China Investment Corporation Meeting with

UNCLAS SECTION 01 OF 04 BEIJING 001308 SIPDIS SIPDIS SENSITIVE STATE FOR EAP/CM AND EEB/OMA TREASURY FOR OASIA/DOHNER USDOC FOR 4420 STATE PLEASE PASS USTR FOR STRATFORD E.O. 12958: N/A TAGS: ECON EFIN PREL EINV CH SUBJECT: China Investment Corporation Meeting with U.S.-China Economic and Security Review Commission REFS: ¶1. (SBU) Summary: China Investment Corporation General Manager Gao Xiqing met with Commissioners of the U.S.-China Economic and Security Review Commission on March 31, 2008. Gao suggested that U.S. officials be patient with CIC as it evolves relative to sovereign wealth fund (SWF) best practices. Other SWFs have had many years to improve their operations. Criticizing CIC management, who are all proponents of reform, too soon and too hard would be counterproductive. Gao sees no problem if SWFs, including CIC, are treated like other large institutional investors. However, CIC would be concerned if it believed it was being held to a separate standard. If the U.S. wants to engage economically with a large transition economy like China which supports market reform, it will need to accept engagement with large state-owned enterprises. CIC is seeking passive investments and is subject to less government direction than western countries assume. Gao perceives a shifting sentiment in the U.S. regarding the CIC that is distinctly anti- China; by comparison, the British have been the most positive and practical, the French most negative, and the Germans the most indecisive. End Summary. CIC Seeks Passive Investment, Not Control -------------- ¶2. (SBU) In response to delegation concerns about CIC taking controlling stakes in its investments, Gao stated CIC does not want board seats and has instructions to take passive roles in its investments. The Blackstone and Morgan Stanley deals are representative of the types of investment terms in which CIC is interested. Much Less Government Control Than the West Thinks -------------- -------------- ¶3. (SBU) When the State Council created the CIC, it did not want to get involved in specific deals, according to Gao. Reporters had it wrong when they said the Chinese Government was directly involved in CIC's investment in Morgan Stanley. The CIC did not even tell the State Council about the deal until hours before it was announced. However, the CIC has to work within the Chinese Government system while at the same time using �00A;market principles. The CIC is operating on a commercial basis and has to take responsibility for its decisions. Gao did acknowledge that long-term financial interests sometimes have a political component but this is no different than the blurred line that exists between the U.S. Government and U.S. business, he added. ¶4. (SBU) Gao's interaction with government officials is mainly through informal channels. There is no regular contact regarding investment decisions, he stated. Board members that previously worked for ministries, however, do report back to their old offices. Former MOF officials rejected the first compensation package because pay was not tied enough to performance. They knew that the package would ultimately pass but they "had their own bosses to answer to," according to Gao. Future of CIC Depends on Performance and Profile -------------- --- ¶5. (SBU) CIC is an experiment; if it is deemed a success (including not attracting too much political controversy) it will get more funds to manage, explained Gao. The financial return target is several percentage points above the rate of inflation. Officials from Norway's SWF told CIC not to be too transparent on its asset allocation because markets will figure out the BEIJING 00001308 002 OF 004 strategy. CIC has instituted international benchmarks for all major asset classes similar to U.S. pension funds. If You Don't Want to Deal with SOE's, Walk Away -------------- -- ¶6. (SBU) In reply to delegation comments that the U.S. is concerned about transparency because government ownership can be an instrument of foreign policy, Gao commented that that the U.S. ultimately needs to decide whether it wants to engage economically with a large transition economy. China is moving towards a free market, but in the interim, state enterprises will still play a role in foreign trade and investment. CIC has sent letters to the SEC and other securities regulators saying it has no intent to control major businesses and is always open to uestions in response to market rumors about its activities. Some delegation members commented that the U.S. is going through a period of angst and stressed that U.S. policy on FDI has been much more stable than rhetoric. Gao noted a similar situation in China. China's Perception of Unfair U.S. Treatment -------------- ¶7. (SBU) In a uniquely Confucian interpretation Gao commented that the U.S., like a big brother, should be more helpful to China rather than saying China has to act in a certain way. He has been working with the U.S. for a long time and feels there is a recent shift in sentiment, with the U.S. now less welcoming to foreign direct investment and foreigners. One delegation member responded that this is because Americans do not see the bilateral economic relationship as balanced. ¶8. (SBU) On the need for greater transparency for SWFs, Gao described U.S. corporate disclosure rules as draconian and questioned why specific classes of investors are being singled out. Commission members stressed that concerns about SWFs are not just about China, and all large money managers are required to disclose their holdings. Gao replied that U.S. disclosure rules are understandable when institutional investors are investing on behalf of small investors, but less necessary when investors (like CIC) are investing their "own funds." While Gao understands recipient countries' concerns about investments by government entities, if SWFs were treated differently than other large investors (hedge funds for example),or CIC is treated differently than some other SWFs (including the Alaska Fund),China would have concerns. ¶9. (SBU) Delegation members noted that, in considering SWF policy, Congress will take into account the source of SWFs' assets, which is an important criterion. Norway's resources are from non-renewable natural resources, while China's is from large balance of payments surpluses due in part to an undervalued exchange rate. The U.S. also has unique concerns about national security in relation to China that differ from Norway. One delegation member noted that China will be treated differently in this regard. Gao emphasized that the U.S. and China are too big to cut off trade and investment and the more the U.S. engages with China the more it promotes reform. CIC officials are the ones promoting reform in China. Give us time, he emphasized. Zhao Haiying, Chief of Strategic Asset Allocation and Research noted that "it takes two hands to clap" and that if the United States did not have a large current account deficit China could not have a large current account surplus. She stressed that both sides need to work together to reduce imbalances between savings and investment, BEIJING 00001308 003 OF 004 though the needed structural policies would take time. ¶10. (SBU) One commission member said that China was violating its IMF obligations by manipulating its currency. Zhao responded that many countries have rigid exchange rate regimes, there was only a consensus in the last few years that the RMB was misaligned, and that the rate of appreciation had picked up. IMF Unfair Regarding Best Practices, Transparency -------------- -------------- ¶11. (SBU) When the CIC was founded Premier Wen established 3 principles for the organization: be transparent and responsible for shareholders, be responsible to markets, and obey laws of recipient countries. This, Gao stated, is consistent with draft IMF principles on SWFs. The IMF, however, needs to be careful not to push too aggressively. The Chinese public see the IMF suspiciously - a "tool of U.S. imperialism." Its policies are directed at singling out specific countries. If the codes of conduct are going to be voluntary, the IMF should support quietly an SWF-led process, and not take a leading role. More broadly, Western countries should give CIC time. The CIC, he emphasized, is only six months old, and it took Singapore and other SWFs twenty years until they achieved transparency. "If you push too hard it will backfire", he added. Mixed International Reaction to CIC -------------- ¶12. (SBU) The British are dealing with the CIC better than the United States, according to Gao, focusing more on quietly addressing practical concerns and less on high-level POLITICAL debates. This is more productive than talking at the Ministerial level and the "see a yellow face and get them out" attitude Gao sees in dealing with the U.S. The French have been "hostile" and wanted CIC to agree to organizational changes in their bilateral communiqu during Sarkozy's visit, which CIC refused. Sarkozy is going back forth on the issue of CIC's investment in France, he added. Germany's Merkel appears to be changing her mind in response to German businesses' desire to do large deals. ¶13. (SBU) CIC frequently consults with Norway's sovereign wealth fund. Relaying their experience, Norwegian representatives noted that CIC is on the right path and that criticism will wane once other countries are more familiar with CIC's leadership and operations. Gao repeatedly questioned why the United States is focusing on unrealized fears. There is a natural tendency for SWFs to go to more welcoming countries, he added. Corporate Structure, Governance, and Remuneration -------------- -------------- ¶14. (SBU) An eleven member board oversees the CIC which includes: five current government officials (Two Deputy Governors of the PBOC (including the Chair of SAFE),and Vice Ministers from the NDRC, Ministry of Commerce and Finance); three Executive Directors (the Chairman, General Manager and a Senior Vice President); two Independent Directors (retired Minister of Finance Xiang formerly Chair of the National Social Security Fund and Wang Xincheng, former Vice Chairman of the NDRC); and one representative of the working staff - a mid-level manager. They meet a mandatory minimum of once per year but convene "from time to time". ¶15. (SBU) Major policy decisions are made by the seven member Executive Committee which is BEIJING 00001308 004 OF 004 comprised of the Chairman, General Manager, Senior Vice President, Chairman of the Supervisory Board, CIO, Deputy CIO, and Chief Risk and Finance Officer. Other organizational structures include an International Advisory Board whose membership has still not be finalized and an Investment Committee which includes the Chairman, General Manager, Chair of the Committee and mid/front-line managers making specific investment decisions. ¶16. (SBU) Salaries are based on the performance of the fund, however, general policy documents issued by the State Council limit compensation, which has been a major impediment to attracting investment professionals. The salaries of the top seven executives are determined by the State Council and are not related to the public sector pay scale. However, senior compensation is limited due to Premier Wen's concerns about public criticism of excessive salaries before CIC had established a successful track record. While salaries should be generally market-based, they should "not be a major contributing factor between rich and poor." Salary increases should be a little less than the fund's profit margin and executive pay raises should not increase by a much higher rate than the general worker's salary increase. Gao noted that Singapore's SWF executives had very low salaries for the first 8- 10 years. ¶17. (U) The delegation has reviewed and cleared this cable.