Chinese Communist Party 3 rd Plenum – Financial Market Reforms and the Impact on IFCs December 2013

Contents and Agenda China Reform Process and the Communist Party Central Committee 3 rd Plenum RMB Internationalisation Offshore RMB Market – Hong Kong Offshore RMB Market – Singapore Offshore RMB Market – London UK-China Relationship and David Cameron’s Delegation Cicero Research - Attitudes in Hong Kong to the rise of China

Communist Party Third Plenum – 18 th C. Committee Annual or bi-annual meetings of the Central Committee of the Communist Party Central Committee is the Highest Decision Making Body of the Communist Party 376 members occupy the top posts in China’s administration and military National Congress held every five years – plenums matter the most Previous Major Plenums: 1984 – countryside reforms expanded to the cities 1988 – wage and price reforms 1993 – start of systemic market reform 2003 – refocus on development and technological innovation

What are the issues? Financial Sector Reform: reform of interest rates, Yuan convertibility State Owned Enterprises: breaking the monopolies in banking, TelCo, energy… Household Registration: breaking down social barriers and supporting migrants Land Reform: extending private property rights to the rural class Local Government Funding: issuance of local government bonds, tackling debt Environment: balancing development with environmental protection Middle Income: avoiding the middle income trap

Four Key Themes What are the themes? Overcoming bureaucracy - new “team” created to drive through reform, reporting directly to the leadership; Power consolidation - creation of a new “NSC” grabs power from the Central Committee; Party-led liberalisation - the free market “will be given a decisive role in allocating resources” but “the Party must give full play to its core role of commanding the whole situation and coordinating the efforts of all quarters”; Reform of property rights - in particular for farmers and rural-dwellers.

What are the views? Xu Hongcai, China Centre for International Economic Exchanges: “The reforms are unprecedented… Reforms in 1990s were limited to some areas, now reforms are all-round.” Jack Lew, US Treasury Secretary: “The direction is significant, but the character and the pace of change matters.” Andrew Sheng, Advisor to the CBRC and President of the Fung Global Institute “A successful transition to the next phase of wealth creation – driven by the services sector and knowledge-based industries – will require a more market-oriented approach, in which the state cedes some control over the economy and focuses instead on protecting property rights, administering welfare services, reducing pollution, and eliminating corruption.”

What are the reforms?

What are the indicators? 2014 GDP Growth Target Target < 7.5% - reforms prioritised over GDP Reform Team Leadership Senior figures = reform programme commitment VAT Reform Replacing business tax with VAT in more sectors SOE Reform Breaking monopolies; allowing SOEs to fail Currency Intervention PBOC has indicated it will cease regular intervention Shanghai FTZ Consistent liberalisation of the “negative list”

RMB Internationalisation RMB – currently trades at two exchange rates: Onshore – CNY (exchange rate with USD fixed by PBOC) Offshore – CNH (traded at a rate of USD/CNH, deliverable RMB in HK) CNH market is very small and illiquid, but growing significantly since 2010 reforms CNY demand is driven by Chinese exporters looking to convert USD into RMB CNH demand is driven by private demand and supply. Supply tightly controlled, therefore CNH trades above CNY CNH market is growing considerably: Some foreign corporates allowed to issue CNH-denominated bonds in 2010 (ADB, McDonalds…) Capital controls are gradually being lifted allowing foreign investors to invest CNH in the onshore market Liberalising the exchange rate: 3 rd Plenum - “China will improve the market based Yuan exchange rate formation system and speed up the marketisation of interest rates”

RMB Internationalisation – Four Stages Exchange Rate Reforms Interest Rate Reforms Capital Account Reforms Pricing Mechanism Reforms PBOC Governor: Central Bank will “basically exit” from regular currency market intervention Continual widening of Yuan trading band Lending rate ceiling removed Introduction of deposit insurance scheme in 3 – 5yrs Expansion of QFII and QDII quotas Scrapping volume limits Increasing convertibility in banking transactions Greater role for markets in determining prices and wages Greater competition – dismantling the SOEs

RMB Internationalisation – Capital Account Reform Qualified Foreign Institutional Investor Programme (QFII) Launched in 2002 Principal means by which foreign investors can invest in China’s securities markets Five classifications: commercial banks, asset managers, insurance companies, securities companies, other institutional investors Controlled through quotas set by the PBOC Managed by SAFE Difficult to repatriate funds Qualified Domestic Institutional Investor (QDII) Launched in 2006 Principal means by which domestic investors can invest overseas, principally in fixed income and money market products Expanded in 2007 to include stocks Initially HK, now expanded to the US Controlled through quotas set by CSRC

Offshore RMB Markets - Asia RMB deposits allowed in Hong Kong Bank of China appointed as a clearing bank 2007 – China Development Bank issues first RMB bond 2009 – pilot RMB settlement system 2010 – HKEX launches RMB securities clearing system 2013 – 75% of world’s overseas RMB reserves held in HK Hong Kong 2012 – two Chinese banks granted QFB privileges 2013 – ICBC appointed clearing bank for RMB 2013 – PBOC and MAS expand bilateral currency swap to RMB 300bn 2013 – MOU signed on “greater RMB business collaboration” 2013 – RFQII quota set at RMB 50bn Standard Chartered Index: Singapore #2 Offshore RMB Centre Singapore

Offshore RMB Markets - London RFQII RMB 80bn Quota RMB 200bn currency swap arrangement between Bank of England and PBOC Agreement on direct trading between GBP and RMB offshore and in Shanghai Chinese banks allowed to establish wholesale branches in London – previously Chinese banks were forced to subsidiarise and often based their HQs in Luxembourg ICBC issues RMB 2bn bond in London November – announcement that Standard Chartered and Agricultural Bank of China will offer a clearing arrangement in London London

UK-China Relationship – Cameron’s Trade Mission Pragmatism reigns – no mention of political or human rights reform Announcement that Standard Chartered and Agricultural Bank of China will offer a clearing arrangement in London Cameron promises to put his full political weight behind a China-EU FTA – eliminating tariffs in 20 key sectors Chinese investment opportunities in HS2 and further nuclear power schemes GBP200m fund to promote scientific collaboration GBP4.5bn JLR deal Trending comments on Weibo – China’s version of Twitter – sum up the difficult history between China and the UK which has in the past been a stumbling block to greater collaboration: Yongmian: "Mr prime minister, are you bringing opium with you?" Glorious Ming: “When will you compensate us for the Old Summer Palace?” Wuyanliuju: “Dalai's friend has come to China for our silver”

Attitudes in Hong Kong – Constitutional Settlement The rise and internationalisation of China has a global impact, not least in Hong Kong. Cicero Research commissioned an online survey of 1000 citizens of Hong Kong earlier in the year. Questions focussed on the role of Hong Kong as a financial centre, and attitudes in Hong Kong to the rise of China

Attitudes in Hong Kong – Constitutional Settlement Q: Regarding Hong Kong's political freedoms, do you think that the Legislative Council should be...?

Attitudes in Hong Kong – Constitutional Settlement Q: Do you think that the Chief Executive of Hong Kong should be directly elected by the people of Hong Kong alone or should they be approved by the State Council of China?

Attitudes in Hong Kong – Cultural Settlement Q: What do you think is currently the most important SECOND LANGUAGE for citizens of Hong Kong? Q: In ten years what do you think will be the most important SECOND LANGUAGE for citizens of Hong Kong?

Attitudes in Hong Kong – Cultural Settlement Q: Chinese history and citizenship should be taught in Hong Kong schools - To what extent do you agree or disagree with the following statements? (Age Breakdown)

Attitudes in Hong Kong – Economic Settlement

Q: Which of the following do you see as the top biggest obstacles to economic growth in Hong Kong?

Attitudes in Hong Kong – Economic Settlement Q: Which of the following do you currently see as being the most important financial centre in Asia? (Now and in ten year’s time) Q: Which of the following statements do you MOST agree with?

Attitudes in Hong Kong – Economic Settlement Q: Which of the following do you currently see as being the most important financial centre in Asia? (Now and in ten year’s time) Q: Which of the following statements do you MOST agree with?

Attitudes in Hong Kong – Economic Settlement Q: Hong Kong is a better place to live because of the end of British colonial rule in 1997 Q: Which of the following is Hong Kong's most important trading partner now?

Cicero Group is an integrated communications agency principally owned by directors and staff. Our expert teams drawn from media, industry and government have a simple mission – to help clients design and implement communication strategies to realise their commercial ambitions, manage their reputation and maximise their return on investment. Founded in the UK in 2000 we have grown rapidly now servicing an international client base from our wholly owned regional office network in London, Brussels, Washington and Singapore. Andrew Naylor Regional Director – Asia Pacific Cicero Group