March 10,2008

China's Capital Outflow: Facing Political Risks and Learning the Ropes

By Ma Wenluo
With abundant assets to support them, enterprises such as the China Investment Corporation (CIC), China’s sovereign wealth fund, and now the State Development and Investment Corporation (SDIC), both directly administrated by the Chinese government, are attempting to purchase large-scale assets overseas, and are raising tension among administrations and legislatures in target countries, afraid that such purchasing, helped along, maybe, with generous funding from Chinese state-owned banks, might not be so much market behavior as they are strategic moves by the Chinese government, and thus may constitute threats to their national security.
 
CIC was launched this last October with funds totaling $200 billion to invest, mostly in international markets. The SDIC is both a new kid on the block and a long-time presence. Set up in May, 1995, to invest in domestic hi-tech projects and fundamental industries, and now holding assets totaling $20 billion, it’s launching its new strategy, focusing in the next five years on overseas financial investment. 
 
And these two are not alone. Other Chinese enterprises are accelerating the pace of their own overseas investments. Since the beginning of March, several companies have made moves. China Minmetals Corporation, a large international metals, minerals and electrical products production and trading group, established a steel company in India jointly with Xinxing Pipes Group, another big state-owned enterprise. Guangdong Yuedian Group Co., Ltd., a power supplier, bought into Whitehaven Coal, Ltd., based in Australia. And The Bank of Communications, China’s fifth largest commercial bank, has declared plans for a greater push in its overseas business expansion in 2008.
 
Political risks to China’s capital outflow
 
But lately there has been some push back. Since 2005, both the bid of China National Offshore Oil Corporation (CNOOC) for Unocal Corporation, a US oil firm, and Huawei’s joint bid with Bain Capital Partners for 3Com, a US telecoms company, have been blocked. The US-China Economic and Security Review Commission held a special hearing and suggested that Congress pay special attention to any investment from Chinese enterprises that may have implications on national security or key industries. Some senators even appealed to the Bush administration to examine every investment, "no matter how small it is," in US enterprises by funds established by foreign (read "Chinese") governments.
 
China is now set to reevaluate political risks in the US. After the rejection of Huawei’s bid for 3com, the Chinese Ministry of Foreign Affairs appealed to the US government to treat this deal in a fair and equitable manner. And earlier, in June, 2007, Li Rongrong, Director of the State Assets Supervision and Administration Commission of the State Council (SASAC) told US Deputy Treasury Secretary Robert Kimmitt during talks that CNOOC was the most marketized firm among all of China’s state-owned enterprises (SOEs), and that China was shocked when its attempt to takeover Unocal, hardly a major US oil asset, was rejected. Mr. Kimmitt responded that CNOOC was jointly responsible for the failure. Both the Chinese government and the company should have explained well in advance to the US Congress the company’s marketized operation and the openness of China’s energy industry. He suggested that Chinese enterprises should more fully communicate with US embassy and consulate economic officials, American councilors and local governments before trying to acquire Amercian companies, and thus build a solid foundation for their acquisitions.
 
SASAC pushing its market players "to use dollars"
 
SASAC, the supervisor of 152 Chinese SOEs, plays the role of investor on behalf of the state. Its responsibility includes guiding and pushing reforms and restructuring of SOEs, advancing the establishment of modern market systems and appointing, evaluating and removing leaders according to laws and regulations. SASAC usually fulfills its duty at arm’s length, mostly by requiring enterprises to formulate their own decision-making procedures and management systems rather than by intervening in the detailed operation of each enterprise. Xiao Yaqing, general manager of Chinalco, Chain’s largest aluminum and alumina producer, which has just bought a 9% stake in Rio Tinto jointly with ALCOA, said that Chinese firms?overseas investment must certainly be approved by government departments due to exchange control policies. But the SASAC, he says, seems to have only two requirements. First, do things in line with economic laws. Second, manage risk. " ‘If you can stand the risk, do it. If not, don’t.?All I have heard are these two sentences."
 
According to regulations of the National Development and Reform Commission (NDRC), enterprises will make independent decisions on overseas M&A projects in which the Chinese party invests less than $30 million, though they must submit related files to the NDRC for the record. Investment over this limit must be approved by the NDRC. The Ministry of Commerce will evaluate these investments according to the investment environment and security situation of target countries in order to safeguard state-owned assets and the legal rights and interests of these enterprises. As for the economic and technological feasibility of such overseas investment, investors need to act on their own judgments.
 
SASAC released a statement in January, 2008, on the dispute between China Eastern Airlines (CEA), which wants to bring in a major investment by Singapore Airlines, and China National Aviation Holding Company, in which it maintained only two points: "First, we support central enterprises introducing overseas strategic investors. Second, enterprises should be operated independently in line with market principles." SASAC stressed that all SOEs should consider bringing in strategic foreign investors, according to market principles, but that this was a decision for shareholders to make for themselves.
 
SASAC focuses on maintaining and enhancing the value of state-owned assets. With the income of central enterprises totaling almost RMB1 trillion, and a ton of foreign exchange reserve, Li Rongrong requires that central enterprises expand their overseas business, cooperate with overseas companies and allocate resources on a global basis. "We must learn to use dollars," he says.
 
Chinese enterprises mainly use their own funds for their overseas investments. Government departments approve such investment plans according to the financial situation and asset liability ratio of the enterprise. After China’s commercial banks have all finished their reform and gone public, their operation aims must be to maximize the interest of investors, including overseas share-holders. It will be impossible for them to disregard risks in support of overseas expansion of SOEs.  As a policy bank supporting China’s foreign trade, the Export-Import Bank of China allocates annually a certain amount of funding to support key overseas investment projects encouraged by the government. In 2006 its loans to overseas construction contracts and investment projects totaled RMB28.781 billion, accounting for less than 17.5% of the $21.16 billion of China’s overseas direct investment that year. So the contention that the overseas investment of Chinese SOEs depends on generous fund support of commercial banks under the government’s thumb is a red herring. 
 
Safety-focused as it is, SASAC is confronted with more complicated risks for overseas direct investment compared with those it faces in the domestic sphere. It requires that firms should invest in projects related to their own business scope. Considering the investment risks the CIC has encountered overseas, SDIC general manager Wang Huisheng said its own overseas investment would start with infrastructure and resource assets, which the company is familiar with, in order to manage risk. Meanwhile, RMB appreciation and the spread of subprime turmoil are providing good opportunities in overseas investment for the Bank of Communications. "Given a proper chance, the Bank of Communications will purchase overseas assets and expand its overseas business while trying best to hold down country risks," said Jiang Chaoliang, chairman of the bank. HSBC, a gargantuan international bank and the Chinese bank’s second largest shareholder, actively supports this intention. The Bank of Communications intends to carry out its plan mainly by acquiring overseas assets and setting up more branches overseas. 
 
The government has also come to realize the role of local intermediaries in helping enterprises to manage risks when "going out," requiring enterprises to be familiar with the legal environment of target countries and to appoint local general legal counsel for the whole overseas negotiation process. The Ministries of both Commerce and Finance are encouraging the member companies of the Chinese Institute of Certified Public Accountants to accelerate their entering of the international accounting market to better serve "going out" enterprises.  A joint venture between COFCO, a leading grain, oils and foodstuffs import and export group in China, and Aon Corporation, a leading provider of risk management services, insurance and reinsurance, will provide investment consultant services for Chinese enterprises "going out" by using its global resource network.

 

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