CITIBANK'S STANLEY ON GDB AND CHINA BUSINESS

UNCLAS SECTION 01 OF 03 SHANGHAI 000161 SIPDIS SENSITIVE SIPDIS STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN FRANCISCO FRB FOR CURRAN/GLICK/LUNG; NEW YORK FRB FOR CLARK/CRYSTAL/MOSELEY STATE PASS CFTC FOR OIA/GORLICK CEA FOR BLOCK USDOC FOR ITA DAS LEVINE AND OCEA/MCQUEEN TREASURY FOR OASIA - DOHNER/CUSHMAN TREASURY FOR IMFP - SOBEL/MOGHTADER NSC FOR KURT TONG E.O. 12958: N/A TAGS: EFIN EINV ECON PREL CH SUBJECT: CITIBANK'S STANLEY ON GDB AND CHINA BUSINESS REF: A. Shanghai 159 ¶B. 06 Shanghai 7112 and prior ¶1. (SBU) Summary: During a March 8 meeting with Beijing Financial Attache David Loevinger, Treasury Asia DAS Robert Dohner, Asia Director Mathew Haarsager and Congenoffs, Citigroup China CEO Richard Stanley expressed great appreciation for USG support which facilitated its December acquisition of a 19.9 percent interest with management control of Guangdong Development Bank (GDB). Stanley discussed challenges in managing GDB and hopes for lifting of the foreign ownership caps. He urged the Federal Reserve Bank (FRB) to find a way to approve a U.S. branch for one of the "better run" Chinese banks, and said the impact on Chinese willingness to further liberalize its financial markets would be significant. Stanley noted the processing of incorporating was going faster than expected. The Chinese Banking Regulatory Commission clearly wanted Citi to be among the first banks to incorporate, due in part to USG interest. The problem was it hadn't yet issued rules for foreign banks to offer credit and debit cards, without which it would be difficult for them to attract RMB deposits. Stanley noted the continued inability to hold open foreign exchange positions longing the RMB and expressed concerns about new foreign debt limitation regulations, opined on necessary changes to QFII and QDII policies, and discussed Citi's extensive efforts to train its China employees, including the 13,000 GDB employees, and to develop rising stars through its worldwide "farm system." End Summary. -------------- -------------- USG Support Critical for Guangdong Development Bank Deal -------------- -------------- ¶2. (SBU) Stanley expressed great appreciation for USG support of its efforts to acquire an ownership stake with management control of GDB. Stanley thought the efforts of Secretary Paulson during the December Strategic Economic Dialogue, as well as extensive support from Treasury and Congen staff were critical to securing final approval. He had highlighted this model of successful business-government collaboration in a global conference of Citi managers. ¶3. (SBU) Stanley said Citi's ability to reform the bank would be much greater with 51 percent or more ownership. Citi looked forward to lifting of ownership caps and had a seven-year option to acquire up to an 85 percent interest if caps were lifted. HSBC's option to acquire up to a 40 percent stake in BOCOM would expire in a year. Right now, Citi had blocking rights at the board-level with GDB, but didn't have the ability to force decisions. Stanley said it was perhaps just as well it didn't have a majority stake yet. If it did, it would have to consolidate its financial statements. As it was, Citi could account for the deal as an equity investment. ¶4. (SBU) Nonetheless, the acquisition presented challenges with U.S. regulators. The FRB considered the acquisition a subsidiary subject to U.S. anti-money laundering (AML) rules. Citi would be under pressure from the FRB and the Office of the Comptroller of the Currency to effect change but neither regulator would have the power to audit GDB. Citi understood the dilemma and the fact that ultimately the regulators could use penalties, fines, sanctions or a forced divestiture if warranted. Stanley believed CBRC would be supportive of its efforts to establish effective AML rules at GDB since China intended to join the Financial Action Task Force (the international organization which develops and promotes polices to combat money laundering and terrorist financing). -------------- -------------- Citi's Investment in Shanghai Pudong Development Bank -------------- -------------- ¶5. (SBU) After the Secretary's financial services roundtable (Ref A),Shanghai Pudong Development Bank (SPDB) Chairman Jin SHANGHAI 00000161 002 OF 003 Yun buttonholed Pol/Econ Chief to explain how Citi had missed the boat by not purchasing a larger stake as he had advised Stanley when SPDB shares were USD 3. Now, at USD 20/share, it would be much more expensive for Citi to increase its stake. Stanley said Jin was absolutely right; unfortunately SPDB wasn't a priority for former CEO Sandy Weill at the time. Stanley explained that, after conversion of non-tradable shares, Citi now held only a 3.7 percent stake in SPDB, although it had an option to increase to a 19.9 percent stake. He said the investment was really a 50/50 synthetic credit card JV, although it was losing money. At current prices, increasing Citi's SPDB stake to 20 percent didn't make sense. Citi would like to spin off the credit card business and then, if possible, increase its ownership stake; otherwise it might prefer to spin off and sell the card business. On a related note, Stanley mentioned that SPDB had worked with Carrefour to develop a co-branded card, and planned to have SPDB ATMs in every Carrefour store in China. SPPB got approval from Visa to do such a co-branded debit card but China Union Pay turned it down. -------------- -------------- FRB Approval of Chinese Branch Could Have a Significant Impact -------------- -------------- ¶6. (SBU) Stanley repeated his oft-urged suggestion that the FRB try to find a way to approve a branch license for one of the better-run Chinese banks, such as China Merchants Bank. He had heard that the FRB might be considering approving a branch from another developing country. While that might be progress in terms of breaking the logjam, it would likely be interpreted in a negative light by China. Approval by the FRB of a Chinese bank's branch application would be extremely helpful to USG efforts to persuade China to further liberalize its financial and capital markets. Stanley said he didn't know how much linkage there was, but Citi had only just received approval for its seventh China branch in Hangzhou; HSBC already had 14. -------------- -------------- CBRC Extremely Helpful with Local Incorporation Process -------------- -------------- ¶7. (SBU) Stanley said CBRC had gone out of its way to be helpful to Citi in dealing with the local incorporation process. China wanted the major foreign banks to apply for approval at the first opportunity on December 11, 2006 and the process now seemed to be moving forward at "a lightning pace." Stanley expected approval as early as April. The week before, a CBRC team had met with Citi to discuss a range of technical issues, including how to treat interbank lending, off-shore transactions and debit cards. (Note: On March 20, Dow Jones reported that CBRC had approved the locally incorporated entities of four foreign banks, Citigroup, HSBC, Standard Chartered, and Bank of East Asia, to begin offering unrestricted local-currency services to Chinese individuals. End note.) Stanley said the local incorporation regulations had worked out OK for Citi, but he understood the end result was not necessarily a great outcome for foreign banks as a whole. Banks like Wachovia and JP Morgan would have difficulty meeting the requirements; Bank of America had agreed to close its own retail presence when it took a minority stake in China Construction Bank. -------------- -------------- But Hard to Attract Customers without Offering ATM Cards -------------- -------------- ¶8. (SBU) Stanley said his main concern at this point was that, due to the delay of issuance of CBRC regulations dealing with how foreign bank subsidiaries could offer credit and debit cards, Citi would be at a competitive disadvantage in attracting RMB deposits compared with Chinese banks. -------------- -------------- QFII, QDII, and Foreign Currency and Foreign Debt Limitations -------------- -------------- SHANGHAI 00000161 003 OF 003 ¶9. (SBU) Stanley said the Qualified Foreign Institutional Investor (QFII) program had been a huge success; there just wasn't enough quota. The Qualified Domestic Institutional Investor (QDII) program needed to have more investment options (particularly equity) to make it attractive enough to offset the potential capital loss on RMB appreciation. Citi looked forward to doing more RMB business since it was more profitable; its RMB balance sheet was already greater than its USD balance sheet. However, in addition to the ATM issue, Citi was concerned that it would be a challenge to meet required deposit/loan ratios, even though the CBRC gave foreign subsidiaries a transition period to meet them. On foreign exchange trading, banks in China were still prevented from holding open positions longing the RMB. (Note: According to recent press reports, Standard Chartered's Bohai Bank, recently received approval to take long-RMB positions overnight. End note.) Stanley was also concerned about new foreign debt restrictions announced on March 2 in an attempt by the Central Government to limit capital inflows. Under the new rules, Citi's foreign debt limit would be reduced in stages over the next two years to 30 percent of its current USD 2.2 billion level. Since Citi now was using only about USD 1.6, the first couple quarterly reductions wouldn't have an immediate impact; they would however, reduce Citi's maneuvering room in managing its liquidity. Furthermore, the limits would increase Citi's cost of funds since it was much cheaper for Citi to borrow in Singapore than on the domestic interbank market. -------------- Training and Turnover -------------- ¶10. (SBU) Citi had an overall 15 percent turnover rate in China, with about 40 percent turnover in consumer banking, mostly sales people. While Chinese banks have expressed concern that greater FDI would increasing poaching of skilled staff, there was little flow of employees between Chinese and foreign banks. Citi's main competitors for personnel were other foreign banks. To ensure its staff acquired the skills they needed and encourage retention, Citi dedicated enormous efforts to training. Over the next year, it planned to provide formal training to 5,000-7,000 of GDB's 13,000 employees. Citi also ran a "farm team" for up and coming China employees, sending them out to other Citi worldwide operations for 3-5 years in order to expose them to Citi corporate culture and broaden their experience. In addition, at any given time, there were about 30 China-based Citi employees at any time on six month out-rotations to other offices. Citi would be delighted to showcase its China training programs to interested USG or Chinese officials as a way to highlight the benefits of FDI in the financial sector. JARRETT