April 15,2008

China Should Press for Wider Openness to US Financial Industry

By Ma Wenluo

While China has followed its promises to widen access to its financial markets with actual steps in that direction, it seems the US, and Europe also, is doing just the opposite and becoming increasingly protective. China is allowing its commercial banks to invest in the US stock market via QDII products, and the China Banking Regulatory Commission (CBRC), in a new policy draft, is readying to loosen the limits for foreign control over Chinese commercial banks. The US Congress, on the other hand, is working to reinforce control over foreign investment in the US financial and "strategic" industries, while the IMF, under US and EU domination, is intensifying its supervision over sovereign wealth funds (SWFs).


On March 20th,the U.S. Treasury Reached an agreement with Singapore and Abu Dhabi on investment principles for sovereign wealth funds. "SWF investment decisions should be based solely on commercial grounds, rather than to advance, directly or indirectly, the geopolitical goals of the controlling government.  SWFs should make this statement formally as part of their basic investment management policies."

Meanwhile, Barney Frank, chairman of the House Committee on Financial Services, has requested Treasury Secretary Henry Paulson to conduct investigations on SWFs, and press the IMF and the OECD to develop voluntary best practices for them. And the Committee on Foreign Investment in the United States (CFIUS), an interagency government committee chaired by the Treasury Secretary and charged with reviewing any foreign direct investment that might raise national security concerns, is to release a policy this month, allowing investigations of foreign acquisitions of equity in American enterprises amounting to less 10%. Until now, any investment under 10% has not required examination. In February this year, several senators appealed to the Bush administration to examine every investment in American firms by a foreign government fund, "no matter how small it is." 

This will certainly apply to the China Investment Corporation (CIC), China’s official sovereign wealth fund, but it is becoming clear that CIC is not seen to be China’s sole SWF. Former Assistant Secretary of the Treasury Edwin M. Truman,a senior fellow at the Peterson Institute for International Economics and the author of A Strategy for IMF Reform, in an April, 2008, article on the IMF’s website titled "A Blueprint for Sovereign Wealth Fund Best Practices," mentions not only CIC but also Shanghai Financial Holdings, operator of a fund of the city’s assets totaling $201 billion, and China’s National Social Security Fund, an $81 billion pension fund. If SWF best practices are implemented, such funds controlled by central or local governments may encounter obstacles when trying to invest in "open" overseas markets. And these and the true SWFs will not be the only victims, as other minor equity investors will also be affected. More investments will be examined with the examination process becoming longer. Any investment coming from China may well be suspected to be of government origin and hit barriers. Huawei’s failed bid for 3com is a good example. If Shanghai Pudong Development Bank, a listed company and subsidiary of Shanghai Financial Holdings, attempts to invest in the US, it may also suffer troubles due to its "SWF" background.

CIC has responded. Deputy general manager Wang Jianxi thinks that SWFs are not being fairly treated and insists that CIC is one of world’s most transparent SWFs, while CIC president Gao Xiqing told 60 Minutes, a heavily watched US TV news program, that erecting codes for SWFs was "politically stupid."  He said that CIC does not intervene in the daily operations of Blackstone, Morgan Stanley or JC Flowers & Co, in each of which it has stakes.

China’s financial supervisory departments are not seeking to retaliate. During US Treasury Secretary Henry Paulson’s most recent visit to China, CBRC and the US Securities and Exchange Commission signed a memorandum, according to which Chinese commercial banks and fund companies are allowed to invest in the US market, making the US the fifth investment destination for Chinese QDII products. Last week, the CBRC released a draft of "Rules Governing Bank Controlling Shareholders," a big gift for Paulson. In this proposal, which states no definite limits for the percentage of overseas shareholdings in Chinese banks, it is perhaps paving the road for foreign investors seeking to take control of Chinese banks.

These new rules have triggered their own protectionist concerns among Chinese analysts, but CBRC explained that the limits for foreign share holdings will not completely disappear. According to China’s Commercial Bank Law and Banking Supervision Law, any shareholder, domestic or overseas, with over a 5% stake in a Chinese bank must be examined and approved by the CBRC. Some analysts believe the new provisions are still too simple. Dr. Yu Yunhui, guest professor of the Department of Finance, Xiamen University, thinks the rules, by which "overseas financial institutes must meet the supervisory requirements of their home countries," actually defers to overseas financial supervisory authorities while the rulings of Chinese authorities are not accepted in the US.  Zhang Hongliang, professor of the Central University for Nationalities, who is also angry at the CBRC’s draft rules, commented that this file would make China "the first country in the world to cede economic and financial control in the globalization process".

China should have the right to say, "Wait a minute!" China has always looked to the discussion on long-term cooperation and development during the Sino-US Strategic Economic Forum (SED) to solve mutual problems, but each time the US moves the goalposts. With the opening of China’s financial industry and RMB appreciation on the way to meeting US demands, the US has now moved away to strategy issues. Treasury Secretary Paulson, rather than discuss opening US financial markets, gave a speech in China as chairman of the Nature Conservancy about environmental protection, and said the fourth SED should focus on sustainable economic growth.

But this time it is China that is asking the US to increase the transparency of its financial supervision, just as the US has done with China, and the US should look to its newly agreed US/Singapore-Abu Dhabi principles for SWFs, which raise requirements for recipient countries as well as investors: "Countries receiving SWF investment should not erect protectionist barriers to portfolio or foreign direct investment. Recipient countries should ensure predictable investment frameworks. Inward investment rules should be publicly available, clearly articulated, predictable, and supported by strong and consistent rule of law. Recipient countries should not discriminate among investors." China requires that similar agreements should also be agreed upon between China and the US as soon as possible. Meanwhile, China should ask the US to step up the information exchange between the two parties and keep China up to date on the details of Secretary Paulson’s reforms of the financial supervisory system so that China will have the time to evaluate their influence.  

China has a strong desire and an interest in investing in Wall Street, which so far has shown no reluctance to take its money, but the US government continues making promises instead of making moves. A clear schedule should be established. The door to the US financial market is ajar, in terms of stock market and fund investment. But China is anxious to gain access to equity investment in American companies, and that seems to be getting increasingly difficult. Regarding Shanghai Financial Holdings as an SWF is a good example.  It clearly operates for the financial benefit of the city, and its subsidiaries such as Shanghai Development Bank are completely public companies.  It is doubtful that it conducts much of China’s foreign policy.

China has complained that the US examination process for Chinese commercial banks drags on too long, and the US has responded that it was aware of the problem, but no progress has been made. Before China submits to the supervisory standards and opinions of the US, which it is planning to do, perhaps it should also ask the US to submit to CBRC standards and opinions. If the US refuses and obstructs the entry of Chinese banks, it would be reasonable for China to refuse to accept any US supervisory opinion letter according the principle of "reciprocal opening".

China’s banks are awash with cash and not crying out for US investment. If US investors wish to get into the Chinese financial industry, maybe China can "reciprocate" with high fees, long waits and minute examinations, or pass laws like those in the US, according to which controlling American banks or setting up branches should be approved by the state government, the Federal Reserve, the Federal Deposit Insurance Corporation, and even Congress.  Investors would scream, of course, but that might just attract the attention of US officials.

 "China should also set fire walls of different levels," suggests Professor Yu Yunhui. "The one-channel opening-up aiming to attract overseas investment should be reconsidered." Yu believes that policies on the opening of China’s banking industry should help to create a "reciprocal opening" situation.



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