Focus: China - December 2001
In brief: Hong Kong-based Senior Associate Kate Axup looks at how foreign access to the Chinese financial services industry will change once China joins the World Trade Organisation.
International financial companies eagerly await China's WTO accession
After more than 15 years in negotiations, China is to become the 143rd full member of the World Trade Organisation (WTO) on 11 December 2001.
The admission follows approval of China's accession by the WTO membership at its meeting in Qatar on November 10, 2001 and Chinese President Jiang Zemin's signature of approval. The move by the Chinese Parliament to ratify the membership ahead of the Qatar meeting means that one of the world's largest trading nations, representing 20 per cent of the world's population, will have opened its doors even wider to foreign participation in the financial services sector.
The history of China's accession process is as long as it is tortuous. The unusual length of the negotiations can be attributed to a number of factors: the fluctuating state of Sino-US relations, resistance from conservatives within the Chinese government, and the debate on whether China should be treated as a developed or developing country. Finally, just when the terms of China's accession were all but finalised in September this year, there was a last-minute hitch due to a dispute between the United States and the European Union regarding the right of AIG, the American insurance giant, to continue to operate wholly-owned subsidiaries in China after China joins the WTO.
Throughout the negotiation process, the issue of foreign access to the Chinese financial services industry has received considerable attention. At present, the ability of foreign banks and insurers to offer services in China is very limited. To the international financial services industry, China's vast population, together with the Chinese people's reputation for being excellent savers, represents a tantalising market. As a result, foreign governments have lobbied for a significant increase in foreign participation in the Chinese financial services sector as part of China's WTO commitments.
One of the most unique and interesting aspects of the development of the financial services sector in China over the past 15 years has been the relative lack of progress in increasing the transparency of the procedure by which foreign companies are granted access to the Chinese market. The lack of progress in this area contrasts poorly with the very large and generally well-received improvements in the laws relevant to the business operations of financial services sector participants. For foreign financial services companies eager to gain access to the China market, the process is theoretically straightforward but in practice, murky and mysterious. Stories of backroom deals, last-minute reversals and Machiavellian manoeuvring have been commonplace. The major benchmark against which the impact of China's WTO accession should be measured is not the state of its domestic laws or legal system but rather the transparency of the procedure by which foreign participants obtain access to the China market.
Banking
Local banks
The Chinese banking sector is not in good shape. State-owned banks account for around 75 per cent of total banking assets and these banks suffer from very high rates of non-performing loans, as in the past, loans were often made to state-owned enterprises on a policy or political basis, as opposed to on a credit-assessment basis.
The Chinese government is trying to solve this problem in a number of ways. Current reforms have included establishing asset management companies into which the bad assets of local banks are being transferred; fully introducing commercial lending/credit risk assessment-based principles and improving accounting standards. To this end, in October 2001 the Ministry of Foreign Trade and Economic Cooperation issued new rules in relation to the sale of non-performing assets to foreign buyers. The rules provide that asset management companies may transfer equity and creditor's rights in non-listed Chinese companies to foreign investors and may auction, transfer or tender assets held as security (for loans that the asset management companies took over from the banks) or use assets under their control to form joint ventures with foreign partners.
One of the main drivers behind the new rules and the government's attempts to improve the health of the local banking industry has been the need to strengthen the local banks to compete with foreign financial institutions after China joins the WTO.
Foreign banks
The Foreign Investment Industrial Guidance Catalogue (the Foreign Investment Catalogue), issued by the State Planning Commission in January 1998, includes banking business in the restricted category.
Foreign banks operating in China are presently limited to foreign currency business. Some have been licensed to conduct business in the local currency, Renminbi (RMB), but these licences are difficult to obtain and grant only limited rights. For example, foreign banks licensed to deal in RMB must be located in Shanghai or Shenzhen and may not conduct any business - except on a very limited basis - with local Chinese companies or Chinese citizens, which clearly eliminates the vast majority of the potential market. Many foreign banks who are licensed to deal in RMB report that the licences have not led to a considerable increase in business - rather, the significance of the RMB licence rests mainly in this being an important interim step for foreign banks in the lead-up to a fully open Chinese banking market.
Post-accession
A surge in banking business is being predicted once China joins the WTO, following anticipated increases in investment and activity in other sectors.
Upon China's accession to the WTO :
- all foreign banks will be permitted to engage in RMB business with foreign customers;
- after two years, foreign banks will be permitted to conduct RMB business with Chinese companies in selected cities including Shanghai and Shenzhen; and
- after five years, there will be no restrictions (i.e. foreign banks will be able to conduct RMB business with Chinese citizens).
In addition, three years after China joins the WTO, foreign banks will be allowed to acquire interests of up to 49 per cent in fund management enterprises and up to 33 per cent in joint venture securities firms involved in underwriting domestic and international debt and equity issues.
Insurance
Pre-accession
China's insurance sector has registered 10 per cent to 15 per cent revenue growth over the past couple of years. The widest held policies have been pension, medical, and life insurance, with a comparatively low rate of property insurance.
Like the banking sector, the Chinese insurance industry is not without its own problems. Many domestic life insurers have payout obligations that exceed their current return on investments and the immature state of China's financial markets has limited the investment vehicles available to domestic insurers.
Foreign participation in the insurance sector in China has been heavily restricted. Insurance companies, brokerages and agency companies are all included in the restricted category of the Foreign Investment Catalogue. Foreign insurers have had to endure long waits to obtain a licence to operate in China and again, as in the banking sector, the rights attached to these licences have been very limited.
Post-accession
Once China joins the WTO:
- licences will be granted on a prudential basis and will not be subject to any numerical restrictions. The prudential requirements will include the applicant having had at least 30 years' experience in a WTO member country, having had a representative office in China for at least two years and having global assets of over US$5 billion;
- foreign insurers may own 50 per cent of a life insurance venture and 51 per cent of a non-life insurance venture (in the case of a non-life insurance venture, increasing to 100 per cent after two years); and
- the scope of services able to be provided by foreign insurers will increase to include health, casualty and pension insurance.
It was the foreign ownership limitation that in September this year triggered the last-minute delay to China's WTO accession. The problem was AIG's status as the only foreign insurer in China permitted to wholly own its Chinese insurance subsidiaries. AIG's special position is an interesting example of the importance of relationships in China. The company was established in Shanghai in 1919 and has used its long history in China and the personal relationships of its executives to manoeuvre itself into this enviable and unique position. The EU has argued that the terms of China's accession to the WTO mean that AIG will have to sell down its holdings in its existing subsidiaries so that they comply with the foreign ownership limitations, whereas AIG has maintained that the Chinese government assured it that no changes would be necessary. The end result was that China made a binding commitment to the US that AIG would be able to continue on the same footing (i.e. to own 100 per cent of its insurance businesses in China), therefore occupying a unique position vis-à-vis other foreign insurers.
The fact that a dispute between the US and the EU regarding one insurance company was able to hold up China's entry to the WTO indicates how important the issue of access to the financial services industry is to foreign banks, insurers and their governments.
For further information, please contact:
- Kate AxupChief Representative,
Beijing
Ph: +86 10 8515 0250
Kate.Axup@allens.com.au