When Deng Xiaoping made his Southern Tour in 1991, his visit included a trip to Shanghai, where he called for a resurrection of China’s historical financial and business center. The city has more than delivered.
The Shanghai Stock Exchange, barely 20 years old, has grown to encompass 873 listed companies with a total market capitalization of US$2.5 trillion. Shanghai has also established gold, petroleum and futures markets, fostering the financial district in Pudong in the hope that Lujiazui may become as synonymous with finance as Wall Street and the City of London. Last year, the central government issued the "Shanghai Opinion," setting an ambitious goal of turning Shanghai into a global financial center by 2020.
"It’s somehow unavoidable that Shanghai [be among] the leading financial centers of the future," said Horst Loechel, a professor at China Europe International Business School.
Shanghai isn’t without competition, though. Hong Kong was once the gateway to China, and remains Greater China’s financial hub, while Beijing and Tianjin are only the most notable examples of other cities that have put forward strategies to develop into internationally competitive financial capitals.
In an interconnected world, falling back on its ideal geographical location is hardly enough to guarantee Shanghai’s position as a financial center, even with the city’s advanced financial infrastructure and a national mandate. Finance follows the money, and only when Shanghai provides both strong investment opportunities and free capital movement will the city be able to take its place among the financial centers of the world.
Breaking down the aims for 2020 offers insight into the city’s strategy. Key to the evolution will be more developed financial markets, a solid base of experienced financial professionals and institutions, and a strong system of taxation and rule of law. A good place to start, say financial industry insiders, is in opening up investment. While the city has highly active financial trading exchanges, only a trickle of foreign capital is able to flow in through the Qualified Foreign Institutional Investors (QFII) scheme.
"On a micro level, they need to open up markets," said Loechel at CEIBS. He sees the recent approval of short-selling and margin trading as a sign that the central government is committed to enabling the more sophisticated business necessary for the country’s financial maturation.
QFII’s narrow pipe is also expected to widen over time. "When the QFII amount reaches a certain level, the limitations will be removed," said Xu Mingqi, deputy director of the Institute of World Economy at the Shanghai Academy of Social Sciences.
Until such liberalization occurs, foreign capital entering Shanghai will tend to come through the conduits of private equity (PE) and venture capital (VC) funds, which recognize Shanghai as a platform to pursue high-growth, long-term investment opportunities in China.
Shanghai has long maintained a thriving VC industry, which has encouraged investment more effectively than other mainland cities. "If you’re in the technology area, the feeling of Shanghai is more aggressively pro-business," said Gary Rieschel, managing director at VC firm Qiming Ventures Partners.
However, Kevin Qian, founding partner at MWE China Law Offices in Shanghai, describes the offshore incorporation of onshore funds as "somewhat inconvenient."
Recent advancements – including the amended Partnership Enterprise Law, which has long been in the works but should allow foreign funds to create a general partner-limited partner structure similar to that found in the West – have made it possible to establish onshore funds in China. Such funds have the option of listing portfolio companies domestically, avoiding convertibility issues and offering a lucrative opportunity to tap into Chinese investors. The innovations have already attracted internationally recognized PE firms like Blackstone and Carlyle Group to establish renminbi-denominated domestic partnership funds.
These funds lay the groundwork for "dealflow" – the rate and volume of investment opportunities – and increasingly complex and frequent financial transactions will over time generate revenues demanding a mature banking and trading infrastructure.
Persuading foreign financial institutions to come to Shanghai will depend on macroeconomic reforms, including currency convertibility and financial regulation. Shanghai isn’t standing still, though, and has provided incentives to mitigate its shortcomings and accelerate the process.
To lure foreign investment professionals, the city has offered large lump-sum bonuses of between US$700,000 and US$2 million to limited liability and partnership PE and VC enterprises. Furthermore, in an effort to compete with Hong Kong’s flat 15% income tax rate, Shanghai has offered tax rebates of up to 40% to the upper management of PE and VC companies. "Tax incentives won’t eliminate the gap, but they will make the decision easier," said Rieschel at Qiming.
Others are more skeptical. "I think the incentives are secondary, really," said Jack Marr, adjunct professor at New York University based in Shanghai. "The big investment banks 10 years ago had the opportunity to move to Lujiazui, but you didn’t see a lot of takers."
In that time, the city has undoubtedly progressed, but Marr believes that financial companies are only just now entering the stage when revenues justify setting up headquarters in Shanghai. "It’s one thing to have a team visiting here, another thing to have a team based here," he said.
Quality of life, long a major concern for foreign financial professionals moving to Shanghai, is now said to be a non-issue. York Chen, president and managing partner of iD TechVentures, believes Shanghai easily surpasses other mainland cities: Foreign families benefit from a wealth of international schools and modern amenities, without the heavy pollution and congestion that typifies Beijing.
Still, even as markets liberalize and Shanghai loses its status as a hardship post, another question remains: In a country with limited hedging options and even more limited financial experience, can China’s institutions develop appropriate risk management practices?
The answer lies in Shanghai’s homegrown human capital. For the time being, the city must continue to import foreign financial professionals with sufficient expertise, but the middle- and back-office infrastructure will be Shanghai’s responsibility to develop. Beyond risk management, this has implications for customer relationship management and other areas tied to creating a successful financial infrastructure.
Financial boot camp
CHINA ECONOMIC REVIEW visited the offices of Oracle Bay, a firm dedicated to training the IT and middle-office customer relations personnel who will fill out much of the domestic supply side of Shanghai’s finance industry. Oracle Bay focuses on assisting with certification and customer service, developing workers for clients as diverse as HSBC and Huatai Securities. With dormitories and cafeterias designed to house and feed students gathered from across China, the company’s facilities resembled a true training ground – ground zero for Shanghai’s emergence as a global financial center.
"They’re re-creating a very tightly knit service industry value chain," said Qiming’s Rieschel. This infrastructure has evolved with what Rieschel sees as a new wave of mid-career financial professionals coming to work in China who are following money, not just following orders.
As Shanghai develops its financial capabilities, the city will inevitably move into more direct competition with Hong Kong. For now, the special administrative region has the upper hand. It retains its position as the more experienced financial center and has a greater familiarity with international standards.
"International practice has developed through decades of experience to deal with crises in the past," said Maurice Hoo, a partner at law firm Paul Hastings in Hong Kong. "Professionals in China have not seen [such crises], and do not think it’s an issue."
Even if Shanghai is able to establish clear rule of law and standards, these may not be enough if Chinese lawyers and professionals cannot learn to function within the established global legal framework. "Diligence is a big problem … ‘Good enough is okay’ is not a standard of business," said Bill McGrath, a partner at MWE China Law Offices.
Over time, China may be able to bend legal standards through sheer dint of its size, but Shanghai’s ability to become globally competitive is dependent in the near-term upon its ability to adapt to international standards and expectations.
Shanghai is also held back because it can only do so much – the final keys to opening the floodgates of international finance are in Beijing’s hands. While Shanghai may wish to rapidly liberalize its markets, offer heavy tax breaks for investment professionals, and fast track renminbi convertibility, this would be politically risky for the central government. Enabling the excesses of finance at the expense of the national Chinese economy may only serve to hurt both Shanghai and the nation in the long-term.
Xu at the Shanghai Academy of Social Sciences said that as much as Shanghai is a place to embrace risk, Beijing remains cautious. "We cannot really have an international financial center at all costs. We must choose the costs we are willing to pay," he said.