Highlights: On December 2, 2013, the People’s Bank of China (“PBOC”) released its Opinions on the Financial Support of the Development of the China (Shanghai) Pilot Free Trade Zone (the “FTZ”) (the “Opinions”).  The Opinions committed to the promotion of reforms and pilots in the FTZ in the sectors of cross-border RMB usage, RMB capital account convertibility, interest rate liberalization and foreign exchange administration.  The Opinions give a roadmap of financial reforms in terms of cross-border RMB usage and RMB capital account relaxation on one hand, but on the other hand lay out to some extent the boundary of financial reforms to be launched in the FTZ.

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PBOC Announced Financial Support Polices on Shanghai Pilot Free Trade Zone

On December 2, 2013, the People’s Bank of China released its Opinions on the Financial Support of the Development of the China (Shanghai) Pilot Free Trade Zone. The Opinions committed to the promotion of reforms and pilots in the FTZ in the sectors of cross-border RMB usage, RMB capital account convertibility, interest rate liberalization and foreign exchange administration.

The Opinions did not offer a timetable for issuance of detailed implementing rules. On the second day after the Opinions were released, PBOC Shanghai branch  informally gave a preliminary schedule to media: (1) most of the upcoming policy initiatives are expected to be implemented within the next three months; (2) those implementing rules would be subject to test and exploration for about half a year to gain experience, and; (3) if the experiments work, the authorities expect to establish, within one year, a financial administration model that is may be duplicated and extended to other regions of China.

Summary of Policy Initiatives in the Opinion

We touch on a few of the significant policy initiatives in the Opinions below:

Free Trade Accounts

At the heart of the Opinions, PBOC establishes a specially tagged bank accounts system for use of such special accounts by companies and individuals in the FTZ in relation to those financial innovation activities allowed in the Opinion.

• Residents in the FTZ will be allowed to open Free Trade Accounts for Residents (“Residents FTA”), while non-residents will be allowed to open Free Trade Accounts for Non-residents (“Non-residents FTA”). Free fund transfers are only permitted for those between Residents FTAs and offshore accounts, non-residents’ onshore accounts, Non-residents FTAs and other Residents FTAs, while the fund transfers between Residents FTAs and other on-shore accounts are still subject to the current cross-border fund transfer restrictions. All commercial banks in the Shanghai area can open Free Trade Accounts for its FTZ qualified clients by way of setting up a unit using a separate account management system.

Cross-border Investments and Financing

The most significant changes PBOC laid out are those that concern cross-border investment. In this area, the Opinions echo the “Specific Measures Supporting and Promoting the Development of the Pilot Free Trade Zone” released by the China Securities Regulatory Committee (“CSRC”) on September 29. However, various qualifiers and terms used in the Opinions are still short on specifics, and need to be fleshed out by PBOC in the implementing rules. It remains to be seen to what extent PBOC will lift its sharp limits on funds entering and leaving China for securities investments.

• “Qualified” Chinese individuals who are “working in” the FTZ will be allowed, in accordance with “relevant rules”, to invest in overseas securities market and transfer their after-tax income earned within the FTZ to offshore accounts. Similarly, “qualified” foreign individuals who are “working in” the FTZ can open non-resident individual domestic investment account to, in accordance with “relevant rules”, make investment in China including securities investment.
• Financial institutions and companies in the FTZ will be allowed to invest in Shanghai’s securities market in accordance with “relevant rules”.

“Qualified” companies in the FTZ will be allowed to directly invest in overseas capital markets including the derivative markets in accordance with “relevant rules”.

RMB Cross-Border Usage

• Commercial banks in the Shanghai area can directly process cross-border RMB settlement related to current accounts (as opposed to capital accounts) and direct investment transactions upon customers’ instructions, on the basis of “know your customer”; “know your business” and “due diligence review” principles, unless the instructing entity is on the “export trading RMB settlement entities watch list”. This reform aims to promote the usage of cross-border RMB in both investment and trade settlement by adopting a macro supervision system.
• ŸPBOC permits financial institutions and companies in the FTZ to borrow RMB funds from offshore markets, but meanwhile, re-emphasizes that those funds cannot be invested in securities or derivatives, nor be used for trust loans.

Living Monitoring of Fund Flow

• ŸPBOC will establish a living monitoring mechanism towards fund flow in the FTZ. PBOC may, at its discretion, put forth stronger supervision of short-term speculative fund flows in the FTZ, and even take temporary control measure against such fund flow.

Our Observations

The list of reforms unveiled by PBOC addresses in more detail the previous scope of reforms in the blueprint of FTZ issued by the State Council on September 27. The Opinions give a roadmap of financial reforms in terms of cross-border RMB usage and RMB capital account relaxation on one hand, but on the other hand lay out to some extent the boundary of financial reforms to be launched in the FTZ.

In relaxing some controls, PBOC also made clear that it would not allow FTZ become a back door to circumvent long standing capital control. PBOC will continue to closely monitor the fund flows between the FTZ and the rest of China.