The fifth National Financial Working Conference (NFWC) was held in Beijing on July 14-15, and the Chinese government website published the manuscript from the meeting. The 5th NFWC has placed more emphasis on preventing financial systematic risks, strengthening financial regulatory accountability, promoting financial service towards the real economy, pushing forward market-oriented financial reforms, as well as continuing with opening-up in a measured pace. More specifically—

The 5th NFWC elected to set up the State Council Financial Stability and Development Committee (FSDC), and to enhance PBoC’s responsibility in Macro Prudential Management (MPA) and prevention of systematic financial risks. Similar to the market forecast going into the NFWC, the coordination between the PBoC and the “3 committees” will likely be strengthened, while the function of regulatory oversight and coordination will be enhanced for the PBOC. So far, we have yet to come across official information on the potential set-up for FSDC, while its specific responsibility and authority remains to be crystalized.

Aside from the announcement to form FSDC, there are a few other points worth noting:

The NFWC put the utmost emphasis on preventing financial risks, while financial regulators will become more seriously accountable for regulatory oversight. The establishment of FSDC aims to strengthen the authority and effectiveness of financial regulatory. Meanwhile, the NFWC has also pointed out that the new financial regulatory framework will be inclusive of all financial services, in order to identify and resolve financial risks in a timelier manner. Furthermore, the more integrated regulatory framework will help prevent policy “blind spots” under the old segmented set-up. More importantly, it is worth noting that for the first time, the NFWC stressed that “negligence and delay in resolving potential risks will be classified as malfeasance”. It is suffice to say that by stressing accountability and related penalty, the 5th NFWC has set up a better-defined and more rigorous regulatory environment. Meanwhile, legislative amendments to match the new regulatory framework will also be commenced in order to set up a long-term mechanism for financial risk management. On the other hand, the NFWC has proposed to strengthen the regulations around internet financing; however, the development of small-medium sized financial institutions will be promoted.

Monetary policy to maintain a “prudent” stance, while the funding cost for the real economy should be further reduced – similar to our views, monetary policy in 2H2017 may be a touch “easier” compared with April-May. It is worth noting that while monetary policy stance was set to be “prudent and neutral” since August 2016, “neutral” was removed from the NFWC statement this time round. Meanwhile, President Xi advocated a few times in his speech to channel more financial service towards the real economy, and to further reduce the funding cost of the corporate sector. We have witnessed some moderate increase in real-economy funding cost since March as the regulatory tightening towards deleveraging stepped up.  Xi’s statement on lowering funding cost may indicate limited room for further sequential tightening of monetary conditions.

NFWC identified reining in SOE deleverage as the key to lowering excess leverage of the real economy. Meanwhile, the clean-up of “zombie companies” may speed up. Apart from an “easier” policy stance on financial deleveraging, the NFWC has zoomed in on SOE leverage as the key for lowering excess leverage in the real economy – identifying SOE and “zombie firms” (often protected by local governments) as the “targeted areas” may help make the “deleveraging” process more pragmatic. Meanwhile, the NFWC has proposed to “restructure existing stock” to promote deleveraging, indicating a potential acceleration in SOE M&A.

Local government financing may be further regulated. The NFWC statement mentioned that the local government debt level should be strictly controlled, while the responsible government officials will be held accountable, even if the event unraveled only after their terms. China’s local government debt expansion has accelerated notably after 2009, while we saw another “growth-spur” of local government debt in 2015-16 when fiscal policy loosened. The 5th NFWC has clarified that local government debt management should be regulated according to the guidelines issued by the central government, while accountability and penalty for breaching the rules will also step up.

The NFWC vowed to continue developing China’s financial markets, promoting direct financing, and introducing more financial market instruments. It is clearly stated that “it is of the utmost importance to promote direct financing” from the NFWC manuscript. Meanwhile, parallel to the strengthened financial regulations, the financial market eco-system should be further cultivated and more market instruments will likely be developed. Financial regulations have adjusted after the 2015 stock market volatilities, which also included some “temporary measures” to stabilize the market. The most recent NFWC indicated that more financial market instruments may be introduced under a better-integrated and more coherent regulatory environment. Therefore, corporate direct financing via equity and bond issuance may continue to be supported, while financial market instruments may be enriched as well, including more commodity futures products. Meanwhile, we cannot rule out the possibility of relaxations of regulations over stock index futures trading.

NFWC proposed to move forward with financial market opening-up and RMB internationalization, in a measured manner. Although the general direction remains the same, the language has become reserved when it comes to capital account opening and RMB convertibility. The 5th NFWC statement indicated a more gradual pace, and with more emphasize on maintaining market stability. Meanwhile, the NFWC has also proposed to promote financial innovation and development of the related regulatory framework for the “Belt and Road” initiative.

In summary, the policy signal from the 5th NFWC is to set up a more integrated and coherent regulatory framework, which is positive to market sentiment. Furthermore, market-oriented reforms may go a long way in improving China’s financial structure and investment returns. Integrated regulatory framework and market-oriented reforms will likely improve the effectiveness of financial regulations, and perhaps more importantly, to prevent regulatory “oversight”, “missteps”, and “unintended over-tightening”. A more coherent policy framework may help reduce the volatility of financial markets, while promoting healthier development of financial institutions. Meanwhile, the overall financial structure and investment returns may be improved, if China is proven to be successful in lowering excess SOE leverage, cleaning up the “zombie firms”, and regulating local government financing.