Seven months after its launch, the Shanghai Pilot Free Trade Zone is still creating a lot of buzz among world business leaders.

The zone, an experiment with financial reform, has rolled out unprecedented measures such as the free convertibility of the yuan inside the zone.

In the past, since the yuan was not freely convertible, currency flows in and out of the country were restricted.

“One of the greatest benefits of the zone is the convertibility of the currency for investing purposes, and it also facilitates cross-border trade and investment,” said Nancy McKinstry, CEO of Wolters Kluwer, a Dutch information services and publishing company, in an interview with Shanghai Daily. “People used to ask the question, can we get the money in and out? Now it’s an old consideration.”

However, with freer flow of capital also comes the increased risk of arbitrage.

Unfettered exchange of the yuan inside the FTZ might attract hot money, with speculators making arbitrage on the differences of exchange rates, said Michael Thomas, Regional Director North Asia at Wolters Kluwer Financial Service. “Keeping the cap on deposit rates is one way that limits the potential for exposure, and this is one of the reasons why the deposit rate is still being controlled inside the FTZ,” said Thomas.

But at some point, he said, the state will have to release that mechanism, but likely in a gradual progression. “Currently the rate is 10 percent. I think it will increase to 20 percent or 30 percent before authorities actually open it completely. It’s too much of a risk to do it overnight,” he told Shanghai Daily.

Money-laundering and other forms of financial fraud, such as tax evasion, also are among the risks of freer capital inflows and outflows. The fear is real but not unique to China. Any free trade zone will attract criminal activity. To promote trade, there are tax benefits to trading through the zone, said Thomas. “There is room for criminal elements to exploit the loophole and claim tax breaks by claiming that trade is going through the zone when it isn’t actually,” he said.

And the profits made through illegal means can also be “laundered” to hide their origin and become “clean” after being moved quickly out of the FTZ.

Heightened risks

The heightened risks for these crimes mean that Chinese financial regulators are confronted with a tougher job.

Since financial innovation is growing exponentially, especially in the e-commerce or Internet banking sector, the regulators are grappling with the task to gather transaction information. However, “they themselves have some doubts about the accuracy of information they get,” said Thomas.