CHINESE BUSINESSMAN ON CIC IN THE U.S., HONG KONG

C O N F I D E N T I A L SECTION 01 OF 02 BEIJING 000397

SIPDIS

STATE FOR E/YON, EAP, EAP/CM
TREASURY FOR OASIA/DOHNER/WINSHIP
NSC FOR LOI

E.O. 12958: DECL: 02/17/2034
TAGS: EFIN ECON EINV PREL CH HK
SUBJECT: CHINESE BUSINESSMAN ON CIC IN THE U.S., HONG KONG
DOLLAR PEG, RUSSIAN INVESTORS, AND PRIVATE EQUITY

Classified By: Economic Minister-Counselor Robert Luke; Reasons 1.4 (b
and d)


1. (C) Summary. The China Investment Corporation (CIC),
China's sovereign wealth fund, remains interested in pursuing
additional investments in the U.S., although not in the
financial sector, according to Charles Liu, a well-connected
Chinese private equity firm manager in Beijing. CIC Chairman
Lou Jiwei, who will visit Washington February 17-20, and some
senior Chinese officials remain troubled by CIC's
unsuccessful 2008 attempt to purchase a 49 percent share of
the U.S. bank Morgan Stanley and believe then-New York Fed
President Tim Geithner may have prevented that purchase. Liu
also claims that high-level Hong Kong officials are
considering shifting the Hong Kong dollar's peg from the USD
to a "greater China"-centered basket of currencies, possibly
with a 40% weight for the RMB, but China's State Council is
reluctant to approve such a change out of concern it would be
viewed as a "slap in the face" to the new U.S.
administration, and also could precipitate a decline in the
U.S. dollar. Liu said Russian investors currently are
exploring various large investments in China, in part due to
deterioration of the Russian economy. The Chinese Government
is taking a cautious approach to development of the private
equity sector, but remains committed to developing private
equity as an alternative to bank lending and a way to improve
corporate governance. End Summary.


2. (C) On February 6, 2009, Financial Minister-Counselor and
Econ Officer met with Charles Yang-Sheng Liu, the founder and
manager of Hao Capital, a Chinese private equity firm that
invests in companies in China. Liu claimed his firm manages
approximately USD 700 million in assets. He previously
worked as a senior advisor to various large international
corporations and was managing director of Lazard Asia Ltd.
from 1993-99. From 1975-90, Liu was employed in various
capacities in the United Nations system. He was born in
Taiwan, moved to the U.S. at age 10, and attended Princeton
(B.A.) and NYU School of Law. In 1975, he relinquished his
Taiwan passport and U.S. permanent residency to become a
citizen of the PRC.

China Investment Corporation
--------------

3. (C) Commenting on CIC's inner workings, Liu said CIC
Chairman Lou tends to focus more on relations with the PRC
State Council, while CIC President Gao is more active in
structuring deals. Last year, however, Lou was interested in
arranging the purchase through a consortium of a 49 percent
share of the U.S. bank Morgan Stanley (MS). Hao said the
impression now in Chinese financial circles is that the deal
was nixed by then-President of the New York Federal Reserve
Bank Tim Geithner. According to Liu, there are reports among
Chinese officials that Geithner reportedly said that having
"funny money" own 49 percent of MS was not acceptable. Lou
and CIC still want to use CIC investments as a way to promote
good U.S.-China relations, and his trip to the United States
is to help CIC decide both the country and sectoral
allocations of CIC assets. Lou is very cautious about
further investments in the U.S. financial sector, due to
CIC's heavy losses on previous investments (and Chinese
public criticism of those losses),as well as what he regards
as the hostile regulatory environment to Chinese investment
in that sector. During his upcoming U.S. visit, Lou will
travel to New York to explore additional CIC placements in
third party funds, particularly mutual funds.

Hong Kong: Dropping the USD Peg?
--------------

4. (C) Liu said high-level Hong Kong officials, including
from the Hong Kong Monetary Authority, in consultation with
mainland officials, are considering shifting the Hong Kong
dollar's current peg from the USD to a "greater
China"-centered basket of currencies, possibly with a 40
percent weight for the RMB. He said Hong Kong officials are
reconsidering the merits of tying their monetary policy to
the Federal Reserve; they are struggling with the effects of
the global economic downturn, while also trying to contain
excessive growth in liquidity as risk-averse investors are
pulling their funds from other Asian emerging markets, such
as South Korea, and placing them in Hong Kong. According to
Liu, however, China's State Council is reluctant to approve
any change in Hong Kong's exchange rate system out of concern
it would be viewed as a "slap in the face" to the new U.S.
administration and could precipitate a decline in the U.S.
dollar. China's senior leaders want to assess President

BEIJING 00000397 002 OF 002


Obama's China policies and actions before taking any actions
that could be viewed as undermining the U.S. If the U.S.
adopts trade protectionist policies or other anti-China
measures, however, the Chinese Government would have numerous
tools for response, according to Liu.

Russians Want to Invest in China
--------------

5. (C) Liu said that as the Russian economy deteriorates,
Russian investors currently are exploring various large
investments in China. For example, one group recently
offered to buy a 51 percent share in a Chinese steel mill,
but were told China does not allow foreigners to hold
majority stakes in steel producers. Now, the Russians want
to buy 49 percent. Liu described these and other Russian
investors as "very scary, because they're all KGB."

Private Equity: China Cautious
--------------

6. (C) Liu said the Chinese Government is taking a cautious
approach to development of the private equity sector, as it
believes the first wave of foreign private equity investment
firms in China were not successful. This in part was because
they relied upon foreign and/or young oversees-educated
Chinese staff to manage their operations in China; neither
group understood the Chinese market well. Nevertheless, the
government is committed to developing private equity as an
alternative to bank lending and a way to improve corporate
governance (through large commercially-oriented strategic
investors). The large state-owned private equity firms
established to date have been set up primarily to fund
specific projects: in Guangdong Province for the nuclear
power industry, in Sichuan for electronics, etc. For each
firm, approximately 80 percent of its funding is for use in
the specified projects, while the remaining 20 percent is for
"dabbling" in other investments. Liu said two provincial
funds have out-sourced asset management to his firm.


7. (C) Liu said that weakness of the Chinese stock markets
has essentially stopped IPOs, an important vehicle for
private equity firms to exit out of these investments.
However, the decline in share prices has also reduced the
cost of "back door listings" in which his company has
actively bought "shells" (low-priced listed companies with
few assets) in Shanghai. He injects new assets into the
shells, then issues more shares. Getting regulatory approval
for the issuance of new shares, as opposed to IPOs, is much
easier and these "back door listings" have proven to be
highly profitable.


8. (C) Finally, Liu said there has recently been a notable
increase in demand for Qualified Foreign Institutional
Investor (QFII) quotas, with some investors now again willing
to pay a premium. This is because U.S. and other foreign
investors have become increasingly concerned about the market
impact of large-scale issuance of government debt and see
RMB-denominated investments, given their expectations of
likely RMB appreciation over the long-term, as a means or
preserving capital.


9. (C) Comment: Although this was our first meeting with him,
Liu appeared highly knowledgeable on a broad range of
financial issues in both the U.S. and China, and frequently
referred to business and/or personal relationships with
prominent Chinese and foreign people. The primary purpose of
our meeting with Liu, held at his request, was to discuss the
scheduled February 17-20 visit to the U.S. of China
Investment Corporation (CIC) Chairman and CEO Lou Jiwei. Hao
said he has been advising Lou "on a personal basis for ages"
and said he wanted to meet with us prior to his scheduled
meeting with Lou. With Lou scheduled to meet Secretary
Geithner and other senior USG officials in Washington
February 18-20, his comments regarding Chinese perceptions of
Secretary Geithner's alleged role in the proposed CIC
investment of Morgan Stanley are interesting.
PICCUTA