China Reining in Illegal Forex Trade — A 100 billion dollar market?
China Reining in Illegal Forex Trade Again
On February 9th, China’s Supreme People’s Court (SPC) and Supreme People’s Procuratorate (SPP) have stepped up efforts to clamp down on illegal foreign exchange (forex) trade by clarifying tougher restrictions and announcing stricter punishments, according to Xinhua News Agency.
People’s Republic of China Foreign Exchange Regulations issued in 1995 and edited in 2008 states that violation of the regulation faces a fine no more than 30% of the involved amount, a severe violation faces a fine over 30% of the involved amount, and any act deemed by explicit stipulations of law as a crime is to be convicted.
The recent explanation on Feb 9th clarified that any illegal forex trade involving more than 5 million yuan ($741,600) or yielding profits of more than 100,000 yuan should be classified as a severe violation, according to a new regulation of the SPC and SPP that took effect on February 1.
According to the new explanation, such crimes could mean a fine equal to one to five times the illegal income and in addition a sentence of imprisonment of not more than five years. Cases involving particularly severe violations could mean a jail term of more than five years, with a fine between one time and five times the illegal income or confiscation of property, according to China’s Criminal Law.
Both tougher clarification and stricter punishment show the determination to prevent further capital outflow. Why? Because the outflow capital was too big a volume to ignore.
A 100 billion USD outflow in 2016
According to the case report by China’s State Administration of Foreign Exchange(SAFE), there were about 130 cases of illegal Forex trade reported during 2018. And Interestingly, among the 33 cases of individual illegal forex trade, 8 cases were explicitly used to purchases property overseas.
According to Xinhua News Agency, public security crackdown more than 380 underground banks cases that involved more than 900 billion yuan in 2016. Underground banks have been used for cross border money transfer and it has become a channel for corrupted officials to move embezzlement overseas. Xinhua News Agency also mentioned that foreign trade and housing industries were mostly involved.
How did they do that
According to SPC and SPP, buying and selling foreign currencies means that offenders buying low and selling high in the domestic foreign exchange black market, and earning exchange rate differences. This type of underground banks is often referred to as forex scalp traders.
There is more disguised illegal forex trade, where underground banks collude with overseas personnel, institutions, or use bank accounts opened abroad to assist others in cross-border remittances. The funds are unidirectionally circulated inside and outside the country, and there is no physical outflow. At present, the main business of most underground banks is cross-border payment, which leads to huge capital outflows and is a key target of the crackdown.
This is not the first time China tightens up such regulations. PBoC had edited the Measures for the management of large-value transactions and suspicious transaction reports of financial institutions by lowering the amount from 200,000 Yuan to 50,000 Yuan on December 30, 2016. The regulation took effect in July 2017. Since then any deposit or withdraw of Yuan or foreign currency equivalent to over 50,000 RMB will be monitored and reported to the PBoC.
Impact on the global real estate industry
As mentioned earlier in this article, an outstanding usage of the outflow capital was buying properties outside China. In addition to the crackdown on illegal cross-border remittance, the Chinese government has also restricted enterprises’ outbound direct investment. Both aims to combat capital outflow and the pressure for inflation of Chinese Yuan. It all boils down to the only game in town, the currency war.
According to Real Capital Analytics, the top 4 outbound commercial real estate investment for China in 2016 was the US, HK, Australia, and the UK. China (excluding Hong Kong) was the largest overseas investor in commercial real estate in the United States in 2016. It was still the second largest overseas investor in 2017, accounting for 25% of the market. The main investment was office buildings and hotel real estate in major cities. New York, San Francisco, Chicago, and Los Angeles accounted for nearly 80% of China’s total overseas investment in 2017. The government’s restriction, among other factors, are causing the shrinking of the real estate industry in said cities.
On the other hand, the capital that stays within China will try to find new investment target, A-Share market, VC investment or real estate. With the first two going bearish, domestic real estate investment might be the only choice in the short term.
The Only Game in Town
Both the crackdown on illegal forex trade and the restriction on outbound direct investment resulted from one thing, the Chinese government’s determination to combat capital outflow and the pressure for inflation of Chinese Yuan.
During the recent slow down of economic growth globally, consumption, investment are both slowing down and no longer serves as a strong growth engine for many countries. Currency might be used as a quick solution for some of them to steal growth from others. A currency war is on the verge. And if not well prepared, the result is devastating.
Venezuela is a good example. And they are trying new ways to escape the devastating result of the currency war.
Venezuela’s President Maduro has said the nation will sidestep the U.S. dollar and phase in use of its controversial petro token for oil sales starting next year. *
What does it entail?
Currency is the backbone of a sovereign country. China has all the reason to rein in the crackdown. The sudden drop of illegal forex trade from 900 billion Yuan in 2016 to 100 Yuan in 2018, what does it entail? Did the Chinese government succeed at preventing further outflow or did the offenders find a new alternative to evade tracking? It is a 100 billion dollar market after all. Then what will the government do to crack down on the new alternative?
