China Finance

Presentation Outline

• Banking and non-banking Financial Institutions

• Trade Finance

• Project Finance

• Securities markets

Banking Structure

• People’s Bank of China Central bank of China--similar to US’s Federal Reserve System

• Specialized banks: (1) Bank of China, (2) Industrial and Commercial Bank of China, (3) Agricultural bank, (4) China’s Construction bank

• Commercial bank

• Foreign banks

People’s Bank of China (PBOC)

Duties:• Implement/administer laws relating to banks• Regulate currency• Formulate interest rate policy• Control credit -loans• Manage FX reserves• Monitoring of banking sectors (M&A etc)

Bank of China (specialized bank)Responsibilities:• All foreign trade and remittance transaction• International inter-bank transactions• FX and gold• International loan syndication• Government bond and securities issues• Foreign investments• Consultancy services to investment on-shore and

off-shore

Industrial and Commercial Bank of China (ICBC)

• Created in 1983• Accept deposits and loans to individuals and

companies• provide payroll management services for state

enterprises• Operate securities, trust and real estate business• Issue credit cards• Deal with FX matters in SEZs

Agricultural Bank of China

• Created in 1979

• 2 largest specialized bank

• Serve rural area for functions similar to ICBC’s functions in urban area

China’ s Construction Bank (CCB)• Created in 1954

• supervise and settle large scale finance of project

• regulate investment funds of state enterprises

• One of the 4 state-owned commercial bank that that control about 80 per cent of the banking business in China

• First state-owned bank to remunerate plan for performance-related bonuses (9/28/99)

– CCB president earns about $361 (monthly) under the current system

– allow the most senior bank executives to have salary six times that of the junior banker

China’ s Construction Bank (CCB)• China Construction Bank (teamed up with Xiangcai

Securities) has become the first mainland financial institution to offer securities-backed loans to stock brokerages (March 2, 2000)

• The bank offers the firms short-term loans secured by shares and securities investment funds.

• Traditionally, most brokerages illegally dipped into clients' funds to finance daily operations but a crackdown on the practice last year has left many firms strapped for cash.

Commercial bank

• The Communications Bank of China

• established in 1987

• support modernization of China

• Deal with both RMB and foreign currency deposits and loans

• Operate the securities market

Foreign banks• Foreign owned and joint venture banks are

allowed to operate in China since 1970s• Book loans denominated in foreign currencies• collect bills and remittances from overseas• discount foreign exchange bills• handle documentary credit arrangement• conduct credit checks• accept consulting engagement• offer safe deposit services

• The Bank of China agrees to provide renminbi loans to HSBC and Standard Chartered to bolster the business of the two British banks in the Chinese market (10/22/99 FT) -- as a good will by the Ziang Zemin’s UK trip

• The deals are expected to total Rmb 3bn ($362m) apiece, making them the largest such loans granted to foreign banks in China since the rules on funding lending business there were relaxed last summer.

• The deals should give the two banks an edge in the Chinese market because they will have more money to lend to corporate customers operating in China than their competitors, all of whom have faced difficulties raising renminbi in the local market.

• Foreign banks see lucrative opportunities in renminbi lending in China but are not allowed to take deposits from the public and may only lend Chinese currency to corporate ventures financed with foreign investment.

• The Chinese government agreed in August to allow foreign banks to raise large loans on fixed maturity terms direct from Chinese banks -- a very short term borrowing in the interbank market.

• But loans granted under the new rules have been much smaller than those now being made available to the British banks. For example, Bank of Tokyo-Mitsubishi raised only Rmb50m in one of the first such deals in August, 1999.

Privatization of Chinese Banks• Shenzhen Development Bank, a state-owned

development, first bank to list shares (IPO) on Shenzhen Stock Exchange after winning approval from the SEZ’s government in early 1990s

• Shanghai Pudong Development Bank,– established in 1993, focusing on project financing

– second state-owned bank to list shares (Shanghai’s stock Exchange) as 400 million (16.6% of its shareholding) A shares ($484 m) on Sept 23, 1999.

– First bank was approved with central government mandate to list shares

– for strengthening capital base and expansion

Privatization (continued)• China Minsheng Bank, another new regional bank, listed

on Shanghai Exchange on December 2000. It is China's first and only private bank and the third bank listed on exchanges. The eight-branch Minsheng is a relatively small bank, with assets of Rmb43bn and 1,800 employees.

• Other banks such as, China Merchants Bank and Citic Industrial Bank have shown in interest to raise public funds

• A handful of Chinese banks (Bank of Shanghai and Xiamen International bank) has foreign financial institutions as minority stakeholders. Now, Bank of communication (5th largest bank) is inviting two foreign financial institutions to be its 15 % holding to bolster its capital and management skills to meet WTO challenges

Shenzhen-based CMB has received approval from the China Securities Regulatory Commission (CSRC) to go public on the Shanghai stock exchange. CMB, the 4th bank to go public, is preparing for a road show to educate domestic investors about its A-share IPO (SCMP, 1/16/02)

• The country’s 4 major state-owned bank plan to swap the debt for equity in the underlying enterprises (to off-load the bad loans). The equity stake will then be sold to the market

• China Construction bank has begun the process

Asset Management Companies (AMCs)

• Such set up is a bold attempt to clean up the mess in its banking industry-- bad loans official estimate to be about 1.8 trillion Yuan or $220 billion-- some estimate to be US$1.08 trillion

• Cinda Asset Management Corporation, a registered capital of RMB 10 billion provided by the ministry of finance, was set up in April, 1999 to take over the compromised assets (non-performing loans) of CCB (RMB 220 billion)

• Cinda is funding via bond issues• Cinda uses debt-for-equity swaps strategy to alleviate

the interest payment for state-owned enterprises

• Cinda did a debt-for-equity deal (RMB 60 million) for Beijing Cement Plant.

• Beijing has launched an asset management company to take over bad loans held by the Bank of China. China Orient Asset Management (COAM) is the second such company to be set up as part of a drive to reduce banks bad debts. COAM, a registered capital of Rmb10bn ($1.2bn), would be allowed to sell stock and creditor rights as part of its efforts to raise funds to buy Bank of China's non-performing loans.– Dongfeng-Citroen Automobile Co (Wuhan-based joint

venture between Chinese and French care makers) convert part of its 12 billion Rmb ($1.45 b) debt into equity.

• City of Shanghai has also launched its first state-owned asset management company as part of state enterprise reform.

Asset

Management Affiliated Bad Loan Companies

company bank ($ billion) affected (e.g.)

Great Wall Agricultural $42.86 Hualu Electronic

Bank of China

Dongfang Bank of China $32.30 Jiangxi Phoenix

Optical Appliance

Cinda China Constr. $45.06 Beijing Cement

Bank and 5 other Plant

companies

Huarong Industrial & $49.17 Ernest & Young

Commercial Bank helps to sell bad

of China loans to foreigners

Source: 11/8/99 and 2/21/01 WSJ

• Huarong Asset Management has cleared up 15.06 billion yuan of non-performance as of July 2001. There were to debts sold to foreigners (road show in Europe and US) (5/10/01 FT). Debts are convertible into equity. The asset recovery rate was 31.7% while the Finance Ministry’s standard is 30%.

• A total of 16.6 billion yuan in loans were up for auction by Huarong. The consortium agreed to buy four of the five pools of assets (45% being loans collateralised by property and the remainder unsecured (11/30/01 SCMP). The Morgan Stanley-led consortium-- Lehman Brothers, Salomon Smith Barney and Chinese investors Zhongjin Fengde and KTH Capital Management, agreed to buy a 10.8 billion yuan (about HK$10.11 billion) portfolio of bad loans from Huarong.

• It is aiming to resolve 407.7 billion yuan. • $170 million loans were transferred into 4 AMCs• 30cents per dollar debt sale will be considered a

success.• Bank of China reports a higher-than- previously-

estimated figure. The bad debt ratio is 28% of its assets ($414 billion)- FT 5/14/01

Resistance to foreign Banks after WTO

• Foreign banks must have US$72.3 m in operating capital to conduct full services (higher than expectation)

• Only open a new branch a year

• Pricing out the foreign banks– Offering loans with low interest rate (even below LIBOR), e.g. BP syndicated

loans

– Direct lending by Chinese banks to foreign firms without using standby letter of credit from a foreign bank if the firm fails (a practice required by foreign banks)

• Central Bank requires financial institutions to maintain 60% of registered capital in local currency and demonstrate “a need” for an office. The rule force banks to disperse capital to individual branches rather than concentrating it at headquarters, boosting operating costs

• China’s 80 financial local institutions have announced plans to complete a national bank card network (costing $200 m) by 2005 to combat increased foreign bank competition. It aims to reach 40 cities. HSBC, Citbank and Bank of East Asia have given approval to offer foreign currency services to Chinese citizens in Beijing and Shanghai. Note: Ericsson incident– The Nanjing-based Ericsson joint venture (Swedish electronics company) reported to dump its Chinese banks in favor of Citbank because they cannot offer services similar to the US competitor. (3/28/02 FT)

Counter Strategies by foreign Banks• HSBC bought 8% stake in the Bank of Shanghai in 2001;

International finance corporation (private arm of World bank) bought stakes in Pudong Development Bank and the Nanjing city Commercial Bank.

• Investment in small Chinese banks allows up to 25% (which helps smaller Chinese banks for foreign capital).

• Four big banks are expected to lose 1/3 of their most qualified staff to foreign rivals, which offer better pay, bonuses and training opportunities.

• Foreign banks now has 5% foreign deposits, 20% foreign loans, and 40% export settlements. They target the big customers for the big 4 banks which derive their 60% profits form these 10% clients. The services include personal finance, credit cards, internet and telephone banking and consumer credit.

Bond Issue

• Big four banks plan to issue up to $48 billion bond sale to retail investors to boost the banks’ capital adequacy requirement of 8% by the end of 2002.

• Current corporate bond market is about rmb 12 billion.

• In 1998, ministry o finance issued Rmb 270 billion to re-capitalize the banks.

Other Financial Institutions(non-bank financial institutions)

• International Trust and Investment Corporations• Rural Credit Cooperatives• Urban Credit Cooperatives• managed funds• Finance companies• Leasing Companies• others

Financial institutions (continued)• All these financial institutions under the oversight

of the People’s Bank of China• comprise 10% of the financial intermediation• finance the non-state sector • Centrally controlled credit plan does not extend to

these institutions, thus moral hazard problem exists because controlling organizations use them to evade regulation and supervision

(International) Trust and Investment Corporations (ITICS)

• More than 200• Designed to promote investment in and from China• Power broader than banks• Make foreign exchange guarantees• raising funds via

– deposits (maturity > 1 year)

– issue bonds

– and overdrafts

• make S/T and L/T loans (infrastructure projects)

• ITICS (continued)

• borrow from foreign banks

• China International Trust and Investment Corporation (CITIC) -- oldest

• Guangdong ITTIC (GITIC) failed in 1998– second largest trust corporation– more than $4.7 billion debts, a large portion

held by overseas creditors

• June 1998, closure of Venturetech Investment Corporation

An Example-CITIC• Leading state-owned conglomerate

• plans to group its expanding financial services under one holding company, creating a financial services “supermarket”, which may be listed in Hong Kong

• New structure (similar to U.S. Citigroup)

– commercial banking

– securities broking and leasing

– insurance

– fund management

• Subsidiaries:

– Citic Pacific (focus on infrastructure finance)

– Citi Industrial Bank - commercial banking

– Citi Securities - brokerage firm

Wholesale Shutdown of Trust Firms• Government plans to close down more than half

of trust and investment companies in 2000

• invest in risky projects (real estate) while paying sky-high interest rates

• Mergers and closures– No. of trust is near 400 (in 1994)– no. of trust is about 230 (in 1999)

Credit Cooperatives

• At least 50 years in history• support local economic development• enhance daily lives of communities• collectively owned and have independent

accounting and operating performance• business- receive deposits/give credit, execute

settlement and remittance transactions for private industry

• provide funds to small or medium size enterprises

Credit Cooperatives

• Two problems with cooperatives – free riding and collusion– non-borrowers and borrow may collude for not

paying (or settle) the loans

Rural Credit Cooperatives

• Exists in every rural township in China

• By September 1998, more than 50,000 rural credit cooperatives

• a quarter of million village credit stations

Urban Credit Cooperatives (UCC)

• Gain popularity in 1990

• End 1998, 3200 UCC

• 80% of credit given to private enterprise of SMEs

• Central bank has developed strategies to merge UCC with urban cooperative banks

Pension Funds

• 1997, The Unified Pension System Reform Law was set up to enforce a mandatory pension programs for part of the population

• Not yet allowed pension funds to invest in securities market

• The only country in Far East not have a private fund cover.

Managed Funds

• Shenzhen Investment Fund Management - first domestic fund manager in China, set up in 1992– for the purpose of fund launching, management

and investment

• Investment choices are bonds and publicly issued stocks

Investment Industry

• Over 150 investment companies

• focus on infrastructure and high-tech industries

• China National Investment Association (CNIA), a quasi-governmental investment organization, has 63 of these investment companies

State Investment Co. (continued)

• Six new investment companies in 1988

• allocate budgetary funds to companies– China National Energy Investment Corporation

– China National Transportation and Communications

– China National Raw Materials

– China National Machinery, Electronics, Light Industry and Textile Investment Corporation

– China National Agricultural Investment Corporation

– China National Forestry Investment Corporation

Others financial institutions

• Finance companies tend to be established by commercial conglomerates

• Leasing companies, first introduced in early 1980s– leases provided a means to obtain foreign

capitals

Insurance Company• 1979, The People’s Insurance Company of China

(PICC), state-owned, monopolistic, offer insurance products

• Two subsidiaries (over 70% of market share):

– China Insurance Company

– Tai Ping Insurance Company

• Other: China Life Insurance• 52 insurers in 2001 ( vs. one in 1980).

– Insurance assets: 400 billion yuan in 2001.

• Hard sell for life insurance in China; however, An insurance market premium income was US$15bn in 1998

• China Insurance Regulatory Commission (CIRC), an industry watchdog, launched a clean-up campaign in 1998, had ended most violations of its rules by insurance agents and brokers.– Sedgwick, the UK insurance brokerage, was forced to

suspend operations for three months for "serious violations of China's insurance laws and regulations", while Jardine Insurance Brokers was ordered to close its Beijing representative office

• China will open more cities to foreign insurance companies and issue more licenses to overseas ventures.

• Currently, foreign companies are permitted to do business only in Shanghai and Guangzhou.

Insurance related to Bank:

• Bank of China sets up an insurance company in Shenzhen-- a strong indication that Beijing’s regulatory demarcation between banks, insurance companies, and brokerages may be crumble.

• Zhongyin Group Insurance Company is the first to be set up by a bank. It is a registered as an insurance company in HK (7/19/01 FT)

• ICBC (Asia) acquired equity stake in Tai Ping insurer that recently won a licence to do business across China

China Insurance MarketPremiums (billion RMB)

Year Total Shanghai1998 125.6 10.31999 140.6 11.52000 159.6 12.72001 210.0

Source: Financial Times, 2/20/01. (Guangshou –10 % market)Investment Outlay:• Earlier, premiums are invested in bank deposits and T-bonds (whose yields are below what the insurance companies agreed to most customers)• Starting November 1999, CIRC permits stock market investments by insurance companies; •About 4 % of insurance company’s assets are in now the stock markets.

• 1992, US-based American International Group (AIG) opened a branch in Shanghai. AIG is the only foreign insurance company in Chain allowed 100 %

ownership of its life insurance operations.•CIRC may ask the AIG to sell 50 % of its current life-insurance operation and form a joint venture with a local partner to expand in the future. Those two moves would bring he U.S. insurer into compliance China’s insurance regulations and WTO.

• Huatai Insurance will become the first insurance company to list on exchange. Huatai would sell less than 25 per cent of its shares (about HK$1.2 billion) to foreign firms (9/26/01).

• It could take one year for the property life insurer to complete pre-listing preparations before getting approval from the CSRC. Beijing has been pushing mainland insurance companies to list and raise funds to speed up restructuring for its WTO entry.

• Other steps would include selling a stake to foreign firms and setting up a joint-venture life insurance firm.

Investment Bank

• China Everbright International Trust and Investment Corporation (CEITIC)

• lease financing

• equity investment

• take deposits and loans in Chinese and foreign currency

Chinese Stock market• Stock market starts at 1990• Shanghai and Shenzhen Stock Exchanges• A/B shares• 1100 companies• capitalization: 50 % of GDP• Most listed companies are SOEs; some are private

firms – Shanghai Zhonglu Industrial (take over 54% of state-owned

Forever Bicycle) under “particular transfer” (PT), which requires a long time before enabling rights offers.

– Sanlian Group of Shandong took control of Zhengzhou Baiwen

• China intends to slash brokers’ commission on stock-trading to 0.2 per cent of the transaction from 0.35 per cent to cut costs and lift turnover

• A shares pay brokers a 0.35 per cent and 0.4 per cent to the government as stamp duty. B shares -- 0.81 per cent

• South Korea - 0.09 per cent to 0.23 pr cent

First Open-End Fund

• Huaan Fund Management Co sets up the first open-end fund with the assistance of JP Morgan.– Set up with $600 million in initial capital– Sold to Chinese individuals– to launch in September, 2001– sold through Bank of Communication outlets– called Innovation Fund– minimum/max purchases: $1,207/$36,231

• An open end fund fluctuates in price daily based on capital flows and the underlying value of shared held in fund. Easier-to-mange closed end funds issue a fixed number of shares and then trade like a stock

• Once China enters the WTO, foreign investment banks and asset managers will be allowed to take 33 % stakes in domestic brokerage firms and fund companies.

• That figure will rise to 49% three years later

• China's first Western-style mutual fund launch was an instant hit September 11, 2001 with domestic investors, who snapped up nearly all its three billion yuan (about HK$2.81 billion) retail subscription allocation, half in the first two hours.

• Ignoring rainstorms, risk warnings and 15-month lows in the markets, investors flocked to 139 Bank of Communications outlets in 13 mainland cities to apply for units in the open-ended Huaan Innovation Fund.

• The remaining two billion yuan of the five billion yuan fund is to be sold to institutional investors.

• China Southern Fund Management is another mainland open-ended funds. China Asset Management signed a technical co-operation agreement last year with British fund-management firm Schroders for assistance in launching the third open-ended fund.

• Mainland investors' choices were limited to closed-end funds offered by 14 fund management companies and managing assets worth 70 billion yuan as of late July, 2001.

Foreign-funded Companies listed on Exchanges

• The foreign-funded firms may allow to issue stocks but must retain a minimum stake of 10%. It might lose their preferential treatments such as tax benefits if foreign holdings were diluted below 25%

• Unilever, The Bank of East Asia, HSBC Holdings, insurer American International Group, French Alcatel (French telecommunications equipment maker) and Eastman Kodak also have an interest such plans

Trade Finance in China

• Cash in advance

• open account

• L/C -- procedure and documentationBank of China requires its bills officers to comply directly to international code

Project Finance

• Since 1980s, private sector financing of infrastructure investments revive

• projects -toll road, bridge, dams and hydroelectricity, etc

• In recent years, private funding takes the form of project finance

Project finance (continued)

• Principal features

Project -separate company

Major portion of project equity provided by project manager or sponsor

Project company - comprehensive contractual arrangements

High ratio of debt to equity

Project Company

government contractors suppliers

Investors

Project sponsor

Lenderscustomers

Parties to Project Financing

Two Categories:• Stock-type Projects

– exploit the existing stock of goods– proceeds to service debt and provide a return to

investors– examples --mines, oil and gas field

• Flow-type Project– generate flows of business– bridges, tool highways, tunnels, etc

When Project finance Is Right?

• Large, complex, and standalone project

• parent is sensitive to debt capacity

• parent concerns total risk of the project

• Parent wants to maintain operating risk over the project

Risks in Project Finance

• Resource risk -- equity-holder• Input Risk-- suppliers• Technical Risk--project manager• Timing risk--project manager and owner• Completion risk--lenders, project manager• Market Risk--customers• Operating Risk--lenders, sponsors• Political Risk--government, all parties

Functions of Project Finance

• Ownership Transformation– vehicle company

• Resolving Principal-agent problems

• Non-recourse financing arrangement

Syndicated Loans

• A method provides large pool of credit

• Mandate initiated by borrower

• Lead bank with other banks via placement memorandum

Parties of the Syndication

• Lead bank– 4 functions: sourcing, structure, sell and service

• Participating bank– Other banks participate in the loan process

• Agent– responsible for collecting payments due and

disbursing these payments to the banks

Project Finance in China• Legal framework of project finance

– Draft BOT Circular– No government debt guarantee– allow 100% foreign ownership of PRC power

projects

• Security Law of 1995

• Foreign-Related Security Rules

• Foreign Exchange Control Regulations of 1996

New BOT Structure

• Local government can invite international developers to bid

• special purpose project company can be a wholly owned enterprise, equity joint venture or cooperative joint venture

• State guarantees the conversion of foreign exchange required for the project in terms of principle, interest and divided

• No government guarantees

Zhuhai Highway Co.• In August 1996, Zhuhai Highway Co (Cayman

registered subsidiary of Zhuhai municipal government) successfully launched a 2-tranche US 200-million revenue bond

• US$85 m, 10-year senior bonds (9.12%)• US$115m, 12-year subordinated bonds (11.5%)• First revenue bond in Asia• First high-yield bond by Chinese entity• Proceeds to finance infrastructure project

Three Gorges Dam Project

• The $24 billion project --spanning Yangtze River is on the 2nd phase of construction

• financial Package includes state and domestic sponsored funds (80%) and foreign funds (20%)

• China three Gorges Project Corporation is considering an International bond issue and listing its IPO on HK stock exchange and NYSE exchange to raise capital