GOLDMAN SACH'S GAOHUA SECURITIES: AN ONLY CHILD

UNCLAS SECTION 01 OF 02 SHANGHAI 000333

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EAP/CM AND EEB
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/ALTBACH/READE
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 KASOFF, MELCHER AND OCEA/MCQUEEN
TREASURY FOR OASIA - DOHNER/CUSHMAN
TREASURY FOR IMFP - SOBEL/MOGHTADER
NSC FOR KURT TONG

E.O. 12958: N/A
TAGS: EFIN ECON PREL CH
SUBJECT: GOLDMAN SACH'S GAOHUA SECURITIES: AN ONLY CHILD


(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels.


1. (SBU) Summary: Goldman Sachs' venture in China, Gaohua
Securities, has both benefited and suffered from being the only
foreign-controlled, full service securities firm in China.
Goldman's method of obtaining control of a Chinese licensed
securities firm by giving unsecured loans to trusted Chinese
business partners was, likely, "not a replicable model, said
Gaohua Securities Company's Executive Director in a meeting with
visiting Finatt on May 16. In addition to explicit rules
barring foreign from having majority ownership in Chinese
securities firms, there are also more subtle barriers such as
onerous licensing examinations for senior managers. Goldman
Sachs looked forward to the day when other foreign securities
firms were doing business in China since securities market
liberalization would not been viewed by the Chinese as having
benefited a single firm. End summary.


2. (SBU) In a meeting on May 16, Gaohua Securities Company
Executive Director Raymond Yin told visiting Embassy Finatt that
the Goldman Sachs-Gaohua model for establishing a
foreign-operated, but wholly Chinese-owned full service
securities firm was most likely "not a replicable model."
Goldman worked out a deal by which it provided two Chinese
individuals with ties to the banking industry with unsecured
loans to cover seventy-five percent of its start-up fees. The
venture capital subsidiary of the Lenovo computer company anteed
up the remaining twenty-five percent to start the Gaohua
Securities Company. Goldman and Gaohua then set up the
Gaohua-Goldman Sachs Banking joint venture in which Goldman has
a 33 percent equity stake, but like other foreign owned joint
ventures, is not allowed to trade A shares either for clients or
on its own account. Gaohua's application for a brokerage
license then took two years to be approved; it was finally
approved at the State Council level, said Yin. Yin noted that
details of how it structured the deal were still sensitive and
not to be discussed with the press.


3. (SBU) Further emphasizing Gaohua's uniqueness, Yin told the
story of the China Securities Regulatory Commission Chairman
Shang Fulin response to Merrill Lynch's request for similar
treatment. Shang apparently said, "You know how China has a one
child policy? Gaohua is an only child." Goldman has
successfully built its brand here so that, in Chinese, Gaohua
means Goldman Sachs.


4. (SBU) Yin said that while the loans to the two Chinese
individuals were unsecured, they were treated as Goldman
partners and received remuneration in the form of Goldman stock.
This had the effect of tying them closely to Goldman's
financial performance and provided a quasi-guarantee for the
loan.

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Subtle Barriers to Securities Business in China
-------------- --


5. (SBU) Yin said that in addition to explict barriers to FDI in
financial services in China, there were also many "subtle
barriers" for foreign companies. To be certified as a "senior
manager" in a securities business, one needed to take the
"Senior Manager Exam." This exam was only offered in Mandarin
Chinese. Yin said that to pass this exam one needed to have
been educated in Chinese as it was highly technical. Yan, an
American citizen and 14-year Goldman partner, admitted that
although he had been born in China and was a native Chinese
speaker, he had to take the exam twice. Once the examination
was passed, the senior manager then needed to have all original
diplomas certified by a special office in Beijing. Finally, the
applicant for a senior manager position must then provide the
passport numbers and names of all of his extended family members

SHANGHAI 00000333 002 OF 002


-- including uncles, aunts, and cousins. This final measure was
to allow the Chinese government to stop these people from
fleeing China in case of fraud investigations. Yin said,
however, it made him feel like he was already being treated like
a criminal. Because his diplomas had yet to be certified, Yin
had to use the title "Executive Director" rather than "General
Manager."


6. (SBU) In addition to the senior management test, 75 percent
of all personnel at a securities firm must be citizens of the
People's Republic of China. This combined with the Chinese
language requirements for senior managers created a difficult
but not insurmountable challenge for overseas firms, said Yin.


7. (SBU) Another barrier, said Yin, was the licensing
requirement to become an "innovative broker." This license
allowed securities firms to create financial products. To
qualify, a brokerage submitted an application to an industry
panel, "made up of your competitors," said Yin. This panel was
then, "invited into a firm's back room, to view all of its
internal processes, and kick the tires," he added.

-------------- --
Gaohua: A Chinese Firm with Foreign Limitations
-------------- --


8. (SBU) While Gaohua had been granted a full brokerage license,
and was technically a wholly-owned Chinese securities company,
it continued to face extra scrutiny and controls from the CSRC,
said Yin. He noted that Gaohua's underwriting of the Ping An
Insurance's initial public offering (IPO) had received a great
deal of media attention. When Gaohua subsequently sought
approval to underwrite another, Yin said, the CSRC indicated
that Gaohua had had "too much publicity" and then refused
permission to underwrite the next IPO.


9. (SBU) Yin speculated that foreign fund management firms and
had been more welcomed in China than foreign securities firms
since the former was a relatively new industry in China and
foreign firms offered technology and know-how that China lacked.
Securities firms, on the other hand, had been established
longer in China and due to financial weakness more reluctant to
face foreign competition. Yin said that Chinese authorities did
not appear interested in following the "London Model" of opening
up their securities industry which had lead to a vibrant
financial center at the expense of domestically owned firms, but
would pursue a more gradual and restrictive approach that would
leave a larger role for domestic securities companies.

--------------
Safety in Numbers
--------------


10. (SBU) Yin was clearly pleased with the leadership position
that Goldman Sachs had taken in China. However, he also
admitted that being the only "foreign" securities firm in China
also had its downsides. He said that currently Goldman was "the
only voice" and that it was forced to break all new ground on
its own. When more foreign securities firms were allowed to do
business in China, Goldman would be able to benefit from having
"a collective voice" to share its concerns. For the meantime,
Yin said, Goldman was attempting to set a good example of the
benefits that foreign firms could bring to China and act as a
good corporate citizen. It had spent a great deal of effort and
time training and advising the CSRC. "We treat them like a
client," he said.
JARRETT