File picture shows a paramilitary police officer standing in front of the Great Hall of the People at Beijing's Tiananmen Square
By Saikat Chatterjee and Michelle Chen
HONG KONG (Reuters) - China is considering the use of international law in a big push to get free trade zones up and running to promote the use of the yuan in global trade, which could challenge Hong Kong longer term as the main offshore center for the currency.
Sources said Chinese leaders have been discussing the adoption of an international legal system in the free trade zones (FTZs) for the first time to help lure foreign companies, although views are varied.
"Authorities recognize that providing a robust legal framework and infrastructure will attract global companies," said a Hong Kong government official briefed on the FTZ discussions. "But agreement on this is far from uniform."
Bankers said such a move would go a long way to make FTZs more competitive with Hong Kong, which has been the only notable success among China's attempts to allow the closely managed yuan to trade more freely.
"The offshore yuan hub in Hong Kong is an experiment," said Marc Chandler, global head of foreign exchange strategy at Brown Brothers Harriman during a visit to Hong Kong.
"And the policy mindset is if the experiment is successful, bring it back to the mainland and if not, abandon it."
Traditionally, Chinese leaders have promoted Hong Kong as the main offshore market for yuan trading. About 18 percent of China's global trade is now conducted in yuan, from just 1 percent in 2009, and much of it is routed through the territory.
Hong Kong's success has been underpinned by a strong rule of law and freedoms under the "one country, two systems" formula adopted when the territory was handed over to China by Britain in 1997.
A closed-door Communist Party plenum from Saturday to Tuesday is expected to set in motion efforts to kick start a number of FTZs around China. The FTZs have been set up, but in many cases rules over how participating companies can operate have been fuzzy, limiting their success.
BACK TO THE FUTURE
Among others, Qianhai in Guangdong, Tianjin and Xiamen in the north and most recently, Shanghai, have set up FTZs.
The gathering of China's leaders this weekend is the third since President Xi Jinping came to power. So-called third party plenums have typically been springboards in the past for key economic changes.
Analysts, including Jun Ma at Deutsche Bank, expect the FTZs to be the laboratories in which the government tests the deregulation of interest rates and the opening of China's capital account, which would mean a more freely traded yuan, also known as renminbi (RMB).
"At the initial stage, I think China may choose some companies to try innovative business with quotas," said Ngan Kim Man, head of RMB Business Strategy and Planning Department at Hang Seng Bank.
The zones are unlikely to match Hong Kong's business environment soon. They might lower mainland corporate tax rates of around 25 percent and try to compete with Hong Kong's rate of 16.5 percent.
Indeed Qianhai, just a one hour drive from Hong Kong, plans to offer a corporate tax rate of just 15 percent.
But bankers and government officials say allowing international law to govern the FTZs would make a big difference in getting foreign companies to join them.
Singapore-based DBS and Citigroup were among the first banks to open offices in the Shanghai FTZ. Other global banks and companies have said privately they would join as well if China allowed special legal rights similar to those available in centers such as Taipei, Singapore and Dubai.
"If China adopts a similar legal framework in these zones, we will see companies and banks making a beeline into these zones," said the head of cross border trader services at a European bank in Hong Kong, who declined to be identified because he is not authorized to speak openly to the media.
"Otherwise, we are likely to see only a token presence by global companies."
Still, it would be a big step, so there remains resistance to the idea among policymakers, said the Hong Kong official.
"By allowing international law in these zones, you are basically ceding control in these areas," the official said.
Although the plenum may provide the policy platform for changes, detailed rules, regulations and laws may take some time to produce.
"By recognizing the fact that officials are at least considering various (legal) models suggests their intent in using these zones as the catalyst for the next phase of reforms. Legal reforms fall under the ambit of administrative reforms which are far more difficult to implement," the Hong Kong official said.
The potential changes suggest Hong Kong can no longer rely on Beijing to keep promoting the former British colony as the major offshore yuan hub, which Hong Kong officials seem to recognize.
"We should complement the policies introduced by the Central Government and play more effectively the first-mover role in the process of developing a diversified financial market in the mainland and expediting the internationalization of the RMB," K.C. Chan, Hong Kong Secretary for Financial Services and the Treasury, said in a written response to a question in the legislative council about the territory's role in light of the FTZs on the mainland.
(Editing by Neil Fullick)