HSBC’s Shanghai Listing to Kick Start Financial Reforms

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By Chris Devonshire-Ellis

Aug. 13 – HSBC’s proposed listing next year in Shanghai is likely to have an extreme knock on effect in terms of accounting standards on the mainland, and is also likely to herald a move to a fully convertible RMB. China has long been wary of foreign banks operating in China, not just because of the political history in bankers been seen as the ultimate capitalists, there to make money at the Chinese people’s expense, but also as China’s own banks are not generally in a position to compete domestically with the far greater financial clout that the world’s largest banks possess.

To date foreign entry in the mainland banking system has been largely restricted to deposit taking and RMB business. However, I foresee a number of changes occurring in China as a result of HSBC listing in Shanghai.

Regulatory Changes for Foreign Company Listings in China
There are already some anomalies in China as regards the definition of a “Chinese company.” These include wholly foreign-owned enterprises, whose status as Chinese companies is defined as “being protected and enjoying rights under Chinese law.” However, when it comes to listing in China, with the exception of a select few test cases, companies registered in China have been barred from listing if they have more than 25 percent foreign ownership, effectively prohibiting them from raising money for future domestic Chinese expansion on the mainland. This forces the overseas parent to continue to fund any expansion by pumping in yet more investment, which is tax inefficient to the parent. HSBC’s listing is expected to change this and to permit majority or possibly, under certain conditions, fully wholly foreign-owned companies to participate in listings on the Shanghai and Shenzhen bourses. This allows foreign-owned businesses to provide shares purchased and traded in RMB, and to allow Chinese public ownership of foreign businesses on the mainland. It is an important step to take, as foreign businesses in China will thus be permitted to raise money from Chinese investors for domestic expansion and capitalization plans.

Better Security for China’s SOEs
The Chinese government either directly or indirectly (through its listing of the many state-owned enterprises) would presumably take steps to invest in foreign businesses, with those shares being held by its SOEs. In the face of increasing foreign competition, such shareholdings are likely to provide at least some cushion and degree of security to China’s SOEs. It would also force them to move their management and other business practices towards international standards in order to properly compete. China’s worst performing SOEs are likely to suffer, however over a period of time competition with foreign businesses domestically is likely to enhance the overall trading abilities and management of China’s SOEs.

A Fully Convertible RMB
The RMB is not convertible or generally tradable on international markets. Its trading position is fixed daily by the People’s Bank of China against a basket of currencies (U.S. dollar, Euro, Japanese yen, South Korean won, and smaller shares including the British pound, Thai baht, Russian ruble, Australian dollar, Canadian dollar and Singapore dollar). However, in order to develop Shanghai as a true financial center, this needs to change. Allowing the RMB to float and be traded freely on the international markets is a scenario that will both please Washington and allow the RMB to find its true value. The road may be rocky for a little while for China while this transition takes place; however it will lead to a more mature approach to the handling of the RMB and will take some of the pressure off China’s central bank in doing so.

Forex Business to Boom
Assuming the RMB does float, the forex business will boom in China, not just on trading floors but also in high street forex shops such as are found in Hong Kong and other Asian destinations.

Accounting and Audit Reform
China’s accounting and audit systems has since its own reform away from fully state-owned practices, been rather slow in providing a level playing field or engaging sufficient talent. A lack of transparency, no publicly available annual reports, and a tendency for Chinese businesses to “do deals” with the tax bureau have been endemic. Part of this is an emerging market phenomenon, when the Chinese government liberalized the legal and the accounting professions over a decade ago, the brightest and best Chinese lawyers and accountants promptly headed off to more lucrative private practices. China’s government has now had time to address that imbalance and possesses some very smart legal and financial intellect. China is likely to impose a new accounting and audit standards authority, and to give the body some serious regulatory and punishment teeth. HSBC are certainly likely to demand it.

Expansion of China’s Tax Collection Base
China’s income tax generation is only supported by about 30 million of its entire population. This is largely due to the relatively high individual income tax threshold (in Chinese terms) that has to be reached in order to become liable for tax. Additionally, the collection of tax at a corporate level is woefully inadequate and often corrupt. China needs to widen its tax collection base, and while moves to bring more Chinese nationals into the scheme will take decades to filter in, this is not so of its SOEs and larger companies. Tax collection at a corporate level in China from China’s domestic companies at the levels of supervision and diligence that are routinely part of foreign invested businesses remit is likely to be expanded more aggressively into the domestic collection bowl.

In short, the listing of HSBC in Shanghai will kick start a new round of reforms, regulatory changes and business environment in China. This has to be welcomed, and although it will not be an easy transition, clearly the acceptance of such a large global corporate as a standards benchmark in China will raise the integrity of China’s position in terms of its financial and regulatory transparency. I predict that the waves of reform that will sweep through China as a result will not just benefit China, but also the international business community investing in it as the playing field levels as a result.

Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates and lived in China for 21 years. He is now based in Mumbai.