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

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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