Race for the yuan

During his October visit to China, UK Chancellor George Osborne pledged to open the doors to inward investors, especially to Chinese banks that seek to open branches in London. The City sees itself as China's financial beachhead in Europe.

As reflected by China's nascent financial deregulation, Shanghai's free trade zone and the central government's impending reforms, Beijing seeks to build a more advanced financial system.

Resting on a fully convertible yuan, China needs a more advanced financial sector to support sustainable growth and a rudimentary social model for Chinese people. As the UK has offered to treat Chinese banks operating in Britain as branches, which are subject to Chinese regulation, rather than subsidiaries, which are subject to British regulation, both Chinese banks and UK economy can potentially reap great benefits.

However, critics argue that British policy-makers may be more eager to encourage Chinese banks' risk-taking, when it benefits the financial markets, than to protect Chinese financial flows, which should benefit Chinese savers.

Last week, the Bank of England and the People's Bank of China reached an agreement to allow the clearing and settlement of yuan trades in London, which UK Prime Minister David Cameron would like to see as the leading Western hub for Chinese trading.

But only days after, Germany's Bundesbank and the PBoC agreed to cooperate in the clearing and settling of payments in yuan. This will allow Frankfurt to corner a share of the offshore market.

Right track, challenging terrain

In Beijing, the sense is that if the EU wants to take bilateral relations to the next level, the FTA would dramatically deepen ties between two of the world's largest markets.

While Europe continues to suffer from low growth and stagnation, it is moving toward a fragile recovery. While China is no longer enjoying double-digit growth, the new leadership has initiated the most massive reforms in China since the Deng era.

An extensive trade pact would certainly increase the interdependence of the two blocs and potentially reduce the risk of new trade disputes.

The Sino-EU investment talks are not a sprint, but a marathon. They are moving towards the right track, but facing challenging terrain.

The author is research director of international business at India China and America Institute (USA) and visiting fellow at Shanghai Institutes for International Studies (China) and EU Center (Singapore). For more, see http://www.differencegroup.net

This article was first published at the EUobserver. To see the original version please visit http://euobserver.com/opinion/123683