Foreign Investors Lining Up to Invest In China

UNCLAS SECTION 01 OF 03 BEIJING 008474

SIPDIS

SENSITIVE
SIPDIS

USDOC FOR DAS LEVINE AND ITA/MAC/AP/MCQUEEN
TREASURY FOR OASIA/ISA KOEPKE AND DOHNER
STATE PASS CEA FOR BLOCK
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN; NEW YORK FRB FOR DAGES/CLARK
STATE PASS USTR STRATFORD/WINTER/MCCARTIN

E.O. 12958: N/A
TAGS: EFIN EINV PGOV CH
SUBJECT: Foreign Investors Lining Up to Invest In China
Banks; Two More Preparing for Hong Kong IPOs


BEIJING 00008474 001.2 OF 003


THIS MESSAGE IS SENSITIVE BUT UNCLASSIFIED. PLEASE HANDLE
ACCORDINGLY. NOT FOR DISTRIBUTION OUTSIDE USG CHANNELS.


1. (SBU) Summary: In a meeting on April 18, Xie Ping, CEO
of China SAFE Investments (aka ?Huijin?),told a group of
New York Federal Reserve Bank analysts that he is seeing
more and more international interest in investing in
Chinese banks. The successful Hong Kong listings of Bank
of Communications (BoCom) and China Construction Bank (CCB)
in 2005 have set the stage for the listings of the Bank of
China (BOC) in late May/early June and the Industrial and
Commercial Bank of China (ICBC) at the end of 2006. Xie
pointed out that strategic investors bring important
credibility to the listing, noting that Bank of America?s
investment in CCB was critical for the IPO?s success. Xie
suggested Citigroup?s interest in the Guangdong Development
Bank is because of its failure to conclude a deal with CCB.
Although three of the four big banks have been
restructured, governance remains a major concern. The
fourth bank, the Agricultural Bank of China (ABC) will be a
bigger challenge and require a much larger
recapitalization. Xie also cited rural finance and the
securities sector as key areas of concern. End summary.

International Investor Interest
--------------


2. (SBU) On April 18, a group of New York FRB analysts met
with Xie to hear his views on the state of China?s banking
sector. Xie said that since the spectacular success of the
CCB listing (in Hong Kong),more and more international
investors have come to China seeking to buy into Chinese
banks. Over 50 foreign banks have either concluded
investment deals or are currently in negotiations. Xie
confirmed reports that BOC will list by late May/early June
and ICBC before the end of 2006. However, before these two
banks list, there is still a great deal of work to do. The
auditors are checking everything on the financial
statements to make sure they meet the international
standard.


3. (SBU) Xie said the strategic investors in the state-
owned commercial banks (SCBs) have been critical to the
success of the listings. So far, two of the large SCBs
with strategic investors have listed in Hong Kong: BoCom,
of which HSBC owns 19.9 percent, and CCB, of which Bank of
America owns 10 percent. He noted that there is still much
opposition to allowing foreign investors to invest in
Chinese banks. However, he argued, without the BofA
investment, the CCB IPO would never have been so
successful. Those who complain about selling stakes in
Chinese banks too cheaply forget just how much money the
Government made with CCB?s IPO. With CCB?s 2005 annual
report, Xie argued that CCB?s level of disclosure is
already approaching the international standard. Although
there are 220,000 investors in CCB, most of them are
foreign mutual funds.

Technical Assistance from Strategic Investors
--------------


4. (SBU) Strategic investors contribute more than just
money, Xie stressed. Each of the strategic investors in
CCB, BOC and ICBC (respectively, Bank of America and groups
led by Royal Bank of Scotland and Goldman Sachs) paid
around US$3 billion, but also pledged to provide technical
assistance. Xie said CCB currently has around 50 advisers
from BofA working fulltime on technical assistance
projects. He said the focus of the BofA advisers is on
risk management, information technology and credit cards.

Citigroup?s Last Chance
--------------


5. (SBU) Xie said he views Citigroup?s current bid for the
Guangdong Development Bank (GDB) as an effort to recover
from its failed bid to become a strategic investor in CCB.
When Citigroup was still negotiating with CCB, Xie said it
had nine branches and a longstanding interest in the
Shanghai Pudong Development Bank. Consequently, after
making an investment in CCB, it would also become a CCB
competitor. Because of this, the deal broke down at the

BEIJING 00008474 002 OF 003


last minute. Xie said that BofA then appeared as an
alternative suitor, and CCB was able to seal a deal.
Unlike Citigroup, BofA agreed to close down the retail
banking operations at its three China branches. Because
the Royal Bank of Scotland does not have a presence in
China, this was not an issue for its investment. Xie said
Citigroup has regretted losing out on the CCB deal ever
since and saw GDB, a ?very bad bank,? as a last opportunity
to get into the market.


6. (SBU) As for the lifting of foreign investment caps in
Chinese banks, Xie noted that China Banking Regulatory
Commission Vice Chairman Tang Shuangning had recently made
a public statement on the subject. In his statement, Tang
suggested that it was not imperative that the Government
have majority ownership of more than the five largest
state-owned banks. Xie said he thought that sounded
correct. In his view, majority ownership is 51 percent.

Governance the Problem
--------------


7. (SBU) Xie said the biggest challenge for Chinese banks
is corporate governance. Although the Communist Party has
power over key personnel decisions, board directors are now
more powerful than ever and can almost rivl the power of
the party. In the case of CCB Chairman Guo Shuqing, he is
also the Party Secretary for the bank. Xie said the CCB
management and board of directors cooperate quite well, but
at BOC and ICBC there are many disagreements. In Xie?s
view, major decisions should be made by the shareholders.
Although Huijin is the largest shareholder of all three
banks, Xie said Huijin encourages competition between the
banks because its greatest concern is the size of the
dividends it receives. Huijin has six directors on the
boards of each bank. For important decisions on management
appointments, the budget, etc., Xie said he consults with
the directors, but for other issues, he lets the Huijin
directors make the calls. Xie noted that all three banks
have major international figures on the boards.

State Bank Restructurings
--------------


8. (SBU) Regarding the status of plans to reform ABC, the
last of the four SCBs, Xie acknowledged that ABC represents
a major moral hazard problem. He noted that with 400,000
employees, ABC may need a different approach. Moreover, as
ABC has RMB 500 billion in NPLs, the recapitalization will
need to be much larger. Whether forex reserves are used
(as in the recapitalizations of CCB, BOC and ICBC) is a
question that will be decided at the most senior levels of
the Government. Some have said ABC is too large and needs
to be broken up into several smaller banks. Maybe the good
bank/bad bank model would be best. Xie said Premier Wen
Jiabao has not yet decided on the right approach. In his
view, if the Government does not begin the reform process
at ABC during 2006, it will have to be postponed until
after the 17th Party Congress (in the fall of 2007).


9. (SBU) Commenting on the recapitalization of ICBC, the
most recent bank to receive capital from the central
government, Xie said the complicated recapitalization
process involved around RMB 270 billion in bonds for loss
loans and around RMB 450 billion in separate PBOC 5-year
bonds for doubtful loans. In fact, Xie reported, he has
been called to testify before the National People?s
Congress (NPC) on May 9 on the way in which the banks were
recapitalized. He noted that the NPC had earlier expressed
resentment at the capitalization of the banks using foreign
exchange reserves, claiming that the use of forex reserves
should also require NPC approval. (Note: When the PBOC
used $45 billion in forex reserves at the end of 2003 to
recapitalize CCB and BOC, it did so without consulting the
NPC. End note.)

Rural Finance Problem
--------------


9. (SBU) Xie said (former Premier) Zhu Rongji had three
goals for the financial sector: reform the banking sector,
deal with the state-owned shares in listed companies and

BEIJING 00008474 003 OF 003


reform the exchange rate. Xie said he is impressed with
the current Government?s record in dealing with these three
areas, but he believes rural finance remains a serious
problem. He noted that the Rural Credit Cooperatives
(RCCs) have been undergoing reform for three years, and
that the Government has already provided RMB 116 billion to
cover half of their NPLs.

Securities Markets
--------------


10. (SBU) Another area of concern is the securities
market. Xie said he is currently the head of four
securities companies. Although Huijin currently controls
these firms, Xie said he hopes to relinquish control soon ?
hopefully, by selling them to foreign investors. Xie said
it was the State Council that decided that the big
securities firms needed to be rescued. Consequently,
Huijin has injected RMB 17 billion into the securities
firms, with RMB 7 billion injected into Yinhe (Galaxy)
Securities alone. The funding for these recapitalizations
came from the investments received from BofA and RBS.


11. (U) This report was cleared by the New York FRB
Delegation.

RANDT