HONG KONG - On December 18, 2003, China
Life Insurance, China's biggest life insurer,
scored what should have been a huge triumph: a
listing on the New York Stock Exchange for US$3.5
billion in American Depositary Receipts (ADRs). It
was the biggest initial public offering (IPO) of
the year, a symbol of what the new China, freed
from its socialist shackles, was about to become.
The unintended consequences of that
listing are still being felt: it inadvertently
turned Hong Kong into the
financial capital of Asia. But China Life's
triumph turned to disaster when the country's
National Audit Bureau forced
the insurer to admit that its state-owned parent
had committed "accounting irregularities" worth
$650 million, spawning a massive shareholder suit
by foreign investors and a probe by the US
Securities and Exchange Commission into fraud and
misstatements in China Life's prospectus prior to
listing.
Since the China Life debacle,
corporate China has conspicuously pulled back from
the "Big Board" in New York. Since the start of
2004, only two major companies - the fixed-line
telecommunications provider China Netcom Group and
Semiconductor Manufacturing International Corp -
have listed there. Last week, the Bank of China,
the country's third-biggest bank, announced it was
seeking regulatory approval for an US$8 billion
listing - in Hong Kong, not the United States.
With the domestic Shanghai and Shenzhen
markets remaining moribund, capital-hungry
companies have flooded instead into the Hong Kong
Special Administrative Region (SAR). But if the
past is any prologue, that shift spells danger for
investors. At some point, the confluence of
Chinese companies with no semblance of rigorous
corporate governance and the torrent of money
pouring into Hong Kong is going to spell disaster.
But not yet - though in mid-April, foreign
investors showed signs of backing away from Asian
markets as they soared to a 16-year high,
stretching valuations to their highest levels
since the dot-com bust of 2000. Last year, Hong
Kong edged out Japan to become the top-ranked
market in Asia for capital raised, and was ranked
fourth worldwide, at US$37.8 billion. In terms of
market volume, Hong Kong ranked second in Asia and
eighth in the world, with turnover at a record
HK$4.5 trillion (US$580.3 billion) and market
capitalization rising to US$1.05 trillion, up 20%
over 2004.
Until last week, hot money, the
funds that slosh from one side of the planet to
the other as investors move from one investment
arena to another for what they hope is high
short-term gains, has moved into Hong Kong as if
1997, the year of the Asian financial meltdown,
had never happened, nor the dot-com bubble that
followed in 2000. On April 5, the Hang Seng Index
rose by 331 points as institutional investors,
many from the Persian Gulf oil states, poured into
the market.
Since 2000, the Gulf countries
have accumulated more than US$1 trillion in oil
revenues. Arab-world outrage after public and
political sentiment in the United States forced
the United Arab Emirates-owned DP World to
transfer its US ports operations to an
as-yet-unformed US entity has reportedly resulted
in the diversion of huge amounts of petrodollars
from the United States into other markets. Hong
Kong has been a particular beneficiary.
Some analysts question the wisdom of
several of the investments. As an example, says
the head of sales for a Dubai-based global
investment fund, look no further than Hunan Nonferrous Metals
Co, an obscure Changsha-based metals producer that
listed in Hong Kong on March 21. Its 1.09 million
shares were oversubscribed 701 times, with Hunan
raising US$227.5 million in new funds.
The
oversubscription "is indicative of the huge
amounts of liquidity pouring into the market", the
Dubai sales trader said. Nor, he said, is the
phenomenon limited to Hong Kong. Markets across
the world are at five-year highs as traders pour
too much money into too few stocks.
The
Chinese companies aren't choosing the Hong Kong
market because of its geographical proximity. Most
don't dare list in the US. Their bete noire
is Sarbanes-Oxley, a US law named for its
architects, Senator Paul Sarbanes and Congressman
Michael Oxley. The reform legislation was passed
by the Congress in 2002 in the wake of the massive
Enron meltdown and other scandals that crashed the
US markets.
Sarbanes-Oxley, now known as
SOX, requires strengthening corporate governance
by corporations seeking to trade on US exchanges.
Regarded as draconian by financial markets, SOX is
probably the most stringent law in the world
governing major capital markets. Among other
things, it requires company executives to accept
personal responsibility for any material
misstatements due to error or fraud. Boards of
directors, once the cozy preserve of the chief
executive officer's friends, must now be composed
of a majority of independent directors.
This is not something that China Life's
company officers, to their sorrow, apparently
considered on their way to the market. But the
officers of Chinese banks and other firms planning
IPOs took serious notice. Fortunately for them,
being blocked by generally accepted accounting
practices from listing in the US turned out not to
be much of a handicap. China's newly listing
companies simply dropped their US plans and listed
in Hong Kong, where a flood of foreign investors
found them anyway.
Mind you, Hong Kong
listings don't attract subscriptions as big as
they do in the US. But for most of those going to
market, getting there at all is fine. Given
China's notoriously poor corporate governance, the
cost of producing accounts that comply with US
accounting standards is prohibitive. Companies
must provide three years of year-end financial
data and in some cases five. Many of China's banks
simply don't have that information, and the ones
that do are rife with fraud. Cleaning up the
balance sheets of China's big four banks,
presumably the best of the lot, has taken years
and at least US$260 billion in recapitalization
from the central government. In addition, the four
asset-management companies set up to peddle dud
assets are selling off many of them for pennies on
the dollar.
As David Webb, a onetime
investment banker turned independent Hong Kong
financial gadfly, pointed out in an October
newsletter prior to the listing of China
Construction Bank, recapitalization efforts "have
taken all the bad loans out of the bank, but what
about the bad lenders? Do you really believe that
thousands of semi-autonomous branches have
suddenly discovered the art of credit analysis and
that the local Communist Party cadres and
bribe-waving wanna-be tycoons will leave them
alone to make good lending decisions?"
Webb, a non-executive director of the Hong
Kong Stock Exchange, said in an interview that
"the banks are not going to go sour straight away.
They will succeed in floating the Bank of China
this year, but it takes a long time for banks to
accumulate ... problems. They will make new loans
and later [these] will start to be recognized as
bad debts. You can expect an accumulation of bad
debts and a banking crisis in about five years."
China Construction Bank, characterized by
Webb and others as "China Corruption Bank" because
of the jailing of former chairman Wang Xuebing for
offenses committed when he was with the Bank of
China, listed last October. It was the largest IPO
in Hong Kong history, obtaining HK$71.5 billion,
or 43% of all the money raised in the SAR in 2005.
There are other ominous portents besides
the 1997 Asian financial meltdown and the bursting
of the 2000 dot-com bubble. Last year, Chen
Jiulin, the former head of China Aviation Oil
(Singapore) Corp, pleaded guilty to six charges of
fraud in a scandal that nearly sank China's
biggest jet-fuel trader, acknowledging that he had
failed to disclose a US$550 million trading loss
and deceived the company's adviser, Deutsche Bank.
It was Singapore's worst financial scandal since
the bankruptcy of Barings Plc caused in 1995 by
trader Nick Leeson, who cost Barings US$1.4
billion in trading losses.
Could the
soaring Hang Seng be ripe for a fall? Webb pointed
out that only about 20% of the companies listed in
Hong Kong are actually domiciled here. "For the
new ones," he said, "very few are [headquartered]
in Hong Kong. They are in Bermuda or the Caymans
or [mainland China]."
Of course, systemic
problems can be addressed. But is there any reason
to believe that Hong Kong's regulators would be
better at doing this than those elsewhere? Enron
went under in the US in 2001. It has taken five
years to get Kenneth Lay, Enron's former chairman
and CEO, and Jeffrey Skilling, his successor, in
the dock, but they are finally there. Would
corrupt company officials go into the dock in Hong
Kong?
The SAR's regulators, never that
strong in the first place, have always had a knack
for placating the markets. On March 26, Webb
pointed out, the exchange scrapped a requirement
for listed companies to disclose large accounts
receivable, which could have warned investors
about impending disaster.
"Dressed up as a
'minor and housekeeping' rule amendment without
consultation, the change is illustrative of the
urgent need to increase investor representation on
the Listing Committee, to produce pro-investor
policy reform," Webb wrote.
So at some
point, with 80% of the newly listed companies on
the Hong Kong market domiciled overseas, the SAR's
regulators are going to have an interesting time
catching up with them if and when yet another
bubble bursts.
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