A ceremony in Shenzhen on Monday heralded the beginning of a challenging new phase of a process that's dramatically changing China's financial scene.

A group of 15 banks in Hong Kong signed an agreement offering loans to companies operating in Shenzhen's Qianhai zone, opening the door for offshore participation in the nation's domestic lending market for the first time since 1949.

The move comes on the heels of last week's long-awaited announcement that the People's Bank of China (PBoC) has signed a yuan clearing agreement with Taiwan, further expanding the currency's global footprint.

The Pearl River Delta, just across the border from Hong Kong, has long been the testing bed for the mainland's bold economic reforms. Experiments started in Shenzhen - ranging from the mainland's first Special Economic Zone in 1979 to yuan trade settlement in 2009 - have formed the foundation of China's economic transformation.

Qianhai, formally known as the Qianhai Shenzhen-Hong Kong Modern Service Industries Cooperation Zone, is Shenzhen's special economic zone - a crucible for economic reforms that will bring China, now the world's second-largest economy, into line and in competition with the great global powers in the financial marketplace.

Qianhai is physically and economically a relatively small experiment, covering just 15 square km. Media reports have indicated that inbound loans are likely to be limited to a total of 50 billion yuan, but its impact is likely to be profound. The local authorities see it as "a useful exploration for China to create a new opening up layout with a more open economic system".

Not only will Hong Kong banks be allowed to extend commercial yuan loans to Qianhai-based onshore mainland entities, the PBoC has indicated that such loans will, for the first time, not be subject to the benchmark rates set by the central bank for all other loans in the country.

Such loosening of the capital account restrictions is not the end. The Shenzhen authorities predict that Qianhai will generate GDP of 150 billion yuan by 2020.

The development also marks the first step along China's road to interest rate liberalization, a key milestone on the road to full internationalization of the Chinese currency.

The potential benefits of the new development go beyond mere economics. When it's fully developed, Qianhai will form a bridge for the mainland to conduct new accounting and legal measures. It is also a protected environment in which international service industries can learn more about doing business in China.

In financial terms, Qianhai presents a series of challenges and opportunities to banks on both sides of the border. HSBC believes that fears the project will drain Hong Kong of yuan liquidity are misplaced. With some 570 billion yuan as of Nov 2012 currently deposited with Hong Kong banks, the likely cap on permissible loans amounts to less than 10 percent of the deposit pool. And, the PBoC has said it will monitor and counter any potentially destabilizing fallout from the loan program.

This new yuan financing channel will add an extra degree of depth and maturity to the offshore market, making it more attractive to investors.

We believe the Qianhai experiment will help boost both the yuan loan business and cross-border yuan liquidity. The cost of yuan loans in Hong Kong, currently between 4 and 5 per cent, is typically 100-200 basic points cheaper than on the mainland.

Qianhai represents a valuable toehold on mainland markets for Hong Kong banks, and the latest measure reflects the true sense of "act first try first." This new measure on cross-border lending will enhance co-operation between Hong Kong and Shenzhen, as well as between Hong Kong and Guangdong province as a whole, and accelerate cross-border convergence.

Qianhai represents significant progress in China's three-step program towards full convertibility of the yuan, which is well on the way to becoming a significant trading currency. The ongoing relaxation of capital controls, represented by Qianhai and the Renminbi Qualified Foreign Institutional Investor Program, signifies that turning the yuan into a global investment currency is not a distant dream.

The yuan as a global reserve currency may still be some way off, but Qianhai is another clear indication, if one is needed, that Beijing is not intimidated by the challenges of reforming the financial sector to achieve its goals.

Anita Fung is Chief Executive Officer, Hong Kong HSBC.

(HK Edition 01/31/2013 page9)