HK ECONOMISTS ADVISE CHINA AGAINST SOVEREIGN

UNCLAS SECTION 01 OF 02 HONG KONG 001931 SIPDIS SIPDIS STATE FOR EAP/CM AMY NICODEMUS AND EB/IFD/OMA DAVID MOORE, US TREASURY FOR HARSAAGER, WINSHIP, AND YANG E.O. 12958: N/A TAGS: ECON EFIN HK CH SUBJECT: HK ECONOMISTS ADVISE CHINA AGAINST SOVEREIGN WEALTH FUND TRANSPARENCY, PRAISE CEPA AMENDMENTS ¶1. (SBU) Summary: A senior Hong Kong private-sector economist has been advising the Chinese government that a high degree of transparency is not in the best interest of China's State Foreign Exchange Investment Corporation (SIC), as it will subject the fund to political pressure and media second guessing. HKMA officials thought that Treasury Assistant Secretary Lowery,s call for greater transparency in sovereign wealth funds was overly critical as the U.S. has long rebuffed Asian calls for greater transparency of large institutional investors like hedge funds. ¶2. (SBU) Investment banking executives are grateful for the market access commitments achieved in SED II. Lack of regulatory transparency and predictability, along with equity caps and the lack of a clear mandate to allow minority shareholders management control of domestic firms remain their primary market access concerns. HKMA officials noted the benefits of collaboration through the SED-JCCT and CEPA to gain greater access for foreign financial services firms and described amendments in the most recent CEPA increasing access in financial services, notably by: 1) reducing minimum asset requirements for Hong Kong banks to purchase strategic stakes in Chinese banks; 2) making it easier for foreign banks to qualify as "Hong Kong banks" and benefit from CEPA provisions; and 3) giving Hong Kong banks priority treatment in applications to open branches in west central and northeast China and in Guangdong Province. End Summary. ¶3. (SBU) Beijing-based Treasury Financial Minister Counselor David Loevinger and Econoff Jim Mullinax met July 13 with several Hong Kong-based senior economists and representatives of international investment banks, fund managers, and the Hong Kong Monetary Authority (HKMA). ============================================= ======= SIC: Transparency Makes Profitability Harder to Find ============================================= ======= ¶4. (SBU) Hong Kong-based economists predicted that the SIC would have difficulty reaching profitability in the near term, given prospects for the RMB appreciating by up to 5% vis--vis the U.S. dollar over the next several years and the interest rate on Ministry of Finance bonds issued to finance the SIC expected to be about 4.5%. (Comment: We noted that there is not yet agreement in the Chinese government on whether the government,s claim in the SIC will be RMB or foreign currency denominated. End comment.) To finance the SIC, Hong Kong economists we spoke to expect the Ministry of Finance to issue bonds to either a special purpose vehicle or a consortium of State-owned banks, which would then sell the bonds to the People,s Bank of China (PBOC). To ensure market pricing, a small quantity of bonds could be auctioned publicly. ¶5. (SBU) One economist has advised the Chinese government that a high degree of transparency in the SIC would not be in China,s interest. Regular reporting on the composition and performance of SIC investments would make it more difficult for the SIC to focus on maximizing long-run returns, subjecting it to greater political interference and media second-guessing. In addition, a high degree of transparency would allow market players to discern SIC,s investment strategy and "front run" it. The economist advised SIC's prospective management that Singapore,s Government Investment Corporation (GIC) and most of the world,s central banks do not make public the composition of investments or returns, suggesting that this was a good model for the SIC to follow. HKMA officials believe U.S. Treasury Assistant Secretary Clay Lowery was too critical in his calls for SIPDIS greater transparency in sovereign wealth funds. They noted the irony of the U.S. position advocating greater transparency in sovereign funds after having repeatedly rebuffed Asian calls for greater transparency in large institutional investors like hedge funds. ============================================= ==== Export Misreporting Not a Factor in Trade Figures ============================================= ==== ¶6. (SBU) The economists noted that expectations that RMB appreciation would slow Chinese export growth had proven unfounded thus far. Based on a recent survey of firms, China,s State Administration for Foreign Exchange (SAFE) believes that disguised capital account transactions in the current account are relatively small, accounting for probably HONG KONG 00001931 002 OF 002 less than 1% of the current account surplus. There are incentives for both under-reporting (tax avoidance) and over-reporting (access to foreign currency to speculate on RMB appreciation) of export receipts. According to SAFE, pre-payments for export receipts (another common tool used to gain illicit access to foreign exchange) are down 40%. ============================================= =============== Equity Caps, Predictability, Control Top Securities Concerns ============================================= =============== ¶7. (SBU) The securities company executives we spoke with are grateful for the market access commitments achieved in SED II, particularly the removal on the moratorium on new securities licenses and the ability for foreign securities JVs to expand into brokerage and proprietary trading. However, equity caps and the lack of regulatory transparency and consistency remain their primary concerns. The lack of regulatory predictability makes long-term planning difficult. Firms cited as examples the moratorium and the ad-hoc nature of foreign acquisitions of Chinese-invested securities firms to date. To the bankers, a more restrictive but transparent and predicable regulatory regime would be preferable to a potentially less restrictive but opaque and volatile one. ¶8. (SBU) While the raising of equity caps in securities remains a priority, and raising the caps even to 49% would be helpful, the promulgation of regulations which clearly give minority shareholders the right to managerial control would be highly welcome, as this appeared to be a major stumbling block in the UBS purchase of Beijing Securities. Promulgating clear regulations on the ability of financial services firms to provide private banking services is also a key concern. Firms advised U.S. officials to point out to Chinese counterparts that the current environment gives a privileged market position to three foreign securities firms, enhancing their ability to extract rents. ============================================= == CEPA Amendments Ease HK Firms' Entry into China ============================================= == ¶9. (SBU) Senior officials of the HKMA described recent amendments to the Mainland/Hong Kong CEPA on financial services. First, while firms still need five years operating experience in Hong Kong to qualify as a Hong Kong financial services firm and gain the benefits of CEPA, they can now count up to two years operating as a foreign affiliated branch (with the rest as an incorporated subsidiary) to meet the requirement. Under previous rules, a bank needed to have been incorporated in Hong Kong for at least five years. Second, the minimum asset requirement for Hong Kong banks to acquire a strategic stake in a mainland bank has been reduced from US$10 billion to US$6 billion. Finally, a new "Green Lane" procedure will give Hong Kong banks priority treatment in considering license applications to set up branches in the central western and northeastern regions of China and, most importantly, in Guangdong Province. Marut