China has unveiled a strategic financial reform plan in the thirteenth Five-Year Plan, that is, “to reform and optimize the financial regulatory framework so that it adapts to modern financial market development”. However, wherever financial reforms occur, there will be inevitably financial risks. How can we better select, confirm and further optimize the design of the financial regulatory framework that “is in accordance with the Chinese situation and the international standards and adapts to the modern financial market development”? How can we promote and implement the plans for the reform of financial regulatory framework and succeed in transforming the old regulatory framework into the new one without causing risks or obstacles? All these issues are extremely important for China to ensure its economic and financial security, to maintain the stability of financial market, and to prevent the systemic financial risks from coming into being.

Therefore, on October, 22nd, 2016, the High Level Forum on the Development of Financial Market and Reform of Financial Regulation, jointly organized by University Think Tank of Shanghai, Finance and Economics Institute of Tongji University, and School of Economics and Management of Tongji University, was held at Tongji University. Over 200 people, including people from the related departments of the government and the government decision consulting departments, specialists from universities and colleges, leaders in the financial area, and faculty and students of Tongji University, etc., gathered together, shared their research outcomes, and exchanged ideas on this topic in the form of dialogues and debates. Through such communication, a series of important conclusions have been reached, and some major ideas are presented in the following sections.

1. The Current Situation and Challenges: New Characteristics and the New Trend in the Development of Modern Financial Market

Professor Shi Jianxun, the director of Finance and Economics Institute of Tongji University and chief specialist of a government decision consulting institute financed by National Social Science Fund, points out that in the period of the thirteenth Five-Year Plan, internet corporates will be more involved in the financial sector; internet-based operation in traditional financial enterprises will be inevitable as well; the whole financial sector will see a profound change. Besides, the financial innovation represented by internet finance and the trend of mixed operation in the financial sector will make the financial market in China more and more complex. Under such circumstances, both the original financial regulatory framework and the departments in charge of it will be faced with grave challenges. Mixed operation is a new trend of development in the contemporary financial industry. It is an inevitable outcome in this era. In recent years, as greater efforts are made to push the financial reform and financial innovation, more and more creative derivatives come into being, businesses such as banking, insurance, security and asset management are more and more interrelated to each other, and financial conglomerates that are running their comprehensive businesses in the holding group/parent-subsidiary forms appear one after another. What is more, as internet finance develops at a fast pace, a new form of mixed operation emerges in the financial industry. The mixed operation in the financial industry now is not only about the issues of overlap and convergence in businesses under different financial service licenses. It is represented more by the mixed operation between online retailing and other businesses of financial service. Such mixed operation in the background of “financial crossover” has brought new challenges to the financial regulatory system in China.

Professor Wu Xiaoqiu, the vice chancellor of Renmin University of China and director of Finance and Securities Institute of Renmin University of China, observes that the financial innovation, which is based on demand, would lead to the changes in China’s financial structure. At present, the center of the financial structural reform in China is in the structure of the financial assets. The proportion of the securitized financial assets is gradually increasing. The development of financial market will change the financial function and the financial structure, and the change and evolution in the financial structure will cause the variation in financial risks. Therefore, it is necessary to use the reform of financial regulation as a means to prevent such variation.

The pattern of financial regulation should change in accordance with the change in financial structure, which can be illustrated by the 2015 stock market crisis. Off-balance sheet activities are one of the examples of the numerous businesses that are under mixed operation. When the scale of off-balance sheet activities in the commercial banks is getting bigger and bigger, these activities will gradually be away from the capital regulation, so a more important measure for the off-balance sheet activities should be to control the opacity. However, the pattern of financial regulation in China is categorized as institutional regulation, so when the commercial banks are having more and more off-balance sheet activities, China Securities Regulatory Commission still has no way to regulate them. In this situation, regulation vacuum is created. This has proved that the change in financial structure requires the reform in financial regulation.

According to Professor Shi Jianxun, along with the financial globalization and liberalization, as well as the rapid development of internet finance and financial innovation, there will be more and more business innovation, overlap, and convergence of the financial institutions. The environment of financial regulation in China is now undergoing great changes, but now China is still using the original regulation pattern, the “one bank and three commissions” pattern, in which the central bank, China Banking Regulatory Commission, China Securities Regulatory Commission, and China Insurance Regulatory Commission would do their regulatory work separately. Such a pattern can meet neither the requirement of financial market development in the present era nor the urgent demand of constructing an open and secure financial system. There are many doubts about the effectiveness of regulation, so it is an urgent need to speed up the reform of financial regulatory system.

2. Principle and Idea: The Aim and Path of the Reform of Financial Regulation

Professor Ruan Qingsong, the vice dean of the School of Economics and Management of Tongji University, remarks that the economic new norm requires new ideas of financial regulation. In the economic new norm, the economic growth of China is slowing, and China is facing the stress of slowing economy all the time. The adjustment of industrial structure cannot be accomplished in the short term, and some businesses and industries are faced with risks at different levels. Under this circumstance, we should come up with new ideas to reform the financial regulation so that the potential systemic financial risks on the regional level can be prevented in advance. Then with the idea of further optimizing the financial regulatory system and making it into a coordinative and integral system, we need to focus on both the integration of macro prudential regulation and micro prudential regulation and the integration of institutional regulation and functional regulation. What is more, no matter what new idea it is, great importance should always be attached to the independence and neutral principle of financial regulation.

According to Professor Wu Xiaoqiu, since the proportion of securitized financial assets will increase in the future, one important direction for the financial regulatory reform in China would be to gradually change the regulation focus, from asset regulation to the regulation that assures the symmetry of information and transparency. The financial assets in China are mostly composed of the financial assets of bank credit. Such a financial structure is of no liquidity, so is the risk. Since the assets are not liquid, the stock risks of them will gradually increase. Therefore, regulation of this type of financial structure will be focused on asset regulation. On the other hand, the risks of securitized financial assets come from the asymmetry or opacity of information, so regulation of the securitized financial products will be focused on assuring transparency. However, at present, the pattern of financial regulation in China is still mainly focused on asset regulation, and transparency regulation is still not playing an important role. In the future, as the proportion of securitized financial assets increases, the importance of transparency regulation will become more and more important, and it will be the time then for China to focus our financial regulation more on transparency regulation. Important as asset regulation is, the change in financial structure will definitely affect its position as the major means of financial regulation.

Professor Shi Jianxun remarks that as the financial industry in China develops rapidly, the gradual transformation of financial regulation from institutional regulation to functional regulation will become an inevitable trend. Based on both the businesses and activities carried out by the financial institutions and the basic functions performed by them, functional regulation manages to supervise beyond the classification of products, industries, and markets. This kind of regulation better meets the requirement of mixed operation for financial regulation. To achieve it, we need to change the traditional “one bank and three commissions” pattern. We need to promote the reforms in a prudential way in three aspects, namely, the financial regulatory system, the way of financial institution regulation, and the way of financial products, and in this way we can build step by step a mega comprehensive financial regulatory system that fits the mixed operation.

Zhang Xin, a researcher of Finance and Economics Institute of Tongji University and associate professor of School of Economics and Management, Tongji University, points out that for a very long period of time the financial system in China provides support mainly to the large-scale enterprises, state-owned enterprises and the government, so most of the loans in China flow to the large-scale enterprises, especially the large-scale enterprises owned by the central government and the real estate enterprises. In the future, concerning the financial regulation reform in China, we should think of changing the financial system that helps direct more capital to the large-scale enterprises. We should bring the financial industry back to its track, making it perform its original function, that is, to serve the real economy, to provide a financing environment that is advantageous to the development of medium/small/micro-scale enterprises, and to build a mechanism to help the “poor/weak” enterprises to develop and become stronger. Such “Helping the Poor/Weak” mechanism aims at encouraging entrepreneurship, boosting innovation, and promoting the development of medium/small/micro-scale enterprises.

Concerning the general framework of reform for the financial regulatory system in China, Professor Shi Jianxun presents the following suggestions. First, we should learn the experiences of financial regulation reforms from other major economies; we should combine such experiences and China’s situation, consolidate the financial security and prevent the systemic risks from coming into being. Second, we should adapt ourselves to the new trend of modern financial development, establish a regulatory framework that can supervise and coordinate the financial activities effectively, and eliminate regulatory competition and regulatory arbitrage on the system level. According to Professor Shi, the feasible reform plan would be to adopt the pattern of “central bank + financial conduct authority” or “central bank + prudential regulation committee + financial conduct authority”, take into account China’s situation, and carry out the reform gradually at a steady pace. The ultimate goal would be to establish a modern financial regulatory framework that incorporates macro-prudential regulation, comprehensive regulation, functional regulation, and conduct regulation, so as to provide enough fundamental and systemic support to ensure the building of an open and secure financial system.

3. Difficulties and Risks: The High Uncertainty over the Reform of Financial Regulation

Although a general consensus has been reached among people in different areas that it is necessary and urgent to reform the financial regulatory system, there still exist a lot of uncertainties. Therefore, the complexity of financial regulation reform should not be underestimated in the future.

Mr. Li Lin, the general manager of Strategic Development Department in Shanghai Pudong Development Bank, thinks that attention should be paid to the superposition effect brought by the negative effect of the policies. The Chinese government is making great efforts to push the structural reform on the supply side. Under this circumstance, the key to macro-economic control includes both maintaining the economic growth and de-leveraging. During de-leveraging, one thing we need to balance is the ratio of loans to stocks. Therefore, when making the policies, it is quite necessary to take into account the complexity of financial regulation reform. Mr. Li points out that when we are making financial regulation policies to regulate the financial system and prevent the financial risks from coming into being, we also need to pay attention to the following two issues. First, the reform of financial system in China should be incorporated with the Chinese characteristics. Indirect finance dominates the financial system in China now, and the other financing channels are still relatively weak, especially when there is debt deflation and when the stock market does not work, the banking system will become the only crucial area to ensure the financial security. Second, we should pay attention to issues such as when to issue the policies and what will happen in the “window period” after launching these new policies, and we should also make sure that the policies are consistent and coordinated with each other. We should pay attention not only to the positive effect of each policy, but also to the negative effect of each policy, and more importantly to the superposition effect brought by those policies together. When we look at one single policy issued by the government, mostly we find it is beneficial for the operation of financial system and the preventing of systemic financial risks. However, in the situation where the economy is slowing, the superposition effect brought by those policies together may bring great burden to the banks and cause the bankruptcy if the situation is too worse. Along with it, there will be more financial systemic risks, which may affect the real economy greatly.

Concerning the reform of regulatory system in the capital market in China, Professor Huang Yuncheng, who is the adjunct professor of Tongji University and used to be a researcher of Research Center of CSRC, remarks that the reform of administrative system should become the theme of the capital market reform. If the reform of administrative system is not carried out successfully, the promotion of the whole capital market reform will become extremely difficult. Furthermore, he points out that from the perspective of capital market, the research topic as to how to ensure carrying out the reform of the state-owned enterprises is very important and we must look into it. The reform of state-owned enterprises in the capital market should be centered in the reform of stock exchanges, but now stock exchanges have not been involved in many of the reforms. If the reform of stock exchanges is not carried out successfully, it is not possible for us to carry out other reforms successfully. At present, the issue as to whether stock exchanges are categorized as markets or government departments is not clearly stated in the law. According to Professor Huang, the difficulty in promoting the reform of stock exchanges is mainly caused by the failure of administrative system reform, which means the regulatory institution regards stock exchanges as its subsidiary. Therefore, Professor Huang points out that the first step for us to start the reform of regulatory system in the capital market in China is to “put the power back into the cage of system”.

According to Professor Shi Jianxun, there are three aspects of uncertainty in the reform of financial regulation. Firstly, the final plan for the regulation reform has not been settled yet. Now there are four major proposals: 1) to integrate “one bank and three commissions” and set up a mega financial regulatory institution, that is, to let the central bank be in charge of all the financial regulation; 2) to maintain the present “one bank and three commissions” pattern, and set up a financial coordination commission on this basis; 3) to transform “one bank and three commissions” into “one bank and one commission”, that is, the general policies made by the central bank is not changed but the regulation of prudential regulation is strengthened; 4) to transform “one bank and three commissions” into “one bank and two commissions”. Each proposal has its own advantages and pitfalls, so the consensus on which should be chosen cannot be reached easily. Secondly, there is uncertainty about the risk of regulation reform. All reforms are risky, but the risk of financial regulation reform is the highest, so we should make sure the reform of financial regulatory institutions is carried out in a way that will not suspend the original regulation of the markets. Thirdly, the “route map” and the “construction drawing” of the financial regulation reform have not yet been settled. There still exists uncertainty about issues such as how to carry out the reform, what to reform first, what to reform later, how to organize the reform, what institutions should be shut down, how to deal with the laid-off in those institutions, which institution is responsible for the market regulation, and how to make sure the market still works normally during the reform. There are businesses and activities every day in the financial market, so it cannot be stopped in any way.

4. Legislation and Amendment: Promoting the Rule of Law is the Top Priority in the Reform of Financial Regulation

The reform of financial regulatory system is a top-down process. We should first build the new model and legislate. Then we simulate the new operation, and as the model is modified and perfected, we can do away with the old model afterwards.

Concerning how to build up the new model, Professor Shi Jianxun thinks that we should guarantee the financial reform by means of legislation. The financial market is the law-based economy, so we should trade stocks and regulate the market in accordance with the laws. Legislation is the premise of the reform. Only by legislation can we guarantee the consistence and stability of the financial reform.

Mr. Wang Zhenying, the distinguished research fellow of Finance and Economics Institute of Tongji University and vice-chairman of Shanghai Finance Society, thinks that the reform of financial system should start from legislation. Now each law is first proposed by the departments in the government, and such proposals may be affected by their concerns of their own benefits and their limited knowledge within their own field. Under this circumstance, it is necessary for us to introduce legislation beyond the interest of departments.

Professor Huang Yuncheng also points out that a very prominent problem exists in the financial regulatory legislation in China, that is, most laws are made by the departments of the government, and since there is a lack of check and balance mechanism to prevent them from making laws in their own interests, severe selfish departmentalism emerges. In other words, there is no problem with the laws themselves, the difficulties lie in the actual implementation. In the financial legislation in China, laws concerning the banking industry are mainly proposed by the central bank and China Banking Regulatory Commission; laws concerning the securities industry are mainly proposed by China Securities Regulatory Commission; and laws concerning insurance industry are mainly proposed by China Insurance Regulatory Commission. Finally, all these laws will be passed over to National People’s Congress and reviewed by them. The major regulatory departments involved in the particular industry for which the laws are made are in charge of proposing the key ideas and principles in the laws, and they are also in charge of the later coordination work with the legislature. In this sense, these regulatory departments are not only enforcing the laws, but also making the laws, so these laws can hardly reveal the supply and demand in the market, which becomes the main reason for the difficulty in promoting the financial regulation reform. If we really want to promote the financial regulation reform, we have to put the public power back into the cage of system, limiting regulatory departments’ chance of participating in legislation.

Professor Liu Chunyan, the distinguished research fellow of Finance and Economics Institute of Tongji University and associate professor of Tongji Law School points out that a feasible way to reform the financial regulation is to start from legislation. From the experiences of the United States, the United Kingdom, etc., we can see that their reform of financial regulatory system all started from legislation or the amendments of the existing laws, that is, legislation or amendments were leading the reform of the financial regulatory system. In the process of amending the laws, thorough discussions were carried out and the final consensus was reached on this basis. Legislation requires both the participation of all parties and the top-level design, and we should strike a balance between these two elements. On the one hand, we should listen to the advice within the system, because people within the system are most familiar with the situation in financial regulation, but the pitfall is that there may be the conflict of interests. On the other hand, we should listen to the advice beyond the system, because people beyond the system are relatively neutral, but the pitfall is that they are not familiar with the actual operation of financial regulation. For China, not only the active research into the American or British experiences is important, but the real situation in China is also essential. We have to understand China’s situation comprehensively and take it fully into account. Besides, the focus of legislation is not on speed, but on thoroughness. In the legislation process, hearings and interpellations should be carried out before making the law amendments, and the legislature should explain the intention of legislation to the public. Technically, we can also try to improve the effectiveness of legislation by applying cost-benefit approach, and retrospective (ex post) evaluation, etc.

Professor Liu also points out that China has established a socialist system of laws by the end of 2010, the idea of governing the country comprehensively according to the rule of law has been raised in the Third Plenary Session of the 18th CPC Central Committee, and Decision of the Central Committee of the Communist Party of China on Several Big Issues of Comprehensively Promoting the Rule of Law has been passed in the fourth Plenary Session of the 18th CPC Central Committee. Under this circumstance, all the reform of financial regulatory system should be started on the basis of legislation.

5. Pilot Reform and Promotion: Establishment of Pilot Programs for the Reform of the Financial Regulatory System

At present, the mechanism and system of financial regulation lags far behind and it is unable to meet the needs of financial innovation and development, so it is in urgent need of reform. However, any reform in the financial industry will inevitably cause some financial risks. All the elements inside or outside the financial domain are closely interrelated with each other, which increases the difficulty and complexity in the reform of financial regulatory system. Any adjustment in a single element will ignite the change of the whole system. Therefore, it is an extremely difficult and highly risky task to achieve the nation-wide reform immediately. We need to admit that, firstly, the reform of financial regulatory system is an urgent task and we should take action at once; secondly, it is an extremely difficult and highly risky task, so there should be a process of trial and error before the completion of the whole reform of regulatory system.

Therefore, Professor Shi Jianxun points out that to promote the reform of financial regulatory system we need a pilot program for trial and error. In the complex situation of economic transition, China’s economy is rising and the promotion of financial regulatory reform is actually a process of trial and error. In this period, it is normal that new problems and new conflicts keep appearing. If we launch a pilot program for the reform of financial regulatory system, we will be able to get the time and space to correct the mistakes that appear in the reform. In this way, we expect to sort out the interrelationships between different issues such as finance and the real economy, the elements within the financial system, different types of markets, every measure taken in the financial reform, etc. Based on these interrelationships, we expect to come up with a more reasonable procedure for the reform and a more suitable reform plan. Then through sufficient experiments, we can finally make a decision on which is the most replicable case for the systemic reform and then promote this best case on a nation-wide basis. Only in this way can we make sure the reform of financial regulatory system is promoted at a steady pace.

Professor Shi Jianxun suggests that we should use Shanghai Pilot Free Trade Zone as a base to pilot the reform of financial regulatory system. There is a complete range of financial elements in Shanghai, so the foundation and environment in Shanghai Pilot Free Trade Zone is relatively beneficial for the financial reform and innovation. Moreover, Lujiazui Finance & Trade Zone has been included in Shanghai Pilot Free Trade Zone, which makes the range of financial elements in the free trade zone even more complete. To set up a pilot program for the reform of financial regulatory system in Shanghai Pilot Free Trade Zone, on the one hand, meets the objective requirements of the financial innovation in the free trade zone and helps control the risks of financial reform effectively. On the other hand, it provides the best model of practice for the optimization of the reform of financial regulatory system in Shanghai and even in China and the successful, replicable and promotable experiences. In this way, the risks such as system transition or lack of regulation can be reduced during the reform of financial regulatory system.

Note: The author (PhD in the School of Economics and Management at Tongji University) is a research associate in the Finance and Economics Institute at Tongji University. This article first appeared in Securities Times on the following website: https://www.stcn.com/2016/1026/12921849.shtml