Walter Hutchens’ Blog

The PRC Anti-Money Laundering Law (反洗钱法 or fan xi qian fa, a literal translation) was passed today as expected by the Standing Committee of China’s National People’s Congress. The law comes into effect January 1, 2007. Its full text in Chinese is here.

More will doubtlessly be published tomorrow, but a brief English China Daily report on the draft is here.

Chinese Commentary on the law from this spring is available here, here and here.

There NPCSC held a press conference this evening. A trasnscipt (or “script”) is on the NPC’s website here (with some pictures and a minute-by-minute chronology!). Below is a quick translation of a fairly vapid exchange concerning the new anti-money laundering law:

Oriental Morning Post Reporter: I’d like to ask two questions about the Anti-Money Laundering Law. First, before this law was passed today, how have administrative agencies investigated and handled money laundering crimes? Second, will a new department be established as the principle agency for anti-money laundering, or an Anti-Money Laundering Bureau? How will the authority be delineated? Thank you.

Mr. Lang Sheng [Director of the Penal Code Section of the NPC Standing Committee's Rule of Law Working Committee]: Anti-money laundering is a new issue that emerged after our socilist market economy developed and is a new challenge we confront in constructing a market economy. Relevant departments of the State Council have worked actively and consistently to respond to this situation over the last several years. Administrative agencies have already promulgated specific anti-money laundering measures for financial institutions and instituted a reporting system for large, suspicious transactions as well as creating an “actual name” system for depositors. This constitutes a series of anti-money laundering measures. According to our understanding, in recent years the State Council’s department in charge of anti-money laundering activities has taken a number of effective enforcement actions. According to information they have provided, last year alone they investigated more than 1,000 entities and disposed of more than a hundred cases. You can consult with the anti-money laundering agency concerning specific cases. Law stipulates that the People’s Bank of China shall be the principal administrative agency for anti-money laundering.

I’m not an expert in this area, but, yes, I’d have to imagine it’s a step forward in anti-money laundering that one can no longer open a bank account in China under the name Mr. Monkey King or Ms. Watermellon.

Separately, 60-odd new laws or regulations came into force today, as detailed on this chart.

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This report on ICBC’s IPO in The Hindu is misguided and perhaps unduly alarmist.

It posits that, “China’s nascent capital market has received a shot in the arm in its bid to compete with India with the infusion of nearly $22 billion in the world’s largest Initial Public Offering by the country’s largest lender, the Industrial and Commercial Bank of China.”

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The Jurist site has done a nice, pithy roundup of English language reports on China’s forthcoming (we think) property law.

ICBC, the world’s largest IPO, did not involve a listing on a US stock market.

The Bank of China did not list shares in the US.

China Construction Bank did not list shares in the US.

Of course, US investors can buy shares in these companies—Hong Kong is outside of China’s Great Currency Wall. But there is a large eco-system around US stock markets (accountants, lawyers and the exchanges themselves) that surely doesn’t like to see these mega IPOs steering clear of the US.

China IPOs aside, there is growing sentiment to trim back some of the perceived excesses of the Sarbanes-Oxley Act. The New York Times reports here on a couple of groups cooking up recommendations on SOX reform and other matters.

One of the groups is headed by Hal Scott, a Harvard professor who also happens to oversee an important annual symposium on China’s financial system.

While I imagine it is unlikely to emerge as a recommendation (or get traction if it does), the Times reports that one prominent securities law scholar has advised scrapping private enforcement of securities fraud altogether. Columbia’s John Coffee suggests the US eliminate private securities litigation, an approach even more draconian than China’s current stance (which requires that a government authority find wrong doing before private shareholder suits can proceed against a company, but at least allows suits once such a finding has been made):

John C. Coffee, a professor of securities law at Columbia Law School and an adviser to the Paulson Committee, said that he had recommended that the S.E.C. adopt the exception to Rule 10b-5 so that only the commission could bring such lawsuits against corporations.

But other securities law experts warned that such a move would extinguish a fundamental check on corporate malfeasance.

“It would be a shocking turning back to say only the commission can bring fraud cases,” said Harvey J. Goldschmid, a former S.E.C. commissioner and law professor at Columbia University. “Private enforcement is a necessary supplement to the work that the S.E.C. does. It is also a safety valve against the potential capture of the agency by industry.”

I agree with Commissioner Goldschmid; it would be shocking, almost on the order of overturning Marbury v. Madison (in which the Supreme Court granted itself the power of judicial review), to eliminate private causes of action under Rule 10b-5. Private enforcement of securities disclosure rules (or, more practically, the threat of private enforcement) is a bedrock of US securities law. It seems virtually indispensable for keeping issuers honest. Jail and administrative enforcement are important, but the investor who loses money (and his or her lawyer) has the greatest incentive to sue to recover some of that loss; we shouldn’t have to simply hope a regulator acts (which probably wouldn’t lead to any recovery for investors, anyway). Coffee is wrong.

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The New York Times reports here on a “small” ($180 million) private equity China-focused fund Lehman Bros. and IBM have created.

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China worked hard to get into the WTO, and now is being asked to live by the terms of it WTO membership.

You can’t do much shopping (or even walking around) in China without running into flagrant IPR violations, but for a more nuanced appreciation of the problem I highly recommend Andrew Mertha’s book The Politics of Privacy: Intellectual Property in Contemporary China. He explains how even the best-intended efforts to enforce IPR standards can be frustrated by China’s splintered and evolving political landscape.

It’s certainly fair for trading partners to hold China to the terms of its WTO membership, but given current political winds in China, I suspect a WTO action will tend to spur resistance or empty gestures more than real cooperation. U.S. politics are of course also at play—perhaps in the timing of this announcement days before elections?

Generally, as China gets richer I am seeing more and more “real stuff” for sale. The other night I walked into an outdoor store with real-deal expensive hiking boots and camping equipment. I’ve seen plenty of North Fakes, but the legit stuff is on sale now, too. There’s a growing domestic lobby for greater IPR enforcement, as well as a thriving black market.

To test the efficiency of China’s piracy trafficking, in my Doing Business in China travel courses I’ve offered a bounty to the student who brings me the first copy of a Hollywood movie released right around the time of our arrival in China (it was a Star Wars installment one year, the Da Vinici Code another). Invariably, the disc is on the streets of Shanghai as soon as (if not before) it is in theatres.

Piracy feels great to consumers (the whole Sex in the City corpus for US 8 instead of 200!), but I follow-up by asking students to name their favorite Chinese brand. Sometimes they think of Qingdao. Maybe Lenovo. Haier or Galanz if they’ve done the assigned reading. But clothes? Silence. I then ask them to check their labels for “Made in China” when they get home; everybody wears stuff made here, nobody can name a Chinese designer brand. More disturbingly, what breakthrough drugs has China discovered in the last 30 years of economic reforms? Despite all their scientific talent, they are under-contributing to human progress and retarding the development of some parts of their own economy. That’s the real cost of rampant knock-offs.
 

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I found this interesting video (8 minutes, requires a Real Player plugin) on the EC’s external relations site. It brags about EU efforts to help China with environmental protection, business education (through the China Europe International Business School or CEIBS, which I admire) and village elections.

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The EU’s” Country Strategy Paper” on China can be obtained from this site (or directly here as a PDF).

It states, “The key objective of the EU’s policy towards China is to support the continued reform and transition processes and to engage China further in the international community and to integrate it further into the world economy[.]”

To get there, the EC proposes to focus on three areas:

The first focus for EC-China co-operation will be to support and provide increased sustainability in China’s economic and social reform process mainly through institutional strengthening and capacity building, human resources development and the promotion of a
sound business regulatory framework and the transfer of know-how and technology in the private sector.

The second focus will be the promotion of sustainable development and assisting China to pursue a better balance between environmental protection, social development and economic growth. The EU could provide knowledge and expertise to assist China’s pursuit of better environmental performance particularly where there is a global consequence, e.g. climate change. Expertise should also help identify a path of economic development, first to facilitate control over the causes of environmental degradation, then over the longer term, to progress towards reversal of the damage and improvement of the environment, and ways to upgrade bilateral co-operation on global environmental issues will be explored.

The third focus will be to encourage good governance initiatives, promote the rule of law, promote grass-roots democracy and the implementation of economic, social and political and civil rights and strengthening of the structures and processes that make up the fabric of a
strong civil society.

At this level of generality, there’s nothing for China’s government to balk at. However, official PRC and EC notions will diverge once (if) definitions are given to “rule of law,” “democracy,” “civil rights” and “civil society.”

The Chinese Communist Party is all for democracy, so long as it doesn’t involve, you know, actual competition for power among multiple political parties.

The same caveat applies to CCP enthusiasm for civil rights, civil society, rule of law and so forth. It’s all good, so long as they remain in charge.

The EC doesn’t explicitly state that they want China’s one-party system to whither away, but that seems implicit in encouraging all those things in the third “foci.” The Chinese Communist Party has no plans to whither.

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The China Financial Futures Exchange has issued draft rules on trading index futures.

The four draft rules are:

1. Shanghai-Shenzhen 300 Index Futures Contract《沪深300指数期货合约》
2. Detailed Trading Regulations 《交易细则》（征求意见稿）
3. Detailed Clearance Regulations 《结算细则》
4. Risk Management Measures 《风险控制管理办法》

A news report on the draft rules from the Shanghai Securities Times is here and their full text is here.

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China must practice “reciprocal openness” to maintain good relations with the European Union, according to this commentary by the EU’s trade and external affairs commissioners.

The commentary, published in the International Herald Tribune, is prelude to a “comprehensive reframing of Europe’s approach to its political and commercial partnership with China” that will be announced this week.”

The commissioners warn that if China fails to practice “reciprocal openness . . . . we could see in Europe the growing defensiveness and protectionism that is becoming evident in some quarters in the United States.”

I’m all for reciprocal openness, and trade does need to be a win-win to avert protectionism. However, our European friends don’t need to invoke US protectionism as the bogeyman here.

The Schumer-Graham tariff bill has gone nowhere; meanwhile, the EU has imposed 16.5% duties on Chinese leather footwear. Also, EU trade commissioner Peter Mandelson, one of the authors of this piece, has made noise about starting WTO proceedings over Chinese IP infringement.

Thus, rather than raising the specter that the EU might be drawn into US-like protectionist sentiments, our EU friends should simply threaten that without greater reciprocal openness the EU will act more like the EU has already been acting towards China.

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Two items of note about China’s auto industry:

1. Keith Bradsher of The New York Times has written a good piece on the plans of PRC auto-makers to export cars to the U.S., reporting that generally PRC car companies are pushing back their plans to launch in the U.S. He finds concerns over safety, styling, emissions, performance (though not necessarily reliability) and marketing are making it “a lot harder than automakers here anticipated to make cars that appeal to Western tastes.”

Of course, Chinese car maker can become quite wealthy without appealing to Western tastes. Besides aiming to dominate their own market, PRC car makers are likely to export cars to Eastern Europe and other developing economies (I imagine quite profitably) before they crack the US/Western Europe/Japanese markets.

But one day, a car company with a name like Geely or Chery won’t sound as silly as it now does to US ears (and as I imagine Honda, Toyota or Hyundai once did, too).

2. GM’s operations in Shanghai are contributing to GM’s precarious bottom line, or so we can intuit from their 37% growth in China sales for the first three quarters of 2006, according to this AP story carried in the IHT. GM says it (and its various PRC joint ventures) sold 645,680 units in China in Q1-3.

My MBA Doing Business in China travel courses have included visits to the Shanghai GM plant in each of the last two years. It’s a popular destination; GM is gracious to let lots of people visit. The production floors are big, loud and impressive (and would seem to be models of efficiency in comparison to the assembly line problems Bradsher observed at a PRC manufacturer, in the Times story above).

However, once you’ve seen the factory, GM’s PR staff is tight-lipped about profitability, labor cost saving and any disputes they may have had with their Chinese partner. My MBA students, getting nowhere with the GM spokespeople, did their own calculations, multiplying unit sales times an average price, then factoring in an estimated labor cost savings, then adjusting for the share in profits taken by GM’s China partner, and adjusting again to assume some other costs are higher in China—and they still figured Shanghai GM is throwing off hundreds of millions of dollars.

The Chinese journalism students I spoke with this week had just visited the Shanghai GM plant themselves; they also found that GM’s spokespeople prefer not to speak on many issues (which led us to a good discussion about what public companies are obligated to disclose).

On a much more general level, as an SUV-driving American I should not cast the first stone here, but I must say the huge upsurge in private cars in China really alarms me.

China might have done something different than mimic U.S. car gluttony, but so far it has chosen not too. There are large benefits in terms of employment and raw economic growth, but will it be worth it in the long term?

Some years ago I commented (when reviewing a paper about China’s auto industry at an academic conference) that one day the Chinese may regret their country’s decision to develop a mass auto industry just as much as many now regret the failure to control population growth under Mao. The decision to develop a mass domestic personal car industry, like the decision to ignore advice about population growth, will have serious, long-term consequences.

Beijing’s traffic is already becoming impossible, and the pollution, which I assume is partly due to the number of cars, is horrendous.

We are just beginning to see the global environmental, economic and political consequences of China’s automobile explosion.

No matter which car companies succeed, will their success really be a positive human achievement?

Unless a super-Prius or some other innovation rides to the rescue, what will happen to the planet when, say, half (or only a quarter?) of the Chinese have cars?

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Today I was in Shanghai to give a talk at Fudan University. The University of Maryland’s journalism school is running a program with Fudan’s journalism school. The program introduces journalism students to covering the financial sector.

I think the idea for the program is great because 1) most journalists don’t get much training in business but need it and 2) financial journalism is comparatively (and I stress comparatively) open in China, so it’s easier for US and PRC institutions to find common ground (I don’t think we’ll be running any joint programs soon on covering indigenous independence movements, political dissent or un-sanctioned religious movements, but economic journalism is another thing entirely).

I didn’t have any prior relationship with Maryland’s fine journalism school, but as a Maryland business school faculty member resident in China, there was an obvious overlap between what they are doing (and where they are doing it) and my background. So I was happy to fly down and help in a modest way with the program.

My lecture focused on the role of law in the financial sector, particularly stock markets and entrepreneurialism.

I tried to help the students understand how stock markets work (at a very basic level) and how mainland Chinese stock markets are different from foreign stock markets.

The upcoming ICBC IPO provided a good jumping-off point.

I got them to list pros of investing in ICBC. They had no trouble doing that. (Massive size, implicit government backing, growth in the Chinese economy). Then I asked them to list potential risks of buying ICBC shares. It was harder to get them to see the downsides, but with prodding they came up with a few. (NPLs, opacity of information about borrowers, increasing competition including from foreign banks due to WTO accession).

Once we had a decent list of pros and cons that an investor should consider, I talked about the basic problem of information asymmetry in business. I explained how people try to lessen information asymmetry through due diligence, contractual provisions and (for listed companies) complying with disclosure duties.

To help them see how law enables (not just burdens) business, I also walked them through a US startup, from eureka moment to IPO. I talked about how law holds the whole process together, from formation of a v.c. fund to making its portfolio investments to operating the business to an eventual exit (through bankruptcy, IPO or M&A).

At the very least I think they picked up a lot of new English vocabulary words. Being able to offer the Chinese equivalents of unfamiliar terms seemed to help a lot.

The students were bright and attentive. Several of them participated actively in the discussion, which pleased me greatly. A few were well informed about macro issues in China’s financial reform process, but for most of them it seemed to be a new area. I was delighted when one participant, after I’d been rattling on about ICBC for a few minutes, piped up and asked, “What’s an IPO?” That helped me pitch the discussion at the right level (I hope).

As usual, I met a few students whose mastery of English left me slack-jawed. Really stunning, particularly for people who have never been out of China.

Fudan’s school of journalism has a nice set of new buildings (with more under construction). They have classrooms with tiered seating, full-on AV capabilities and Internet connections (though none apparently was available in the room I was in).

I stayed at the Fudan Crowne Plaza, a new hotel directly across the street from campus. It’s fabulous—certainly the best hotel adjoining (or inside) a PRC college campus that I’ve ever seen.

All in all, a very pleasant visit, and I hope one that provided some benefit to the students.

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Nan Tung Bank is not on the list of China’s Big Four banks.

It’s not even on the list of China’s second or third tier banks.

In fact, it only has about 40 employees and a single branch.

Nonetheless, global heavy weight Morgan Stanley has agreed to acquire Nan Tung.

Morgan Stanley is not after Nan Tung’s sole branch or its 40-odd employees; rather, they want Nan Tung’s commercial banking license. That will help them do RMB-business in China.

At the end of this year the geographical and scope of business restrictions on foreign banks are supposed to end in China. That’s long been a headline about China’s WTO entry.

But the fine print is important. Foreign banks will still need all kinds of approvals and licenses to really do business in China. Buying this banks helps Morgan Stanley move forward with getting some of those approvals (though it certainly doesn’t complete the process).

A Reuters story about the acquistion is here.

Based on information in ICBC’s IPO prospectus, Morgan Stanley only needs to add 18,037 more branches to catch up with ICBC!

Of course, foreign banks will not aim for the vast Chinese population. They will target China’s affluent individuals and companies, and those are generally concentrated in major cities.

I have previously opined that China should simply auction approvals to do business in certain lucrative sectors, the way the US auctions radio spectrum for 3G services. Morgan Stanley could help them run the auctions.

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In his role as Morgan Stanley’s chief economist for Asia, Andy Xie got quoted by the media all the time. He must have been quick to return journalists’ phone calls and spent a good bit of time doing it. He commented liberally (and sometimes incisively) on all sorts of PRC economic developments.

Xie doesn’t work for Morgan Stanley any more. He resigned after some of his comments on Singapore appeared in the media. The comments in question were from emails Xie sent friends; clearly they were not intended for broad public consumption.

In the emails Xie reportedly griped that a forum on India and China was being held in Singapore. He opined that, “Singapore’s success came mostly from being the money laundering center
for corrupt Indonesian businessmen and government officials.”

He further observed, “To sustain its economy, Singapore is building casinos to attract corruption money from China.”

Here we should mention that 1) the Singapore government is a major international investor through Temasek Holdings and 2) Morgan Stanley would like to continue helping Temasek on many lucrative deals. Goodbye, Andy.

I haven’t always agreed with Xie’s analysis, but I feel sorry that he apparently got fired had to resign due to public disclosure of email he intended to be personal. It’s chilling to think you can never type an email that you don’t want to be “TO: WORLD.”

It sort of makes the distinction between emailing and blogging superfluous. I may not use enough restraint when blogging, but sometimes I let my guard down even more when writing emails to friends.

Besides being fun, being hyperbolic can actually help one test out an idea. It’s appropriate for a non-public forum where you won’t be taken too seriously or literally.

Or so Andy might have thought.

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The London Times has a good story here (originally from the Wall Street Journal) about China Netcom and its efforts to reform its corporate governance.

I like the story, but its headline way over-states what the captioned article really says about Netcom, and it certainly over-states the reality in China generally.

The headline reads, “China turns to western-style governance“

Netcom is a company; that I suppose does reflect China’s turn towards Western economic models (it could instead still be a state-owned monopoly).

Moreover, Netcom is listed on a foreign stock market. That makes it subject to “Western-style” disclosure rules.

Netcom also has seven outside directors on its 13-member board. One of them is John Thornton, a former Goldman Sachs banker.

The article begins with an anecdote about a time Thorton disagreed with Netcom’s CEO Zhang Chunjiang. The article describes their boardroom disagreement as “something extraordinary” and quotes CEO Zhang saying, “This was the first time I had ever encountered opposition[.]”

Thorton won Zhang over on the particular issue (a procedural one about how Netcom should choose which investment bank would advise it on an asset transfer involving Netcom’s parent), and Netcom later hired outside consultants to help it, in the words of CEO Zhang, “develop a corporate-governance system that could let investors relax.”

Under the new system, 2/3 of Netcom’s board (as noted, a majority of whom are outside directors) must approve certain major changes.

That’s all lovely. Really. Netcom has done a lot. And nobody denies that China has for nearly thirty years been moving in a new overall direction. The world acknowledges the results have generally been fantastic.

But this article’s headline suggests China (not just a few firms like Netcom) is adopting Western-style practices of governance.

Surely they lacked space to insert (or thought the context supplied) the word corporate governance. Western style governance, in a general sense, relies on independent courts, multi-party democracy and individual freedoms that don’t exist in China.

In terms of adopting Western-style corporate governance, the text of the article notes:

1. The PRC government owns 75% of Netcom.

2. The Netcom CEO is the secretary of the Communist Party within Netcom.
3. The Party has authority to make key corporate decisions.
4. Before being appointed to head Netcom, CEO Zhang was a career government officer.

If this is turning towards Western-style corporate governance, it is like a smoker turning towards quitting by trying to smoke less or change brands.

Netcom has adopted a veneer of Western-style corporate practices, but governance, in the sense of ultimate power, remains in the Party’s hands.

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China’s foreign exchange control authority reports that US$44.8 billion flowed out of China to purchase securities on foreign markets in the first half of 2006, according to this Xinhua story in the People’s Daily online English edition.

Of course, these legal flows are all subject to SAFE’s approval.

China now has 13 billionaires (according to one recent rich list), but none of them could directly open a brokerage account in the US and buy say a few million shares in Google just because he or she (and the #1 is a she) likes the YouTube acquisition.

Rather, the outflows are from institutional investors (who may be acting on behalf of individuals, or might be insurance companies looking for investments).

China has approved large FOREX quotas for those institutions that have obtained QDII status since that scheme was finally launched in July. However, the Chinese government’s purchase of US treasury bonds remains the PRC’s largest capital account outflow.

Note that some of the outbound flows could be for investment in PRC companies listed on foreign stock markets (such as the Bank of China, which is listed in Hong Kong but has not yet issued A-shares).

SAFE’s report is available here in PDF format in Chinese (it runs 40 pages).

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Goldman Sachs has an investment banking venture in China, one carefully (and creatively) structured to be able to do the full range of activities they might want to do (but not be allowed to do under China’s ostensible rules on JV investment banks). I wrote about the venture’s creation here, here, here and here.

Despite the creative structuring (and special donation Goldman reportedly made to get the deal approved), the venture has not so far taken the PRC investment banking world by storm.

The venture has recently undergone a management reshuffle. Joe Stevens quit as CEO at the end of September. Now Bill Wicker will leave and return to Goldman in New York. Richard Ong will come to Beijing from Singapore to take Wicker’s place.

Fang Fenglei remains. He is the head of Gao Hua, the Chinese party in the joint venture and the entity that holds licenses for activities the JV is not permitted to engage in. Gao Hua, though classified as a Chinese entity, was reportedly capitalized by loans from Goldman. Presumably these loans came with some contractual provisions that allow Goldman to run the show so that it can control the JV and Gao Hua itself, at least so long as PRC regulators and Fang remain cooperative.

Reuters reports on the personnel changes based on a Goldman memo they got their hands on.

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The Securities Association of China will hold a China Financial Derivatives Forum (中国金融衍生品大会（2006) on October 24 in Beijing at the Diaoyutai State Guest House. Registration costs RMB1,800. The announcement in Chinese is here and includes a link to a registration form, and draft agenda for those interested.

Last year I spoke at another conference on derivatives in Shanghai organized by the Chicago Mercantile Exchange, the Shanghai Stock Market and Shanghai Futures Exchange.

China has made some progress with derivatives recently. They now for instance allow some warrants to be publicly traded, and interest rate swaps are traded on the inter-bank market.

I saw in the draft prospectus for the ICBC IPO that ICBC has hedged its risk of exposure to foreign currency exchange rate fluctuations, so the practical use of derivative products is clearly understood within China’s elite financial circles.

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ICBC will pay its underwriters about US$350 million in fees for the Hong Kong tranche of its IPO, or 2.5% of the amount raised, Reuters reports.

That’s less than half, in percentage terms, of the fees these banks usually get.

My first thought is that this shows, regardless of whether you are buying a watermelon or running the world’s biggest IPO, that the Chinese drive a hard bargain and really know how to squeeze down a margin.

(I hear shrieks from those appalled by the broad ethnic stereotyping in this statement. But I also imagine most of my Chinese friends nodding in agreement, probably with pride. Let me qualify it only by saying capitalism puts the squeeze on everybody, as any Chinese supplier to Wal-Mart must be painfully aware).

My second thought is, wow, that’s a lot of money! A small percentage of the world’s biggest IPO is no small sum. What a windfall for the participating banks!

The Reuters story gives some useful data on the who, what, when, where and how much of each of the recent PRC bank IPOs.

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According to this Xinhua story, the CSRC has warned that unless misappropriated funds are “paid back” by the end of this year, it will seek to hold legally accountable parties who, acting as controlling shareholders or “actual control persons” have looted listed company assets.

The article notes RMB 20.4 billion in misappropriated funds has already been returned to 309 listed companies; however, it indicates 25.4 billion is still owed to another 102 listed companies.

This is not a new problem. For years the PRC financial press has talked about the problem of parent firms treating listed subsidiaries “like an ATM.”

Of course it is good that the CSRC is working to protect these firms and help them recover plundered assets, but 1) shouldn’t the CSRC seek to hold looters accountable, even if the money is paid back? and 2) why aren’t enterprising lawyers bringing derivative suits to win back this money?

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Most shares of most listed firms in China are in government hands, and, until recently, were classified as non-tradeable (fei liutong) shares. China has not been privatizing its listed firms by selling off the government shares; however, it has been doing away with the distinction between tradeable and non-tradeable shares, making all shares technically eligible for public trading.

The process has been a gradual one, with each listed firm cutting a deal with holders of its tradeable (listed) shares to get their consent for converting the unlisted shares into technically tradeable ones.

The CSRC created an incentive for firms to undergo this process by refusing to let ones that hadn’t issue any new securities.

To let investors distinguish between firms that have already reformed their share classification system (to make all shares technically tradeable) and those that have not, the exchanges required that a G be affixed before their ticker symbol of the already-reformed companies, as in G-Moon Cake Co. instead of just Moon Cake Co. The G indicated at a glance that the company had already changed (gai is a Chinese word for transformed).

Now the vast majority of firms qualify for the G designation, so the exchanges have announced the G-share designation will be dropped and an S designation will be added to the ticker symbol of those companies that have not yet gone through the process.

At first I mused that this S designation might be intended to mark the hold-outs as, um, shit. But actually I think they got it from 尚未 or shangwei, meaning “still haven’t [reformed their share classification system].” S-companies will continue to be barred from raising additional capital by issuing new securities.

A brief article in Chinese about the change is here. A long account of a conference on the share reclassification program is here.

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Many people are happy that share prices are rebounding in mainland China. Monday the Shanghai index closed at 1,758, a 5-year high. 

For the year the index is up 54%. I imagine that makes Shanghai the world’s best performing stock market for 2006 (not that it is open to the world, but nonetheless a noteworthy distinction).

We are still far below the index’s historic high of 2,237 in June 2001, but a lot of the value wiped out since mid-2001(when the market began a slide that erased half its value) has been restored.

Few people enjoy a 4-year bear market. In China it isn’t possible to short a stock, so I imagine virtually no one was happy about the long bear market. Thus the present rally is undoubtedly a good thing, right?

Well, of course it is a good thing for people who owned shares that were under water. It also is encouraging news for companies hoping to list or issue new securities (whether in IPOs or follow-on issuances). There are lots of other beneficiaries in the eco-system around the market, including of course brokerage companies (who’ve really been hurting), underwriters, specialized law and accounting firms, clearing agencies, local governments who get tax revenues from trades, and all the media that focus on the markets (several newspapers and magazines, plus China’s versions of CNBC).

But to judge the value of this rally, we need to ask why is this happening? Several reasons come to mind, but I fear they do not, in total, mean the market has overcome all of its fundamental problems.

First, there is a lot of money sloshing around China, and it needs a place to go. An appreciating market creates a positive feedback loop. Recent policies have made putting capital into real estate and other sectors less attractive.

Second, people seem to perceive that the problem of the overhang of unlisted shares has been addressed. The slide that began in 2001 started when the CSRC announced that each new issuance (whether an IPO or secondary offering) would have to include a portion of the firm’s un-listed shares (to fund social security, which was a clever way to address two problems at once—reducing the overhang of unlisted shares and raising funds for the under-funded social security system).

Though quite modest (the policy only applied to new issuances and only required unloading a fraction of a firm’s unlisted shares), the policy spooked the market. Investors seemed to think the policy stood not for what it said but rather signaled that a deluge of previously un-tradeable shares would soon hit the market.

The CSRC quickly withdrew its 2001policy (and some of its proponents were assigned to other agencies). After extensive public debate and consultation they came back with something else, requiring each listed company to get holders of its tradeable shares to approve a plan to make its untradeable shares tradeable. That approval has generally been acquired by offering free new shares to existing shareholders (that has always struck me as an amazing phenomenon—a transfer of state-owned assets to a very small subset of the population, a group never promised the overhang of untradeable equity wouldn’t become tradeable . . . recall they bought common shares, not bonds or preferred shares!).

In any event, all but a few hundred listcos have now converted their unlisted shares into theoretically tradeable shares. Thus, lots of investors may now think the overhang demon has been exorcised and thus think it’s safe to re-enter the market.

They may be wrong. Just as the 2001 measures were misunderstood, investors may now be in error in thinking the overhang problems has been solved. The converted shares still haven’t entered the market. They are simply now able to be traded (in fact now they now can effectively enter the market with no warning). So the risk of sudden and massive over-supply continues.

Another of my perennial complaints about China’s stock markets is that the government picks who can list (and naturally favors its own companies). This problem hasn’t been addressed.

Also, listing a company in China means a firm gets capital but doesn’t expose itself to real market discipline. That’s because flotations are comparatively small in percentage terms. This, too, hasn’t changed (e.g., ICBC will remain >70% in government hands after its IPO this month).

Investors still lack a meaningful way to sue listed companies that engage in disclosure fraud, which means incentives to comply with China’s very fine disclosure laws remain relatively weak. Thus the information asymmetry between dispersed public investors and company insiders is likely to remain and function against investors in the long run.

For all these reasons, I am less excited about the current market rally than some of my friends with money in the markets. To be sure, the PRC government has done a lot in the last few years to try to make corporate governance better and to enhance minority shareholder protections. But since the government still picks who can list and generally doesn’t give up real control of the companies it chooses to list, I think the present market rally, however encouraging to investors, probably doesn’t indicate a fundamental shift in the value of the mainland’s stock markets to the Chinese economy.

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Industrial and Commercial Bank of China (ICBC) will soon be listed in Hong Kong and Shanghai. The underwriters are having no problems lining up buyers for this gargantuan IPO. They plan to raise $19 billion dollars.

Strategic investors—including Goldman Sachs and American Express—and the Chinese government pumped billions of dollars of fresh capital into ICBC in the run up to this IPO.

Once ICBC lists, only one of China’s big four banks will remain unlisted. That one is Agricultural Bank of China (ABC). I suspect we’ll have to wait for ABC’s listing quite a while.

China Construction Bank and Bank of China were each huge IPOs. ICBC will be larger still.

Besides its sheer size, another noteworthy aspect of the ICBC listing is that shares will be simultaneously offered in both Hong Kong (a market open to global capital flows) and Shanghai (a market behind the Great Currency Wall of China).

Pricing in Shanghai will be the Hong Kong price times the officially-managed exchange rate.

That’s how it will start. How trading in ICBC’s shares unfolds over time on the two markets will be interesting to watch. The prices will probably diverge over time.

The idea of listing ICBC and the other banks is of course to 1) raise money and (probably more importantly) 2) get China’s banks to act like banks. Making them companies; giving them shareholders and boards of directors; subjecting them to outside monitoring through listing (with teams of lawyers, accountants, regulators, analysts and reporters pouring attention on them)—these and many other measures are being applied to help BOC, CCB and now ICBC act in a commercially sound way. Their doing so, it is believed, will help China continue to grow rich and strong.

Market economies do tend to outperform planned economies, and I’m all for economic liberty in China. Thus I think bank reform and listing is in general a good thing.

However, it’s easy to lose sight of something here. When expressions like “IPO,” “pricing at the top of the range,” and “institutional investor” are flying around, it is easy to forget only about 24% of ICBC will be in public hands after this IPO.

China’s Ministry of Finance and Huijin, a PRC government entity created to act as a holding company, will together own more than 70% of ICBC after the IPO.

Ultimately the leadership of the Communist Party appoints the people who pull the strings at those two dominant shareholders.

Thus, after its restructuring and listing ICBC may act like a private bank, but clearly it is not being privatized!

Instead, what’s happening here is that lots of investors are contributing lots of cash to an an entity controlled by the Chinese government.

It is an open question whether the trappings of privatization will discipline these banks like real privatization.

But facts giving rise to these concerns and many others are detailed in the prospectus. An English version of it (for the Hong Kong tranche) is currently here.

When you click on the sections of the prospectus you get PDF files with cryptic names like EWP106. I wish HKEx would make things easier to find and provide a way to download the whole prospectus at once instead of just parts of it. Also, note this URL seems to be a temporary one.

If you need a quick summary of the PRC banking system or PRC corporate law, you could do worse than clicking on those sections of ICBC’s prospectus.

The very interesting Risk Factors section is here. It starts off, unsurprisingly, by acknowledging non-performing loans have been a problem and may continue to be.

NPL issues aside, you’ll also find in the Risk Factors such gems as the fact that ICBC occupies 25,393 properties in the PRC. The word is “occupies” not “owns” because 6% of these properties have unclear titles (or at least lack the proper documentation for clear title). That’s actually better than I expected, and how I pity the poor associates who had to go through all that!

“In addition,” ICBC continues (meaning I think in addition to the 25,000 properties just mentioned), ” . . . 5,228 of 7,651 leased properties” have unclear titles. Ahh, the transition from socialist to market economy is still underway!

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Back in July I mentioned that in China some officials have advocated doing away with undergraduate majors in law (and business). Today’s China Daily has here a substantial article about the ongoing legal education reform debate.

According to the article, “Ministry of Education figures showed that last year China had more than 200,000 students studying for bachelor degrees in law at nearly 600 universities.” That means there are more students studying law in China now than there are lawyers in China.

The article cites a study that found “62 per cent of this year’s [sic] graduates with bachelor degrees in law failed to find jobs[,] one of the lowest employment rates among the fields of study.” I feel sorry for those law grads who can’t find desirable work, but I don’t think China needs to throttle back on legal education and probably doesn’t need to require that students obtain a graduate degree before practicing law.

I’d observe:

1. China has an under supply of lawyers, not an oversupply. The number of lawyers is reportedly under 200,000 (quite a bit under, actually, according to these stats from last year). China’s few lawyers serve a population of 1.6 billion! That means there is one lawyer for every 13,000+ people in China (and a lawyer doesn’t mean a person with a college degree in law, either). In contrast the US has about a million lawyers for a population of about 300 million, meaning one lawyer for about every 300 people. Of course China should not blindly mimic the US (complaints about too many lawyers there are common). Nor do I mean to suggest there is some inherent “right” number of lawyers for a society based merely on its population. However, i) official policy in China is to strengthen the rule of law ii) China has plenty of unresolved disputes (see, e.g., recent articles about the horrendous number of unresolved cases in its xinfang or letters and visits petition system, or see the article linked to above which claims many places in China lack a single lawyer) and iii) the sheer size of China’s economy and its trajectory towards a larger private sector suggests China needs more, not fewer, lawyers.

2. Rather than trying to cut the supply, China needs to continue legal and economic reforms so that the demand side revs up.

3. Markets rather than bureaucratic fiat can solve any oversupply problem anyway. If most undergrad lawyers aren’t getting good jobs compared to their classmates with other majors, the number of students majoring in law or trying to find legal work with only a BA should decrease naturally.

4. The US 7-year model for legal education (an undergrad degree in anything, then 3 years of law school) probably isn’t the right model for China. It exists in the US for historically contingent reasons, and the Guo qing or national conditions in China don’t seem to me to call for such a drawn-out process to produce lawyers.

5. Zhu Chongshi, president of Xiamen University in Fujian Province, who is identified as a proponent of doing away with undergrad law degrees, also advocates making the study of law obligatory for all undergraduates. Though I think Zhu is wrong about doing away with law as an undergraduate major, I agree with him that a basic law course is a good idea for all college students. Think what a boost it would be to legal conciousness if China were to require all college students to take at least one course in law. More generally, basic legal literacy is a social good. Most US business schools require a course in law (often called the Legal Environment of Business); that’s one of the staple courses I’ve taught at the University of Maryland. My experience has been that most students taking the course, though quite clever, have little prior understanding of legal institutions, basic legal doctrines or the relation of law to business. That knowledge, like a basic civics class, seems to me fundamental to being an educated person. Law is pervasive, touching nearly every area of human activity. People need at least one “law appreciation” course. Plus law can be used to teach critical thinking, research, and writing skills (one could teach composition through a law course as well or better than an English literature course, for example).

6. The current “line” in Chinese politics is about building a harmonious society, and since the regime may see lawyers as troublemakers, I imagine that increasing the number of lawyers in China is probably not going to become a near-term priority.

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Harvard Law School has revised its first year curriculum, supplementing and modifying the standard set of courses on contracts, torts, civil procedure, criminal law and property. They’ve added a course on statutory law (legislation and regulation), a new January-term course called “Problems and Theories” that will apparently be application-oriented, and new electives on international law.

A few quick reactions:

1. It’s Harvard, so HLS’s “innovations” will likely influence many other schools. The sacrosanct 1L curriculum, a rite of passage for generations of lawyers (like boot camp or a hazing ritual?) will now be reexamined by lots of schools, many of which will probably make modifications very similar to Harvard’s.

2. One of the ironies of US legal education is that, despite the ranking-obsessed nature of the law school admission process, every student takes essentially the same classes, taught by graduates of basically the same few schools, using basically the same teaching methods, often reading identical cases regardless of which school is attended.

I don’t mean HLS doesn’t have greater resources, more illustrious faculty and on average smarter students than a lesser ranked law school. What I mean is that the credentialism of the profession seems wildly disproportionate to actual differences in education among law schools.

3. As a lawyer who teaches in a business school, I’ve long been struck by how business school faculties seem radically more innovative than law school faculties in terms of course requirements and offerings. Business schools are eager to distinguish themselves with e-commerce majors and other novelties, whereas this Chronicle of Higher Ed story (sub. req’d) notes these HLS curriculum changes are Harvard Law’s fist curriculum overhaul “in more than 100 years.” A hundred years!

There has of course been curriculum change at HLS over the last 100 years. The number of electives has grown enormously. They now publish rafts of specialized journals. They have clinical courses. Ideological fads have come and gone (or, in some cases, stayed). Shortly before announcing these changes to the first year curriculum they announced the creation of concentrations for upper-level students.

Nonetheless, I think it’s accurate to perceive that law school course requirements have been 1) remarkably stable and 2) remarkably uniform across schools.

There are some simple reasons for this, I think. Law is an inherently conservative profession. Like the law, law school curricula evolve incrementally.

But more importantly I think, law schools move slow because they are monopolies. Basically you don’t become a lawyer except through a law school. Ensconced as gatekeepers to the profession, they are like state-owned enterprises protected from completion. Consumers don’t have much meaningful choice; to become lawyers they have to go to a law school, and schools teach pretty much the same things, particularly in the first year.

Of course people choose among law schools. But inertia, accreditation standards and perhaps bar exam content assure competition among law schools stays within well-worn channels.

In radical contrast, nobody needs a license to practice business. Business schools are not gatekeepers to the business profession. An entrepreneur needs approval from paying customers, not a panel of older entrepreneurs. And the business environment changes faster than the legal environment.

Thus business schools must continually examine their value propositions and recalibrate. Law schools, comparatively, don’t have to and don’t.

4. HLS will apparently spend less of the first year teaching property. To the extent this means less time teaching estates in land, it makes sense, but I imagine lawyers need more basic training in intellectual property law even though they now need much less training in feudal conveyances. For instance, my 1L property course didn’t even touch on IPR, but dwelt endlessly on future interests.

My own property teacher was wonderful—a brilliant scholar of the infamous Rule Against Perpetuities. His course was like the grandest LSAT logic game ever conceived. I enjoyed it, oddly, but it was far from the best imaginable use of my time in terms of the substantive content (the retort would be that it was a skills course not a black letter law course, but 1) I’d like to think I had decent critical thinking skills before the course and 2) in any event I could have sharpened my analytical tools on more relevant doctrines).

5. More attention to statutory law makes sense. I took courses on legislation and administrative law and found them extremely helpful. Parsing cases is a good exercise and important legal skill in a common law jurisdiction, but since Langdell’s method was instituted there has been an explosion in statutory law. It’s about time the 1L curriculum reflected that.

6. Shifting some 1L emphasis from private law to public law makes sense (it always amuses me how all those students fresh from writing admissions essays about how they want to save the world are thrown into learning about how to sort out who owes what to whom, a much more conservative project). But I do hope these HLS students are exposed to “theories” of how the protection of property rights and economic liberty are basic human rights, critical for liberty and freedom.

Harvard has posted a statement about the curriculum changes here. According to the statement the faculty approved the curriculum overhaul unanimously. It’s hard to imagine such a large, contentious law faculty agreeing unanimously on anything!

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On the DEMO website I saw a video about ThinkFree, an online office suite. I test drove it and like it very much.

They currently give you a free gigabyte of storage. With today’s high-megapixel cameras a gig might only store a few hundred photos, but for the text documents, spreadsheets and PowerPoint-type files that ThinkFree wants to handle, a gig is a lot of storage.

Within a few years using a non web-based (or non-web-enabled) word processor will seem as retrograde as using an old typewriter. Web access and the easy collaboration it provides will probably be as compelling as not having to re-type something to change it.

ThinkFree is the slickest of the web-based office suites that I’ve tried, though with Google and Microsoft bearing down, they will have to move fast, even with a great product, if they want to have the luck of YouTube whose investors and 60-odd employees are now divvying up $1.6 billion in Google stock.

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The New York Times reports that that old-line v.c. firm Sevin Rosen has “returned commitments” (meaning they’ve either returned cash or canceled rights to call down cash) for one of its funds. They’ve purportedly done so because they believe right now exit opportunities just aren’t good enough to justify taking more money from investors.

Hmpf.

I am used to inveighing (along with many others) that China’s lack of stock market exit mechanisms contributes to China’s under-achievement in many high tech areas (we certainly can’t blame a lack of human talent!); however, the notion that a lack of appealing exits will thwart U.S. v.c. funds is, um, novel.

A few differences should be noted. First, the U.S. is awash in v.c. money. This Times story notes, “At the end of 2005, venture capitalists had a combined $261 billion under management, more than at any time in the industry’s history[.]” So this can be seen simply as one well-funded firm crying uncle about a glut of supply compared to its perception of available investment opportunities and the likely returns on those investments. Although China has lots of cash (including staggering FOREX reserves and bank deposits), I don’t think it has a similar glut of v.c. funding.

Second, China lacks exit mechanisms for v.c. funds because of the way the PRC government has structured China’s stock markets (and to a lesser extent M&A markets). Sevin Rosen, in contrast, is making a judgment about market conditions, not regulatory blocks.

It’s bold for Sevin Rosen to return cash. If they don’t think they can earn desirable returns it is the right thing to do—much better than taking the cash and succoring themselves on the management fees while secretly hoping their analysis is wrong.

Still, whether or not they have correctly judged the market is unclear. Will there still be a lack of good exits down the road? Personally, I’d want to hedge that bet (and v.c. money is not after all supposed to be the core portfolio of a retirement fund!). Plus, if returns look lower for v.c. investors compared to historic highs, that may not mean v.c. funds won’t outperform other investments. What are portfolio managers supposed to do with their risk capital, put it in U.S. real estate? (I’ve got a house for sale in the DC area that’s been languishing for months now, and my anticipated return has been dropping lock a rock!).

Besides general economic uncertainty, it seems to me there is a there there in all the Web 2.0 buzz. Check out the videos and links from DEMOfall 2006 to get a sense. Not every scheme will be a YouTube or MySpace, but some will.

The Times story is titled A Kink in Venture Capital’s Gold Chain and is by Miguel Helft. With registration it is available here.

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