BANK OF CHINA TAKES CREDIT FOR TIANJIN/HONG KONG

C O N F I D E N T I A L SECTION 01 OF 02 HONG KONG 002263

SIPDIS

SIPDIS

STATE FOR EAP/CM AND EEB/IFD/OMA, NSC FOR WILDER AND TONG,
TREASURY FOR HARSAAGER, YANG, WINTON, CUSHMAN, BEIJING FOR
LOEVINGER

E.O. 12958: DECL: 08/27/2017
TAGS: EFIN ECON HK CH
SUBJECT: BANK OF CHINA TAKES CREDIT FOR TIANJIN/HONG KONG
INVESTMENT SCHEME

REF: HONG KONG 2183

Classified By: Acting EP Chief Craig Reilly, Reason 1.4 (b)


1. (C) Summary: The August 20 announcement by the Chinese
State Administration of Foreign Exchange (SAFE) that it would
allow Chinese investors to open Hong Kong investment accounts
through Bank of China (BOC),Tianjin - Binhai branch helped
Hong Kong stocks overcome the fallout from the U.S. subprime
mortgage problems and pushed the Hang Seng Index to a record
high on August 27. Although the announcement came as a
welcome surprise to the market, BOC and SAFE had been
discussing this investment scheme for over a year, according
to Bank of China International (BOCI) Managing Director for
Research Anthony Lok. Lok predicted that Chinese investors
would be able to access the Hong Kong Stock Exchange through
the BOC, Tianjin - Binhai accounts by mid-September. BOC
proposed this reform to SAFE and the People's Bank of China
(PBOC) in 2006 and took the lead in developing the innovative
mechanism to meet SAFE's concerns about losing control of
capital flows. While other Chinese banks are eager to hop on
the bandwagon, BOC claims it is the only institution capable
of handling the tens of thousands of expected new individual
brokerage accounts. BOC expects that it will have a monopoly
on Chinese investment in the Hong Kong Stock Exchange for at
least the next year. End Summary.


2. (U) From the last week of July through August 17, the
Hong Kong Stock Exchange fell over 3000 points (about 13%) as
international investors tapped the Hong Kong market for much
needed liquidity in the wake of the U.S. subprime mortgage
generated credit crunch. Local investors were also selling
on concerns about the prospects for the U.S. economy.
However, the August 20 SAFE announcement that Chinese
investors would soon be allowed to open special accounts to
invest in the Hong Kong Stock Exchange reversed what had been
up to that point the Hang Seng Index's worst month in several
years. By close of trading on August 27, the Hong Kong Stock
Exchange not only regained the lost 3000 but pushed to a
record high of 23577.73. Despite the enthusiasm for SAFE's
announcement, press reports have generated some confusion
about who will be allowed to open special investment
accounts, how the accounts will operate and when money from
Chinese investors could begin entering the Hong Kong Stock
Exchange.

============================================= =====
Plans to Allow RMB into HK Market Long-established
============================================= =====


3. (C) Bank of China International Managing Director for
Research, Anthony Lok (protect) explained that although the
announcement took the market by surprise, the plan to allow
the opening of special accounts had been on the drawing board
for some time. BOC had first broached the idea with SAFE
more than one year ago and since that time has been
developing the mechanisms to allow Renminbi (RMB) deposits to
move out of the Chinese market, reducing inflationary
pressures in China, while simultaneously meeting SAFE's
desire to retain control over RMB outflows. BOCI was
surprised by the timing of the SAFE announcement but had
expected the scheme would be announced before the end of the
year.


4. (C) Lok dismissed speculation that the announcement had
been pushed forward to halt the Hong Kong stock market slide.
Instead, the timing of the announcement was driven by SAFE's
concern about domestic inflationary pressures before the
National People's Congress in early 2008. He noted that
there was no limit to the size of the special investment
accounts, in contrast to the US$ 50,000 limit on Qualified
Domestic International Investor (QDII) accounts. He
attributed the unlimited nature of the BOC accounts both to
SAFE's confidence in BOC's ability to create a "closed
system" that would prevent RMB from leaving the country and
to BOC's own role in developing the model. BOC's proposal
was market driven and would not suffer from the same delays
and problems that have limited QDII investment thus far, Lok
said.

=====================================
Special Investment Accounts Mechanics
=====================================


5. (C) Lok explained that Chinese investors from all over

HONG KONG 00002263 002 OF 002


China will be able to participate in the BOC managed accounts
as long as their local BOC branch has a reciprocal
arrangement with BOC, Tianjin - Binhai branch. (Note: the
State Council has indicated in the past that the Binhai
Special Economic Zone could be developed as a financial
innovation center and that the RMB could be traded more
freely there. End Note). Currently over 40 branches in
major Chinese cities have such a relationship with BOC,
Tianjin - Binhai, with more expected to follow. RMB or
foreign currency deposits can be used by accountholders to
purchase any Hong Kong-listed security. Upon placing their
order with BOC, either in person or on-line, BOC will
transfer the currency through BOC Tianjin - Binhai to
individual investor accounts managed by BOCI in Hong Kong,
where it will be exchanged for Hong Kong dollars and invested
in the Hong Kong Stock Exchange according to the wishes of
the accountholder. The mechanism meets SAFE's requirements
that it retain ultimate control of the RMB assets since the
accounts will be fully retained within the BOC system.
Investors will not have personal access to foreign currency.
If they wish to withdraw funds from their special investment
accounts, they will need to repatriate the money to their own
branches through BOC Tianjin Binhai, where it will be
available only as RMB deposits.


6. (C) Although BOC President Li Lihui announced to the
press August 26 that Chinese accountholders could begin
investing in Hong Kong as early as this week, Lok insisted it
would take at least a few more weeks for accounts to become
active. Over 10,000 individuals have already signed a
waiting list to establish accounts, he said. It will take
some time to solicit needed information, transfer funds, and
generate accounts for each investor. Lok expects the first
Chinese investment accounts will be operational by
mid-September. Since Chinese investors would be able to
invest in any asset traded on the Hong Kong Stock Exchange,
he predicted that trading in warrants would quickly outstrip
stock purchases as Chinese investors sought increased
returns.

===============================
BOC Takes Credit, Gets Business
===============================


7. (C) While other Chinese state owned banks have been
lobbying to join the special investment account scheme, Lok
said only BOCI currently has the capability to support the
large numbers of individual investors and the funds to manage
such an operation. Analysts at Deutsche Bank speculated that
total RMB outflows from the scheme could reach as high as 280
billion over the next 10 months. BOC's position as one of
the largest brokerage houses in Hong Kong and its role in
developing scheme should give it a monopoly on servicing
mainland investors in Hong Kong for at least the next year,
according to Lok.
Cunningham