THE Shanghai Free Trade Zone introduced “free trade” accounts last month, hailed as another step toward fully opening the capital account eventually in the pilot zone.

The new measure is supposed to cut red tape for current-account transactions, inbound and outbound direct investment, and cross-border lending.

According to Dai Haibo, deputy director of the zone’s management committee, nearly 500 free trade accounts were opened by foreign and domestic institutions and individuals in the first two weeks after the accounts were announced.

Market watchers said it’s only a matter of time until China fully opens the capital account in the zone.

“The free trade account system is a significant instrument for the promotion of financial reforms, such as capital account conversion,” King & Wood Mallesons, a Hong Kong-headquartered law firm, said in a report on the FTZ.

“It is expected, once the system is actually set up, that the financial environment in the FTZ will be highly integrated to the international financial market, with controlled connectivity to the domestic market outside the zone,” the report said.

So, at this stage, controls are still in place for currency convertibility and fund transfers.

Under the new rules, only yuan accounts are eligible. Foreign currency free accounts aren’t expected for at least six months.

Nikos Antoniades, chief executive of Easy Forex, an online financial market investment platform, said detailed policy directly related to the foreign-exchange industry has not yet been released.

Risk control tool

“To some extent, the account is more a risk management tool for authorities because it aggregates all company funds into one account,” Antoniades said. “Sometimes, companies prefer to have multiple accounts for various purposes.”

Yuan funds can be transferred between free trade and non-free trade accounts of onshore institutions, including FTZ-registered branches of foreign companies. However, such transactions are regulated as cross-border transfers because the free trade accounts are deemed to be offshore accounts.

At this stage, only five Chinese banks are operating free trade accounts: Bank of China, the Industrial and Commercial Bank of China, China Construction Bank, Shanghai Pudong Development Bank and the Bank of Shanghai. It took eight months for the banks to work with the authorities on establishing the entire framework for the liberalized accounts.

Although there are a dozen of foreign banks that have established a presence in the FTZ, none of them has yet been authorized to provide such services.

In order to set up free trade accounts, banks need to pass two stages of regulatory scrutiny.

First, they need to modify their core systems, set up split accounting modules for free trade accounts and establish the framework for the new service, including risk management and anti-money laundering mechanisms.

Second, they need to connect the modified systems to the People’s Bank of China’s central system for further testing.

It may take foreign banks at least six months to complete the two-stage process, according a banking source.

King & Wood Mallesons said the free trade account system is also applicable to other types of financial institutions, such as securities and futures companies.

That bolsters broader policy possibilities for further opening up in the domestic capital market, the law firm said.

The Shanghai Gold Exchange, the biggest bourse for physical bullion in the world, has signed clearing agreements with four Chinese banks to open free trade accounts for overseas investors who participate in the international gold trading board in the FTZ. The international board is expected to open in the next quarter.

Shanghai Daily has collected some basic facts about free trade accounts.

Free Trade Account 101

What is free trade account?

A free trade account is a yuan or foreign currency-denominated bank account that is subject to split accounting in the Free Trade Zone.

It is available now only in yuan, though financial authorities are expected to roll out a foreign-currency version later.

What is split accounting?

Split accounting refers to the fact that free trade accounts in the zone must be structured separately from non-free trade accounts.

What is a FTZ split accounting unit?

The unit is the free trade accounting system set up at city-level branches of Shanghai banks specifically to handle split accounts.

Who can open free trade accounts?

FTZ-based institutions, including registered institutions and the zone branches of foreign institutions;

Offshore institutions;

Chinese citizens employed by FTZ-based institutions for over one year;

Foreigners employed by FTZ-based institutions for over one year.

What are the five types of free trade accounts?

One for FTZ-based institutions and registered individual industrial and commercial households;

One for offshore institutions;

One for financial institutions;

One for Chinese individuals;

One for foreign individuals.

What does a free trade account do?

The free trade account can facilitate freer currency conversions and fund transfers for current-account transactions, for cross-border investments and for innovative financing, which may include:

Cross-border direct investment by institutions such as private equity investment companies;

Investment in offshore capital markets by individuals, such as in Hong Kong and US stocks;

Investment in offshore capital markets by FTZ-based institutions, such as stocks and derivatives;

Yuan-denominated bond issuance by the offshore parent company of a FTZ-based institution;

Offshore lending by FTZ-based non-bank institutions.

How can I open a free trade account?

At the moment, only five banks provide the service: the Industrial and Commercial Bank of China, China Construction Bank, the Bank of China, Shanghai Pudong Development Bank and the Bank of Shanghai.

China Merchants Bank and the Bank of Communications have received the green light to provide these accounts but have not yet rolled out the service.

Offshore institutions and foreigners should go to bank outlets in the FTZ, while any others may apply at any branch of participating banks.