Want to get FX deposits out of China? The plot thickens: Analysis

For many retail FX companies that do not have joint venture operations within mainland China, conducting business in the People’s Republic is often viewed as a hit and miss affair.

In one very attractive respect, it is a massive land of opportunity, with extremely knowledgeable traders across the entire nation continually analyzing the global markets in order to invest the monthly returns from gigantic real estate investments into liquid FX trading, often to the tune of tens of million per customer, all in managed funds accounts, neatly administered and organized by equally knowledgeable introducing brokers.

The opposite end of this is the closed nature of China’s business environment, locked behind the most sophisticated internet security system in the world, operated by two million government officials to ensure that absolutely no direct contact with the free market economies of the world can be established, and thus leaving all Western companies wishing to participate at the complete mercy of the Chinese government.

In December 2016, The State Administration of Foreign Exchange, which is China’s currency regulator that is owned by the People’s Bank of China, which in turn is owned by the government stated that it wanted to close loopholes exploited for purposes such as money laundering and illegally channeling money into overseas property.

The regulator left unchanged quotas of $50,000 of foreign currency per person a year, hence citizens faced extra disclosure requirements from January 1 this year, the most important being that customers sending funds abroad under this amount have to declare and sign for what the purpose of the transfer is, and if it is for securities trading (including FX), then it is not permissible.

Whilst the official government stance is one aspect, there are several methods in action which attempt to circumvent the system used to identify funds being transferred out of China, one of them being the use of algorithmic payment solutions providers that use a third party to deposit the funds, and then transfer them to the end destination once outside the firewall.

This is a method that is widely used, however it is worth considering that last year, PacNet, which owns Counting House, was placed on the sanctions list by the US Department of Treasury for money laundering, largely due to its activities in passing payments to third parties to ‘clean’ them before sending them to their end destination. FinanceFeeds conducted considerable research into this matter at the time.

This week, a new perspective has been put forward by the un-transparent State Administration of Foreign Exchange, in that the regulator has stated that there has been no regulatory obligation issued with regard to transnational financing of imports, this being contrary to some mainstream analysis that the Chinese government was continuing to clamp down on capital flows overseas.

Just two days ago, the Chinese regulator reiterated that enterprises can handle authentic, legal foreign exchange revenue and payments directly in banks and also clarified that cross-border guarantee business with authentic trade and investment backgrounds are not affected.

This is absolutely contrary to its report in December, however it is important to recognize that the Chinese government does not necessarily have an obligation to report its exact line on any specific policy, and that news reports in Chinese media on this matter are heavily censored and often littered with red herrings.

If it is the case that overseas enterprises can handle FX payments directly to banks, then that means that the operation of an omnibus account between an IB and Western brokerage should be uncompromised, however any IB or brokerage prepared to take the risk of doing so would have to be prepared for a potential seizure of the account should the Chinese government decide that operating in that fashion is not aligned with the correct method, which is via joint venture partnerships and the establishment of an office in mainland China which is subject to government control.

According to the vast majority of brokerages in mainland China that have discussed this at length with FinanceFeeds, market execution and accurate pricing is paramount, and it is clear that there is a homogeneous commonality among Chinese portfolio managers, brokerages and large scale introducing brokers in the level of detailed understanding of the entire structure upon which the electronic financial markets system operates globally.

Simply receiving money from clients via various algorithmic payment channels, or forging remote relationships with introducing brokers has been a model employed for quite some time now, which is an absolute display of lack of ability to navigate the business environment in China.

Thus, there are two status quo situations that exist at the moment:

Firstly, the method by which Western firms establish a joint venture partnership with a Chinese entity, with sufficient government control and commercial interest in order to make the joint venture count as a Chinese company, completely hosted and operated from within China.

Many western prime brokerages operate this model and provide service to Chinese IBs and brokerages across the country. This enables Chinese brokerages to access global liquidity on an aggregated, multi-source basis and is one of the main reasons why so many brokerages and IBs the length and breadth of the land favor companies such as FXCM, Saxo Bank, Advanced Markets and GAIN Capital as partners.

These companies operate Chinese-centric offices and have that ability to distribute bank and non-bank liquidity via Tier 1 interbank partners in London, as well as electronic communication networks which consist of non-bank counterparties such as Hotspot FX, XTX Markets, Citadel Securities, FXall and Currenex.

It would be extremely foolhardy to assume that, despite the impenetrable firewall and continual government interference, Chinese IBs and brokerages do not understand how these companies aggregate liquidity or what the quality of it is in terms of pricing and execution. They all do, very clearly indeed.

The second method, which is about to absolutely mushroom is the Chinese domestic banking system’s market liquidity extension to OTC derivatives firms.

The advantage that this has is that there is a uniformity throughout the entire component system from bank to prime brokerage, to brokerage and risk manager. The entire set of firms that provide each service are overseen by the government, (in most cases partially owned by the government), and would operate in a ‘hewn from granite’ fashion rather than as a set of separate solutions, and would be inside the firewall that protects the most enormous and highly educated retail and institutional market in the world, thus no barriers would be present.

Thus, bearing in mind the continued ambiguity that surrounds China’s ruling on cross border payments for the purposes of operating FX firms, those who do not establish in China and continue to hope for the best would be, well, hoping for the best.

FinanceFeeds maintains that the only way to operate correctly and with any sustainability is to operate a joint venture partnership within China, partially (or fully) owned by a Chinese entity with the mandatory government stake and full Chinese banking and account funding facilities via UnionPay and bank transfer.

Image: The Bund, Shanghai. Copyright FinanceFeeds