Cablegate: Shanghai Defining Its Role As an International Financial

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FM AMCONSUL SHANGHAI
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RUEHSH/AMCONSUL SHENYANG 2215
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E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV PREL CH
SUBJECT: SHANGHAI DEFINING ITS ROLE AS AN INTERNATIONAL FINANCIAL
CENTER

REF: A. A) SHANGHAI 187
B. B) SHANGHAI 191
C. C) HONG KONG 1163

SHANGHAI 00000410 001.2 OF 005

1. (SBU) Summary: Shanghai received a large rhetorical boost
this past spring in its quest to build a modern financial sector
that might eventually rival New York and London. The State
Council, after months of delay, issued an endorsement of
Shanghai's goal to become China's international financial center
by 2020. However, Shanghai continues to struggle with
regulatory barriers that will limit the ability of Shanghai
officials to use the State Council document to implement
far-reaching financial reforms. End Summary.

==========
Background
==========

2. (SBU) EconOff in recent weeks met with a variety of contacts
on Shanghai's plan to become an international financial center
by 2020, the outlines of which were announced in April 2009
following a late-March State Council meeting (Refs A and B).
According to a top official with the Pudong Financial Services
Bureau, the plan had been strongly supported by the late Huang
Ju, who was Mayor and then Party Secretary of Shanghai before
moving to the Politburo Standing Committee in 2002. However,
the State Council's April announcement embraced only part of
earlier formulations, calling for Shanghai to become an
international financial center and an international shipping
center, while dropping mention of Shanghai becoming an economic
and trade center. (Note: Shanghai officials, including Party
Secretary Yu Zhengsheng and Mayor Han Zheng as of late September
continue to promote development of "four centers" in Shanghai.
See septel. End note.)

3. (SBU) The "two center" plan was endorsed with great fanfare
at this May's second annual Lujiazui Forum, held in the heart of
Shanghai's financial district. (Note: Pudong is an eastern
district of the Shanghai metropolitan area, largely built up
over the last twenty years. Lujiazui is that portion of Pudong
directly across the Huangpu River from Shanghai's historic Bund
and old city neighborhoods, and is home to the national or
regional headquarters of a number of Chinese and foreign banks,
as well as home to China's largest stock exchange, the Shanghai
Stock Exchange. End note.) Top financial officials opened the
Lujiazui Forum with lengthy speeches supporting the goal,
including People's Bank of China Chairman Zhou Xiaochuan, China
Banking Regulatory Commission Chairman Liu Mingkang, China
Securities Regulatory Commission (CSRC) Chairman Shang Fulin,
and China Insurance Regulatory Commission Chairman Wu Dingfu, as
well as Shanghai Party Secretary Yu. The plan will take another
eleven years to implement, according to Shi Haining,
Director-General of the Pudong Financial Services Bureau: it
took five years (2001-2005) to build the foundation, will take
until 2010 to set up, and then until 2020 to complete.

==========================================
The International Market Will Decide . . .
==========================================

4. (SBU) Much of the debate over Shanghai's plan to establish
itself as China's international financial center focuses on
Shanghai's ability to outcompete other Chinese cities --
including Hong Kong, which is acknowledged to have a substantial
lead (Refs A and C), Beijing, Tianjin, and Shenzhen -- and to
eventually hold its own against the acknowledged international
centers in New York and London.

SHANGHAI 00000410 002.2 OF 005

5. (SBU) Officials closely tied with Shanghai's financial
center plan say that Shanghai's best chance to compete for
international status is to develop its comparative advantages
and "allow the market to decide." Fang Xinghai,
Director-General of the Shanghai Financial Services Office, and
Jeffery Chen, Deputy Director-General of the Pudong Financial
Services Bureau, both said that Shanghai's strongest card
relative to its domestic rivals is its proximity to financial
markets. They pointed out:

- Shanghai is the base for China's largest stock market,
largest commodities futures exchange, the world's largest gold
exchange, China's only bond market, and China's only financial
futures exchange. Fang Xinghai further claimed that all these
markets are rated in the world's top five or ten.

- Fifty percent of China's asset management companies are
headquartered in Shanghai, in order to be close to these
markets, said Chen. Private equity and venture capital firms
are strongly attracted to Shanghai for the same reason.

6. (SBU) In turn, the confluence of domestic markets and
players in Shanghai has already brought in international
financial firms looking for a foothold in the China market.
Fang noted that Shanghai has more foreign-invested bank
headquarters than any other Chinese city, as well as being home
to the most international insurance companies and
foreign-invested mutual funds.

7. (SBU) By contrast, both interlocutors acknowledged that
Beijing has the lead in terms of headquarters of major
state-controlled banks and domestic insurance companies. Under
these conditions, an executive at a foreign-invested bank
explained to EconOff, China could have more than one financial
center, although in her view, Beijing would no longer challenge
Shanghai for overall preeminence. (Note: Of China's Big Five
(state-owned commercial) banks, Industrial and Commercial Bank
of China, Bank of China, China Construction Bank, and
Agricultural Bank of China are all headquartered in Beijing,
close to the regulators; only Bank of Communications calls
Shanghai home. Shanghai is headquarters to only three of
China's top ten insurance companies as ranked by 2008 premium
income, accounting for approximately 14 percent of total
national premium income. End note.)

8. (SBU) Comment: Shanghai's argument that competition among
domestic localities should be decided by the market -- rather
than a diktat from the Central Government -- appears to reflect
confidence that it already has nudged aside its domestic rivals
on the international stage, while also acquiescing that it
cannot gain a monopoly in the domestic market. End comment.

============================================= =
. . . With A Little Help From Local Incentives
============================================= =

9. (SBU) Shanghai is offering some incentives to financial
companies establishing local offices to level the playing field
with rivals. As described by Shi, these include the following:

- Individual income tax reimbursement. This is a "big
challenge," said Shi, because Shanghai must compete for talent
with Hong Kong and Singapore, where taxes are low, but given
China's current fiscal revenue situation in which revenue growth
has slowed considerably over the last two years it is not a
propitious time to convince leaders to lower taxes for
high-income persons. In addition, local governments are

SHANGHAI 00000410 003.2 OF 005

forbidden to reduce income taxes. Instead, Shanghai is offering
reimbursements: 40 percent for the top executive, and 20 percent
for mid-level management personnel.

- One-time bonuses from the Pudong government to new employees
in financial institutions.

- Fiscal subsidies, including for hiring college-educated
interns. In total, through spring 2009, Shanghai had provided
RMB20 million in subsidies to financial firms. (Note:
Approximately US$2.9 million. End note.)

- Assistance cutting bureaucratic red tape. For instance,
accelerating transfer of residency status (hukou), placing
children of financial firms' employees at the head of the line
for local schools, and helping to locate office space.

10. (SBU) Shanghai also provides indirect incentives, note the
officials. For instance, Shanghai has one of China's best
educational systems. Other cities -- such as Tianjin -- can
offer educational preferences to employees' children, but they
will not be as effective, since the schools are not as
attractive. Pudong Financial Service Bureau's Chen also said
that Shanghai has a more transparent regulatory environment,
helping to control costs as a company sets up operations.
Shanghai's goal is to reduce taxes and transaction fees, so that
it becomes a place where international firms can grow. Shanghai
does not want to be "a center for headquarters," he said, but "a
center for capital."

==========================================
Financial Center Bureaucrats Gaining Clout
==========================================

11. (SBU) Pudong District, home to Shanghai's tallest
skyscrapers and the Lujiazui Finance and Trade Zone, is gaining
bureaucratic clout as Shanghai pushes to build an international
financial center. In May, for instance, the State Council
approved bordering Nanhui District to merge into Pudong
District, more than doubling Pudong's land area. According to
Chen, this measure will open opportunities to develop Nanhui's
largely rural land base, to gain economies of scale from
combining administration of the large port facilities in each.
In addition, the Pudong Financial Services Bureau was upgraded
from its former status as an office and made independent of the
Pudong Reform and Development Commission, said Chen.

===========================
Pilot Projects . . .
===========================

12. (SBU) Chen said that Shanghai is lobbying the Central
Government to allow pilot projects in Shanghai as a way to
achieve financial sector liberalization. Shanghai has succeeded
in lobbying for pilot projects by arguing that local firms and
officials will not try to skirt the spirit of the law during
implementation. For instance, Shanghai-based Hua'an Asset
Management received CSRC licensing as the first Qualified
Domestic Institutional Investor (QDII, a program under which
China-based fund managers can invest in overseas assets), said
Chen, because the Pudong Financial Services Bureau offered
assurances to CSRC. Fang of the Shanghai Financial Services
Office said that Shanghai used the same argument in order to set
up the local pilot for using renminbi in trade settlement (Ref
B).

13. (SBU) Shanghai officials and financial sector players also

SHANGHAI 00000410 004.2 OF 005

mentioned the following measures currently under consideration
that would liberalize the financial sector:

- Exchange-traded funds (ETFs). Both the CSRC and the State
Administration of Foreign Exchange would need to approve ETFs,
which would allow domestic investors to purchase instruments on
the Chinese stock markets that mimic the performance of an
overseas investment, said Chen. A likely first ETF on the
Shanghai market would be the New York Stock Exchange (NYSE)
index, he said. Asset management companies are lobbying for
this measure.

- Listing by overseas firms on the domestic market. Peng Su, a
representative of NYSE-Euronext in Beijing, told EconOff that
the NYSE index ETF for now is not being emphasized as he works
on smoothing regulations to allow overseas firms such as
Coca-Cola to gain access to fundraising to through the Chinese
market. One continuing sticking point is whether or not to
permit U.S. Generally Accepted Accounting Principles to be used
in the Chinese books of these overseas firms, said Peng. Some
Chinese regulators want a quid pro quo with Chinese firms being
allowed to use Chinese accounting standards when listing on the
NYSE.

- Real estate investment trusts (REITs). Shi said that the
proposal to begin licensing REITs in Shanghai had been generated
by his office, since there are experts on staff who research and
propose financial liberalization measures.

- Opening a "credit card park." China Construction Bank has
established its credit card business in Shanghai, said Shi, and
Bank of China has a payment and settlement center. There are
plans to establish a Shanghai Financial Information Services
Park as part of the Zhangjiang High-Technology Park in Pudong,
which would build off these existing services in collaboration
with China Union Pay, China's leading credit card payment system.

============================================= ==
. . . Cannot Always Overcome Regulator Log Jams
============================================= ==

14. (SBU) The formal process for approving new financial
products is unwieldy, say our interlocutors. For instance,
noted Shi, asset management companies are currently allowed to
introduce only two products per year. Fang -- formerly a top
executive at the Shanghai Stock Exchange (SSE) -- said each time
the SSE prepares to offer a new product, such as a simple option
on stocks, it is blocked because the CSRC must approve it and
then report it to the State Council. If one person believes
that a product is not necessary, said Fang, then it can be
blocked. Fang said that he hopes the Central Government can
delineate a few areas where decisions can be made in Shanghai --
more like the system used by the NYSE, in which pre-approval is
not needed.

15. (SBU) A recent episode involving pilot incentives for
private equity (PE) firms in Shanghai, however, illustrates how
quickly log jams can reappear after being broken up. In June,
Chen said, Pudong extended to PE firms incentives -- such as
income tax reimbursement -- that are available to other
financial firms. Even though it was not clear that the Central
Government would approve the move, Pudong was able to convince
the well-known firm Blackstone to establish a PE fund. Other
multinationals quickly followed in order not to cede the
first-mover advantage to Blackstone. However, Chinese media
reported in September that Central Government authorities are

SHANGHAI 00000410 005.2 OF 005

now reviewing the policies.

16. (SBU) The lack of an arbiter to break deadlocks at the
Central Government level will probably continue to slow
Shanghai's financial liberalization pace, say financial sector
professionals. One Shanghai financial official said that a key
part of the State Council's Shanghai financial center plan was
for a working group to be authorized to make timely approvals
(Ref B). However, as of mid-August, the working group, which is
to be headed by the National Development and Reform Commission,
had not yet met, a Shanghai official told EconOff.

=======
Comment
=======

17. (SBU) The biggest challenge remaining for Shanghai's
aspirations to build an international financial center by 2020
is improving China's regulatory structure, as Shanghai's hands
remain largely tied by overly cautious bureaucrats in Beijing.
Shanghai Financial Service Office's Fang said that he lobbies at
every opportunity to open markets to foreign financial firms,
which he estimates will bring much-needed expertise to
Shanghai's financial sector. He said a cause of the global
financial crisis was too little regulation, whereas China
continues to have too much. While there are voices in the
Chinese government that are using the Shanghai international
financial center plan to press for greater financial
liberalization, there are also clearly groups in China lobbying
to limit financial liberalization, in part to protect domestic
financial players.CAMP

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