Shanghai is set to test the water for further financial reform after the Chinese central government approved the establishment of a pilot free trade zone in the business hub.

The city released detailed guidelines including measures to allow more private capital in the banking sector and promote cross-border use of the yuan.

The guidelines consist of 42 entries divided into three categories: those that are already in place yet need reinforcement, those that are ready to be launched and those that still await approval.

The 12 entries marked as “innovative reform,” which still await a green light from relevant ministries, are mostly measures to lessen foreign exchange control and encourage cross-border yuan flow to facilitate trade and investment in the region.

“These measures are all within the scope of the instruction released by the State Council in July. ... We’re still waiting for the starting gun from the central government,” said an official with the Shanghai government’s financial office.

“There are no set patterns or regulations for some of these measures at the moment, but we would like to see these measures carried out in Shanghai first once they’re good to go.”

The Ministry of Commerce said on Thursday that the State Council ― China’s cabinet ― has formally approved the plan to establish a 28-square-kilometer free trade zone in Shanghai, which comprises four areas under the special supervision of customs.

The plan was passed at an executive meeting chaired by Premier Li Keqiang on July 3.

A detailed plan will be released when the adjustment of legal framework is complete.

Although these measures are not exactly from the blueprint of the long-expected Shanghai Free Trade Zone, he admitted that the FTZ could serve as a testing ground.

According to the guidelines, Shanghai vowed to promote cross-border settlement of yuan and expand the use of the currency in trade, investment and insurance.

To do so, the city will strengthen its role as a settlement center for international trade and pilot fund management for multinational companies’ headquarters. It also looks to include more businesses in its inter-bank foreign exchange settlement.

In the meantime, Shanghai will develop a mergers-and-acquisitions investment fund and encourage innovation in private equity and venture capital investment.

The city will also accelerate the establishment of its futures market and introduce treasury bond futures within the second half of this year, according to the guidelines.

According to Ge Yufei, vice president of SPD Bank’s Shanghai branch, the bank has already set up a team to prepare for the launch of these measures.

Initial plans include setting up an office within the Shanghai FTZ, and developing innovative products and services to meet various demands, Ge said.

Various proposed rule changes will help create channels that can lower the cost of funding to businesses. Other provisions would allow rich individuals a much wider choice in where to park their wealth.

There is a proposal that seeks to encourage enterprises undertaking consolidation of production capacity to raise funds more cheaply and simply by issuing preferred, rather than common, stock, which is a financial instrument that consists of both debt with fixed dividends and equity with potential appreciation.

Unlike bonds or other debt instruments, preferred stocks are not counted as liabilities and they don’t require the issuers to pay a fixed interest, said Zhang Qi, an analyst with Haitong Securities Co Ltd. What’s more, they aren’t going to dilute the issuer’s share price because there is no increase in outstanding share capital, he added.

Another proposal calls on the authorities to regulate and promote asset securitization that can provide greater funding flexibility for financial institutions.

“The securitization of credit assets could be an innovative method of financing to diversify the risks of lenders as well as increase financing efficiency,” said Zhang.

The plan also includes a proposal to progressively lift the control on direct foreign investment by domestic investors. The limited investment channels in the domestic market are widely believed to have forced many wealthy individuals to park most of their money in property, helping to drive prices in major cities to levels fewer and fewer people can afford.

“I am tired of being trapped in the property market and A-share market, making very little profit, so I am keen to go out of the Chinese mainland to make direct investments in overseas projects such as property with high returns,” said Chen Yanchuan, a 47-year-old owner of an electronic device company in Wenzhou, Zhejiang province.

By Yu Ran and Wei Tian

(China Daily)