Market is closed, opaque, undeveloped but ambitious

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The Shanghai stock market has been, for most of this year, the best-performing stock market in the world. But foreigners have very little access to it, and local investors have very little alternative to it: China's financial markets remain closed, opaque, and underdeveloped. From this primitive base, can Shanghai possibly transform itself into a global financial centre by 2020, as Beijing has decreed?

It is hard to find any financial professional in Shanghai who is willing to bet on it. “You can't even short the market,” says one exasperated analyst for a foreign investment bank. Beijing announced late last year that it would introduce short selling and margin trading on a limited basis – ironically, at exactly the moment that many western exchanges were halting or restricting short selling. But since then nothing has happened. It is a common pattern: Beijing announces that it is ready to introduce one financial innovation or another – and then nothing happens.

Financial futures are the clearest example of an innovation that, though much trumpeted, so far has not happened: Shanghai created a financial futures exchange nearly three years ago, but it has yet to trade a product. Officials say they expect trading to begin later this year – but then, the imminent launch of Shanghai stock index futures trading has been predicted before, and failed to materialise.

Of course, officials can be forgiven for thinking that what once was condemned as an excessively timorous pace of reform has since begun to sound sagely cautious: “China has dodged a lot of bullets successfully and that is why there is a very long gestation period,” for reforms, says Peter Alexander, of Shanghai-based investment consultants Z-Ben Advisors.

Fang Xinghai, head of the Shanghai Financial Services Office, argues that caution has paid off: “China has been very good at controlling risks when it comes to innovating in the financial services sector because every innovation has to go through a process of regulatory deliberations and approvals, often involving several regulators.” He does not need to point out that western financial officials can claim no such success.

So have the tribulations of recent months delayed the opening and modernisation of China's financial market even more? Officials and analysts delicately point out that it is arrogant to suggest so: “In China, we have plans [as in, five-year plans],” says Wang Jianmao of China Europe International Business School (CEIBS). “We have our own agenda, and it is very unlikely to speed up or slow down because of something happening outside the country.”

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“The messages are very consistent and have been for five years,” says Richard Yorke, CEO of HSBC in China. “And since China is likely to recover from this slowdown quicker than any other major economy ... the importance of both China and Shanghai as a financial centre will probably be increased.”

But whatever comparative advantage China may reap from the global crisis, no one underestimates the scale of the challenge of turning Shanghai into a financial centre to rival Hong Kong and Singapore (which has long been plotting a coup of its own), not to mention New York and London.

Convertibility of the currency is a gargantuan barrier. Officials say the goal is to make the renminbi “more convertible” – but they admit that there is little appetite for such a goal in government circles, where officials are still congratulating themselves over having avoided the pitfalls of too much financial openness.

The legal system is also a big barrier. Experts say a rudimentary legal system may be adequate for the early stages of economic development, but a sophisticated financial services industry requires a much more transparent, predictable and fair system. “Being a global financial centre means your neighbour puts money in your pocket. At the moment, the confidence is not there for that,” says one Chinese analyst for a foreign investment house. An unpredictable legal system, which cannot be trusted to treat foreign and domestic litigants equally, is a big obstacle, he says.

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Shanghai officials admit there is also a serious talent gap between the demand and supply of experienced financial professionals.

The government of Pudong, the heart of financial Shanghai, is building low-cost serviced apartments to try to attract financial professionals, and the city is working hard to recruit overseas, to take advantage of the rout in the US.

But China's punitive 45 per cent income tax, and deficiencies in its healthcare and education, may make it difficult to recruit experienced professionals.

Intangible challenges will be even harder to surmount. China needs a more robust system of corporate governance and far more transparency.

The deadline of becoming a global financial centre by 2020 may seem distant now: but it is a short one for all that the city must accomplish beforehand.