HAITONG SECURITIES ON CHINA'S STOCK MARKET

UNCLAS SECTION 01 OF 02 SHANGHAI 000334 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: HAITONG SECURITIES ON CHINA'S STOCK MARKET REF: A. SHANGHAI 251 ¶B. SHANGHAI 325 (U) This cable is sensitive but unclassified and for official use only. Not for distribution outside of USG channels. ¶1. (SBU) Summary: Representatives from Haitong Securities Company told visiting Embassy Financial Attache (Finatt) on May 16 that competition from foreign companies would ultimately strengthen China's securities industry. Haitong has struggled to accurately value China's listed companies and manage risk in the face of insufficient information and an overheated stock market. Haitong's joint venture relationships with two foreign banks in the fund management business had increased its risk control and management abilities although there had been some conflicts caused by cultural differences. End summary. ¶2. (SBU) Visiting Embassy Finatt met with Haitong Securities Company Internatonal Business Department General Manager Liao Rongyao and Haitong Securities Research Institution Deputy Director Zheng Zu on May 16. Haitong Securities was a full-service brokerage that conducted initial public offering (IPO) underwriting, institutional investing and proprietary investing. Haitong also had two joint venture (JV) mutual fund management companies and was considering opening a venture capital company, according to Liao. -------------- Companies Only Grow Strong With Competition -------------- ¶3. (SBU) Liao said that its JV fund management companies, one with Bank of Montreal and the other with Fortis Bank and other domestic investors, had been very successful. She noted that in its four years of cooperation with the foreign companies, Haitong had "learned a lot" about risk control, investment processes, and technical and managerial skills. Nevertheless, there had been "conflicts in working styles." Liao said that according to regulations, a securities fund was allowed to be a part of only two fund management companies. Liao also noted that Haitong had plans in place with unnamed foreign companies, to form JV securities brokerages should regulations allow JV investment in underwriting, asset management and financial consulting. Haitong also was also in discussions with foreign firms to create partnerships that would give it access to foreign know-how in the financial derivatives business (Ref A). ¶4. (SBU) While discussing the possibility of foreign securities companies being permitted to open in China, Zheng acknowledged that competition brought "both good things and bad things." Zheng said that China's brokerages would benefit from competition in terms of an increased service level to clients and improved risk management abilities. The downside of competition was, of course, "competition" he said. "Companies only grow strong when there is competition; they do not grow under protectionism," he added. -------------- -------------- Interest Rate Hikes Aimed at Economy, Not Markets -------------- -------------- ¶6. (SBU) Zheng said despite the recent increases in value of China's equities market, it still only represented a very small portion of China's overall economy and thus any macroeconomic impact of a downturn in the market would be limited. He believed that interest rate hikes were aimed at cooling the whole economy, not just aimed at an over-heated stock market. In general, interest rate hikes did have an effectively negative impact on the market, although the recent hikes had not affected the market. Zheng said that the most effective way to cool the market was to increase the number of good quality IPOs. By increasing the supply of stocks, prices would stabilize. SHANGHAI 00000334 002 OF 002 ¶7. (SBU) Haitong's Liao agreed that overheated equity market was due to being lack of investment channels for Chinese investors. Increasing market supply was the only way to cool the markets down. One way to increase the supply of listed stocks, Liao said, was to allow foreign companies to list in the Chinese equity market. She had heard that HSBC might list on Shanghai Stock Exchange. -------------- Managing Risk in a Hot Market -------------- ¶8. (SBU) Haitong's Zheng told Finatt that it was especially difficult to manage risk in such a volatile market (Ref B). Haitong's Research Department's investment philosophy was to look at the value of the company. A year ago, he said, it had been "easy" to recommend stocks based on the company's intrinsic value. Now, however, given the massive market gains and high price/earnings ratio, "this year was very hard." Zheng said at times he "felt very embarrassed" with customers when trying to explain why a stock Haitong "had valued at RMB 20 had gone up to RMB 30." Outlining the risks, he said, "In this market, it was very difficult to keep a clear mind and not follow the sentiment of the market." ¶9. (SBU) Despite the current bull market mood amongst investors, Zheng said that eventually the market would go down. Haitong was not concerned that it would be liable for customer losses, however, and Zheng asserted that Chinese investors were not blind to the dangers inherent in a market. "Customers had four years of a bear market; they know the risks of the market and understand that no one will compensate them," he said. ¶10. (SBU) Liao said that when Haitong customers opened new trading accounts, they signed risk disclosure statements. "But we do not know if they can afford that risk. That is another issue," she said. Applicants for new accounts were required to show their government-issued identification card. Liao acknowledged the difficulty that most of Haitong's customers would have accessing or understanding research reports. -------------- The Mechanics of Haitong's Risk Assessment -------------- ¶11. (SBU) Zheng said that his department tried very hard to get an accurate picture of the companies that it was researching. Nevertheless, he acknowledged that the information Haitong's analysts received was "less than 100 percent." Haitong had 120 branches throughout China, and he relied on staff at the local branches to "have good relations and contacts with listed companies" in their area. This local knowledge allowed his researchers to know "who was upstream and who was downstream." In the face of incomplete information, Haitong's researchers would "evaluate what we do not know so as to control risks." (Comment: Should foreign securities firms be permitted to operate in China, it would be unlikely that they would have a similar network of branch offices from the start. End comment.) ¶12. (U) Embassy Finatt cleared on this cable. JARRETT