, including financial derivatives, securitizations, and other modern capital markets products. Though the pace of China's financial reforms has not been as fast as many observers would like, China has recently taken notable steps in a number of areas. Banking China's top leadership and foreign industry participants alike consider banking a pivotal sector when addressing potential areas of macroeconomic instability such as capital misallocation and excessive investment. Banking sector reforms also address microeconomic challenges such as developing new credit and investing options, developing healthy businesses in rural areas, and aiding small and medium-sized enterprises. Since its WTO entry in late 2001, China has gradually granted foreign banks somewhat greater powers and market access. Perhaps the most important example is the permission foreign banks gained in 2006, consistent with China's fifth-year WTO commitments, to set up operations across China to offer services to domestic consumers. For the most part, the China Banking Regulatory Commission (CBRC) has been the principal authority for regulations related to banking. In some cases since 2006, however, elements of China's financial system development were beyond CBRC's scope. In 2007, for example, the National People's Congress passed the Enterprise Bankruptcy Law; the People's Bank of China (PBOC) sought to further develop China's credit information database, and the NPC pushed for a related privacy law; and PBOC, China Insurance Regulatory Commission (CIRC), China Securities Regulatory Commission (CSRC), and CBRC took further steps to authorize crossover shareholdings. Finally, the government recapitalized several Chinese banks, and some banks began to prepare for stock market listings. Since 2006, CBRC has made several reforms in its own areas of responsibility. These include releasing new bankowned leasing company regulations, proposing a scheme for deposit insurance, and reviewing more than 100 city commercial banks and four large city-based banks for listing. CBRC has also reviewed branching regulations for city commercial banks, officially opened the individual consumer banking sector to foreign companies on December 11, 2006, produced local incorporation regulations for foreign banks as well as accompanying implementation details, and approved 12 foreign banks in the first step toward full registration in China to conduct renminbi (RMB) business with all individuals. Several have been fully approved (see China Data: Foreign-Invested Financial Institutions in China) Though CBRC retains the lead role in implementing banking reforms, PBOC, SAFE, CSRC, and CIRC have some overlapping authority in this sector. China has floated the idea of a new super-regulator for the financial sector, but discussions have not yet yielded concrete plans. The creation of such a regulator could affect the division of work among ministry-level regulators. Though the clear demarcation of roles and jurisdictions would be a welcome development, any lack of transparency in a new chain of command for decisionmaking could pose challenges for market participants. Overall, foreign banks have reported strong growth in revenue and expansion of their customer bases and business scopes, stemming largely from domestic economic growth, energetic marketing, and high-quality service offerings. Nevertheless, regulatory restrictions remain heavy: Foreign banks face high capital requirements, limitations on their business scopes, and burdensome branching requirements, and must incorporate in China (rather than rely on branches to conduct business on behalf of foreign headquarters) if they wish to provide the full array of banking services to domestic PRC customers. Only a small number of foreign banks have established a longterm presence in China, and these banks have set relatively modest near-term goals. Foreign banks could contribute substantially to China's economic and financial development, however, as they bring valuable skills and services to the market. Their presence also encourages an efficient, competitive banking environment that benefits corporate and individual Chinese customers alike. Recommendations The efficiency and depth of China's banking sector would improve greatly if PRC regulators were to: Eliminate or relax foreign ownership restrictions in Chinese banks; Reduce the lengthy approval process for opening new branches and offering new products and services; Clarify regulator responsibilities as they apply to overlapping duties, multiple approvals, and other administrative jurisdictional issues; and Harmonize capital requirements for foreign bank branches with those for domestic banks. Regulators would also benefit the sector as a whole by allowing foreign banks greater access to China's debt and equity markets and allowing foreign banks to offer customers more products and services, such as online banking and credit and debit cards supported by brands of their choice. Securities China has made progress over the past several years in building its stock exchanges and gradually allowing greater domestic access to individual and institutional investors. In response, China's securities markets have expanded rapidly: the Shanghai Economic Composite index for the Shanghai Stock Exchange rose 67 percent between January and July 2007, and total market capitalization on the Shanghai and Shenzhen stock markets grew by 176 percent in 2006 and 123 percent in the first seven months of 2007 to surpass $2.7 trillion. Moreover, since June 2006, when CSRC lifted its moratorium on the listing of new domestic initial public offerings, 115 domestic companies have listed on the A-share market. China has also increased investment opportunities for domestic investors in other areas, including corporate bonds, derivatives, and investment funds. CSRC, the State Administration of Foreign Exchange (SAFE), and CBRC introduced a joint effort to expand the qualified domestic institutional investor (QDII) and qualified foreign institutional investor (QFII) programs. Notable developments over the past year include PRC approval of foreign entities such as the International Finance Corp. and the Asian Development Bank to issue RMB-denominated bonds on the China market to finance development projects and regulations that lowered the threshold for participation in QFII—though not for commercial banks or securities firms—from $10 million of managed securities assets and 30 years of experience to $5 million and 5 years. QFII investors may also contract with up to three domestic brokerage firms and hold multiple brokerage accounts. In addition, CSRC approved 18 new QFIIs in 2006, bringing the total to 52. PRC leaders also pledged to increase the number of corporate bond offerings and to transfer oversight of most types of corporate bonds from the National Development and Reform Commission to CSRC, thus bringing corporate bonds under the same regulatory umbrella as other securities offerings. At the same time, China has taken small steps toward expanding the ownership roles and activities available to foreign firms in the domestic securities sector. At the second Strategic Economic Dialogue (SED) meeting in May 2007, China confirmed its intent to lift the moratorium on approving new foreign-invested securities firms and to resume licensing securities companies by the end of 2007. In addition, China agreed that before the third SED meeting in December 2007, it would permit foreign securities firms to conduct a broader range of activities in China, including brokerage services, proprietary trading, and fund management. CSRC and SAFE also agreed to increase the quota cap for QFIIs' investment from $10 billion to $30 billion by the third SED meeting. PRC officials at the second SED meeting also committed to allow the New York Stock Exchange and NASDAQ to set up offices in China and did so under regulations that were implemented on July 1. QDII programs, which allow domestic institutional investors to access a variety of financial instruments and capital markets outside of mainland China, are an important step in China's liberalization of investment opportunities. Yet these programs have been, to date, small relative to the potential pool of Chinese funds that are now legally allowed to invest in these programs. The Financial Times reported in April 2007 that only 5 percent of China's $18.5 billion QDII quota had been invested abroad and the vast majority of that amount was in the form of Hong Kong-listed H shares. Since then, however, several sets of measures have been released to reform the QDII program to allow a greater number of domestic investors to invest in a broader range of overseas investment products. Recommendations As China's securities sector expands, the country's ability to manage this growth can be aided by: Removing or raising the 33 percent cap on foreign ownership in joint-venture securities firms and the 49 percent cap on foreign ownership of asset management firms; Eliminating ownership restrictions on foreign banks trading RMB and RMB-linked products; Expanding the role of foreign institutions in investing in sophisticated financial products such as asset-backed securities and futures and allow foreign brokerages to participate in the derivatives market; Lowering capital requirements for securities firm participation and for participation in the futures market; Allowing foreign firms to sell and trade A shares; and Increasing transparency and establishing a transparent road map, on an agreed timetable, to allow foreign securities firms to engage in a full range of securities activities. Moreover, the activities foreign firms may conduct are limited. Foreign securities firms should be able to offer a full range of financial activities, including trading in and underwriting all tradable classes of securities, including A, B, and H shares. Foreign firms should also be allowed to participate on an equal footing in China's less-developed financial sectors, including futures and derivatives markets. Foreign expertise and capital have the potential to play a pivotal role in accelerating the development of these markets, and foreign players can also assist in creating new products and services while demonstrating the benefits of high corporate governance standards. This would benefit issuers, investors, and markets in China's economy, as well as provide competition that would strengthen domestic securities companies. Insurance Since the third quarter of 2006, CIRC has rolled out a series of regulations aimed at increasing guidance and monitoring of the domestic insurance industry. In June 2007, CIRC released a draft of the Provisional Measures for Insurance Fund Management for comment. Though CIRC allowed only one month for comment, the release was a step toward more transparency in the regulatory process. Insurers hope that the significant laws that are currently in the pipeline—namely the draft insurance and pension laws—will also be released for comment. Since 2006, some of the most important regulations that CIRC has drafted strengthen oversight of the issuance of insurance licenses; bolster transparency and corporate governance in the insurance industry and define disclosure requirements; detail oversight procedures and requirements for the administration of life insurance products; and emphasize supervision and corporate governance. In February 2007, the Ministry of Labor and Social Security and PBOC announced that annuity funds from non-bank corporations would be allowed to invest in China's interbank bond market. Observers are keeping a close eye on PRC authorities' moves to issue licenses for wholly foreign-owned insurance subsidiaries that offer nonlife insurance (including insurance for vehicle, enterprise property, cargo, casualty, liability, and other areas). China made this commitment as part of the 2003 Joint Commission on Commerce and Trade (JCCT) and 2007 SED insurance dialogues. Recommendations Several insurance-related concerns remain, including: National treatment in approval processes including concurrent, rather than consecutive, issuance of branching licenses for both life and nonlife foreign insurers; Fulfillment of 2003 JCCT and 2007 SED commitments to approve and issue licenses for wholly foreign-owned nonlife insurance subsidiaries; Permission for all qualified companies to provide political risk insurance for Chinese companies with exposure abroad; and Release of draft regulations for comment. Several important insurance sectors remain closed to foreign investment. These include the so-called "statutory insurance" sectors, such as mandatory third-party auto liability insurance. In light of the growing number of vehicles on the road, liberalization of this sector will ensure the inflow of expertise and quality products and services that will help forestall a rise in insurance claims and premium costs. Sudden increases of claims and premium could overwhelm the capital resources of Chinese insurance companies. In sum, further liberalization will ultimately benefit China's companies and society. Futures and asset-backed securities PRC regulators have also gradually begun to develop other investment and risk management markets. CSRC issued several draft measures in April 2007 designed to regulate the futures market. These measures included a risk warning index for futures companies, as well as high capital requirements for participation in the markets—¥15 million ($2 million) in net capital, ¥45 million ($6 million) for exchange settlement net capital, and ¥90 million ($12 million) for comprehensive settlement net capital. A revision of earlier rules governing certification and activities of brokers in the futures market was issued in July 2007. Unfortunately, high capital thresholds and other regulations have deterred many investors. Stipulations that require comprehensive settlement net capital to exceed ¥90 million ($12 million) automatically exclude most futures companies from participating, considering that the average registered capital of such companies in China is about ¥30 million ($4 million). Though China has seen a few high-profile issuances of asset-backed securities—including China Development Bank's 2005 issuance of ¥4.3 billion ($573.3 million) in securities backed by unsecured corporate loans—it limits the number of issues, range of issuers, and the variety of assets used to back securities. Recommendations PRC regulators should follow through on publicly stated intentions to liberalize and diversify their financial markets. CSRC, PBOC, SAFE, and other regulators should develop regulations that will promote the growth of the corporate bond, futures, asset-backed securities, and other derivatives sectors and encourage Chinese investors to invest in these new markets. The proliferation of investment and lending options for individuals and financial institutions will contribute to the more efficient allocation of capital and provide new market opportunities for Chinese and foreign firms. Opening investment in financial derivatives and in a greater variety of bonds, including asset-backed securities, will expand investors' options and China's capacity to manage increasingly sophisticated financial instruments. Foreign firms with proven expertise in these areas can facilitate this process. Lifting capital requirements and raising ownership limits would allow this expertise to grow in China. Rating agencies CSRC promulgated measures in August 2007 that govern credit rating services in China. The measures, which took effect September 1, require agencies planning to apply for a securities rating license to meet certain requirements, such as possessing legal entity status and registered capital or net assets that exceed ¥20 million ($2.6 million). These new regulations are an important step in establishing some ground rules for credit rating agencies (CRAs), though a number of issues remain. Foreign investors face a 49 percent cap in ownership in PRC CRAs. Moreover, the law imposes liabilities on CRAs for their opinions by requiring them to verify the accuracy of the information received from issuers. This requirement could have a marked effect on the willingness and ability of CRAs to issue ratings efficiently. In addition, a lack of regulatory clarity threatens to prevent open competition. Matters regarding foreign ownership requirements also remain unclear for acquisitions. Unless resolved, these concerns may make it impossible for US CRAs to issue ratings in China. Recommendations Despite PRC regulatory efforts to lay out a clear foundation for the operating landscape of CRAs in China, the process is incomplete. The flow of accurate financial information would be facilitated if authorities: Lift the restriction on 49 percent foreign ownership of established credit rating institutions and clarify rules relating to foreign ownership requirements; and Adjust or ease regulatory burdens and verification requirements for CRAs. A new chapter begins In concluding its WTO commitments roadmap, China has partially opened the door to foreign financial service providers. Yet several commitments remain unresolved and some broader, structural questions remain unanswered. To gain the full benefits that the presence of foreign financial companies can bring to China's economy, China must not only complete its WTO commitments but move beyond them. Such progress and market openings would benefit both China and its commercial partners. Improving Transparency Transparency is an important part of a robust financial sector. Though PRC regulators have attempted to increase transparency by involving industry in the review process for new regulations, draft regulations are often released for a week or two, or a month—insufficient time, given the complexity and detail of the regulations involved. Improved transparency will serve all sides by allowing regulators a more steady dialogue with affected industries, thus making it more likely that outcomes reflect established, international best practices. As authorities move toward financial stability facilitated by foreign cooperation, having a transparent road map and agreed-upon timetable to provide securities firms with the ability to engage in a full range of securities activities will be necessary for these authorities to make the most out of the openings they provide in good faith. Financial services-related laws and regulations that should be released for adequate public comment periods prior to finalization include the insurance and pension laws and pending bank card regulations. These are just three of the pending laws and regulations in many financial services sub-sectors that would benefit from improved transparency. —USCBC staff The US-China Business Council (USCBC), publisher of the CBR, is a nonprofit membership organization that has been serving US companies doing business in and with China since 1973. USCBC is headquartered in Washington, DC, with offices in Beijing and Shanghai. This article is adapted from a longer USCBC paper, Financial Services in China: An Overview and Assessment of Reforms and Market Openings with Recommendations for Further Progress. Further Reading Letter from Beijing: WTO Is Only the Warmup Life Insurance Industry Heats Up Banking on Reform Tapping into China's Securities Industry Click here for copyright permissions Copyright 2007 US-China Business Council Top of Page Table of Contents
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Departments

Focus: Financial Services

Financial Services

Financial sector reform has proceeded steadily in recent years—but still has some way to go

Banking

Recommendations

Securities

Recommendations

Insurance

Recommendations

Futures and asset-backed securities

Recommendations

Rating agencies

Recommendations

A new chapter begins

Improving Transparency

Further Reading