I INTRODUCTION

China's capital markets have gone through decades of development since the economic normalisation. It was not initially an attractive financing option for most private Chinese enterprises. The Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE) were established in the 1991 as arms of the central government to solve the capital shortage problems of state-owned enterprise (SOEs) and sell shares to outside investors, thereby raising the value of the government's stake in these companies. However, China's capital markets have sped past various milestones. In 2016, Chinese companies raised US$20 billion of equity capital, more than the combined amount raised in the United States and Europe that year. As of June 2018, China has the world's second largest stock market, even excluding Hong Kong, with a combined aggregate market capitalisation of US$7.5 trillion. Having grown to be among the largest in the world in just over two decades, China's capital markets are usually cited as a counterexample to the significance of law for financial market development. However, a thorough examination of the development of China's capital markets will reveal that the law is actually critical to sustaining growth. Just as the experience of China suggests, law and market growth exhibit a bidirectional rather than a unidirectional causal relationship, and the course of development is more like 'growth-law-further growth'.

The legislation of the capital markets includes, first, several fundamental laws, most importantly the Company Law of the PRC and the judicial interpretations of that law made by the Supreme Court of the PRC (together, the Company Law), and the Securities Law of the PRC (the Securities Law), followed by a fiddly series of rules promulgated by central government (including the State Council and its delegated departments). Laws and regulations of the capital markets in China, originally borrowed largely from the legislation of developed economies, have the skeleton of a regulatory set-up supervising equity market (mainly shares), fixed income products (mainly government bonds, central bank bills, financial bonds and corporate bonds), derivatives (including futures, yuan interest rate swap and share index futures), securitisation products (mostly asset-backed securities), and foreign exchange in a broader sense.

However, the laws and regulations have many distinctively Chinese characteristics, inevitably, among which the most notable is the structurally inward-looking feature, which is evident in two ways in particular:

a the restricted access to and unequal treatment of foreign participants (issuers, investors and intermediaries) into China's domestic capital market; for instance, foreign issuers have been always barred from offering shares in the PRC and security firms are still subject to strict foreign ownership limitation; and

b the regulatory regimes concern not just the domestic capital market but also share-and-bond issuance of the 'red-chip' companies. Red-chip (market-created business jargon rather than a legal term) generally refers to the corporate structure in which the business interests are mainly within the PRC but are owned by holding companies established overseas, which are in turn controlled by Chinese citizens or state-owned bodies. Since shares and bonds issued by red-chip companies are sold to international investors rather than within China, and the companies are only listed on overseas exchanges, if they are listed at all, the government should not have bothered about regulating this kind of operation too much, if at all. However, owing to the Chinese government's near-paranoid prejudice against foreign ownership, the red-chip structure is seen more as a way of getting round government supervision, and thus is subject to a series of complicated and less-transparent requirements.

Only the central government is involved in the legislation of the capital market. Within central government, the regulatory bodies are mainly the one bank and two commissions (formerly one bank and three commissions) that regulate the financial sectors,2 but also include a few departments and self-regulatory industry organisations delegated with certain administrative functions. Under the motto 'Stability conquers all', the Chinese regulators place a great emphasis on maintaining the stability of the capital markets by intervening and reasserting control of both the primary and secondary markets. Inevitably, people cast doubt on the effects of this intervention. For instance, it is widely believed that policies pursued by the government in search of new sources of growth are at least partly to blame for the creation of the bubble that burst in the summer of 2015; even worse, in early 2016, the China Securities Regulatory Commission (CSRC) suspended the rule introducing a circuit breaker to the stock market after only four days because it was working in completely the opposite way to what was intended and fuelling massive trading losses. China's dramatic and short-lived experience with a circuit breaker revived the debate about whether existing financial systems in China are able to accommodate the growth of capital markets so as to support a sustainable economy. Nonetheless, despite some unsatisfied government interventions, China is determined to reform its capital markets in its own way to better serve its own purpose, for example, most recently, by returning to the basics of supporting a 'real economy' or non-financial economy.

II THE YEAR IN REVIEW

In the past, China's financial model was based to a large degree on state-owned banks lending to SOEs, which in turn exported products to developed markets or financed domestic infrastructure projects. This cycle was ultimately funded by China's large base of domestic deposits, which are the result of high savings rates, the lack of alternative investment options and the relative security of bank deposits. While this financial model is undoubtedly successful in an export-driven economy in the early stages of development, expected changes in demand from Western economies, an ageing demographic, increasing labour costs and new infrastructure needs will require a more balanced and stable growth model. As regards the capital markets in particular, this means a further opening up, an increase in the proportion of direct financing and cultivating the healthy development of multi-layered capital markets. China's financial markets have already benefited from increased openness and a range of reform efforts during the past two decades, supported by global and regional organisations such as the World Trade Organization, the International Monetary Fund, the Asia-Pacific Economic Cooperation and the Asian Development Bank. Nevertheless, while the pace of economic growth in China continues to exceed that of most developed and developing economies, the structural development of its capital markets has not kept pace.

However, in recent years, China has witnessed significant liberalisation of its capital markets. During the past 12 months, its capital markets have further developed and opened up at an unprecedented pace. We have witnessed the announcement of the lifting of ownership caps for securities firms, funds and futures, the launch of Bond Connect, and the opening of local bond ratings to global agencies. Other recent examples of this dramatic progress are the opening of the Chinese Interbank Bond Market to a wide range of international investors under accommodative conditions; the introduction of registration systems for the Qualified Foreign Institutional Investor (QFII) and Renminbi QFII (RQFII) programmes, replacing the slow and less transparent quota application system; and the Stock Connect scheme, unique in design yet operating smoothly and developing further for more than three years. These examples hint at the potential for China's capital markets to transform themselves and adapt to the requirements of a growing economy and an ever-more sophisticated populace. In the meantime, we should point out that, since nearly all reforms and open-ups are government-led rather than market-driven, some, or perhaps many, of the top-down initiatives may have to face bumps or even failures.

i Developments affecting debt and equity offerings

The introduction of the Chinese depository receipt and its mysterious abeyance 

On 30 March 2018, the General Office of the State Council issued a new paper originally promulgated by the CSRC, namely, Several Opinions on Launching the Pilot Programme of Shares or Depository Receipts by Innovative Enterprises (the CDR Paper), seemingly joining an arms race between major listing venues worldwide while the Hong Kong Stock Exchange (HKSE) completed a consultation on a listing regime for companies from emerging and innovative sectors and the New York Stock Exchange allowed Spotify's unusual 'non-IPO' listing. The idea of the CDR Paper, in a nutshell, was to set the regulatory baseline of a new regime under which selected PRC-based enterprises (referred to in the CDR Paper as the Pilot Enterprise) in seven specific industries will be allowed to directly offer A shares or Chinese depository receipts (CDR) in the PRC and list on PRC stock exchanges, regardless of the fact that the issuers may be incorporated outside China, may be listed overseas, or, though incorporated in the PRC and unlisted, still remain unprofitable or have accumulative loss. Apparently, this new regime is meant to supersede the decades-old practice of A share issuance and listing, making it potentially a rather ambitious breakthrough within the legal framework of the Securities Law. It has since prompted the CSRC to revise the current regime and promulgate an implementation rule, Measures for the Administration of Offering and Trading of Depositary Receipts (for Trial Implementation), and thus encouraged a few mega companies, notably Xiaomi and Alibaba, to officially submit an application for CDR issuance. However, only weeks later, on 18 June 2018, Xiaomi withdrew its submission and pursued only a sole listing on the HKSE rather than its previous plan for dual-listing, and has since announced that it is postponing CDR issuance indefinitely. It is certainly a blow to China's plan to allow overseas red-chip companies to float on China's equity market, and is followed by an apparent cooling down of discussions about CDR in both the government and the market. It seems the plan for CDR issuance has been temporarily shelved by Chinese government. While there has been no official admission, denial or reasons given, it is widely believed that the poor performance of China's stock market (major indices are even lower than those of 10 years ago) is mainly to blame.

Even so, the CDR Paper and its implementation rules are worth mentioning for the following reasons:

  1. The expansion of red-chip. As stated earlier, to decide whether an enterprise is 'red-chip', the key is to assess both the ownership and the company structure. However, in the CDR Paper, the definition only refers to company structure (i.e., red-chip enterprises are foreign-incorporated enterprises of which the main business activities are based within the PRC). Therefore, the inclusion of this term is made all the more significant in that foreign-controlled enterprises that centre their main business activity in the PRC will, theoretically at least, qualify as pilot enterprises. For instance, a branch of an international technology conglomerate business in Greater China may even qualify.
  2. The true purpose and a possible slippery slope. A listed company and an unlisted company under the CDR Paper are polar opposites. If listed, a company's market capitalisation needs to be a whopping 200 billion yuan (US$31.4 billion), whereas if it remains unlisted, it only needs to have one-tenth of that valuation. This essentially reveals the CSRC's true purpose in persuading the relatively large number of unlisted innovative companies (known as 'unicorns') into choosing the domestic capital market as their first listing venue. However, the slippery slope may be just around the corner – a listed red-chip company may be incentivised to privatise itself and become an unlisted company, which in turn may qualify as a pilot enterprise. The simple fact of delisting can change a company's situation completely.
  3. CDRs are more favoured. The CDR Paper does not stop at CDRs but also provides the possibility of direct share issuance by non-PRC entities of red-chip enterprises. However, the CDR is systematically favoured in the CDR Paper. It appears that the CSRC, by offering two sharply contrasting options, is trying to convince red-chip companies to choose CDRs rather than shares. Considering that both CDRs and shares are to be offered to investors in the PRC and traded publicly, and CDRs have been explicitly defined by a CSRC official as a type of basic security similar to ordinary shares, rather than a derivative, it should carry the same weight and have the same effect as shares. For the time being, the reason why the new regime is favouring CDRs over shares is anyone's guess.
  4. From cherry-picking to beauty contest. It may be safe to assume that the initiation of the pilot programme is almost certain to be limited to some pre-selected companies on a shortlist. However, if things go according to plan, sooner or later the pilot programme may be further promoted to include more companies, and finally evolve into an 'application review decision' system. Until then, the special counselling committee in charge of selecting innovative enterprises will be just another administrative procedure within a review process, although with murkier standards and broader discretion. It may not be a safe assumption that they will make wiser selections for really innovative enterprises to stand out.
  5. Possible clash of policies. The CDR Paper admits variable interest entity (VIE) structures bluntly. This is the first-ever official acknowledgement of VIEs' validity on a state level. As is widely known, the VIE structure for most adopters serves as a get-around for the restrictions of foreign investments in certain industries. However, the underlying rationale for setting up VIEs is exactly why the VIE structure must have sounded so alarming to the central government, since VIE concerns more vital areas of national interest, such as national security implications. The Foreign Investment Law (FIL), which is still in draft form, may solve some problems, but creates others. In brief, if adopting the 'see-through' ownership approach by the FIL, a VIE may be deemed as domestic, since it is ultimately Chinese-owned or controlled. The concern of the VIE's dodge of foreign investment restrictions is supposedly solved. However, more problems may remain.
Introduction and suspension of initial public offering reform registration system

A pledge to allow the 'market to play a decisive role' in the economy in the Third Plenum of the Chinese Communist Party's 18th Congress in 2013 has been seen as a major innovation in China's stock market. It helps to accelerate the development of direct financing and to provide investors with more diversified investment channels. One year later, the State Council promulgated the Opinions on the Sound Development of Capital Markets, which was instrumental in providing a roadmap and guideline regarding capital market development for the next five to 10 years in the 'new normal' phase. The Opinions stated that the development of capital markets had to be centred around economic needs. It set up a framework for multi-layered capital markets, and laid out the principles and direction of a disclosure-based registration system for a reform of the initial public offering (IPO), in comparison to the merit-based approval system currently in use.

The operation of a merit-based system has long been criticised as one of the fundamental deficiencies in China's stock market. Merit review and approval essentially represented a form of state 'paternalism' in which the value judgements of investors are replaced with those of the securities regulators. They 'unnecessarily constrain' the freedom of entrepreneurs and impede the flow of capital to its most efficient use. Therefore, China follows the global trend, in particular in the Asia-Pacific region such as Japan, Malaysia and Singapore, to move from a merit-based approach to a disclosure-based one to regulate the issuers.

After the Third Plenary Session of the 18th Central Committee, the CSRC incorporated the decision of the Committee into its Opinions on Further Developing IPO System Reform. The State Council then published a new guideline (New Nine Measures) setting various capital market reform goals that placed the IPO registration system at the top of its agenda. In December 2015, the State Council approved a shift to a US-style registration system for stock market flotation, removing a stumbling block that has distorted supply and demand, and artificially inflated valuations of new stock offerings. The new registration system will replace the current IPO approval process by the CSRC, which has been criticised for its complexity and strict requirements. The changes were expected to help companies raise money more efficiently and reduce the involvement of regulators in the capital markets. To coordinate with the reform, the CSRC even sped up its approvals of listing applications to eliminate the barrier lake of applications and prepare for the new system.

But later, first the State Council announced that the stock exchanges had to wait for at least two years to adopt the new IPO registration system, after receiving approval from the Standing Committee of the National People's Congress. This was followed by the announcement by the CSRC that the reform would be gradual and not as fast as previously expected. Since 2017, the reform of the registration system has barely been mentioned by the official mouthpieces, which would suggest that it is not a priority for the CSRC. Therefore, the market suspects that it may have been decided that this noisily promoted reform has been shelved indefinitely. And a new barrier lake has since reappeared.

Lifting of foreign ownership restriction for securities firms

For several years, China has continued to improve market access for foreign firms. The State Council, for example, released Measures on Further Opening up to Foreign Investment on 17 January 2017, which state that market access will be improved and equity caps will be lowered in a variety of service sectors, including banking and financial services, securities, securities fund management, futures and insurance services. However, until 2018, there had been a foreign ownership cap of 50 per cent for onshore securities joint ventures (JVs), trust JVs, asset management JVs and credit ratings agencies.

In 2018, the industry warmly welcomed the announcement made by the State Council shortly after the Party Congress to increase and ultimately eliminate foreign ownership limitations for securities firms, futures firms and fund management companies. Indeed, this is a timely and important step towards the continued opening up and reform of China's economy. Ownership caps in these sectors will be relaxed to 51 per cent and, after three years, eliminated completely. The industry is encouraging a speedy implementation of the announcement and the removal of other indirect impediments and hidden barriers that could still prevent a level playing field for foreign firms operating in the PRC. To that end, the CSRC finally promulgated the Administrative Measures for Foreign-invested Securities Companies on 28 April 2018.

Foreign financial services firms operating in China still face significant market restrictions, including limits on ownership stakes, licensing moratoriums and national treatment issues that prevent them from providing products and services that would facilitate growth of the domestic capital markets. However, with such openings in sight, a level playing field for foreign and domestic financial services firms operating in China is now visible on the horizon. And it will definitely serve as a necessary precursor to developing and modernising China's financial markets.

Reform of delisting rules

Clear rules and consistent implementation of a process for delisting illiquid and substandard companies – those that no longer meet listing requirements – are crucial. From 1995 to 2016, China delisted only 0.8 per cent of total listings. Since the first of these in 2001, China's A-share market has only seen 57 firms leave the market despite the reform of delisting rules in 2014. This is a small number compared to global rates that range as high as 10 per cent and above and suggests that some substandard companies remain listed on Chinese exchanges that should not be. The authorities recognised the shortcomings of the delisting process and, in 2015, the CSRC introduced new rules that require a greater level of information disclosure and delisting for illegal acts and fraudulent issuance. On 21 March 2016, authorities delisted ST Boyuan from the SSE because of illegal disclosure of important information. This was encouraging and the market widely looked forward to the continued consistent application of the new approach.

On 27 July 2018, the CSRC amended its delisting rule (Several Opinions of the China Securities Regulatory Commission on Reforming, Improving and Strictly Implementing the Delisting System for Listed Companies) after months of public consultation. The amendment states that listed companies involved in fraudulent issuance, violations of major information disclosure or other major illegal activities concerning national security, public safety, ecological safety, production safety or public health and safety, the stock exchange shall move to suspend or terminate the listing of the company's shares. Another major revision states that the securities regulator can suspend or terminate the listing when illegal activities are found. This compares to the previous version in which companies carrying out significant legal violations would first suspend trading and then withdraw from the market. Accordingly, the two exchanges have also introduced detailed rules for delisting from them, stipulating that companies will be ousted from the market if any evidence is found of fraudulent initial public offerings, cheating in financial disclosures or law violations.

The idea of toughening delisting rules is to shut the door behind uncompetitive companies on the one hand while opening the door to attract listings in the new technology and new economy sectors, namely the CDR issuance plan, on the other, collectively to create a healthier flow of listed companies. However, with the open-door initiative having been postponed, the voice of the shutting door appears to have gone quiet too.

Ease of market access by updating QFII and RQFII mechanism

Foreign investors are not able to invest in domestic listed companies except by participating in QFII or RQFII programmes, unless they seek to be the 'strategic investor' of a listed company as defined by the CSRC's Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors, which must seek to purchase at least 10 per cent of a listed company's outstanding shares at one time but will be subject to a 30 per cent cap of ownership in the same listed company. Also, until recently, China's bond markets were generally restricted for foreign investors before the expansion of the QFII and RQFII schemes to allow foreign investors to invest in Chinese bonds.

Since the QFII regime was introduced in 2002, followed by the launch of the RQFII regime in Hong Kong in 2011, China has taken a step-by-step approach towards opening its capital markets to foreign investors. In early 2017, the State Administration of Foreign Exchange (SAFE) introduced substantial changes to the quota allocation mechanism so that both QFIIs and RQFIIs can now determine their own basic quota based on a certain percentage of their asset value (or assets under management) or that of their group, and a routine filing with SAFE will suffice. If an additional quota above the basic quota is needed, QFIIs and RQFIIs must then seek SAFE's approval.

The new basic quota filing system marks a milestone in the evolution of the QFII and RQFII regimes. It is expected to expedite investment by QFIIs and RQFIIs through a more transparent and streamlined process. In addition, capital repatriation for both QFIIs and RQFIIs may now be done daily rather than monthly, and repatriation will no longer reduce the quota of a QFII or RQFII, which means that the quota may be used on a revolving basis. Furthermore, the CSRC has removed the requirements that 50 per cent of the assets of the QFII or RQFII must be invested in stocks and no more than 20 per cent of those assets may be held in cash. In addition, the previous six-month fund injection timeline for QFIIs and non-open-ended funds of RQFIIs has been removed, and the capital lock-up period has been shortened from one year to three months for non-open-ended funds starting from the date on which a specific amount (i.e., US$20 million for a QFII and 100 million yuan for an RQFII) has been remitted into China on an aggregate basis.

Furthermore, the monthly cap on repatriations equal to 20 per cent of a foreign investor's total assets in China as of the end of the previous year from the QFII and RQFII scheme was finally lifted on 12 June 2018, and the lock-up periods for investors for holding QFII and RQFII products was removed. These measures will be key to attracting more international investors since they have resulted in greater liquidity and allow investors using the schemes to hedge currency risk onshore.

Further development of Stock Connect

The concept of the Stock Connect programme was introduced by China as another channel for opening up the capital markets. In November 2014, mutual market access between the SSE and the Stock Exchange of Hong Kong Limited (HKEx) was established, and was the first time that two stock exchanges have linked up in this way.

The typical route for investors to buy stocks in another country is through a relationship between the broker in its originating country and a corresponding broker in the target country. Stock Connect, by contrast, is a direct link between exchanges. The link enables brokers who are members of the HKEx to execute orders through a link to the SSE, rather than to broker members of the SSE. As China's capital account is restricted, foreign investors are not allowed to open accounts at financial institutions except for specific approved purposes. Stock Connect enables Chinese authorities to allow money to flow in and out of shares through a single controllable conduit. Investors must purchase offshore yuan in Hong Kong or have their broker arrange a purchase on their behalf. When a foreign investor sells shares through Stock Connect, the yuan proceeds are delivered in Hong Kong. Stock Connect creates a 'closed loop', segregating the yuan used to buy shares from the rest of the Chinese economy. Stock Connect allows any investor in the world, institutional or retail, access to A-shares. There are no lock-up periods or repatriation restrictions for Stock Connect. In contrast, QFII and RQFII, which have been steadily liberalised over the years, are restricted to approved institutional investors.

With the success of the Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect (Shenzhen Connect) was launched on 5 December 2016. In contrast to the large SOEs that predominate on the SSE, listings on the SZSE are tilted towards small and mid-caps, with a significant proportion of companies from cutting-edge industries such as software, high-tech and biotechnology. As a result of the addition of Shenzhen Connect, Stock Connect now provides investors with a much wider menu of equities and considerably increased opportunities for diversification and stock selection.

Launch of Bond Connect

Another major announcement was the launch of Bond Connect, which shows that China is accelerating the liberalisation of its capital markets. Bond Connect is a new mutual market access scheme that allows investors from Mainland China and overseas to trade in China and Hong Kong's bond markets through a connection between the related Mainland and Hong Kong financial infrastructure institutions. Northbound trading commenced on 3 July 2017, allowing overseas investors from Hong Kong and other regions to invest under Bond Connect through mutual access arrangements in respect of trading, custody and settlement. Southbound trading under Bond Connect will be explored at a later stage. It is also argued that the addition of further trading platforms, tax clarification for foreign investors and real-time 'delivery versus payment' for China government bonds are needed for Bond Connect to fully develop.

ii Developments affecting derivatives, securitisations and other structured products

Innovations within the securitisation market

China's securitisation industry has seen explosive growth in recent years. In 2015, the volume of domestic asset-back security (ABS) issuances in the interbank bond market and exchange markets grew to approximately 602 billion yuan – an almost 30-fold increase since 2013.

Securitisation was introduced by several central government departments in China through the Credit Asset Securitisation (CAS), a pilot programme in 2005, but was suspended in 2008 following the onset of the global financial crisis amid concerns relating to securitised assets. The CAS framework, normally used by banking and non-banking financial institutions, was restarted in 2012, with an initial quota of 50 billion yuan. This has since been increased to 500 billion yuan, pursuant to an announcement by the State Council on 13 May 2015. Despite the explosive growth of ABS issuances in China, existing laws permit only a limited class of investors to subscribe to ABS issuances adopting the special purpose trust (SPT) structure; this closed group mainly consists of domestic banks, insurance companies, securities companies and mutual funds. When credit assets originated by a commercial bank are repackaged into ABS sold to other commercial banks on the interbank bond market, there is no true transfer of risk. The situation is more akin to an exchange of risk within the banking industry, with no real offloading of risk to the capital markets.

Several innovations have been seen in recent months in the Chinese securitisation markets. These include a programme of securitisation of non-performing loans and trust structure asset-backed notes issued by corporates in the interbank market; this is similar to the SPT structure under the CAS framework. This is a welcome development since corporate issuers now have access to the more liquid interbank market. Also, for the first time in several years, collateralised loan obligation issuances by banks (which merely moved corporate loan assets from one bank balance sheet to another) has accounted for a smaller share of ABS issuances in 2017, relative to other forms of securitisation. This is also a healthy development. On the other hand, existing regulations do not permit direct foreign investment into an onshore trust holding securitised assets. In addition, existing routes for foreign investors to access domestic ABS issuances are very restrictive.

iii Cases and dispute settlement

In the past, the most effective legal remedy for misconduct or wrongdoing in the capital markets has always been to seek government intervention, rather than a private dispute resolution. During the past year, the CSRC has broken several records in the amounts of fines for misconduct in the secondary market (i.e., a record 1.8 billion yuan fine for a case of manipulation of a stock price was soon surpassed by a 5.5 billion yuan fine for another similar case). However, for wrongdoings before IPOs, the CSRC's punishment is still not much more than a slap on the wrist, especially considering that delisting rules might not be implemented in the way they are written. The legal remedies available to investors are also extremely limited. Under current Chinese securities and civil procedure laws, they may not sue a company and its intermediaries for fraud, and there is no effective mechanism for class-action litigation for investors to take collective action. The lack of effective deterrents and the failure to provide effective protection for investors in China are in sharp contrast to the efficient investor protection mechanism in the developed economies.

iv Relevant tax and insolvency law

Commencement of the Common Reporting Standard

The Common Reporting Standard (CRS) is an Organisation for Economic Co-operation and Development initiative to increase tax transparency by requiring financial institutions in adopting jurisdictions to report account holder information where an account is held by a resident of a partner jurisdiction. More than 100 jurisdictions have committed to adopt the CRS by entering into multilateral or bilateral Competent Authority Agreement (CAA).

China signed a multilateral CAA on 17 December 2015 confirming its commitment to implement the CRS by 1 January 2017 and exchange of information by September 2018. On 9 May 2017, China released the final legislation and FAQ, while setting up the mechanism for the exchange of tax-related information for financial accounts and regulating the due diligence conduct by financial institutions with respect to tax-related information about the financial accounts owned by non-residents. This has finally introduced a degree of tax certainty for financial institutions both within and outside China.

v Role of exchanges, central counterparties and rating agencies

There have no significant changes to the role of the exchanges, central counterparties and rating agencies in China during the past year.

vi Other strategic considerations

On the equities side, the decision by the MSCI to include 222 Chinese A-shares in its Emerging Markets Index in 2018 was a milestone in capital market development. Inclusion took place in two stages, with the addition of Chinese A-share stocks in May and August of 2018. A-shares represent only 0.73 per cent of the weight of the MSCI Emerging Markets Index at a 5 per cent partial inclusion factor. As of June 2017, US$1.6 trillion assets under management are benchmarked against the MSCI's emerging markets indices and China's inclusion is expected to lead to a growth in the influx of funds into the Chinese market from international investors.

III OUTLOOK AND CONCLUSIONS

While China has come a long way in 40 years – and made many significant developments in 2017 alone – further and accelerated reform is needed to support the country's transition from a phase of rapid growth to a new stage of high-quality development. This transition will not be possible without the support of the financial sector and the capital markets. While a 'big bang' approach is not, we suggest, an accelerated reform programme for capital markets, development is now likely to be needed. On one hand, the likely end to a low-interest rate environment globally may well see global capital (including Chinese capital) seek higher yields in the United States, and perhaps other developed economies as yields rise, leading to a more capital-constrained environment for developing markets including China. On the other hand, the greater complexity of China's economy and sophistication of its market participants call for a financial infrastructure that is both flexible and robust.

A broader reform agenda that encourages the development of a deeper, more liquid capital market with a greater choice of investment products is the best counter-weight to the exchange rate-driven concerns that are resulting in greater outflows of capital. While yuan internationalisation appears to have reversed at least temporarily, the choice between financial stability and the freedom and flexibility of a global currency demanded by international investors will increasingly become a challenge if capital markets are to be developed to ease the transition to a consumption-led economy. There is no single easy answer to this tension, but rather a constellation of interrelated actions leading to the larger goal. With so much at stake, it is anybody's guess how this would be done well mainly with the visible hand. Now is the time to reflect on the nature of the capital market: after all, it is, first and foremost, a market.


Footnotes

1 Lei (Raymond) Shi is a partner at Tian Yuan Law Firm.

2 'One bank' refers to the People's Bank of China, China's central bank. The two commissions are the China Securities Regulatory Commission, which regulates the securities industry, and the China Banking and Insurance Regulatory Commission, which regulates the banking and insurance industries.