China Flexes Its Muscles on Wall Street

First, it was the massive accumulation of China’s foreign reserves in Beijing’s wallet, the largest in the world, with $1.4 trillion. A major portion of that money has flowed into the U.S. Treasury bonds, subsidizing much of the Bush administration’s deficit-driven economy. Then, there was the global expansion of large Chinese companies searching for energy and resources to satisfy its hungry growing economy, offset by a failed $18 billion takeover effort of the U.S. energy company Unocal by China National Offshore Oil Corp. (CNOOC). Now, China has begun to accelerate and diversify its foreign investment portfolio in a much more confident manner. Last month, CITIC Securities Co. reached an agreement with Bear Sterns Companies to invest $1 billion in each other. This was followed by the announcement that the Industrial and Commercial Bank of China Ltd. (ICBC) will buy 20 percent of South Africa’s Standard Bank Group Ltd. with $5.5 billion in cash. Time has come for China’s financial giants to flex some of their muscles.

“Partners of Choice” Investment Approach

Both transactions have made history in China’s financial and banking sectors. CITIC Securities Corp. is China’s largest stock operator and one of the biggest in the world. Its $1 billion investment in the New York-based securities firm Bear Sterns Cos. is by far the largest overseas expansion by any Chinese securities firm. The deal gave CITIC a 6 percent stake in Bear Sterns, which will in turn have 2 percent equity in CITIC. If approved, the transaction will give CITIC direct access to Wall Street. The two firms also plan to form a new joint venture company in Hong Kong to explore expansion possibilities in the booming Asian market.

Call the CITIC-Bear Sterns deal a “perfect match” or “marriage of convenience,” but the fact is that CITIC has the extra cash and Bear Sterns is looking for new opportunities. CITIC Securities has seen its fortune growing with unbelievable speed. This year alone, its market value has more than quadrupled to $50 billion, leaping to No.1 stock brokerage status in Asia. Moreover, the fast-running bull’s net profit in the first nine months of this year is about $1.1 billion, seven times more than the same period last year (Reuters, October 22). On the other hand, Bear Sterns, 84 years-old and the fifth largest U.S. securities firm, has suffered from the subprime mortgage meltdown with two of its hedge funds going bankrupt, and its stock value dropping 37 percent this year. The new alliance with CITIC is projected to strengthen Bear Sterns’ competitiveness in the Chinese market.

The ICBC $5.5 billion purchase of a fifth stake in Standard Bank, in contrast, is by far the biggest overseas banking acquisition effort by any Chinese company. ICBC, listed in both Hong Kong (HKEX) and Shanghai Stock Exchanges (SSE), is the now the world’s largest bank, with a market capitalization of about $319 billion, managing assets worth about $1.1 trillion (Mail and Guardian, October 30). The 20 percent stake in Standard Bank gives ICBC access to Standard Bank’s banking and financial operations both in the African continent and in 38 resource rich countries in the Middle East, Latin America and Asia. For Standard Bank, the Chinese cash infusion turns South Africa into China’s largest foreign investment destination in the African continent, giving Standard access to the fastest growing economy in the world, and enabling it to manage financial flows between African and Asian markets.

China’s “Go-out” Strategy for Surplus Capital [1]

These transactions are the latest in a series of Chinese banking and financial outreaches around the world in recent months. Fueled by a rapidly expanding domestic stock market and the continuous inflow of foreign investment, China’s capital market is loaded with an excessive amount of money seeking investment opportunities. The Chinese authorities have accordingly relaxed controls over institutional and private investments abroad, and announced new rules to encourage outflow of Chinese capital. Here are some of the latest developments:

• In May, the Chinese government spearheaded the overseas capital rush by announcing that it would invest $3 billion in Blackstone Group, to be managed by a newly established State Investment Company. Clearly a diversification effort from putting China’s huge foreign reserves into U.S. Treasury bonds, Beijing characterized the 10 percent stake in the New York-based firm as “just looking for better return” (Bloomberg, May 22).

• In June, Beijing delivered the first $1 billion of a $5 billion commitment to the China-Africa Development Fund which was set up to enhance China’s economic ties with African countries, and to help Chinese trade and investment in the continent ” (Xinhua, June 27).

• In July, China Development Bank (CDB), a state-owned policy bank, agreed to spend $3 billion to purchase a 3 percent stake in Barclays PLC of Britain. This will make CDB the largest share holder of Barclays which is the largest issuer of credit cards in Europe and the third-largest banking group in Britain with around 27 million customers and clients in more than 50 countries and regions (Xinhua, July 24).

• In October, Minsheng Banking Corporation, China’s seventh largest bank by market value, announced that it would spend $317 million for a 9.9 percent stake in UCBH Holdings Inc. and may eventually own up to 20 percent of the San Francisco-based commercial bank. This marks the biggest leap abroad of a Chinese private bank (Shanghai Daily, October 8).

• Beijing has also moved to allow private citizens to invest overseas through a growing number of Chinese banks, security companies, fund-managing firms and insurers under the Qualified Domestic Institutional Investor program (QDII). Furthermore, it was reported that the latest Chinese QDII investor raised more than $13 billion, over 3 times more than its originally projected amount (China Daily, October 16).

These developments—the shift from government managed funds to provide sector initiatives—have represented a small leap forward for China’s capital outflow into the world financial market, and it has raised concerns about both the nature of these investments and Chinese intentions behind them.

Unocal: Lesson Learned but Barriers Ahead Still

It was not so long ago that China’s banking and other financial institutions were perceived as burdened with bad loans, non-transparent, lagging behind in much needed reform and facing the danger of collapse. Chinese leadership, however, seems to be determined to prevent these problems from becoming worse. There is also no doubt that, while all these issues may come back to haunt the Chinese economy, China’s booming stock market in the past few years has injected new confidence into China’s newly emerged financial power houses. Their march toward the world stage seems to be based on a few lessons learned from the past.

First, unlike CNOOC’s failed bid to buy Unocal two years ago, none of the latest Chinese financial activities abroad pursued 100 percent takeovers or majority holding status of any foreign financial institutions. Rather, their common feature is to be participants in a minority holder position, ranging from a few percentage points to no more than a 20 percent equity share. By coincidence or by design, these acquisition efforts were carried out in a fashion that clearly tried to avoid creating any major threat perceptions or raising alarms about China’s intentions.

Second, all these investments are targeted at partners that can further expand China’s financial and investment portfolios around the world. These partner institutions will provide an established global financial infrastructure that the newly emerged Chinese counterparts lack, thus satisfying future development needs of China’s overseas investment drive.

Third, in these investment transactions, the Chinese firms were aiming at a small part of equity rather than asserting control over the execution of the new partnerships. The Chinese institutions are all aware that they lack managerial know-how, operational knowledge and market expertise in global finance, and hope to learn from their foreign counterparts through these new joint ventures.

Finally, Chinese ventures involved in the latest overseas expansions have emphasized the commercial nature of their actions. Equity, profits, management skills, access to markets and sustaining China’s continuous economic development, they argue, are the true motives of these overseas investments.

While many welcome China’s new financial adventures that bring new opportunities, others have expressed serious reservations comparable to the tense debates surrounding CNOOC’s bid for Unocal in 2005, although CITIC Securities’ $1 billion investment in Bear Sterns Co. only gives the former a 6 percent equity in the latter. Notwithstanding, the U.S. Treasury, under its Committee on Foreign Investments in the United States (CFIUS), will work with several departments—including Justice, Commerce, State and Defense—to investigate whether the deal raises concerns for national security, according to a report from the Telegraph (Telegraph, October 24).

Another deal—the Chinese tech company Huawei Technologies’ proposed $2.2 billion purchase of U.S. communication firm 3Com—one which Huawei is pursuing with its U.S. partner, Boston-based equity firm Bain Capital, has also aroused strong sentiments in some quarters of the United States for its perceived national security risks. The buyout proposal gives Bain Capital 83.5 percent of 3Com stock while Huawei has only 16.5 percent. U.S. Congressman Duncan Hunter (R-CA) declared during a recent CNN interview that the recent bid “goes right to the heart of cyber security,” referring to some of 3Com’s U.S. government contracts, which might be compromised if the acquisition materializes (Caijing.com.cn, October 23).

Such rhetoric from the U.S. Congress is familiar, but if the Chinese firms have learned their lessons from the CNOOC-Unocal episode and are now approaching their global reach-out with caution, the U.S. Congress does not seem to be behaving any differently than during the time when it treated the Unocal bid by CNOOC as a potential national security threat. Rather than rushing to simplistic conclusions and overacting, both sides could benefit when reminded that China’s booming-hot capital outflow, although still under the shadow of communism, is traveling on the path well laid out by the logic of modern capitalism.

Notes

1. Shanghai’s city government adopted a “Go-out” economic strategy in 2001, characterized by the strategy of “foster[ing] a group of influential multinationals and establish a group of overseas production bases to boost its transfer of matured industries to overseas” (People’s Daily, June 6, 2001).