Executive Summary

  • The Financial Stability and Development Committee (FDSC) falls short of a ‘super commission’, but has the potential to change China’s financial sector nevertheless
  • Regulatory incompetence and political stability are the two main motivations for the formation of this body by Xi Jinping, who sees both as linked to internal social stability
  • Appointments during or following the 19th Party Congress are likely to determine how effective the Committee will become
  • If effective, the Committee will usher in a new three-tier regulatory framework, with the financial Commissions relegated to implementation-level work

New Oversight Body

The National Financial Work Conference, a closed-door conference that decides on major financial reforms, was held on July 14 and 15. It was decided by Chinese leadership that a Financial Stability and Development Committee (FSDC) would be set up to better coordinate regulatory efforts and avoid market arbitrage.

This was perceived as a disappointment to some observers wishing for an overhaul of the current financial regulatory system that would make the People’s Bank of China (PBOC) the super-regulator or merge the PBOC with the China Banking Regulatory Commission (CBRC).

Context

When the Work Conference was held on July 14 and 15, it was led by President Xi Jinping together with three politburo standing committee members instead of being presided by the Premier, likely signaling a sidelining of Li Keqiang. Xi’s key message during the Conference defined financial safety as a crucial part of national security, with curbing financial risks being the “eternal theme”. Xi also called on the PBOC to strengthen its role in “macro prudential management and safeguarding against systemic risks”.

There are clearly two motivations at play. Firstly, the existing regulatory environment is considered by the leadership as not fit for purpose. Secondly, there are strong political and ideological forces that are influencing Xi’s decisions. While containing risks including those in liquidity, real estate, local government debt, internet finance and banks’ non-performing loans fall under the former, social instability triggered by a poor economy falls squarely under the latter.

Shadow banking, which currently encompasses the RMB 60 trillion asset management industry, is the most worrying. These asset management products (AMPs) are currently issued by a wide range of entities including banks, securities firms, trusts, and fund management firms all governed by different regulators. This confusion has meant that AMPs are often used to disguise high-risk lending and result in high leverage. These high-risk ‘products’ have then become alarmingly intertwined with the financial sector as they are traded between banks, trusts and other entities.

Politically, regulators were blamed for their actions (and ensuing public instability) during the 2015 stock market crash, such as PBOC’s decision to depreciate the yuan when the stock market was weak, and CSRC’s implementation of the circuit breaker which only exacerbated market panic. Although former CSRC governor Xiao Gang was removed due to the latter, Xi is also well-aware that removing personnel does not eliminate financial risks that are caused by structural flaws, which requires improved coordination if better risk management and prevention is to be achieved.

The Committee will have a difficult task ahead dealing not only with issues of competency but also political and ideological pressures. Despite misgivings and a lack of clarity on the powers of the Committee, it is still likely that it will achieve effective oversight over China’s financial regulators. With the promotion of the PBOC’s internal position, the three commissions are likely to see their roles downgraded to executing tasks issued from above. The Committee will likely see its powers consolidated after the 19th Party Congress later in 2017.

Indicators

The evolution of the Committee as a body with political clout will be dependent on the following indicators:

  • The appointment of a close Xi ally as the head of the Committee: this would indicate a high level of political backing from Xi himself, and the potential powers that such a party appointment might draw upon, such as the CCDI.
  • Unified policies issued by PBOC: such as centralizing data collection of AMPs, and direct oversight over systemically important financial institutions. These will indicate that the PBOC is gaining power from the Commissions.
  • Continued dismissals: of senior regulatory heads from the three Commissions, which will clear the way for more structural reforms, and more power for the PBOC and the FSDC.

Theory vs. Reality: Scenarios

Based on these indicators, there are three likely scenarios going forward:

chinese financial reform scenarios

What’s Next

Considering Xi’s personal interest in curbing financial risks, and the fact that the three Commissions have already pledged their allegiance to the Committee, the second scenario will be the most likely outcome. Should a three-tier regulatory system be formed, drastic change is still unlikely to happen before the 19th Party Congress, although the groundwork will be laid beforehand. Even after the Congress, it will likely be a gradual process until the Committee gains supremacy over the existing regulators as responsibilities shift.

Yvonne Yu
Yvonne Yu

Yvonne Yu is a project consultant in APCO Worldwide’s Beijing office, specializing in researching government and regulatory policies. Read More