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Shanghai is on track to becoming the world's largest financial centre within the next decade, as China continues to open up its capital markets and expand its investor base.

In absolute size, China's equity markets have now grown to a significant level, from US$400 billion in 2005 to US$4 trillion in 2010. This growth has been fuelled by over 500 initial public offerings, including the listings of China's largest banks. Shanghai now has some of the world's largest companies represented on its bourse.

A joint report by KPMG, FTSE Group and Dagong Global Credit Rating, "China's Capital Markets – The Changing Landscape," highlights the importance of the internationalisation of the RMB and progress towards the launch of the International Board on the Shanghai stock exchange. The new board aims to enable foreign organisations to access the Chinese markets allowing domestic investors direct access to foreign listed companies for investment purposes.

"We expect to see the launch of the new International Board occur in the near future, but we note that no timeline has been indicated, although there are clear indications regarding the areas of regulation that need to be resolved as a precursor to any launch," says Simon Gleave, Regional Head, Financial Services, KPMG China. "These include regulations on financial reporting, accounting and auditing, cross border supervision and stock exchange disclosure requirements. Once appropriate listing rules have been developed and published there will also be a need for clarifications around capital account convertibility, dividend payments and arbitrage."

Meanwhile, the formal introduction of ChiNext and of Stock Index Futures has significantly helped to broaden the market for domestic investors. And as China's stock market evolves, the investor base continues to expand, with products for Qualified Foreign Institutional Investors (QFIIs) playing a more prominent role. The report notes that as the QFII pool has continued to grow, the total quota is expected to expand to US$30 billion in the near future.

"At FTSE, we've seen growing demand for market access products for QFIIs, including those based on the FTSE China Index Series and we anticipate continued interest. It will be paramount for index providers, issuers and exchanges to continue to expand the breadth and depth of products available to meet the needs of investors, as QFII quotas expand," says Donald Keith, Deputy Chief Executive, FTSE Group. "With their index trading experience in international capital markets, QFIIs could help to broaden the investor base of China's financial markets through the increasing use of index-linked vehicles, such as Exchange Traded Funds (ETFs), futures and, more recently, stock index futures."

The focus is on China's capital account liberalisation and the potential implications for the future development of equities, bonds and derivative products. The rapid development of both the stock and bond markets could generate a huge demand for derivative and hedging products.Gleave adds that although China's corporate sector remains highly dependent on bank financing, there is growing interest in corporate bonds. He says there will be greater interest in bond and equity financing as the market matures. "We expect this growth to continue, particularly if there is further tightening of the bank and regulatory environment. Meanwhile, the internationalisation of the RMB will also help to support China's ambitions to transform Shanghai into an international financial centre. In order to achieve these goals, we may need to see full capital account convertibility, and opening of RMB-denominated A-Shares to foreign investors," notes Gleave.

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