When the People’s Bank of China (PBoC) approved the establishment of the Shanghai Free Trade Zone (SFTZ) in Q3 2013, this piqued the interest of the global audience and in 2015 there have been a number of pilot initiatives launched within the zone. But how does SFTZ compare to the nationwide programmes, and does it make a difference to treasury practice? Citi’s Regional Head of Global Liquidity Management Services, Asia Pacific, Sandip Patil, has the answers.

The integration of four existing bonded zones in the Pudong district into the single Shanghai Free Trade Zone (SFTZ) has always been seen as a sign of China’s commitment to reform. With the intention of simplifying the way that business is conducted within China, SFTZ is indeed a bold and progressive move. The reforms launched through SFTZ, while paced, have largely followed the original blueprint, and the mere fact that reforming measures are alive and well should be celebrated. So, some 18 months after its launch, it is worth asking what difference does SFTZ really make to a company’s treasury practices and its business in China?

“It is the most significant event in China’s financial history over the past decade, simply because it is seen as the test-bed for liberalisation of policies that could be rolled-out nationwide,” explains Sandip Patil, Citi’s Regional Head of Global Liquidity Management Services. He says that, as a pilot scheme, it is necessary to assign SFTZ “very significant importance”. When it was launched, he says it had a strong driving force largely to prepare China for the challenges of liberalised trade, to promote the currency and to further open up the economy. It has since been catering to the internationalisation of China’s trade effort, taking a journey towards major change such as initiating interest-rate liberalisation – before certain parts of the experiment went nationwide last year.

In February 2015, ‘third wave’ guidelines were issued by PBoC, opening up new financial channels for SFTZ-based entities (see the March/April 2015 edition of Treasury Today Asia for detail on the first two waves). These ‘upgraded’ the existing approval and quota system for companies borrowing RMB and foreign exchange outside of China. The changes afford corporates (and non-bank financial institutions) operating in SFTZ a lot more flexibility when structuring their foreign debt profiles – as indeed they do for the hived-off foreign trade accounting units (so-called FTUs) of Shanghai-based banks for all client business booked in the Zone.

Specialist zones

Considering the changes implemented to date, there were several public observations made last year questioning the value of SFTZ, notes Patil. “Our view remains that it is a very fruitful and meaningful experiment. The deregulation coming up is proving the point that it is just increasing in scope; slowly but surely China is committing itself to further deregulation of its economy, especially around capital markets and capital accounting forms.” He believes that the progress seen so far has been impressive. The first major evolution is the SFTZ itself; the second is the SFTZ expanding to broader horizons within Pudong District (the original 28 sq km area is now almost four times the size) facilitating three more physical locations – for high-tech, manufacturing and financial services – creating specialised hubs within SFTZ. The third major manifestation of progress will be the expansion of ‘free trade’ to three more zones, namely Guangdong, Fujian and Tianjin. The suggestion is that it will afford more freedom for foreign-funded firms to retain their foreign exchange capital without converting into yuan. It is anticipated that each new district will also operate along specialist lines. “We expect formal confirmation in the near future,” says Patil. Although no specific timeline has been set, he comments that it is all “clearly progressing in a very positive direction, giving a greater amount of financial liberalisation power to the entities operating in the free trade zone.” Progress, he concludes, “is very satisfactory”.

As a test-bed for the wider liberalisation of the Chinese economy, with planned geographic expansion, it is absolutely achieving what it was set up to, confirms Patil. As one of the first banks to set up in SFTZ, Citi’s view is that there has been good adoption rate by its client-base, with billions of financial flows in and out – both core objectives. To contextualise this flow, he points out that at this time last year there were around 3,000 registered entities in SFTZ; today there are more like 16,000. “It clearly shows more and more entities are interested in establishing themselves in SFTZ and more are doing cross-border business. It is achieving its objectives – and a lot more is to come.”

Broader reach

By looking at the benefits seen by the multinational corporate segment when effecting cross-border trade, tangible results can be demonstrated. Cross-border pooling has increased as more of MNCs are engaged in borrowing and lending RMB. Trapped cash has been an issue for many such businesses and, says Patil, “many clients are now able to deploy that cash in business operations outside of China”. Experimentation around lowering onshore funding costs for Chinese businesses is also heading “in a positive direction”. Newer concepts such as in-house banking, ‘on behalf of’ payments and collections, and netting have similarly risen up the agenda of MNCs seeking greater efficiencies as SFTZ delivers on its initial promise. “Since the pilot scope was expanded, it has given increased power to many more customers who are benefitting from some of these concepts by implementing them nationwide – within a controlled mechanism.” This, Patil feels, should give the regulatory authorities the confidence to take the entire experiment fully nationwide. Indeed, he says, giving those companies in SFTZ many more tools to function more efficiently and now facilitating the opening of an FTU, takes the free trade zone concept “to the next level”.

No project of such monumental importance is going to be delivered without first experiencing some challenges. The first of these challenges is for MNCs to connect funding with their onshore businesses, to support all of their needs; the ability, for example, to bring offshore money to fund working capital is limited by the amount that can be borrowed. The second is around China’s capital account; this is an experiment in that direction too, it is not yet fully liberalised. As such, it is cheaper to fund outside of China, however, the new rules announced in February materially increased the previous limit on the amount of offshore funds a company in SFTZ can raise, which is now limited to twice its capital. In comparing SFTZ with more financially liberal spaces such as Singapore or London it is clear that SFTZ still requires the clarity and definition in terms of legal and taxation structures. “But it’s likely to progress in that direction as FTU/FTZ adoption grows in size and scope,” comments Patil.

Reaching further

It is also likely, given the steady progress to date, that there will be further benefits as PBoC increases the scope of reform and expands the number of FTZs. For Patil, the FTU concept has been a major recent enhancer of opportunity and driver of demand, vastly improving treasury and working capital cycles: “if your objective is to borrow or lend more offshore, across local or foreign currency, you can”. Being part of an FTU in SFTZ also means being able to access FX markets onshore and offshore. “It’s the best of both worlds,” he comments. “A company can execute all its FX onshore with CNY (Chinese yuan) and all the associated needs it might have around these transactions. It can also gain access to the CNH market (the Chinese offshore yuan).”

Clearly, market expectation is rising with each new announcement, and the conversation is heading towards bringing the capital markets and the different types of financial instrument onshore. There are calls, too, for further liberalisation of China’s capital account. Patil is anticipating a positive outcome, not least, he says, because such issues are now being discussed in the market. “It is difficult to predict when this will happen and in what form we will see these changes, but we do expect further reform.”

A roll for both

Despite the advantages of SFTZ, it is still an experiment, says Patil, and as such it is unlikely to satisfy all onshore business requirements. Operating an onshore or nationwide treasury is therefore “a must” to support a major business; companies will continue to run these units simply because they have to and “SFTZ just happens to be an experiment in their journey”. As far as domestic business is concerned, Patil believes that the role of onshore treasury is not going to change materially in the short run. And when specifically referring to some of the liquidity tools and techniques currently available in China, certainly more freedom in terms of onshore location is now possible. The ability to pool RMB regionally or globally, for example, means there is no circumstance where a business is ‘geographically’ forced to set up an entity in SFTZ. However, by the same token, this is the time for clients to finalise the roadmap of globalised treasury and execute against that in phases.

So how important is the role of a global bank? Citi is a tier one institution with a global footprint. It therefore has clients to match. It has also been in China for over 100 years and has created a local client base and a depth of capabilities and talent that goes with such longevity. This, says Patil, enables it to keep in touch with the regulators and maintain a position that helps it shape the most appropriate response to global market needs. As vice-chair of the Shanghai Banking Association, a working committee amongst banks in Shanghai, we are able to add value to our clients by providing insights from the industry to the regulator, he says. “We also play an advisory role for our clients; this is a material benefit in terms of informing them of regulatory change.” In talking to, listening to and advising all parties over the years, Patil says a bank with the status of Citi can effectively communicate and demystify the changes across its network, facilitating client feedback “to help the regulators take the experiment to the next level.”