PROBLEMS LOOMING FOR M&A AND VENTURE CAPITALISTS

UNCLAS SECTION 01 OF 02 SHANGHAI 000337 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 EINV PREL CH SUBJECT: PROBLEMS LOOMING FOR M&A AND VENTURE CAPITALISTS REF: A. TARNOWKA-LOEVINGER 5/18 EMAIL ¶B. SHANGHAI 70 ¶C. SHANGHAI 250 (U) This cable is sensitive but unclassified and for official use only. Not for distribution outside of USG channels. ¶1. (SBU) Summary: International private equity (PE) and venture capitalist (VC) representatives told visiting Embassy Finatt, on May 16, that Chinese regulations which took effect in September 2006 have effectively shut them out from doing business in China. Since the "Provisions for Foreign Investors to Merge with Domestic Enterprises" rule took effect last year, no Chinese company had been granted permission to form a special purpose vehicle (SPV) that in preparation for listing on a non-Chinese stock exchange. As a result, international VC and PE firms were reluctant to invest in China since they had no exit strategy. The company representatives asked that this concern be raised within the context of the Strategic Economic Dialogue (SED). While this regulation would eventually hurt NYSE and NASDAQ, enough companies had received permission prior to this rule's enactment to not impact their current business, according to the NYSE. End summary. ¶2. (SBU) Shanghai-based international PE and VC representatives The Carlyle Group China Chief Representative Luo Yi, ChinaVest Chairman Robert Theleen, and New Access Capital Managing Partner Andrew Qian discussed China's mergers and acquisition's (M&A) environment with visiting Embassy Finatt on May 16. They raised serious concerns about China's "Provisions for Foreign Investors to Merge with Domestic Enterprises" rule that took effect September 8, 2006. (Note: These rules required that any Chinese company seeking to list overseas via a special purpose vehicle (SPV) and therefore transfer company assets overseas be approved by six government agencies. These were the Ministry of Commerce, State Assets Supervision and Administration Commission, State Taxation Bureau, State Administration of Industry and Commerce, State Administration of Foreign Exchange and China Securities Regulatory Commission (CSRC) (Ref B). End note.) ¶3. (SBU) According to Carlyle's Luo, there had been no PRC approval for any Chinese company to create an SPV since the rules took effect on September 8, 2006. Forming an SPV was the best, and often only, route for small- to medium-sized Chinese companies to list on foreign stock-exchanges as it created a "clean" company unencumbered by potential contingent liabilities. They claimed, unless modified, the rule could have a major negative impact both on U.S. exchanges (NYSE and NASDAQ) and on the ability of Chinese start-up firms to access the capital they need to research and develop innovative products. ¶4. (SBU) Additionally, international VC and PE firms would be reluctant to invest U.S. dollars in Chinese start-ups if they were unable to list overseas since they would find it otherwise difficult to capitalize their gains and exit out of their investments. Most Chinese start-ups did not receive bank loans and were unable to meet listing requirements for Chinese exchanges, which had more stringent profitability requirements than NASDAQ, said Theleen. ¶5. (SBU) Qian had also heard rumors of even more restrictive implementing regulations soon to be issued (including a possible requirement of USD 1 billion market capitalization to qualify for an overseas-only listing). This had exacerbated the international VC and PE companies' concerns, he added. ¶6. (SBU) Luo, Qian and Theleen provided talking points that could be used by Treasury in upcoming SED meetings (transmitted Ref A). They understood it was likely too late to have their concerns in the May 22-23 SED II meetings in Washington. (Note: Finatt plans to seek appropriate opportunities to raise these concerns with relevant Chinese authorities in Beijing, including SHANGHAI 00000337 002 OF 002 the National Development and Reform Commission, CSRC and MOFCOM. End note.) -------------- The Jurassic Park Rule: Nature Finds a Way -------------- ¶7. (SBU) In a separate meeting on May 16, Gaohua (Goldman Sachs) Securities Company Executive Director Raymond Yin told Finatt that there had been "a very direct message" to state-owned enterprises that they should not list overseas, but should list in China. This was a clear move, he said, to provide more and better stock offerings into the Shenzhen and Shanghai stock exchanges in an attempt to provide more supply and contain upward pressure on stock prices. He said that restrictions on SPVs were a reflection of this. However, he added, he had also heard that these restrictions originated with Chinese leaders unhappy with the "Unocal failure." ¶8. (SBU) Nevertheless, Yin said that the Jurassic Park movie tagline, "Nature finds a way," also applies to the market. "Smart venture capitalists" would always be able to find a way for their capital to both enter and exit China. This would lead, he believed, to companies resorting to the unregulated over-the-counter (OTC) market. -------------- NYSE Not Yet Worried -------------- ¶9. (SBU) Asia Pacific NYSE Group Executive Director Michael Yang told Econoff on May 23 that his contacts at the CSRC had indicated that the September rules were aimed largely at preventing state-owned enterprises (SOEs) from "being sold too cheaply to foreigners." Yang said that another genesis of these regulations was Carlyle's attempted purchase of a controlling stake in the Xugong Group Construction Machinery Company. This had worried Chinese leadership who were concerned about foreign ownership of Chinese companies, he said. Yang also believed that CSRC's leadership wanted to promote China's stock exchanges and wanted more good companies to list in China. ¶10. (SBU) Nevertheless, Yang said companies that had finished the paperwork necessary to form an SPV prior to September 8, 2006 were able to list overseas. Yang estimated that there were "many hundreds, up to a thousand" such companies. While not all of these companies would meet U.S. standards for listing, Yang said that he knew of between 40 and 50 Chinese companies that were planning to list on NYSE or NASDAQ this year and an equal number in 2008. Unless there were changes after 2008, however, the "Provisions for Foreign Investors to Merge with Domestic Enterprises rule" would "begin to hurt our business," he said. -------------- NYSE Ready To Apply for Rep Office -------------- ¶11. (SBU) Yang said that NYSE would submit its application for a representative office on July 1, as soon as allowed by CSRC (Ref B). Yang said that he had heard from CSRC contacts that the regulations to allow representative offices had been drafted in such a way to try to exclude stock exchanges from countries other than the United States from qualifying. He attributed this to the CSRC wanting to be as protectionist as possible while still fulfilling its commitment to Secretary Paulson. Yang reiterated that being allowed to have a legal presence in China would be a huge symbolic boost for NYSE's business. He expected that 2007 would be NYSE's best year for listing Chinese companies, noting that four had listed so far and two more companies would list in early June. ¶12. (U) Embassy Finatt cleared on this cable. JARRETT