UK banking deal with China could give Chinese banks advantages over European competitors, says expert

Banking specialist Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said that George Osborne appeared to be "breaking down the regulatory barriers" for Chinese banks at the same time as UK and European regulators were "busily erecting them".

Osborne, who is currently on a trade visit to China, has announced that London is to become the first place outside of greater China which will be able to grant licences allowing direct investment in Renminbi (RMB) denominated shares and bonds. A pilot scheme will allow London to grant RMB Qualified Foreign Institutional Investor (RQFII) licences worth up to 80 billion RMB, or £8.2bn.

Chinese banks will also be able to apply to the UK's Prudential Regulation Authority (PRA) for permission to establish wholesale branches in the UK under the terms of the agreement, which came following two days of talks between Osborne and his Chinese counterpart, Vice Premier Ma Kai. The five largest Chinese banks already have a presence in London, but most of these have had to establish UK subsidiaries in order to do so.

"A great nation like China should have a great global currency," Osborne said. "Today we agreed the next big step in making London – already the global centre for finance – a major global centre for trading and now investing the Chinese currency too. More trade and more investment means more business and more jobs for Britain."

The agreement forms part of the fifth UK-Chinese Economic and Financial Dialogue, which last took place in 2011 and led to an agreement between the UK and China to support London as an offshore RMB hub. London has traditionally been at the centre of western RMB trading due to the UK's relationship with Hong Kong, and currently accounts for 62% of all global RMB trading conducted outside of China and Hong Kong.

Under the terms of the most recent agreement, investors will be able to apply for a RQFII status which will enable them to invest RMB directly into China from London. The UK is already the second largest European investor in China; but as its banks do not have trading authorisation any RMB-denominated transactions have to be routed back into China via counterparties into Hong Kong. This can result in higher costs for investors.

Osborne will also begin negotiations with the PRA aimed at allowing Chinese banks to increase their business activities in the UK by letting them carry out wholesale banking activities through branches in London. Currently, Chinese banks in London generally operate as subsidiaries and are subject to the same regulatory requirements as local banks. Those banks wishing to offer consumer services will still need to establish subsidiaries.

Banking expert Tony Anderson said that permitting Chinese banks to operate as branches, rather than as subsidiaries, would mean "lighter capital and liquidity requirements imposed upon them" than under the previous system.

"How confident can we be in the effectiveness of Chinese regulatory supervision over Chinese banks operating in the UK, and what concerns will this create for UK customers of such banks?" he said.

"It will also be interesting to see whether Chinese banks will be asked to become direct members of UK payment systems, as we are seeing currently with other international banks," he said.