Category Archives: Market Structure

China’s Financial Reform: ‘Making Progress While Maintaining Stability’

There were no great expectations of China’s fourth quinquennial national financial work conference that has just ended in Beijing. And it seems to have met them.

These two-day meetings of top political leaders and policymakers set broad policy objectives for the coming five years. In the past they have provided a blueprint for significant financial-system reform. But with a leadership transition already underway, the start of a new five-year plan and growing nervousness among policymakers and political leaders alike about the volatile outlook for the global economy and the potential implications for China’s growth, there is no great appetite for much beyond keeping a steady ship.

“Risk-aversion should be the lifeline of our financial work,” said Prime Minister Wen Jiabao. He also said that there would be greater supervision of the banks, which, he said, needed to improve their governance and risk management.

Risk control and prudent macroeconomic management were the order of the day, as they were at last month’s annual economic work meeting. “Making progress while maintaining stability,” is the mantra. The emphasis is currently on the stability.

More detail about the financial work meeting will likely drip out over the coming days. The post-meeting statement dealt in generalities, but two leading topics of discussion were the currency and interest rates. Moves towards more market oriented interest rate mechanisms are necessary if China is to become more efficient at capital allocation, as it needs to be as its economy develops from its invest and export model of the past three decades. But steps have been tentative in the face of some vested interests who have thrived on cheap and ready bank loans. We expect the equally tentative steps to develop bond markets to be given priority over interest rate liberalization, with provincial and local governments being given more scope to sell bonds to firm up their finances. However, when it comes to developing a corporate bond market, don’t underestimate the political task in getting the big state owned enterprises to be supportive of a new source of credit that will be more demanding of their performance.

The internationalization of the yuan is also likely to continue at a measured pace, while the exchange rate against the dollar won’t be allowed to drift much higher. Policymakers feel that with the trade surplus shrinking the currency is at the right sort of level. It has risen by a third since the peg with the U.S. dollar was first broken seven years ago. Wen said China “will steadily proceed with efforts to make the renminbi convertible under capital account to improve its management of the foreign-exchange reserves”–though that is pretty much boilerplate.

This is an edited version of a post that first appeared on China Bystander.


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The Transaction Tax That Never Was, Never Will Be

The ‘Tobin tax’ — the EU’s proposed tax on financial transactions named for the American economist who advocated taxing currency trades in the 1970s — looks increasingly likely to be stillborn. It will be politically hard enough within the EU to get all member nations to agree to it, regardless of its populist support in France and Germany. The UK has already set its face against it, unless it is implemented globally, which is even more improbable than it being accepted in Europe. The US, Singapore and China won’t readily throw away a windfall gain in competitiveness for their financial centres viz-a-viz London. And London knows it. A classic Catch-22. The lobbyists won’t even have to work that hard to scupper the proposal.

The details of the tax that will never be are as follows: The EU wants to introduce it in 2014, at a rate of 0.1% on the exchange of bonds and shares and 0.01% on derivative contract transactions. It would apply when at least one party to the transaction is located in a EU member state. We can only imagine that there would be a boom in transaction tourism to offshore havens.

Another reason the tax will be still born: though the EU Commission reckons that the tax could raise 57 billion euros ($77 billion) a year for EU governments’ coffers (the EU would set a base rate that national governments could top up), it also estimates that it could cut Europe’s long-term growth by more than 1.7% of GDP. That loss of growth would be the price for eliminating what the Commission reckons would be 90% of the derivatives transactions in Europe. Yet in today’s global markets, the business might disappear but not the risk. That would be a hard sell even for cash-strapped euro-governments.

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Banks’ Lobbying To Limit Financial Regulation To Move To Agencies

The devil is usually in the detail. The detail that matters with America’s newly passed financial reform legislation will be the rules and regs yet to be written and the appointments made to oversee the writing and enforcement of those rules and regs. Congress has passed a broad set of instructions to regulators but left, let us say, 75% of the work still to be done over the next four years. That leaves plenty more time and scope for the financial services industry to lobby to water down the provisions of the Restoring American Financial Stability (RAFS) Act still further.

As it is, the act does little to reduce systematic risk. The work being done on capital requirements, liquidity and leverage limits by the the G20’s Financial Stability Board to create global standards for systemically important financial institutions is likely to prove to be of more lasting significance in that regard.

Legislate first, regulate second is not novel in the U.S. Sarbanes-Oxley, the corporate governance legislation hastily enacted by Congress in 2002 in the wake of the WorldCom and Enron scandals, was similarly broad-brush. That its subsequent rule making was in line with the strict spirit of the legislation owed much to the presence of an activist chairman at the Securities and Exchange Commission in William Donaldson.

RAFS will involve many more regulatory agencies than just the SEC, offering not just a less natively uniform regulatory landscape but all the more opportunity for the financial services industry to divide and rule. Banks have already weakened in the act the impact of the proposed Volker Rule to limit their proprietary trading. Their next step will be to expand even further through rule making the types of proprietary trading they are allowed to undertake. The exemption for proprietary trading on behalf of customers gives them a massive loophole to start from. Similarly, banks will be lobbying to keep a growing range of bespoke derivatives trading off-exchange, while making sure new rules for trading standardized contracts on-exchanges aren’t too burdensome.

One area where there will be less scope for post-legislation tinkering is the new Consumer Financial Protection Bureau, which has been uncharacteristically tightly and narrowly drafted by the standards of the rest of the RAFS Act. Who gets appointed as its head and their skill in negotiating the Washington bureaucracy will be key. But even before then, as the president gets to nominate the candidate but the Senate has to confirm him or her, the tenor of consumer protection within financial services could turn on November’s mid-term elections as much as anything.

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If Adam Smith Had Been Chinese

If China can have state guided capitalism and state-owned corporations there wouldn’t seem to be any reason that it can’t have state-guided markets, too. Its proposed carbon trading market due to start in 2014  seems to fall squarely into that category.

Feng Shengbo, deputy director of the China Clean Development Mechanism Project Management Center of the Energy Research Insititute of the National Development and Reform Commission (NDRC), told Bloomberg that authorities are drawing up rules for a market to be run by “associations” overseen by  government. “The government will not directly control the market,” Feng said, “but if the associations make misleading policy it’s for the government to guide them.” Not exactly Adam Smith’s invisible hand.

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