STUDENT VIEW 1

Capital Market Liberalization – What Can
China Learn from Japan in Opening Up Its
Financial Markets?
By Ziyue Li

Author Ziyue Li

Introduction
In July 2019, when trade tensions between China and the UnitedStates were as hot as the summer sun, China’s State Council
established 11 new rules to further open up its financial sector(http://www.gov.cn/xinwen/2019-07/20/content_5412220.htm).
Many believe the move could open doors for the wolves of WallStreet, who have long been eyeing the Chinese market. Sceptics
worry about a possible lost decade as the move could be seen as acompromise to strike a deal with the US. Japan’s lost decades was
the period following the burst of the stock and real-estate bubble inthe 1990s, which practically halted the growth momentum of Japan’s
economy. As pressure on the Chinese currency mounted, there wasfear of another potential “Plaza Accord”, which was believed by many
to be a major factor in Japan’s lost decades.
As the time of this writing (April 2020), the new rules have comeinto full effect. This article seeks to explain the latest policies forliberalizing China’s financial sector, in particular regarding capital
markets, and with my limited experience I will argue why I believe a“Plaza Accord 2.0” is a myth, at least given the current policies. Yet
the fact that there are worries and fears, especially learning fromJapan’s lost decades, sparks my interest in comparing the twocountries’ histories of financial sector liberalization and deregulation.
What lessons could China learn from Japan? What is next fordomestic and foreign financial institutions as the sector opens up?
As a student aspiring to work in this field, I am interested in taking aclose look at these questions.

Latest Policies in a Nutshell
The financial sector covers banking, capital markets, asset andwealth management, insurance and other subdivisions. To limit thescope of discussion, this article will focus on capital market
development, namely equity and bond markets, and their supporting
institutions and infrastructures. There are reasons to zoom in on this
topic: capital markets have witnessed the most drastic changes in
the past decades in China. Moreover, “capital market” itself seems
fundamentally paradoxical in a socialist state.
By definition and function, capital markets connect private entities

https://www.jef.or.jp/journal/that need money to those who have spare money to invest. It
channels spare resources in society freely based on market forces,and hence “capital market” has a capitalist nature. However, eversince Deng Xiaoping outlined “Socialism with Chinese
Characteristics” in the 1980s, elements of market economics havebeen legitimized for wealth creation and economic growth. Though
the first stock market after independence was established in
Shanghai in 1990, it had unique features such as Initial Public
Offerings being approved by the central government, highly
controlled foreign capital inflows and domestic outflows, andminimal participation of foreign institutions. Hence, when we look atcurrent policies, we have to see them in a comparative light: as awhole, capital markets are not and possibly never will be fully open
by Western standards, but compared to their initial construct they
have achieved a huge step. Let us look at some of the latest policies
on capital market liberalization.
Out of the 11 policies, four specifically touched upon capital
markets:
1) The timing of lifting restrictions on foreign shares of securities,
fund management and futures companies will be advanced from2021 to 2020.
2) Foreign-funded institutions are allowed to obtain Type A leadunderwriting licenses in the inter-bank bond market.
3) Investment of foreign institutional investors in the inter-bankbond market will be further facilitated.
4) Foreign-funded institutions are allowed to conduct credit
ratings on all types of bonds in the inter-bank bond market and theexchange bond market.
What do these measures entail? There are three parts to it – thebusiness scope of foreign financial institutions as service providers,
their participation in the capital markets as investors, and supporting
infrastructure to make domestic capital markets more robust. First ofall, foreign financial institutions are allowed to take control of theirChinese joint ventures or directly enter the market. Right after thedate the policy became effective on April 1, 2020, Morgan Stanley
and Goldman Sachs both went on to apply for majority control of
their local securities joint ventures, Morgan Stanley Huaxin
Securities and Goldman Sachs Gao Hua Securities (https://www.
ft.com/content/22e8f770-ba64-4c8f-a9f5-a47885d0b7dd). They are

Japan SPOTLIGHT • September / October 2020

55

STUDENT VIEW 1

able to access more products and service provisions in the local
markets and better report their Chinese earnings. Since Chinese
financial services have long been heavily driven by licenses, granting
lead underwriting licenses in the inter-bank bond market allows more
underwriting business for foreign companies. Secondly, foreign
players are encouraged to participate more in the inter-bank bondmarket, bringing in capital and liquidity. The approval of foreign
rating agencies like S&P, Moody’s and Fitch in rating bonds is a
crucial milestone to enhance investor confidence and to show
China’s commitment to improve its bond market.

China’s Rationale
Before we associate rapid financial liberalization and deregulation
with the alarming financial crisis we saw in Japan and Southeast Asia
in the 20th century, it is worth elongating the timeline and analyzing
rationales.

1) Experimental & Gradualist Approach

single step. Moreover, there is no mandatory lock-up period unlike
the QFII scheme.
A parallel development emerged in the bond market. Foreign
investors were initially allowed to invest in domestic bond markets
with QFII and Renminbi Qualified Foreign Institutional Investors
schemes, and later on were provided with more options such as the
China Interbank Bond Market and Bond Connect, which have no
specific quota or lock-up period restrictions. The innovation of Panda
Bonds allowed foreign issuers to tap into domestic investors, which
gradually opened up to a larger pool of international investors
utilizing Bond Connect.
If we consider the capital markets as a pool, crucial factors toenable it to mature include enlarging the pool volume, increasing theamount of flows, and making the flows consistent. For this reason,
allowing more companies to be listed and gradually opening up toforeign investors serve the first two purposes well. In recent years,
as China A-shares have been added to Morgan Stanley CapitalInternational’s emerging market index, and China’s domestic bondmarkets into the Bloomberg Global Aggregate index, the third
purpose of consistent flows is slowly being achieved (Chart 1).

Policies outlined and implemented in 2019-2020 are not a sudden
push, even though they seem a rapid step possibly due to trade war
2) “Liberalization Forces Internal Reforms”
pressure.
China has a track record of “kai fang dao bi gai ge” – which
Starting with the equity market, one of the first notable attempts toliterally means “liberalization forces internal reforms.” Joining thewelcome foreign investors was the launch of the Qualified Foreign
WTO and the subsequent economic boom testify to the strategy. By
Institutional Investor (QFII) program in 2002, as a promise to theWorld Trade Organization (WTO) to open up
capital markets. Through this channel,
CHART 1licensed foreign institutions are allowed toMarket capitalization by stock exchanges(as of May 2019)
invest in onshore stock exchanges, as wellas the bond markets. Initially, the(Trillion $)qualification was much more stringent and25
had a tight quota of only $40 billion. Such
23.21
quota was increased to $80 billion in 201220
and recently was scrapped completely. The
restriction on licensing has been gradually15
relaxed as well, but a certain lock-up period
is still implemented to prevent speculation
11.22
and excessive volatility.
10
Another more innovative channel is Stock
Connect, a mutual market access
5
5.61
5.01
mechanism initially implemented between
4.31
4.27
3.97
3.36
Shanghai and Hong Kong Stock Exchange0(HKEx) in 2014. China’s tight capital control
NYSE,
NASDAQ,Japan
ShanghaiHong Kong
Euronext
LondonShenzhen
US
US
Exchange
Stock
Exchange
EuropeStock
Stockdoes not allow foreign investors to openGroup
Exchange,
Exchange
Exchange,
ChinaGroup,
China
onshore accounts. Linking HKEx with
UK and Italy
China’s onshore stock markets, foreign
Note: By 2019, Chinese stock exchanges, including Shanghai and Shenzhen Stock Exchanges, and Hong Kong
investors, whether institutional or retail, are
Exchanges, are among the largest stock exchanges in the world by market capitalization.
Source: Compiled by the author based on Statista
able to gain access to onshore stocks in a

56 Japan SPOTLIGHT • September / October 2020

STUDENT VIEW 1

the same logic, faster liberalization could transform the domestic
market into a more robust one.
China’s stock market has exhibited price swings, with likely
reasons being thin trading, the investor mindset and investor
composition. For a stock market to be healthy, there needs to be an
appropriate mix of three strategies – value investing, relative
investing and speculation. The Chinese stock market is driven by thelatter group of investors, who focus more on speculating on amarket consensus and for short-term gain. Worse still, theseinvestors are more often retail investors, with the remaining being a
few wealthy insiders who are able to influence the market with theirstrong positions. There is a lack of long-term institutional investors
who can inject large and constant volumes of capital. For this reason,
welcoming foreign investors is a necessary step to change theenvironment.
As for the primary markets and financial service industry,
welcoming foreign institutions is a step to increase the competitivemarket landscape in China. As mentioned, the Chinese financial
service industry has been reliant on licenses in carrying out different
lines of business. Foreign financial institutions that have reputablepricing ability, merger and acquisition experience and other services
were only allowed limited business in China. This might breed asense of complacency for domestic peers, and opening up services
will hopefully create a more dynamic market and benefit more
corporate clients.

3) Aligned with Macro Directions
Apart from rejuvenating the capital market itself, broad
macroeconomic conditions also suggest a need to open up. Firstly,
more investing and financing channels are needed for people andfirms. As the Chinese population grows more affluent with a highsavings rate (36.1% household savings rate in 2016), people
struggle to find means to preserve and grow their wealth, withhousing so far being the main investment opportunity – which rings
a bubble alarm (https://tradingeconomics.com/china/personalsavings). Developing capital markets could help stabilize the housing
market by providing people with a sustainable, long-term investment
channel. Similarly, financing in China has historically been dominatedby indirect financing, where larger commercial banks shouldered themain lending responsibilities. One obvious drawback is the lack offinancing channels and the high level of information required toobtain loans, which for a period bred shadow banking and P2P
lending that twisted the market dynamics.
Secondly, China is undergoing economic transition and carryingout a large-scale deleveraging campaign (at least before Covid-19 hit
the country). Since the post-2008 4 trillion yuan ($586 million)
stimulus package, China has experienced a surge in debt andprompted a policy response to deleverage, especially by cracking

down on risky shadow banking and unlicensed lending practices.
This, however, collides with the transition from a fast-growing
economy to a modestly-growing economy, where ample financing
means are still required to stimulate growth. Therefore, instead of
merely shutting down informal funding channels, formal and moresophisticated channels such as stock, bond and derivatives markets
should be developed to meet the growth needs of the economy.
Especially for the bond market, a slowing economy with a wellmanaged inflation rate could benefit it due to likely lower interest
rates. In fact, foreign investors have shown their appetite whenrushing to find safety nets for their investments amid Covid-19, as
they injected $10.7 billion into Chinese bond markets in February2020 alone using the aforementioned liberalization policies (https://www.ft.com/content/41044876-6ab4-11ea-a3c9-1fe6fedcca75).

Japan’s 1980s Financial Liberalization
People look at history when confused by current events, andJapan’s history leading up to its lost decades alarms many. The valid
reasons for such a comparison include a similar economic
relationship with the US and a set of similar capital market
liberalization policies. This section is a brief reminder.

1) Japan-US in the 1980s
Japan and the US have enjoyed an amicable relationship sinceWorld War II, with Japan’s economy not only recovering but also
flourishing after its war-torn state. Much of it could not have
happened without US economic assistance. However, the late 1970s
was tough for the US, when the sharp increase in oil prices coupledwith soaring inflation and unemployment rates created stagflation.
When its domestic policy of increasing interest rates could not
suffice (instead further depreciating the dollar and widening thecurrent account deficit), the US turned to Japan, its biggest trading
partner, for “help” – which was not framed in a direct call forassistance, but reflected in a series of liberalization policies with theestablishment of the Yen/Dollar Committee. Specifics are detailed
below.

2) Japan’s Liberalization Policies
Academics in Japan tend to view 1984 as a crucial point in its
financial market development. (“Japan’s Experience of Financial
Deregulation Since 1984 in an International Perspective” by Kazuhito
Osugi, BIS Economic Papers No. 26, January 1990). Before 1984,
Japan had taken a gradualist approach to liberalization, with key
events such as OECD membership in 1964, liberalization of direct
and securities investment in the early 1970s and issuance of euroyen bonds by non-residents in 1977. These events happened across
two decades at a measured pace.

Japan SPOTLIGHT • September / October 2020

57

STUDENT VIEW 1

However, measures post-1984 were seen as sudden if not rushed.
Bilateral dialogue between Japan and the US outlined three goals –Japanese capital market liberalization and deregulation,internationalization of the yen, and strengthening of the yen.
For the former two goals, a series of policies were introduced to
drastically lower the barriers to capital flows. For the equity markets,
the Tokyo Stock Exchange’s (TSE) full opening to foreign
membership was one of the most notable events. Thoughpermission was theoretically allowed in 1971, the actual membershipwas minimal due to policy revisions and quotas. In 1985, such limits
were scrapped, and six foreign securities companies wereimmediately listed on the TSE. For the bond markets, internationalbond issues experienced rapid deregulation as requirements forforeign issuers were eased substantially. The derivatives market was
further developed after revision of the Securities and Exchange Act in
1985, as futures began to be traded on the TOPIX and Nikkei 225
index.
The US not only wanted an enlarged market, but also greaterbusiness opportunities for their underwriters, which resembles thecurrent Chinese policies. In 1984, the Ministry of Finance gave theright for foreign underwriters to be lead managers in euro-yen bondunderwriting, and in 1985 foreign banks were allowed to conduct
securities business.
The immediate effects of financial market liberalization were thefluid flows of foreign capital in and out of Japan. Unlike FDI
investments that are more long-term and support the real economy,
securities investment flows tend to be “hot money” that is driven byshort-term capital gains. Risks are more imminent with the easing of
capital controls (Photo).

Photo: Japanese book “The Outlook for the Capital Tokyo” (Seiji-Shimbun Sha, c. 1960)

3) Plaza Accord & Bursting of the Bubble
However, liberalization and deregulation at best lowered the barrierof hot money entry. What explained the motivation behind such entry
and the actual build-up of the stock and real-estate bubbles wasmore a combination of Japanese consumer sentiment, the effects of
the Plaza Accord, and an expansionary monetary policy. For the US,
the most important goal was to strengthen the yen and correct its
trade imbalance. In the late 1970s, the dollar-yen exchange rate wasaround 300 yen and after the Plaza Accord the yen strengthened
sharply to 130 yen to the dollar in 1987 (https://www.macrotrends.
net/2550/dollar-yen-exchange-rate-historical-chart). Such currency
appreciation not only created an illusion for the already affluent
Japanese consumers to pour investments into stock and real-estatemarkets, but also attracted foreign capital inflows from those who
were equally eager to bet on a bull market. Coupled withexpansionary monetary policies, the basic discount rate dropped
seven times from 6.25% in 1981 to a historical low of 2.5% in 1987
(https://www.boj.or.jp/en/statistics/boj/other/discount/index.htm/),and the consensus among individuals and businesses alike was toborrow more and invest more. From 1980 to 1989, the Nikkei 225
grew exponentially from 6,000 to 38,000, creating a stock miracle.
Japan’s Real Residential Property Price Index also increased from
120 to 170 during this decade (https://www.ceicdata.com/en/
indicator/japan/real-residential-property-price-index).
Even so, the lost decades cannot be entirely attributed to astrengthening yen, but more to a policy response to the bubble.
Instead of slowly deflating the balloon, the Yasushi Mieno monetary
policy chose to burst the bubble by drastically levering up theinterest rate engine. From 1987 to 1990, a mere span of three years,
the basic discount rate was increased five times from 2.5% to 6%,
putting a sudden halt to the borrowing momentum. The stock market
and real-estate market collapsed accordingly, leaving many out ofwork yet burdened with life-time mortgages (Chart 2).

Comparison
Though similar in many ways, I believe the policies taken by China
and Japan are fundamentally different on two levels – rationale andextent.

1) Difference in Rationale

Tokyo Stock Exchange’s original building in 1960

58 Japan SPOTLIGHT • September / October 2020

As discussed, China is undergoing a transition wheremacroeconomic conditions propel the need to open up its capital
market. Slowing economic growth, the transition from an exportdriven to a consumption-led economy, and lingering debt problems
require a more robust capital market to support these changes.
While a capital market is indeed a ground for negotiation amid tradetensions with the US, many of the policies were originally scheduled

STUDENT VIEW 1

CHART 2

Japan’s Basic Discount Rate from 1980 to 1990
10
9
8
7

9
8.25
7.25
6.25

6

5.5

5
4
3

6
5

4.5

5.25
4

3.5

4.25
3

3.25

3.75

2.5

2
1
0

1980. 1980. 1980. 1981. 1981. 1983. 1986. 1986. 1986. 1986. 1987. 1989. 1989. 1989. 1990. 1990.
03.19 08.20 11.06 03.18 12.11 10.22 01.30 03.10 04.21 11.01 02.23 05.31 10.11 12.25 03.20 08.30

Note: Rates here are Discount Rate of Commercial Bills and Interest Rates on Loans Secured by Government Bonds,
Specially Designated Securities and Bills Corresponding to Commercial Bills (abolished on Jan. 4, 2001).

Source: Compiled by the author based on the Basic Discount Rates and Basic Loan Rates, Bank of Japanfor 2021 and only brought forward to 2020.
Regardless of the broader environment, developing top-tierfinancial centers is always a mid- to long-term goal for the central
government, and we could not achieve it without a mature capital
market. Current policies also fit under the two pillars of “reform” and“open up”, which have shaped China’s post-1978 economic history.
Gradual opening up is necessary to force domestic participants toreform and auto-correct themselves, whether it be in their investing
mindset or business competitiveness.
Japan’s liberalization policies came at a time of already highly
fluid, mature capital markets and without many macroeconomic
concerns. Its rapid liberalization and deregulation to a very large
extent was US-driven. Hence, China’s policies could be considered aspressure from within, whereas Japan’s were more of pressure fromoutside.

2) Difference in Extent
Another major difference lies in the extent of liberalization,
especially regarding the scale, the pace, and the bottom line ofdomestic policies. In 2019, before this policy round, even though byabsolute number China’s A-share market was a substantial $8 trillion
by market capitalization, foreign ownership was only 2.7% (http://
docfinder.bnpparibas-am.com/api/files/E22A3C33-1691-455D-AFD17407D1BACBAE). China’s capital market was barely open in the firstplace and hence had room to be opened up. The policies, as
discussed were rolled out over a long time span as compared to thesudden push of policies in Japan in the
1980s.
Most importantly, China remains
committed to its bottom line of capital
control, which in extreme conditions could
prevent massive capital flights and impact
on the Chinese currency. In fact, one of themost common arguments for not worrying
too much about liberalization is that foreign
capital that flows in would not flow out aseasily as might be wished, as tightrestrictions are still in place. At least for thetime being, China shows no sign ofcompromising on its currency or engaging
in a policy as extreme as the Plaza Accord.
Even so, the Plaza Accord was not thedirect cause of the lost decades,
considering the later monetary policies.

Conclusion: Measured
Optimism

Much of the discussion has the benefit of hindsight – if we wereJapanese in the 1980s we most likely would not have foreseen acrisis coming. However, if history is of any value, it teaches us how
to act today to the best of our abilities. There are objective
observations: China today has valid reasons from within to open up
its capital markets, it is doing so at a measured pace, and it is notcompromising its bottom line. This at least provides a dose of
optimism, but it should be a measured one. Such observations canonly be proved to be facts in hindsight, and an overly optimistic
outlook in itself influences investor mentality and could makeproblems worse than they seem. Only measured optimism allows
investors and policy makers alike to constantly monitor situations
and make rational decisions accordingly.
On the other hand, though foreign players are invited to a lucrative
game, they have little control over the rules of the game and are puton the same level playing field as their peers. Ultimately, capital
markets work by the golden doctrine of risk and reward.
Liberalization brings down competition barriers and creates more
rewards, but who reaps them most will depend on the player’s ability
and risk appetite.

Ziyue Li is an undergraduate student in the ESSEC-Keio Double Degree
program, and has a strong interest in international business and finance. She
has lived and studied in China, Singapore, France and Japan.

Japan SPOTLIGHT • September / October 202059