Hainan and a Bold Plan on Cross-Border Fund Flows

The Chinese Communist Party's Central Committee and the State Council jointly released the Master Plan for the Construction of Hainan Free Trade Port on June 1. In his instructions on the Hainan Free Trade Port, CCP General Secretary Xi Jinping stated that building the free trade port is a major strategic decision made by the Central Committee to foster innovation and push ahead with socialism with Chinese characteristics. Focused on overall development at home and abroad, the Plan is of great importance in assuring progress in a new era of China's reform program and the opening up of the economy. Xi also stressed the importance of adhering to the leadership of the CCP and to socialism with Chinese characteristics, while maintaining the demanding requirements of international economic and trade rules, promoting the smooth flow of production factors and building Hainan into a high-quality free trade port.

The Smooth Flow of Capital

A free trade port is a special economic zone with the highest level of openness in the world today. Normally, it refers to a specific customs territory where most goods are exempt from tariffs and there is free movement of people, funds and products. This has been amply demonstrated in practice in China's Hong Kong, Singapore, and Dubai. Among all these factors, the flow of funds is the most critical. China's Hong Kong and Dubai have allowed the free flow of funds since the establishment of their free trade ports. In 1969, Singapore set up its first free trade zone and in 1978, the Financial Supervisory Authority of Singapore issued its Announcement No. 754, which completely eliminated foreign exchange controls and cancelled all foreign exchange management procedures and approval requirements on the flow of funds. Residents and non-residents were allowed to open accounts at home and abroad and transfer funds freely between those accounts. To accommodate the free flow of funds, free trade ports usually adopt stable exchange rate mechanisms. China's Hong Kong and the United Arab Emirates (Dubai) both peg their currency to the US dollar, while Singapore uses a link to a currency basket.

It is worth mentioning that, although funds are allowed to move freely, there are restrictions on trade and investment. (All of the listed restrictions in this section about China's Hong Kong, Singapore and Dubai draw on the information in the International Monetary Fund’s Annual Report on Exchange Arrangements and Exchange Restrictions [2018].)

In terms of trade, except for certain special commodities, most goods can flow freely through the free trade port and are exempt from tariffs. In China's Hong Kong, Singapore and Dubai,

In China's Hong Kong, the importation of chlorofluorocarbons requires an import license and there are quotas, while a licensing regime exists for imports of loose diamonds and Chinese medicines. Exports of formula milk powder (for infants) and Chinese herbal medicines require an export license.

There are restrictions on the issuance and purchase of securities in the local market by non-residents, including registration and currency requirements

Imports are tax-free in principle, but "health" taxes are levied on imported cigarettes and other tobacco products, as well as alcohol, methanol and other hydrocarbons (including domestically produced ones). Singapore uses a positive list as well as a negative list to manage trade. Items on the positive list can be imported without license, while items on the negative list cannot be imported due to health, safety and environmental protection considerations. Importing or transshipping certain special goods requires prior approval or licensing. For exports, a licensing system is in effect. For instance, the export of rubber and ozone-depleting substances requires an export license. Dubai adopts a licensing system for imports. Only goods listed on the license can be imported. Additionally, imports of goods manufactured by Israel and foreign companies blacklisted by the Arab League are banned, while trade with Qatar is strictly forbidden. Imports of some other goods are also prohibited due to health, safety and ethical considerations.

In terms of investment, China's Hong Kong, Singapore and Dubai apply prudent management policies to activities in their financial sectors and impose restrictions on investments in their local market by non-residents, but there is no restriction on overseas investments by local residents. Restrictions on non-residents' investments include:

Industry restrictions: China's Hong Kong imposes regulatory requirements on investments in the local broadcasting industry, while no other restrictions are applied to direct investments in other fields. Dubai (United Arab Emirates) stipulates that non-residents shall hold no more than 49% of the total equity of a company while investing in local markets, though in the free trade port, this proportion can be 100%.

Tax restrictions on purchases of real estate in the local market: In China's Hong Kong, non-residents who purchase a home pay a 15% stamp duty in accordance with the Stamp Duty Ordinance. In Singapore, non-resides are allowed to freely purchase a residential unit, but that does not include public housing. Purchases of real estate must be approved by the Singapore Land Authority. Both properties and real estate can be purchased by non-residents in Dubai, but all transactions are subject to certain rules and regulations.

There are restrictions on the issuance and purchase of securities in the local market by nonresidents, including registration and currency requirements. In Singapore non-residents may sell or issue stocks and bonds, but non-resident financial institutions must convert Singapore dollars obtained through Singapore dollar loans (over 5 million Singapore dollars), as well as stock listings and bond issuances into foreign currencies before they can transfer funds overseas for overseas financial activities. Non-residents must register and submit a prospectus before issuing stock, bonds or notes as well as mutual investment funds to Singapore investors. Dubai allows non-residents to issue stock and bonds under the regulatory framework of local authorities. Non-residents in Dubai’s free trade port are allowed to purchase up to 100% of a company's equity in the local market, while the proportion is capped at 49% in principle for other regions in the United Arab Emirates. As for derivatives, the China's Hong Kong Stock Exchange has clear management requirements over the information disclosure and position limits for derivatives.

Prudent management over the financial sector: In China's Hong Kong, loans and lines of credit that financial institutions provide to any one nonresident customer shall not exceed 25% of their capital base. In Singapore, the liquidity coverage ratio (LCR) of all currencies shall be 100%. In Dubai, banks subject to the liquidity coverage ratio (LCR) requirement must retain eligible liquid assets, and those liquid assets must be consistent with the net outflow currency. Moreover, China's Hong Kong requires companies engaged in banking, insurance, securities and futures transactions, to obtain a license or authorization regardless of their place of registration.

Inbound and outbound cash declaration management: For anti-money laundering and anti-terrorist financing purposes, inbound and outbound foreign currency banknotes and unregistered bills exceeding the stipulated limit must be declared. In Singapore, the limit is 20,000 Singapore dollars or the equivalent in foreign currency, in such case a report must be submitted. The limit is 100,000 dirham or the equivalent in foreign currency for Dubai.

Funds exchanges with sanctioned countries are strictly prohibited according to the sanctions resolutions of the United Nation Security Council.

Chinese Characteristics, International Economic and Trade Rules

During the construction of the Hainan Free Trade Port, we should fully learn from the experiences of China's Hong Kong, Singapore and Dubai, and emphasize the need for reform and innovation. We should always be ready for worstcase scenarios. We need to remember that China's Hong Kong, Singapore and Dubai are all relatively independent economies with a high degree of overall openness, while Hainan is a part of China. In our efforts to build the Hainan Free Trade Port, it is necessary to absorb international experience and embody Chinese characteristics.

Chinese Elements

First, we must uphold the leadership of the Communist Party and maintain our socialist system with Chinese characteristics. The Master Plan on the Hainan Free Trade Port notes the essential nature of the CCP's centralized and unified leadership, the need to follow the path of socialism with Chinese characteristics and the importance of upholding a people-centered development philosophy. We must also embody core socialist values and move forward in the proper direction. Second, we must coordinate our plans to open up with the retention of our connections with the mainland. As opposed to

the independent economies of China's Hong Kong, Singapore and Dubai, the Hainan Free Trade Port bridges the mainland market and the outside world. While maintaining a high degree of openness, it must retain its connection with the mainland market. Third, we must make good use of the ecological environment of Hainan to consolidate the industrial foundation for free trade port construction. Tourism, modern services and high-tech industries will be the key drivers of development in Hainan. With this foundation we should promote the development of a hightech, ecological and environmentally friendly real economy with Hainan’s own characteristics.

International Economic and Trade Rules

The Master Plan set out the liberalization and facilitation measures of the Hainan Free Trade Port in terms of trade, investment, funds and personnel movement. It also established an institutional design that promotes smooth trade and investment activities as well as the free flow of cross-border funds and personnel, convenient transportation, adequate security, and the orderly flow of data. It also applies a "zero tariffs, a low tax rate, a simplified tax system, the enhanced rule of law and phased" taxation institutional arrangements, so that there is a true integration with highstandard international economic and trade rules.

Implementation will be steadily promoted based on the Master Plan in a phased manner that creates a set of free trade port policies focusing on trade and investment facilitation across all of Hainan island by 2025, building an economy with a new level of openness by 2035 and a free trade port with a high degree of global influence by the middle of the century.

A pilot free trade zone or FTZ is a regional free trade zone within a country or region that employs a special customs supervision system and allows more favorable trade, investment and taxation arrangements. Since the establishment of the Shanghai pilot FTZ in September 2013, China has set up a total of 18 pilot FTZs. Experience over the years has demonstrated that pilot FTZs can effectively test reform and innovation measures and promote the replication of these measures in other parts of the country in a timely manner. This has contributed to the deepening of reform. But if we compare free trade zones with free trade ports, there are significant differences.

A High Degree of Openness

The Hainan Free Trade Port is positioned as an important portal for opening up the economy overall. The Master Plan clearly states that a goal is to build Hainan’s free trade port into a special customs area that enhances international competitiveness and carries commensurate influence. While according to the relevant files issued by the State Council, the pilot free trade port mainly focuses on accelerating the transformation of government functions, actively exploring innovation in regulatory management, and promoting trade and investment facilitation.

New concepts, methods, systems and measures developed during the construction of the free port can be used as references for other areas in China, but they should not be replicated directly. The pilot free trade zone, however, aims to explore new paths and accumulate new experience to comprehensively deepen reform. Innovative measures developed in an FTZ can be replicated and promoted nationwide.

The Hainan Free Trade Port enjoys innovative policies of both the pilot FTZ and a free trade port. In September of 2018, the State Council approved the establishment of the Hainan pilot free trade

Master Plan for the Construction of the Hainan Free Trade Port, the port was able to offer innovative policies of both the pilot FTZ and as a free trade port.

Cross-border Capital Flows

In terms of cross-border trade, the Hainan Free Trade Port will further promote the facilitation of cross-border trade in goods and services and new international trade settlements. Banks will be able to shift from a policy of prior review of transactions to post transaction verification. In contrast, the current policy for the free trade zone is: banks in the pilot zone review foreign exchange receipts and payments under the current account in accordance with due diligence and know your customer requirements. They independently handle foreign exchange purchases and payments, foreign exchange collection and settlement, and transfers under the current account.

In terms of cross-border direct investment, the Hainan Free Trade Port will fully implement the management system of pre-establishment national treatment plus a negative list and explore forms of cross-border investment management that adapt to the new demands of the market. To this end, there will be pilot programs using the QFLP (qualified foreign limited partner) and QDLP (qualified domestic limited partner) mechanisms in the Hainan Free Trade Port. In the pilot free trade zone, direct investment policy facilitation has been confined to allowing enterprises in the zone to register, change and cancel the basic information of domestic direct investment at any bank within the jurisdiction of the branch.

In terms of cross-border financing, a new system will be set up in the Hainan Free Trade Port to comprehensively implement full-scale macro-prudential management of cross-border financing. The system will also steadily expand the scope of cross-border asset transfers, make it more convenient for foreign debt fund exchanges, and gradually realize independent cross-border financing for market entities. In the pilot free trade zone, innovative measures for internal and external debts are limited. The zones allow more relaxed requirements on currency consistency – that is, companies' cross-border financing contract currency, withdrawal currency, and repayment currency must be consistent. Second, enterprises that have already chosen foreign debt management making use of the difference between actual and registered investment to adjust their choice to borrow foreign fundss through the macroprudential management model for cross-border financing.

In terms of cross-border securities investment and financing, the Hainan Free Trade Port will focus on serving the investment and financing needs of the real economy, supporting the development of sectors with distinctive features and comparative advantages, giving priority support to overseas listings and bond offers, and simplifying exchange management. In contrast, there are currently no innovative measures related to securities investment and financing in the pilot free trade port.

In terms of financial infrastructure, there will be an "electronic ring-fence" around funds in the Hainan Free Trade Port. This will be based on existing domestic and foreign currency accounts and free trade accounts to facilitate the smooth flow of cross-border funds between the free trade port and abroad.

In terms of financial risk prevention, an early warning and monitoring assessment system and a macro-prudential management system will be established in the Hainan Free Trade Port to manage cross-border flow of funds and enhance the regulatory systems and mechanisms of combating money laundering, financing of terrorism, and tax evasion. Moreover, in another difference from free trade zones, an independent financial supervision and coordination mechanism will be set up for the construction of the free trade port.