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A New Class of Investors
Under the new Shanghai FTZ reform, individuals can invest overseas
By Wang Jun | NO. 46 NOVEMBER 12, 2015


An aerial view of the China (Shanghai) Free Trade Zone (XINHUA)

Domestic investors will soon be able to set up individual accounts to buy foreign assets under a pilot scheme that will advance the reforming of the China (Shanghai) Free Trade Zone (FTZ) in a bid to make the metropolis a global financial center.

The central bank, the People's Bank of China (PBOC), launched the scheme on October 30, though a timetable for when the reforms would take place was not released.

Zhang Zhi, a bank clerk, plans to invest in e-commerce giant Alibaba, which is listed on the New York Stock Exchange. "I've been waiting a long time to buy Alibaba stock, and now the opportunity is coming," he told International Finance News , a weekly newspaper published in Shanghai.

Under the new guidelines, the Shanghai FTZ will spearhead the country's initiative to make the yuan a fully convertible currency. The zone will also take a leading role in the qualified domestic individual investor (QDII2) scheme and allow qualified individuals to directly invest in overseas businesses, real estate and financial products, according to a PBOC statement detailing the pilot scheme. Additional institutions and individuals will be allowed to trade securities and futures in domestic and foreign markets in the zone, which will also support establishing overseas private equity funds, according to the statement.

Making the yuan fully convertible and reviewing QDII2 are the major reforms detailed in the statement and are expected to be carried out during the first half of 2016, Chen Bo, Secretary General of the Institute of Free Trade Zone at Shanghai University of Finance and Economics, told International Finance News .

Looking abroad 

The PBOC launched a free trade account in Shanghai in June 2014. Companies registered in the FTZ can use the account for financing, investment and other cross-border transactions.

The account allows free convertibility between domestic and foreign currencies based on that day's exchange rate. Under current regulations, companies operating in the zone can borrow up to double their capital in foreign markets, which can then be fully converted into the yuan.

The new rules and QDII2 will extend those benefits to individuals and further loosen curbs on offshore borrowing. Individuals are currently allowed to exchange $50,000 worth of renminbi each year for traveling or spending, but Chen told International Finance News  he expects this quota to increase with the new regulations.

In fact, he sees QDII2 as a type of innovation. Various reform measures have been carried out over the past year, but QDII2 is the most substantial advancement China has made toward improving individual investments, he said.

Chen said that he anticipates additional legitimate channels to be opened to allow domestic investors to put money in foreign stock markets and buy overseas-listed stocks, insurance or wealth management products.

"Overseas investment under the QDII2 system will bring a lot more business to financial institutions engaged in wealth management. After the system is issued, most of the investment will be made in financial, industrial and real estate sectors in foreign markets," Xiao Benhua, a professor with Shanghai Finance University, told International Finance News .


While individuals will now be able to invest in overseas markets, the real winners of the reform are financial institutions that will be permitted to push their money abroad, Chen said in the article.

"But huge opportunities are also followed by huge risks," he said.

The biggest challenge in making the yuan a fully convertible currency is supervision. Once the currency is liberalized, a large amount of capital will flow into China, causing the yuan's exchange rate to fluctuate. To make the exchange rate more flexible, the PBOC will have to relinquish more controls to allow the fluctuations in the exchange rate. This raises concerns over whether the Shanghai FTZ is capable of controlling cross-border capital flow, according to Chen.

Indeed, some scholars say the yuan won't be fully convertible anytime soon because of the possible consequences of letting go of the controls. Xi Junyang, Deputy Director of the Research Center of Modern Finance at Shanghai University of Finance and Economics, toldInternational Finance News  that the controls prevent both a large amount of outbound capital that would impact China's sustainable economic development and a sudden inflow of foreign speculative capital that would impact the country's financial stability.

Sun Lijian, Director of the Financial Research Center at Fudan University, thinks now isn't the right time to make the yuan fully convertible.

"Considering the history and China's current conditions, I think the disadvantages will outweigh the advantages if we advance free convertibility of renminbi now," said Sun, in an interview with International Finance News . "Industry and finance are most important for a country, with industries being the base. If industries are not well developed and people are making money only through investment, this is speculation, which is not healthy. But this is exactly the situation in China."

China doesn't have enough publicly-listed companies with good performance histories, Sun said. And once transnational corporations withdraw their money, Chinese companies will be left to operate independently. It would be dangerous, he said, for the government to make the yuan fully convertible now.

While Sun and other academics think it's too soon, timing is of the essence for the government to free the currency as it is currently trying to get the yuan accepted into the IMF's basket of global reserve currencies.

Media reports published in October say the IMF plans to add the yuan to the Special Drawing Rights, which is used as a supplement for IMF member countries' official money reserves and can be used for emergency payouts. The U.S. dollar, pound, yen and euro currently make up the reserve.

Zhou Xiaochuan, Governor of the PBOC, said at the IMF's annual meeting in April that China has achieved full or partial convertibility in 35 out of the 40 items the IMF uses to classify capital account transactions.

An HSBC report on renminbi published on October 20 said the yuan "ticks all the right boxes" to be included in the reserve.

"Others set the stage for the renminbi to play a more important global role over the longer term," Paul Mackel, the report's author, wrote.

"Confidence in the renminbi and, hence, voluntary reserve diversification flows into China could rise with the endorsement of SDR inclusion."

Copyedited by Jordyn Dahl

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