The Weinstein Company is backing the production, which has been in pre-production in China since last September and was scheduled to start shooting next month. It's the biggest project so far to be backed by TWC's Asian Film Fund.
'This obviously comes as a shock to all of us. We don't know exactly why we have been turned down,' Hafstrom told the Dagens Nyheter daily on Saturday.
Mike Medavoy and Barry Mendel are producing the long-gestating project, which originally had John Madden attached to direct. Ken Watanabe and possibly Chow Yun-fat are also set to star.
Hafstrom said he did not expect Chinese authorities to reverse their decision and said he was planning to move the shoot to Hong Kong.
It's understood that the film is one of many projects either put on hold or forced to re-locate as China's Film Bureau puts the brakes on shooting permissions for foreign productions.
Controversy surrounding the release of Chinese films Lust, Caution and Lost In Beijing, along with increased caution in the run-up to the Beijing Olympics, are being blamed for the clampdown.
Although sex scenes from both films were cut from the mainland release, they were widely circulated on the internet, causing alarm among high-ups in the Communist Party.
The government is also keen to avoid any films that might portray China in a negative light in the year that the country is hosting the Olympic Games.
Shanghai is set in 1940s Shanghai and it is thought to include scenes of opium smoking and prostitution.