Shanghai Free Trade Zone Unlocking new trade, investment and financing opportunities The development of the Shanghai Free Trade Zone is creating new trade, investment and financing opportunities for companies doing business with or in China. Denise Zhou, Senior Vice President of RMB Internationalisation at HSBC, considers the unique benefits and services the zone offers and how multinationals can capitalise on them.

“First and foremost,

The launch of the Shanghai Free Trade Zone in September 2013 marked a defining point in the Chinese government’s intensifying drive to reform the country’s financial systems, starting with the liberalisation and internationalisation of the RMB.

liberalise and open up

The SFTZ’s location is particularly significant. Covering approximately 29 sq km, it incorporates three existing special zones: Waigaoqiao Free Trade Zone (including Waigaoqiao Bonded Logistics Zone); Yangshan Free Trade Port Area; and Shanghai Pudong Airport Comprehensive Free Trade Zone. In 2012, these three zones reported a combined trade volume of USD113.1 billion. That is approximately 3% of China’s total trade. Government commitment Given its timing and location, it is clear that the Chinese government is fully committed to making the SFTZ a success. Backed by Chinese Premier, Li Keqiang, it is the first free trade zone established by the Chinese government. Its launch came as the country’s economy showed the first signs of slowing in over a decade. Evidently, China’s old growth model is no longer sustainable but a new growth model has not yet taken root. Accordingly, the SFTZ is designed as a pilot zone. The experiences of reform that it produces will help to shape reforms in other parts of China, helping to boost trade and create new opportunities throughout the country.

the SFTZ should be seen as part of China’s overall strategic plan to its economy further; as a means to experiment with reforms that can support trade and investment growth; and − in particular − to enable financial services to become a more powerful driver across China as a whole.”

The SFTZ has been hailed as the most important attempt at financial reform since 1980, when Shenzhen, at the border with Hong Kong, became a special economic zone. So, it is not surprising that the SFTZ has attracted so much attention from the international media and global business community. Currently, over 6,000 corporates are registered to operate inside the zone and by February 2014, around 30 banks had also established offices there. Principal objectives The Chinese authorities established the SFTZ with two principal objectives in mind: to speed-up domestic reforms; and to act as the forerunner for financial liberalisation.

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The zone is already delivering benefits in the shape of new trade, capital investment and financing opportunities for companies doing business with or in the Mainland, as follows: Creating trade opportunities The fact that DHL, the world’s largest logistics business, chose to open China’s first truly modern international transshipment centre in the SFTZ testifies to prolific trade opportunities the zone is already creating. The new facility covers 88,000 sq m and is capable of handling 40,000 parcels and envelopes per hour. Inside the centre, located at Pudong International Airport, cargo from international transshipments is unpacked, sorted and repackaged according to destinations − without having to receive customs checks or pay duties. Before the centre was opened, such cargo could only be handled in Japan or Singapore. Using the new route could save eight hours out of the three-day journey from the German city of Leipzig to Tokyo compared with the old route via Hong Kong.

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Creating investment opportunities The SFTZ is also set to play an instrumental role in attracting more investment into China by giving outside investors greater access to China’s markets and industries. Among other measures, this will involve: Streamlining government to reduce administrative controls Here, the focus is on exploring ways to establish an administration management system that is compatible with international trading rules and investment standards while consolidating government regulatory procedures to improve efficiency. Encouraging more open investment focusing on service industries – the six key areas The SFTZ will gradually open up investment opportunities in six key areas: financial, shipping, commercial, professional, cultural and social services. Encouraging investment will involve suspending or cancelling qualification restrictions for investors and the equity limits within the 18 sub-sectors.

Advances of this importance are

The aim is to establish a management model based on a ‘negative list’ approach for foreign investors in

set to establish the SFTZ as an international hub for cargo transport. Demand for transshipment business in the zone is rising fast and by 2015, the throughput of cargo is set to reach between 5 and 7 million tons annually.

the SFTZ, under which investment is allowed unless prohibited by the government. For projects that are not covered by the ‘negative list’, domestic and foreign investors in the SFTZ will be treated in the same

“At times, it is easy to forget that steps towards adding the RMB to the list of internationally tradable currencies only started in 2009. By the end of February 2014, it was the seventh most used currency for payments worldwide − and the SFTZ is set to accelerate the currency’s liberalisation and internationalisation.”

way. Although the ‘negative list’ is long − with 190 measures covering over 1,000 items − Shanghai policymakers say it will be shortened. Promoting China’s competitiveness in technology, branding and services The aim here is to boost trade and help China’s enterprises move up the value chain. Multinationals from inside and outside China will be encouraged to set up Asia-Pacific headquarters in the SFTZ, along with international operation centres for trading, logistics and financial settlement. Creating opportunities in the financial services sector and markets Unlocking the full potential of the emerging trade and investment opportunities listed above can only happen if China opens up its financial services sector and markets – starting in the SFTZ. Among other steps, this process will focus on five key areas of innovation: interest rate liberalisation; expanding cross-border RMB usage with new services and solutions for corporates; reforming China’s foreign exchange (FX) management regime, creating favourable conditions for a trial of RMB capital account convertibility; establishing a Free Trade (FT) Banking Unit and FT accounts; and making financial institutions more accessible. When it comes to encouraging cross-border RMB flows, HSBC played an instrumental role in two ground-breaking transactions in this area. The first involved Dover, a world-leading manufacturer of diversified industrial products; and the second involved French multinational Saint-Gobain (see Case Study panel). As for RMB convertibility inside or outside the SFTZ, there is still no clear roadmap for how this is likely to happen. But, it is expected that

corporates’ investment and financing flows could be a focus during the SFTZ’s early development phases, and enterprises will be able to use both onshore and offshore markets for financing. To accommodate the changes this will cause in the SFTZ, the regulator has been planning adjustments to the FX regime. Pros and cons The SFTZ is certainly opening up a world of trade, capital investment and financing opportunities. That said, a number of financial and business professionals are still seeking clarification over the principle challenges and issues associated with the SFTZ and what it was designed to achieve. When assessing the pros and cons of operating inside the zone, it is important that corporates and financial institutions have a clear understanding of the strategic context and practical implications involved. For a start, the SFTZ was never supposed to be an end in itself; nor was it designed to trigger a ‘big bang’. Rather, it is a three-year pilot initiative that is continuously evolving and the Chinese government is expected to take a selective approach towards making new financial solutions available to corporates. It is also worth repeating the key message that the SFTZ is designed to act as a controlled testing ground for reforms across the rest of China. If it succeeds, the learnings and experience it produces will eventually be replicated across other parts of China. As such, the SFTZ is a forerunner that will play a pivotal role in transforming China’s economy into a market-driven economy. This is why corporates and financial institutions should look at developments inside the zone as an indication of how business will eventually be conducted across China.

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“Ultimately, the successful development of the SFTZ is expected to spearhead China’s next phase of growth by providing a framework for the rest of the country that supports trade, investment and the real economy in a sustainable fashion.”

Cautious approach The fact that the zone is a testing ground helps to explain why the regulators are being so cautious at this early stage. After all, they are looking at a bigger picture with a long-term view on the future of the Chinese economy. Equally, corporates and financial institutions must take care to ensure that joining the SFTZ aligns with their long-term strategic objectives. For example, there are definite advantages to being one of the first movers into the SFTZ. At the same time, entities with physical operations in the zone are likely to benefit most from these advantages. Then again, moving operations into the zone could be a costly exercise. So, it is vital to weigh cost versus benefits carefully. Long journey Finally, some commentators have suggested that the SFTZ poses a threat to Hong Kong or Singapore. In the near-term, this does not appear to be likely. After all, Shanghai has a long way to go before it matches those two centres as the blueprint of a global financial centre. That said, the long journey towards aligning China with the world’s leading financial centres has now started − and its departure point is the SFTZ.

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SFTZ: delivering tangible benefits Among other benefits, the SFTZ allows, or will allow, multinational corporations to: • Access offshore RMB and FCY markets for funding options • Conduct hedging transactions to mitigate risk in the SFTZ as well as offshore markets • Invest in onshore markets (Shanghai Exchange) and offshore markets with fewer restrictions • Make more streamlined goods/services trade settlements • Enjoy greater access to China’s markets and industries for foreign investors, with more liberalised control over the ‘negative list’ and national treatment • Simplify FX administration for direct investment since banks are allowed to handle the FX registration process directly for corporates • At the appropriate time, SFTZ entities will be allowed to exchange RMB and FCY funds deposited in FTZ accounts freely

CASE STUDY

HSBC pioneers two-way cross-border RMB sweeping from the Shanghai Free Trade Zone In January 2014, HSBC executed its first two-way, cross-border RMB sweeping transaction from the Shanghai Free Trade Zone (SFTZ) on behalf of Dover, a world-leading manufacturer of diversified industrial products. Headquartered in Illinois, USA, Dover is a multi-billion dollar, global producer of innovative equipment, specialty systems and value-added services for the industrial products, fluid management, engineered systems and electronic technology markets. With extensive activities across China, Dover is among the first foreign-invested enterprises to take advantage of this pioneering sweeping service in the SFTZ – and the benefits are already clear. According to Michael Zhang, President of Dover Asia: “RMB two-way cross-border sweeping means a great deal to Dover Corporation, not only enhancing the efficiency of Dover’s regional cash management, but also significantly improving the company’s Asia operations. It will better support the business expansion of our subsidiaries while also speeding up the process of RMB internationalisation within our group of companies.” Among other benefits, RMB two-way cross-border sweeping enables multinational corporations like Dover to deploy funds on a pre-set automated basis between their onshore and offshore entities by linking their Mainland and overseas cash pools. It also brings greater transparency to their operations and enhances their ability to optimise their working capital management.

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As Helen Wong, Deputy Chairman, President and Chief Executive Officer of HSBC China, comments: “HSBC is actively exploring and developing new financial solutions for customers in the SFTZ in accordance with policy guidance. As the zone’s financial liberalisation continues, companies in the SFTZ will have wider options in financial solutions, such as cash management, funding and settlement, and a greater capacity to manage financial risk. “HSBC is ideally placed to serve customers in the SFTZ through our global network, cross-border connectivity and international financial expertise. We continue to explore innovative financial solutions under the relevant policies to support our customers’ business growth and the development of the zone.”

“This pioneering service exemplifies the benefits that multinational clients can capture by deploying funds between their onshore and offshore entities through the SFTZ.” Accordingly, HSBC announced in February 2014 that it had become one of the first banks in the SFTZ to launch a centralised RMB cross-border transaction management solution for its corporate clients by delivering the new service to French multinational Saint-Gobain via its subsidiary in the pilot zone. This innovative cash management solution covers functions such as pay-on-behalf and receive-on-behalf (POBO/ ROBO) and netting. Saint-Gobain, world leader in the habitat and construction markets, is now able to centralise payments and collections for merchandise and services trade settlement, along with other current account items, and therefore improve the efficient use of RMB settlements across its group.

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SFTZ at a glance Location Pudong, Shanghai Area 29 sq km approx. Newly registered corporates 6,600 (February 2014) Newly registered banks 30 (February 2014) Key milestones – 3 July 2013 In-principle approval of General Plan from State Council – 22 August 2013 Formal approval of General Plan from State Council – 27 September 2013 Promulgation of General Plan – 2 December 2013 Promulgation of PBOC’s 30 guidelines – February 2014: Promulgation of detailed rules Estimated lifespan 3 years

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