Few things are as important to the world over the next few decades as the reform of China's domestic financial markets. China's growing share of world trade, the size of its economy and its role as the world's largest creditor mean that what happens within China is directly relevant to the rest of the world.
The restructuring and opening up of China's financial markets have been at the heart of China's reform agenda for the last two decades.
A year after Xi Jinping took over at the helm of the Chinese Communist Party the upcoming Third Plenum will provide the clearest signals for some time about China's economic direction and capacity and commitment of the new leadership team to push through further reforms.
The Third Plenum runs from 9 to 12 November and is a plenary session of the Party's Central Committee, the body from which the Politbureau is selected. It provides one the first real opportunities for Xi Jinping, as Party leader and President, to flesh out his economic vision for the country.
Expectations are high. As China enters a new era of slower growth - with a shift to a more sustainable economic model – there is wide agreement that significant changes are now needed.
The case for financial reform is compelling. The era of double-digit annual GDP growth underpinned by a growth model based on export and investment-led growth is coming to an end.
President Xi and Premier Li are now building Party support for rapid action on an economic agenda that they hope can manage China's transition to a very different form of economic growth and to deliver sustained annual growth of between 7 and 7.5 per cent.
What should we be looking for?
What we know already is that the path ahead will see domestic consumption and substantial financial innovation and liberalisation replacing the emphasis on exporting, and heavy public sector investment, as the prime drivers of growth.
The financial reform process over the last 20 years points to a carefully sequenced road map which has witnessed the creation of the platforms, institutions and laws needed to support, supervise and regulate financial markets and their participants.
The pace of major reform has slowed somewhat over the last few years and many are hoping for the process to be re-energised with the continued incremental roll-out of reforms.
This would involve deepening the capital markets, developing the corporate bond market, allowing for greater private ownership within the banking sector, increasing oversight of the "shadow" banking market, loosening restrictions on China's cross-border capital flows by expanding the QFII/RQFII and QDII schemes, relaxing the controls on deposit rates (especially following the introduction of the mooted bank deposit insurance scheme) and further developing strong independent regulatory bodies to support the integration of China's financial sector with the global financial system.
A stated end-goal in the sequencing is to make the Renminbi (RMB) an international currency and one that is freely convertible. China is already actively promoting the use RMB to settle international trade contracts but realizing its ambition for convertibility will require new efforts to support the development of deep and liquid domestic RMB markets, as well as developing deeper bond markets and derivative markets to hedge currency and other risks.
These changes are on the wish-list for many within China's power brokers and reformers, but those expecting rapid change may be disappointed.
Policy making and reform in China these days are less about charismatic leadership and more about forging a consensus, especially in the face of strong resistance from vested interests that have benefitted from the economic model of the last 20 years. The Plenum is a Party meeting and it is unlikely that there will many specific policy announcements.
More likely a broad policy "road map" will be laid out, with new policy settings directed to a more efficient allocation of capital (especially for smaller enterprises and in the private sector) and deepening of the capital markets.
Implications for Australian business
The changes that these reforms will bring about for Australia – and the world - will be profound.
Australia's financial services sector is one of the most efficient and sophisticated in the world. It is well-regulated and its financial institutions well-capitalised and profitable. There are linkages to the region through trade flows, in-bound investment into the booming resources sector, outbound superannuation funds and the activities of foreign (including Chinese) banks in Australia.
Despite all this, the general level of investment and business interests directly into China remains under-weight when compared to the growing importance of China to Australia's economic success.
Continuing to see China as a customer, offering two–way trade and investment flows and foreign exchange service, as well as some relatively narrow service offerings such as managed investments is a short term option only.
Longer term, our priority must surely be to integrate with the region, forging deep partnerships that make Australia's financial services industry a truly regional industry with a strong Australian base, providing services seamlessly across the region.
The strategies that can be adopted by organisations will vary, but there are several aspects of China's reform process that suggest significant long-term opportunities:
- Wealth management: Any policy move by Beijing
away from reliance on bank deposits and lending, and associated
support for regulated wealth management products, will allow
Chinese investors access to more sophisticated, higher-yielding and
longer-term investment and insurance instruments.
Years of experience gained in managing Australia's burgeoning superannuation funds, expertise in product development and skills in critical areas such as fee income generation, credit risk assessment and cross-selling of products and asset management position Australian wealth and funds managers and insurers to take advantage of these opportunities.
- Renminbi internationalisation: Off the back of
rising regional trade flows, the RMB is already an important
intra-Asian regional currency. Within the next 10 years the RMB
will take its place as a new global currency.
Policy support this year from the Australian government through a range of initiatives, and new business platforms provided by banks in Australia mean that Australian companies are now able to use RMB invoicing to save fees, grow markets and reduce currency risk when dealing with Chinese counterparties. The RMB is no longer a matter of long-term strategizing, but something that all corporate treasurers should assess now.
- Opening up of the bond market: This is the
most critical of the steps in China's sequential reform
process. The domestic market is growing rapidly and Australian
institutions are well-positioned to combine their experience in the
origination of fixed income products and services with Chinese
banks' local knowledge, relationships and distribution
More significantly, the opening up of the local bond market to foreign issuers and investors heralds the potential for a diversified and exciting new investor base.
- Alternative financial funding solutions: Policy reform is encouraging the development of "innovative" financing techniques. A recently re-invigorated pilot program for asset securitisation has proved to be highly successful. Australian expertise in this area is renowned and offers opportunities to work with local partners to create new financing options for the China's mid corporate market and at the same time ensure that this segment of the market develops in accordance with global best practice.
- The "going-out" of Chinese banks: Chinese banks are expanding internationally as they seek to support Chinese enterprises abroad. Australia has been an important testing ground for investments, helping Chinese banks to acquire experience, skills and capabilities. Partnerships with Chinese banks have the potential to provide further banking services in Australia and to unlock opportunities within China itself. Over time Chinese banks in Australia will expand the range of services and products they offer, creating more competitive pressure in the local market.
- China as a source of capital: China has potential to be a source of capital to finance Australia's investment needs. Xi has spoken of UD$500 billion outbound investment by Chinese interests over the next 5 years. Australia has been the beneficiary of much of China's first wave of outbound investment. Our challenge now is to ensure we retain our "fair share" of this new wave of capital, and that our policy settings and community views are aligned to ensure Australia does not miss out on the benefits that can flow from this once in a lifetime event.
- Deploying our intellectual capital: More generally, Australian financial institutions, legal advisers and other experts can play an important role in working with Chinese institutions to improve their systems of corporate governance, risk management, internal control and to adopt best practices, all of which are essential building blocks for a strong, integrated regional financial system.
Gearing up for the ride
How individual institutions take advantage of these opportunities will depend on the strategy of each institution, its market and product alignment, its risk appetite and the amount of capital an institution is willing to deploy.
What is clear, however, is that to be successful, Australian business and policymakers have to develop a longer-term (10 to 20 year) game plan and work closely to deliver it. Our policy horizons and national policies need to reflect those of our key regional partners, China being the most important.
Now, more than at any time in the past, success will be linked to the creation of partnerships, collaborations and strategic alliances.
China's reform processes are underway. We should not underestimate the determination of the leadership to press resolutely ahead with reforms.
The announcements coming out of the Third Plenum have the potential to be game-changers – for China and the world.
The changes will bring with them a massive rebalancing of the world's financial markets. The ride will not be smooth, but for those prepared, the opportunities will be significant.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.