Shanghai's Hub Dream

(Interview with China Daily on February 24, 2012, Professor Ning Zhu, Deputy Director of SAIF, said that Shanghai still faces many challenges in building itself into an international financial hub.)

Shanghai's Hub Dream Still Distant

The National Development and Reform Commission recently put forward detailed plans for Shanghai to develop over the next few years as it aims to become a global financial center by 2020.

China's economy is likely to keep growing at a rate of over 8 percent a year, a figure that dwarfs that of most other economies. To keep up that growth it is imperative that China remain open and continue to integrate into the global economy. If that is done, and with central government support, it seems only a matter of time before Shanghai does become a global financial center.

You only need to look at the city's development, in particular its financial sector, over the past few years to see how realistic that prediction is. With the hosting of the 2010 World Expo, Shanghai revamped its infrastructure and made itself one of the most attractive cities to foreigners in China. At the same time, the amount of capital raised and total trading volume of the bourses there has made it one of the leading primary and secondary markets in the world.

The Chinese economy and financial markets are leading the rest of the world in many quantifiable ways, and fundamental reforms are needed before equally important yet less tangible changes can happen to turn Shanghai into a truly global financial center.

Many cite the constraints on international capital flow as a major hurdle that any mainland city has to overcome to become a truly global financial center. During and since the expo Shanghai has managed to build a highly international image.

Here is a city that mingles the modern with the traditional, gleaming skyscrapers juxtaposed against narrow alleys, and with its warm and open people, all making it a magnet for foreigners looking for opportunities.

If you are in Shanghai looking for someone working in trade or shipping you do not need to look far, because that is where they make their living, but finding professionals in the financial sector can be problematic. Many foreign institutions are still in the process of learning about the market and trying to find out more meaningful ways to leverage their global presence in the Chinese domestic capital market.

The development of Shanghai into a truly global financial center hinges on how the Chinese domestic capital market integrates into global financial markets. With the development of the warrants market and the index futures market over the past several years, the world has witnessed how much enthusiasm Chinese investors have for financial innovation and new financial instruments.

The question then becomes how to create new markets and further reform the existing markets so that lines on maps called borders become less of a hindrance to those on either side of them.

This is one reason why some argue that Shanghai would have to overtake Hong Kong to become a global financial center. Such a view tends to have the two superb cities competing against each other to an unnecessary degree. Whereas Hong Kong remains an attractive destination, there is great potential for Shanghai to leverage on China's drive to boost domestic consumption and gravitate toward higher-end manufacturing and export.

That said, it is critical that Shanghai find its strategic positioning as a global financial center, especially with existing regional financial centers such as Hong Kong, Singapore, and Tokyo. With modern communications, distance is less critical than it used to be. In that regard, Shanghai faces the difficult challenge of building up the kind of trust that existing financial centers have taken decades to build, much of that work having been done when most business was done locally.

One potential area for future development is the fixed income market. Shanghai is now the center of the inter-bank lending and bond market. With the introduction and development of the local government bond and corporate bond market, it is conceivable that the fixed income market will one day catch up, and even surpass the Chinese stock market in both the amount of capital raised and the amount of securities changing hands. If the fixed-income market develops the way many hope it does, Shanghai may continue to enjoy its present standing and become a financial center that has both capital raising and trading capacity in domestic and international markets, through the debt and equity markets, via direct and indirect financing.

Finally, Shanghai is in desperate need of talent in almost all areas of finance. According to some statistics, about 10 percent of the work force in the city of London is employed in the broadly defined financial sector. Trailing it are New York and Hong Kong, with a high single-digit percentage of their work forces in finance. In contrast, only about 2 percent of Shanghai's workforce is in finance.

The financial services industry is after all a special part of the service industry, and the quantity and quality of the work force directly determines the size and health of that industry. Hence, Shanghai has to do its best and come up with innovative ideas to educate and attract talent, especially at a senior level from overseas.

Apart from the strategic considerations, many foreign institutions choose to locate their regional headquarters in other Asian cities, most notably Hong Kong and Singapore, for more practical considerations. Many companies, especially those from British Commonwealth countries, favor Hong Kong and Singapore because of a common legal background. Differences in the legal framework, some senior corporate managers say, is pertinent not only to business transactions, but also property rights and even personal privacy and safety. As a result, luring foreign institutions wary of such legal complexity, Shanghai may need to work with the central government in coming up with some innovative policies.

Taxation is another reason often cited for corporations and individuals shying away from Shanghai. In China, corporate and personal income tax at their current levels are a deterrent to business. Local governments can of course offer various incentives to attract capital and talent, and Shanghai may have something up its sleeve in the area of finance. After all, the long-term tax revenue of the Shanghai government hinges on its ability to keep the financial sector growing and on attracting more talent. Any concessions offered now could justifiably be regarded as investment in the future.