FTZ: the struggle continues in 2017

Two and a half years after the launch of the first pilot free trade zone in Shanghai, the authorities appear ready to inaugurate a third batch of FTZs. But recent moves to restrict capital outflows have ended up hurting foreign enterprises, dealing a blow to China’s efforts to open its capital account.

  • By Paolo Danese
  • 20 Feb 2017
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The third batch of FTZs is now approaching the final stage before an official launch. While a date is uncertain, which is not unusual with China's policy decisions, state media reported on February 13 that the seven new FTZs could be cutting the ribbon as early as the end of this month.

Set to join the club are the provinces of Henan, Hubei, Liaoning, Sichuan, Shaanxi and Zhejiang as well as the municipality of Chongqing. The group would bring the total FTZs across China to 11.

But the entry of the new FTZs is not the only recent development. The State Council has put forth more proposals to further promote the pilot zones on themes such as systemic reforms.

"The opinions [of the State Council] state that development zones shall continue to adopt the improvement of the business environment as their primary task," the American Chamber of Commerce in China wrote in a February 14 statement.

Accounting firm KPMG said it expects more developments to facilitate capital flows in both directions.

“Further liberalisation of the FTZs, especially in Shanghai, is expected to encourage better use of RMB in trade settlement, but also to enable qualified individuals and perhaps institutions to directly deploy their capital offshore,” the firm said in a January report.

Ease of cross-border funding has long been the pillar of the Shanghai FTZ's appeal. Starting in early 2015, FTZ entities were allowed greater flexibility in their cash management through the use of free trade accounts (FTAs) via the use of cash pooling structures and cross-border sweeping facilities.

Capital clampdown

However, the authorities' attempts to rein in a surge in capital outflows over the past year, in particular through the use of window guidance by the State Administration of Foreign Exchange (Safe) to local and foreign banks in China, have created issues for foreign firms.

The window guidance, first communicated to banks in November 2016, targeted the movement of capital from China by levying approval requirements for cross-border capital outflows from capital accounts for amounts above $5m, the European Chamber of Commerce in China told its members in December.

The rules covered even approved dividend payments, which were put on hold, and were independent of whether the payouts were to be made in RMB or a foreign currency. Approval for early prepayment of offshore loans is also now required from Safe, even if the amount is less than $5m.

While current account transactions were technically not covered by the measures, the European Chamber said at the time that it expected more scrutiny across categories of payments.

That seems to have been the case. Sources familiar with the operations of foreign corporates in China told GlobalRMB that the window guidance measures have ended up affecting trade-related transactions.

"I hear that one second tier foreign bank in Shanghai did not process intra-company cross-border payments for finished goods for one merchandise company for as long as a month," the source said.

The situation is made all the more complex by the fact that restrictions and thresholds put in place for banks and corporates in the FTZ often differ from those in other cities, creating further confusion for companies trying to navigate the more restrictive regime.

This has created enough discomfort to push the European Chamber to lobby Safe into establishing a hotline for companies seeking to gain a better understanding of which cross-border capital flows face restrictions and which don't, the organisation said in a statement on January 24.

The State Council, in turn, has tried to assuage the concerns in recent statements.

"The opinions make it clear that qualifying enterprises situated within development zones are allowed to raise funds in renminbi and foreign currencies from overseas by means of obtaining loans, issuing bonds, or other [channels], under the framework of prudent management of external debts and capital flow," Amcham China wrote.

One pilot too many

The tightening of regulation on cross-border transfers has also not given a boost to another initiative by the regulators in the Shanghai pilot zone — the launch of an FTZ bond market.

The market debut took place via an issue by the Shanghai Finance Bureau of Rmb3bn ($437m) commercial paper in the interbank market and aimed at local and international institutional investors with FTAs.

A number of foreign banks, including HSBC, Standard Chartered and DBS, participated in the syndication of the deal — the first time that non-Chinese institutions have underwritten a local government bond.

The custody and settlement of deals in the newly-established FTZ bond market take place via the China Government Securities Depository and Clearing, which opened a Shanghai branch in 2015. Foreign investors are, however, not bound to using onshore infrastructure, as international central securities depositories (ICSDs) such as Clearstream have already launched links with the Shanghai Clearing House.

This allows foreign investors to continue using existing settlement accounts without the need to set up separate accounts in China.

Local media has reported that approved pilot commercial banks have been given the ability to transfer existing bonds to the FTZ market, though it is not clear whether any have done so. The difficult environment is also reflected by the fact that the first issuance by the local municipal authority has yet to be followed by other entities.

“In the larger scheme of China’s reforms, the FTZ bonds will remain small potato,” one head of China fixed income research told GlobalRMB

  • By Paolo Danese
  • 20 Feb 2017

GlobalRMB Panda Bonds league table

Rank Arranger Share % by Volume
1 Bank of China (BOC) 28.62
2 CITIC Securities 21.06
3 China CITIC Bank Corp 9.72
4 China Merchants Bank Co 9.18
5 Industrial and Commercial Bank of China (ICBC) 7.56

Panda Bond Database

Pricing Date Issuer Country Size Rmb (m)
1 12-Jan-18 Mitsubishi UFJ Financial Group (MUFG) Japan 1,000
2 12-Jan-18 Mizuho Bank Japan 300
3 10-Jan-18 Daimler Germany 3,000
4 22-Nov-17 Province of British Columbia Canada 1,000
5 15-Nov-17 Daimler Germany 4,000

Offshore RMB Bond Top Bookrunners

Rank Bookrunner Share % by Volume
1 Standard Chartered Bank 55.56
2 CLSA 22.22
2 Mitsubishi UFJ Financial Group (MUFG) 22.22

Latest Offshore RMB Bonds

Pricing Date Issuer Country Size Rmb (m)
1 17-Jan-18 IL&FS Transportation Networks India 100
2 10-Jan-18 IL&FS Transportation Networks India 900
3 08-Jan-18 Westpac Australia 500
4 30-Nov-17 Ministry of Finance of the People's Republic of China (MoF) China 7,000
5 15-Nov-17 Bank of China Paris Branch (BOC Paris) China 1,000