Chinese Enron? Bank of China’s Planned New York Stock Exchange Listing Collides with Systemic Corruption Revelations

(Washington, D.C.): A $2-5 billion initial public offering (IPO) and New York and Hong Kong stock exchange listings of the Hong Kong and Macao operations of one of China’s four largest banks — The Bank of China (BoC) — has been thrown into question by a series of high-profile corruption scandals. Taken together, the amounts involved may end up exceeding $500 million. This long-anticipated, landmark IPO, designed to be the flagship of China’s banking sector, is reported to have as its lead underwriters Goldman Sachs & Company, UBS Warburg and Bank of China International, BoC’s Hong Kong-based investment banking unit.

IPO Beneficiaries Implicated

Ironically, the most visible of the BoC scandals rocking both sides of the Pacific involves the bank’s Hong Kong operations as well as its branches in New York and Los Angeles. The focus of multiple investigations has been BoC’s former Chief Executive Officer, Wang Xuebing, who is presently being detained for alleged “misconduct” concerning a $23 million loan that reportedly benefitted, among others, Wang’s wife, Zong Lulu. As the New York branch of BoC reportedly paid off the allegedly fraudulent loan — originated out of BoC’s Los Angeles branch — it came under the jurisdiction of the Treasury Department’s Comptroller of the Currency to conduct the U. S. investigation. The outcome of that investigation was revealed just a few days ago: a fine levied on BoC in the amount of $20 million.

Run That By the US Again…

In a case of twisted logic and justice that is more emblematic of the Enron debacle, it was ordered that the $20 million fine be divided into a payment of $10 million to U.S. regulators and the remaining payment of $10 million to the People’s Bank of China (PBOC) — the latter of which has the same Chinese government ownership as the Bank of China. This would be akin to U.S. regulators fining a wholly-owned Enron subsidiary and requiring that half of the fine be paid to Enron’s head office. In effect, the Chinese government is receiving a refund of $10 million for the offense of one of its financial organs.

The Plot Thickens

Not surprisingly, the Beijing government — and especially Wang Xuebing’s mentor, Premier Zhu Rongji — was loath to recognize the alleged corruption of an individual that Business Week on 28 January described as “one of the brightest stars in the often dark sky of the Chinese financial world.” Accordingly, upon Wang’s departure from BoC two years ago, Beijing placed him at the helm of another of the country’s “Big Four” banks, the China Construction Bank (CCB). According to a Wall Street Journal article of 14 January, during his two-year term as CEO of CCB, Wang was also Chairman of China International Capital Corp (CICC), described by the Journal as “an investment-banking joint venture in which the Construction Bank of China and Morgan Stanley are the two largest shareholders.” CICC has served as a near-monopoly investment bank established by Beijing to serve as a partner of foreign investment banks for large-scale equity offerings in New York and Hong Kong such as the controversial PetroChina and Sinopec offerings in 2000. Predictably, the fee-splits were handsome on these and other multi-billion dollar IPO’s.

A few particulars concerning the shareholder abuse at the Bank of China (which at this writing presumably consists of Chinese taxpayers but soon could include major U.S. institutional investor’s) are as follows:

Is It Really Banking?

A Western banker broke the code in the New York Times when he remarked, “These bankers have very close ties to the government and the management is not appointed for professional skills but for loyalty and for links to the government or the party.” This same banker, who reportedly has worked closely with many Chinese banks, went on to state, “There’s a lot of lip service to commercial concerns, but in the end they’re not being paid to act commercially. When you ask why they made a loan they’ll often say. We know it’s wrong, but we were told to do this.'”

A key question that should be clarified for prospective U.S. investors before a New York Stock Exchange listing and IPO are launched is precisely what are the loans that BoC carries on its books, including the portfolio of the Bank of China’s head office. Are they, in part, political loans to failing state-owned enterprises or, worse still, to entities affiliated with China’s military and/or intelligence services (e.g., the PLA companies, etc.)?

Compounding the acute problem of “political loans” is the invitation to corruption represented by top executive salaries at China’s “Big Four” banks that are reportedly in the range of $3,600 to $4,500 a year. A lengthy Business Week article of 4 February quoted an unnamed advisor to several mainland enterprises as saying “You have government officials controlling substantial amounts of revenue and you pay them almost nothing. It provides an incentive for people to steal.”

Bottom Line

This sad state of affairs in China’s banking sector would be merely of academic interest were it not for the planned BoC listing and IPO in New York in the coming months. Subjecting unwitting American shareholders and institutional investors to this culture of corruption, non-transparency and lack of accountability is a serious matter and one that deserves the urgent attention of the Securities and Exchange Commission and possibly relevant oversight committees of the Congress. What American investor’s don’t need in the wake of the Enron collapse is a Chinese equivalent likely to be marketed as having put in place new management, U.S. accounting standards, independent directors, elaborate new shareholder safeguards and high quality credit controls. There will probably also be a significant portion of the BOC “roadshow” dedicated to the Chinese government’s high-profile arrests and renewed anti-corruption drive.

Fortunately, the Business Week article of 28 January makes plain that the “The IPO will not be successful unless these questions [arising from the aforementioned scandals] are answered.” Considering that the People’s Bank of China in early January censured all of the “Big Four” banks — that control some two-thirds of the country’s banking assets — administered punishment to 686 staff members, found a serious “breach of rules” at some 100 branches and closed 1,585 post-office bank branches, one can either be heartened or worried. The Casey Institute recommends the latter impulse.

Regrettably, the worries over BoC are not prospective, but are presently afflicting some U.S. portfolios today. What virtually all of the reporting on this recent spate of scandals has missed is that the Bank of China has already issued some $1.9 billion in dollar-denominated bonds, the bulk of which are most likely held by American investors.

Cosmetic fixes at the Bank of China and vigorous Chinese government advertising of “clean- ups” cannot offset the absence of the rule of law, genuinely independent regulators and accountants, enforceable shareholder rights, authentic corporate governance and a free media that can perform the necessary “watchdog” function. Accordingly, the Casey Institute recommends the postponement of Bank of China’s New York listing and IPO until such a time as American investors have a fighting chance of truly understanding BoC’s operations, the composition of senior management and the particulars of its loan portfolio and that of its parent institution. Most importantly, there needs to be an exhaustive disclosure and discussion of the material risks involved in holding BoC stock in pension plans, mutual funds and other investment portfolios of the American people.

For additional information see “PetroChina Coalition Urges American Shareholders to Divest — and to Expand Political Risk’ Assessments” (No.00-R99, 12 December 2000); and “Sinopec Comes to Market as China Taps Unsuspecting U.S. Investors for Funds to Support Nefarious Activities” (No. 00-C84, 19 October 2000).