SPEAKING FREELY China risks caution overkill after Bear prudence
By Sebastian F Bruck
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When over 80 years of Wall Street history came to a crashing end with the
demise of Bear Stearns on March 17, the shock waves of bankruptcy reached as
far as Xinyuan Nanlu, Beijing. There, on the 9th floor of the Capital Mansion
building, executives of CITIC Group immediately decided that there was no point
in throwing good money after bad.
In October 2007, CITIC Securities, a brokerage controlled by CITIC Group, and
US investment bank Bear Stearns had agreed a seemingly visionary mutual
shareholding deal. Under the terms of
the agreement, CITIC Securities would have taken a 6% stake in Bear Stearns for
about US$1 billion, while the latter would in turn have taken a 2% stake in
CITIC Securities, also valued at $1 billion.
As a result of the transaction, CITIC seemed set to expand its global reach
while picking up valuable deal-making skills along the way; meanwhile, Bear
Stearns hoped to boost its already flagging fortunes with unprecedented access
to China's booming capital markets.
Five months later, things looked a little different for Bear Stearns following
misjudged subprime market adventures and facing a lack of liquidity. JP Morgan
Chase, aided by the US Federal Reserve, was bound to fetch the whole of Bear
Stearns for a mere $236 million in a speedily arranged fire sale that implied
paper losses of about $985 million for CITIC Securities if its own deal with
the Americans had gone ahead as scheduled. As sensible bankers, CITIC's leaders
went for the natural solution, balked at the investment and pulled out of the
negotiations.
What could appear as an isolated tale of a merger and acquisition (M&A)deal
gone bad might yet spell greater significance for the future evolutionary
course of China's financial markets. To appreciate this point, a bit of history
is necessary.
Following the onset of "reform and opening up" in 1978, China essentially
operated a so-called universal banking system under which its nascent
commercial banks, investment banks and trust and investment companies were free
to invest in each-other's areas of business, merrily mixing deposit-taking,
lending and capital markets-related activities.
This messy state of affairs only came to an end following a massive asset-price
bubble and inflationary episode in the mid-1990s. Given inflation rates of
above 20%, China's first Commercial Bank Law, enacted in 1995, clearly drew a
line between commercial banking, investment banking and insurance, thereby
forcing numerous banks to divest their trust and investment divisions and
subsidiaries and stemming the excessive flow of savings into speculative
activities. Subsequent legal initiatives, such as the 1998 Securities Law,
further reinforced this regulatory approach of "separated banking".
Strategy undermined Right from the start, however, China's cautionary financial sector
strategy was being undermined by market players. Four trends in particular
combined to challenge legal orthodoxy: first, there was outright non-compliance
with the new laws and regulations. For example, Chinese state-owned commercial
bankers, prodded on by local government officials concerned about growth in
their localities, dutifully continued lending to and operating trust and
investment companies.
Furthermore, legal loopholes remained open for banks to cross over into capital
markets. Bank of China, for instance, concentrated its investment banking
operations in Hong Kong while Industrial and Commercial Bank of China engaged
in less contentious brokerage business such as M&A advice at home.
Third, outright legal exceptions to the norm of separated banking existed. In
one prominent case, China Construction Bank was allowed to go ahead with its
planned investment banking subsidiary China International Capital Corporation,
jointly run with America' s Morgan Stanley. Too much reputational capital had
already been invested in this venture on the international stage to pull the
plug on it following adoption of China's 1995 Commercial Bank Law. No doubt the
fact that former Chinese premier Zhu Rongji's son worked for China
International Capital Corporation and US Vice President Dick Cheney acted as a
lobbyist for Morgan Stanley also helped to keep the company in business.
Finally, and most important, China's new financial sector strategy was
gradually being undermined by the demands the country's new economy placed on
the nation's banks in the 21st century. In a country that was since 2001 part
of the World Trade Organization, companies were hungry for capital to expand
both domestically and internationally while consumers were increasingly keen on
attractive savings and investment opportunities to make their newfound wealth
work for them.
Faced with foreign competition on their home turf, banks themselves were
clamoring for more business. Given these developments, it only seemed natural
to once again give banks more freedom of maneuver to service the economy's
various needs, especially since their risk management capabilities appeared
stronger than ever following international stock market listings and strategic
investments by foreign financial institutions.
Almost a decade after the adoption of the Commercial Bank Law, the Chinese
state and its regulators also felt more equipped to take on financial risk than
they had in the past. After all, the regulatory apparatus had been
restructured, carving out separate specialist agencies in charge of overseeing
banks, securities firms and insurers. In addition, regulators had also invested
in boosting the skills of their employees, for example by promoting cooperation
with regulatory bodies from abroad.
The stage was thus set for important changes to China's Commercial Bank Law in
2003 and Securities Law in 2005. These allowed for greater cross-sectoral
investments by banks and securities companies, later accompanied by changes
that phased-in competition between banks and insurers.
At the same time, following the endorsement of such a move by the 5th Plenum of
the Chinese Communist Party's 16th Central Committee in 2005, "trial financial
holding companies" including CITIC, Everbright and Ping An Insurance began
combining different financial business lines under one organizational roof.
Bulging war chests In a natural extension of China's changing approach to regulating its
financial sector, the country's largest financial institutions in the 21st
century also started venturing abroad in their quest to tap into new growth
areas. Consequently, with war chests bulging from their initial public
offerings and/or China's massive foreign exchange reserves, in 2007 alone
Chinese financial institutions acquired equity stakes in Britain's Barclays
(China Development Bank), South Africa's Standard Bank (Industrial and
Commercial Bank of China), Belgian-Dutch financial group Fortis (Ping An) and
US private equity group Blackstone (China Investment Corp).
CITIC Securities' move for Bear Stearns also fell into this category of
business line expansion coupled with increasing geographical reach. The deal's
dramatic cancellation as well as problems with other such ventures (the
investments in Barclays and Blackstone have led to significant losses for the
Chinese side) may induce renewed caution on behalf of Chinese policy-makers,
regulators and bankers when it comes to loosening the rules governing the
permissible business scope of the country's financial institutions.
The fact that the pernicious effects of the subprime crisis will be around for
a while only adds to this new cautious attitude. While caution is definitely in
order in the brave new world of securitisation finance, a return to the world
of rigid financial sector compartmentalization would not be in the best
interest of China and the global financial system.
For one, unnecessarily strict regulation would make it harder and more
expensive for Chinese firms and consumers to satisfy their increasingly
sophisticated financial needs. At the same time, Western banks and securities
firms are in greater need than ever of capital infusions from countries with
savings to spare. Let's hope it takes more than a wounded bear to scare off a
dragon.
Sebastian F Bruck, who has studied in Oxford, London and
Taipei, recently completed his PhD in Financial and Management Studies at the
School of Oriental and African Studies, University of London. He works for an
international strategic consulting company.
(Copyright 2008 Sebastian F Bruck.)
Speaking Freely is an Asia Times Online feature that allows guest writers to
have their say.
Please click hereif you are interested in contributing.
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