PBoC introduces a financial stability law draft; analyzing John Lee’s bid for HK chief executive

     SinoInsight  1     

• No unit or individual may establish financial institutions without approval, or engage in financial business activities without approval or in a disguised form.
• Financial institutions shall operate prudently and in compliance with the law, and carry out activities within the approved business and regional scope.
• Financial institutions shall establish a reasonable shareholding structure, strengthen corporate governance and internal control mechanisms, and prevent manipulation by major shareholders and insider control.
• Shareholders of financial institutions shall make capital contributions from their own funds unless otherwise stipulated by the state.
• Shareholders of financial institutions shall not make false capital contributions, engage in circular capital injection, carry out capital evasion, and illegally use financial institution funds.
• Financial institution actual controllers shall not cover up actual control of the institution by means of entrusted equity holdings, concealment of affiliated transactions, etc.

OUR TAKE
1. The PBoC’s financial stability law and financial sector purges are part of Xi Jinping’s long-time effort to make the sector adhere closer to PRC law, clean it up, and consolidate his control over it.

The Xi leadership was unable to make inroads into the financial sector during Xi’s first term because the latter was still consolidating power and could not more safely move against the Jiang faction, Party princelings, and other interest groups who dominated the regime’s financial field through “white gloves” and financial elites (Chinese “oligarchs”). Meanwhile, the Jiang faction and others in the “anti-Xi coalition” took advantage of their strength in the financial sector to repeatedly stir trouble for Beijing, including the 2015 stock market turbulence that many Chinese observers described as a “financial coup” ;exploiting Li Keqiang’s internet finance project (互聯網金融, including P2P financing); idling funds in the financial system; state-owned enterprises and financial elites taking advantage of low interest rates to engage in usury; worsening the financialization of the real estate sector to the detriment of the real economy; and bolstering the “fictitious economy” over the real economy through increased financialization, such as Ant Group’s spinning 3 billion yuan in funds into 300 billion yuan through asset-backed securities.

The Xi leadership took more active measures during Xi Jinping’s second term to rein in the financial sector and clamp down on factional rivals. Near the end of Xi’s first term in July 2017, he proposed at the National Financial Work Conference in Beijing that “financial security is an important part of national security.” In November 2017, the PRC established the Financial Stability and Development Committee (FSDC) under the State Council to deal with financial risks. The drafting of the PBoC’s financial stability law appears to be an effort to standardize through legal provisions what the FSDC has been doing through means of policy guidance and coordination with various financial departments.

The financial stability law also allows the Xi leadership to legitimize its rectification of the financial sector. The authorities have drawn flak for taking over and reorganizing companies who engaged in “disorderly expansion of capital” like HNA Group, Anbang Group, and Tomorrow Group, as well as cracking down on internet companies like Didi Chuxing.

2. The CCP’s roll out of a financial stability law draft, targeting of corrupt financial officials, and continued easing of real estate sector restrictions suggest that it is aware that the regime faces serious financial risks and is concerned that they would be triggered this year owing to a “perfect storm” of domestic and external problems.

At home, Beijing is struggling with COVID-19 outbreaks, and particularly in areas that are carrying the Chinese economy like Shanghai and Shenzhen. Beijing also has to deal with the worsening real estate sector debt crisis and growing financial contagion, two problems that are exacerbated by the pandemic.

Abroad, Beijing has to contend with the “spillover effects” of several developments. The PRC is caught between a rock and a hard place over its support for Russia amid the Russia-Ukraine conflict, complying with international sanctions against Russia, and the looming threat of sanctions against China and its chilling effect on foreign investment. The PRC is also troubled by the U.S. Federal Reserves’ efforts to curb inflation and coming interest rate hikes, including a likely 50 basis point raise in May. Fed interest rate hikes could see the Sino-U.S. interest rate spread turn negative after hitting a high of over 250 basis points in July 2020, triggering massive capital outflows and starting a vicious cycle.

Some of the Xi leadership’s financial problems are self-inflicted. Efforts to rein in the financial sector and property sector, including the introduction of the “three red lines” in August 2020 and various crackdowns in 2021, resulted in the real estate debt crisis and foreign investor hesitancy in pouring capital and funds into China.

3. Xi Jinping has no choice but to tighten his grip over the financial sector and clear up the “disorderly expansion of capital” if he is to preserve regime stability and survival over the long term. However, Xi has triggered dire political risks for the regime and himself in the short term through his policies. While Xi might have been able to weather the storm under normal conditions, the pandemic and other geopolitical factors have compounded the PRC’s financial struggles, putting the Xi leadership under even greater pressure.

Xi’s political enemies will look to exploit his current vulnerabilities to go on the offensive as they seek to deny him a third term at the 20th Party Congress. As Xi’s political “achievements” evaporate one after the other, he will be forced to double down on the anti-corruption campaign to “maintain stability” and ensure his political survival.

     SinoInsight  2     

OUR TAKE
John Lee very likely has Beijing’s blessings to run for Hong Kong chief executive. His background in Hong Kong’s security apparatus, weaker business and bureaucratic connections, and obedience to Party Central work in his favor given the Xi leadership’s preoccupation with “maintaining stability,” safeguarding regime security, and shutting down factional struggle-related shenanigans in the city since the 2019 anti-extradition bill protests.

The CCP has long been wary of efforts by “hostile foreign forces” to transform Hong Kong into a “counter-revolutionary” base from which “color revolutions” and regime change can be exported to the mainland. Within the regime, Xi Jinping has struggled to bring Hong Kong more fully under his personal authority since taking office in 2012 and prevent the Jiang Zemin faction from using the city as a “counter-revolutionary” and “anti-Xi” base to undermine his leadership.

With an eye to addressing personal and regime interests, the Xi leadership expanded the CCP regime’s supra-authority national security apparatus on the mainland to Hong Kong in 2020 through the passage of the Hong Kong National Security Law and the establishment of the Committee for Safeguarding National Security of the Hong Kong Special Administrative Region. The election of John Lee, a long-time member of the Hong Kong security apparatus and national security committee, as the city’s chief executive would be the logical culmination of the “securitization” and power consolidation process that Beijing put in place two years ago.

The Xi leadership also very likely accounted for factional politics and the need to rebalance local power dynamics in choosing a candidate to serve as Hong Kong’s next chief executive. Xi would have noticed that Hong Kong grew more chaotic and less prosperous under Carrie Lam and Leung Chun-ying, two chief executives with deep connections to the city’s business and bureaucratic networks and elites. Those elites and networks have in turn been long influenced by the Jiang faction and other Party interest groups that have enriched and entrenched themselves in Hong Kong since the handover. We previously looked at how Hong Kong became a proxy battleground for the Xi-Jiang factional struggle (here and here).

Since the 2019 anti-extradition bill protests, the Xi leadership has sought to marginalize Hong Kong’s establishment elites. Beijing has blamed them for creating the socio-economic problems that led to social instability, targeted property developers over their abuse of “Ding Rights,” and changed the composition of the Hong Kong Election Committee to diminish their control over local politics. John Lee as chief executive would mean the further erosion of Hong Kong establishment elites and thus the ability of CCP factional interests to sway affairs in the city via their informal ties to the local elites, while ensuring that the Hong Kong leadership is in lockstep with Party Central with “Comrade Xi Jinping at the core.” Having a compliant chief executive who duly follows Beijing’s commands to the letter is also a plus for Xi Jinping if he encounters fierce pushback from the Jiang faction and the broader “anti-Xi coalition” (2022 is a Party Congress year), and is looking to make counter moves in Hong Kong, including playing the “Falun Gong” card.

Beijing may or may not “find” competitors for Lee before the chief executive election in May. However, very few would want the city’s top job now given Hong Kong’s swift deterioration as a prestigious international hub in recent years. The “securitization” of the city and the implementation of very strict epidemic prevention and control measures have led to people leaving in droves. Net departures from Hong Kong between 2019 and 2021 totaled 130,000, and net departures in the first three months of 2022 was nearly 157,000. Meanwhile, Hong Kong equity fundraising declined to its slowest pace since 2008 in the first quarter of 2022, with total fundraising from debut offerings, follow-on share sales, and convertible bonds dropping 87 percent from a year ago to $4.9 billion, according to data from Refinitiv. Poor financial and economic prospects, as well as the exodus of residents, mean that Hong Kong’s new chief executive has the unenviable job of turning around a “basket case” situation.

The CCP’s ramped-up efforts to “communize” Hong Kong (赤化香港), sideline “one country, two systems,” and growing international pressure over the Party’s erosion of freedoms in the city would further dissuade people from running from for office. Capable people often want a degree of agency and initiative in running the show, and very few can stand to serve as a mere puppet of Beijing. Further, not many suitable candidates for public office will be willing to leave themselves vulnerable to being sanctioned by the United States and other countries as they implement Beijing’s “stability maintenance” measures in Hong Kong; John Lee was already sanctioned by the U.S. in 2020 for “undermining Hong Kong’s autonomy and restricting the freedom of expression or assembly” during the 2019 anti-extradition bill protests.