Shanghai FTZ blazes national reform trail

China's pilot free trade zone in Shanghai is not merely a place with special regulations, but will pioneer reforms for the rest of China, officials have claimed.

Since the zone was established last September, the corporate community has tried to benefit from the promised international standard business environment, while authorities from other parts of the country who want their own FTZ have looked on both enviously and greedily.

At least 20 local governments have reportedly submitted proposals for similar zones, each claiming some "unique" strength.

This FTZ frenzy goes back to before the Shanghai zone was even inaugurated. Last year, south China's Guangdong Province announced an upgrade to one of its "special economic development zones", calling it a "trade zone" and boasting of unrivalled connections with neighboring Hong Kong.

This year has seen other provinces maneuvering to join the party: The coastal city Qingdao in Shandong Province wants to leverage its proximity to Japan and South Korea; Xiamen in southeastern China's Fujian Province says the same about Taiwan; Chongqing pleads that it will open up in China's wild wide west.

Despite all these proposals clogging the pipeline, authorities have given almost no indication that they intend to approve another, similar zone.

At Tuesday's forum in Shanghai on financial innovation, officials from both the city and the FTZ reiterated the implications of experiments in the zone, saying that they only make sense if best practices in the zone can be applied elsewhere in the country: The success of the FTZ lies creating a system that can be replicated elsewhere.

To ensure that success, Shanghai's deputy mayor Tu Guangshao said on Tuesday that activities in the zone must be aligned with the reform agenda for the entire country. Trials in the zone, Tu added, should be carried out with prudence. A real difference will be made only when breakthroughs in the zone are extended to the rest of the country.

There is real concern that liberalization of existing controls may increase exposure to imported risks, and effective mechanisms are needed to hold them at bay.

The People's Bank of China, China's central bank, has asked banks to set up separate accounting units to handle cross-border capital transactions in the zone. Yuan transfers from these accounts to domestic ones is limited to current account transactions, loan repayments and non-financial investment.

Louise Zhang of Deutsche Bank sees these conditions as satisfying legitimate capital needs while containing speculation.

"It all comes down to one simple thing: no business activity in the zone should serve speculative ends," she said. Though there are still limits in many cross-border transactions, there is enough wriggle room for day-to-day operations. "We understand these limits are there mostly to weed out arbitrage," Zhang added.

Acknowledging the achievements of the Shanghai FTZ, Zhu Xiaoming, executive president of China Europe International Business School (CEIBS), said both financial and non-financial institutions surveyed by the school are still confused. Although facilitating cross-border capital flow has aroused interest in innovation, companies in the zone are still concerned about crossing regulatory redlines.

He urged regulators to address what he called the "information asymmetry" between policy makers and market participants in the zone. One suggestion he offered is to introduce a third-party institution to run orientation programs for companies.

Jian Danian, deputy director of the Shanghai FTZ's administrative committee, said during a forum held by CEIBS last month that the FTZ is not just another development zone with preferential treatment.

"(The FTZ) is where we test bold reform initiatives. If it works at the FTZ, we consider expanding it nationwide. If something doesn't work there, then we drop it. This is what happens in the FTZ," Jian said.