Interest rate liberalisation, seen as the next step in China’s financial reforms, is imminent, according to a white paper by J.P. Morgan Asset Management. The white paper was published in 2014 but has been updated in June 2015 to reflect recent developments. The group's analysis stated that this “fundamental change in how Chinese financial institutions price interest rates and manage risk will have significant implications for investors”.

Financial sector reform is considered a must for China's long-term economic strategy, which aims to effect a shift from a “centrally-planned, government-controlled economy to a unique Chinese hybrid best described as a socialist market system”.

The proposed liberalisation includes:

• the introduction of a deposit guarantee scheme;
• a legal framework by the government to remove the implicit guarantee of all financial institutions, allowing failing banks to default;
• liberalisation of deposit rates; and
• removal of PBoC capital allocation controls.

The white paper stated that such reforms should ensure more accurate, market-driven interest rates, a broader range of financial products and more competition. However, it added: “But they will also create greater uncertainty, risk and instability. More rigorous risk and credit analysis is critical for institutional investors to confidently invest in this new regime.”

The June 2015 update to the white paper stated that the Chinese government is fostering a greater awareness of credit risk through its scheme, introduced in May 2015, to transform implicit state guarantees for banks into an explicit guarantee on deposits only, as well as a measure to reduce inefficient borrowing and remove the implicit central government guarantee of municipal and local government financing vehicles. The State Council has also clarified the mandates of the three policy banks, reducing their commercial role while confirming their policy mandate.

Reforms have also been made to China's money market funds. In May 2015 the China Securities Regulatory Commission (CSRC) published its new guidelines for MMFs, seen as the most significant changes to the sector since it was introduced in 2004.

The updated white paper, intended for institutional investors, can be viewed here.