MIXED RESULTS FOR TAIWAN FSC'S FIRST YEAR

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 003117 SIPDIS DEPT PASS TO AIT/W AND USTR DEPT FOR EAP/TC, EAP/EP AND EB/IFD/OIA TREASURY FOR OASIA ZELIKOW,WISNER AND OCC AMCMAHON TREASURY ALSO PASS TO FEDERAL RESERVE BOARD OF GOVERNORS, SAN FRANCISO FRB AND NEW YORK FRB E.O. 12958: DECL: 07/08/2020 TAGS: ECON EFIN PINR PREL TW SUBJECT: MIXED RESULTS FOR TAIWAN FSC'S FIRST YEAR REF: A. TAIPEI 2984 ¶B. 04 TAIPEI 04050 Classified By: AIT DIRECTOR DOUGLAS PAAL, REASON 1.5 B/D ¶1. (C) Summary: The first anniversary of the establishment of Taiwan's Financial Supervisory Commission (FSC) in July coincided with the removal of Lee Chin-chen as head of its investigative unit because of his suspected involvement in an insider trading scheme (ref a). During a lunch with AIT on July 20, 2005, FSC officials accentuated the Commission's positive accomplishments in successful investigations, internationalization, and consumer protection. They downplayed the irony noted by some U.S. business people that recent allegations of insider trading by FSC officials has increased rather than reduced doubts about the transparency of Taiwan's financial sector. End summary. ¶2. (SBU) In July 2004, Taiwan consolidated regulatory authority over banking, insurance, and securities under the FSC in order to increase confidence in the local finance sector through more vigorous investigation of economic crimes. Taiwan authorities reasoned that audits and examinations conducted by a single regulator with authority over the entire range of banking, insurance and securities products offered by financial holding corporations (FHCs) would provide more efficient and thorough supervision (ref b). No Disappointments with FSC,s First Year -------------- ¶3. (C) Director General for International Affairs Andrea Lee told AIT on July 20, 2005 that he had no major dissatisfaction with how the FSC had performed during its first year. He listed several significant FSC accomplishments in recent months including the rapid and thorough investigation of several major white collar crime cases. A second major FSC accomplishment during the first year has been promoting international awareness of Taiwan markets. Direct portfolio investment increased by over US$ 20 billion from 2004 to 2005. The FSC has established a representative office in New York (and will soon have one in London) to improve its supervision of Taiwan financial institutions' overseas branches and provide direct communications with the headquarters of foreign financial institutions in Taiwan. A third significant FSC accomplishment has been the greatly improved consumer protection created by new disclosure and truth-in-advertising regulations for financial institutions. Another FSC official echoed the positive assessment and noted the improved efficiency and communications between banking, securities, and insurance regulators now that they were part of one agency. Swift and Strict Justice -------------- ¶4. (C) DG Lee said the FSC has been more transparent and quicker in disciplinary actions than its predecessors. It publishes planned measures, draft laws, and regulations for comment in advance. It also publishes its actions. For example, in the second half of 2004, the FSC suspended several CPAs, certifying authority for their failure to identify problems in a listed company's financial statements linked to a NT$6.3 billion embezzlement scandal. In the past, no Taiwan CPAs has ever been penalized. In the first half of 2005, following a quick investigation, the FSC penalized the chairman of a financial holding company (International Bills) for his company's involvement in money laundering. The FSC also penalized another financial holding company (SinoPac) because its chairman concurrently served as chairman of numerous SinoPac's subsidiaries. A penalty of NT$2 million was given a bank for setting up offices without prior permits. A credit card company was fined NT$1 million for selling customers, credit information to other financial firms. ¶5. (C) Lee continued describing FSC efforts to make listed companies more transparent. The FSC began in Q1 of 2005 to require listed companies to publish their investment in China. In addition to quarterly, semiannual, and annual financial reports, listed companies are also now required to project their future performance. The FSC has published and posted on the internet such key financial data as the non-performing loans (NPL) ratios, bad debt reserves, capital adequacy ratios, and rates of return for all Taiwan banks, credit coops, and trust companies. Deregulation, International Standards -------------- ¶6. (C) The FSC, according to Lee, has spared no effort to deregulate and meet international standards. In January 2005, it adopted a &negative list8 system under which financial institutions are no longer required to obtain prior permission before offering new financial products. Foreign portfolio investors are no longer required to obtain prior permission for investment in Taiwan. In response to foreign portfolio investors, complaints about listed companies distributing profits to employees, the FSC began in the second half of 2004 to set restrictions on such profit sharing. The FSC plans to relax the daily stock price fluctuation limits from 7% above or below the closing price of the previous day to 15%. The FSC has promoted implementation of the new Basel Agreement by Taiwan's banking community. The FSC has translated and published the new Basel Agreement in Chinese. Banks are required to meet the new requirements in July 2005. International definitions of NPLs are now used in Taiwan. Lee said that as a result of the FSC,s several carrot and stick measures, NPLs were reduced by 22% to NT$577.8 billion in May 2005 from NT$740.5 billion at end of June 2004. During the period, the average NPL ratio dropped from 4.9% to 3.6%. The capital adequacy ratio in December 2004 rose to a four-year high of 10.7%. Damage from Insider Trading Scandal -------------- ¶7. (C) However, Tim Yang (Wei-wen) senior counsel for PriceWaterhouseCoopers in Taiwan told AIT there could be widespread damage to Taiwan's entire financial sector if media coverage of the Power Quotient International (PQI) insider trading scandal leaves the impression of official corruption or of rigged trading on Taiwan's stock exchange. The impact on Taiwan's ability to attract and hold foreign direct portfolio investment and attract foreign investors to state-owned companies could be significant. Yang also noted that the FSC,s loss of authority over state-owned financial institutions to the Ministry of Finance (MOF) had lessened the FSC,s influence on financial reform. ¶8. (C) Yang thought the most significant change brought about by the establishment of the FSC was consolidation of auditing and inspection authority from various regulatory agencies in the past to an &Examination Bureau8 (EB). Until the allegations of EB DG Lee Chin-chen's involvement in the PQI insider trading scandal became public, it was widely believed that the FSC had succeeding in being more transparent and effective than its predecessors, Yang said. That conclusion now seemed suspect. Organization -------------- ¶9. (SBU) The establishment of the FSC upgraded Taiwan's financial regulatory authority to ministerial level. The FSC chairman is a cabinet member devoted to financial regulatory duties. Prior to July 2004, financial regulation was handled by bureau directors reporting to the Minister of Finance, who had duties covering financial regulation as well as taxation, national properties and fiscal resources. Under the FSC, auditing and examination authority were concentrated in the EB. The Bureau of Monetary Affairs (BOMA),Insurance Bureau (IB),and Securities and Futures Bureau (SFB),all now part of the FSC, no longer audit or inspect financial institutions and have transferred their auditors and examiners to the EB. The Central Deposit Insurance Corporation also ceased inspecting deposit-taking institutes, and all of its inspectors moved to the EB. The Central Bank of China keeps some examiners for inspections related to monetary policy and foreign exchange issues, while the rest were reassigned to the EB. A new office known as Division 6 was set up within BOMA specifically to supervise FHCs. Ostensibly Independent Commissioners -------------- ¶10. (C) The FSC Commission is composed of nine members, all of whom were academics or business executives prior to their appointments. Lin Chung-cheng is the only commissioner who was active in the ruling Democratic Progressive Party (DPP) before his appointment. FSC Chairman Kong Jaw-sheng is not officially a DPP member although he was known as a DPP supporter prior to his appointment as FSC Chairman. Vice Chairman Lu Daung-yen used to be SFEC Chairman. Vice Chairperson Susan Chang was BOMA Director before she was promoted to Director of the MOF Treasury Department and subsequently as Vice Finance Minister. The remaining five FSC commissioners have strong professional backgrounds. Lee Shyan-yuan was a professor teaching courses in bonds and bond markets at National Taiwan University (NTU). Wu Chung-fern was teaching at the Fisher School of Accounting in the United States before she returned to teach at NTU. Chin Wen-yueh used to be a merger and acquisitions lawyer practicing law in New York State before she returned to join a local law firm. Ling Kuen-bao had been President of the Taiwan Life Insurance Company and Huang Hsien-hwa had been CEO of Barits Securities Company, a large underwriting firm. Independence Challenged by Executive Branch -------------- ¶11. (C) The independence of the FSC has been undermined in several ways: The FSC has to report to the Executive Yuan (EY),and Chairman Kong Jaw-sheng attends all regular cabinet meetings. A few months after the inauguration of the FSC, the EY reassigned overall oversight responsibility for state-owned financial institutions from the FSC to the MOF. (The FSC still has regulatory responsibility, but now lacks the authority to order these state-owned financial institutions to accept merger or privatization offers.) The EY is currently weighing whether the FSC should have any policy-making authority. On some occasions, the FSC has compromised its independence to go along with executive branch policy. In March 2005, the EY adopted a set of economic stimulus measures, including a promise to provide loans of NT$100 billion to small and medium enterprises (SME). To facilitate this, the FSC offered banks achieving better SME lending performance a waiver of its ban on setting up new branches. ¶12. (C) In October 2004, President Chen Shui-bian announced second-stage financial reform goals including reduction by half of the number state-owned banks prior to the end of 2005 and reduction by half of the number of all (both state-owned and private) FHCs prior to the end of 2006. However, the loss of authority over state-owned financial institutions (the government has significant stakes in six of Taiwan's 14 FHCs) has compromised the FSC,s capability to promote financial consolidation. ...as Well as by Legislative Branch -------------- ¶13. (C) The FSC is also supervised by Taiwan's Legislative Yuan (LY). FSC Chairman Kong and his senior staff report regularly to relevant committees and to the floor of the LY. The LY has repeatedly cut funding for the FSC, undermining its capabilities. The LY has provided barely 10 percent of funding requested to extend the life of the Financial Reconstruction Fund (FRF),a mechanism similar to the RTC of the United States, well short of funding needed to resolve existing problems at financial institutions. Confrontation with MOJ -------------- ¶14. (C) The PQI insider trading scandal generated a mud-slinging match between the EB and the Ministry of Justice MOJ) with each side publicly accusing the other of corruption, and mutual refusal to cooperate in the investigation (ref a). At a meeting with AIT on July 21, 2005, MOJ Prosecutorial Affairs Director Tsai Ching-hsiang downplayed the conflict, saying it was the direct result of evidence of EB involvement in the PQI scandal. He said that the MOJ and EB had worked together in investigating other economic crime cases, and the MOJ's refusal to work with it on this case was not part of an attempt to diminish the EB's authority to investigate. ¶15. (C) FSC Chairman Kong told AIT Director recently that he was confident that the FSC and its EB had weathered the controversy over their authority with their credibility largely intact. Kong said he learned valuable lessons as a novice dealing with Taiwan's media, including the need to be seen to act quickly when allegations arise. ¶16. (C) Comment: Even if EB DG Lee is proved innocent and full cooperation between the two agencies restored, it is still unclear whether the FSC has in fact put the PQI scandal behind it or whether MOJ leaks to the press have damaged the EB's credibility and capability to perform its duties. While the FSC has accomplished a great deal in its first year, it may take some time to overcome this latest blow and restore confidence in Taiwan's financial sector. A five member team of U.S. Federal Reserve System officials will be in Taiwan July 24-29 to conduct an assessment of the regulatory environment. While their visit has no connection with the PQI scandal, but rather is due diligence prior to approving expanded operations by Taiwan financial companies in the United States, their evaluation of the situation should be instructive. End comment. PAAL