China Forex (English)

Hainan and a Bold Plan on Cross-Border Fund Flows

- By Liu Xu

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.

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