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Do China’s Stock Markets Matter? Carl Walter Berkeley Center for Law, Business and the Economy

Do China’s Stock Markets Matter? Carl Walter Berkeley Center for Law, Business and the Economy University of California, Berkeley November 1, 2011. Overview. What role do China’s stock markets play in the overall political economy?

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Do China’s Stock Markets Matter? Carl Walter Berkeley Center for Law, Business and the Economy

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  1. Do China’s Stock Markets Matter? Carl Walter Berkeley Center for Law, Business and the Economy University of California, Berkeley November 1, 2011

  2. Overview What role do China’s stock markets play in the overall political economy? How can an economy with no private property develop equity capital markets? How were state-owned enterprises transformed into corporations and listed? - slicing and dicing corporates - creating the National Team - some consequences of this original restructuring approach - restructuring the banks - some consequences of this restructuring approach Final comments Berkeley Center for Law, Business and the Economy, November 1, 2011

  3. China’s equity capital markets are not important financially Corporate capital raised in Chinese markets Equity = 5.7% Bank Loans = 85.4% Corporate Bonds = 8.9% Berkeley Center for Law, Business and the Economy, November 1, 2011 Aggregate number of domestic Chinese IPOs Plus 800 Chinese companies listed on international markets

  4. SOEs—an indivisible part of the State The State provides supplies and the State distributes the output The State Berkeley Center for Law, Business and the Economy, November 1, 2011 State-owned Enterprise 2

  5. Southern Tour Standard Opinion SEHK MOU CSRC estab. 9 “H” Shares 1992: China embarks on Corporatization for its SOEs The Contract System is Replaced by Corporatization Shenzhen Riots January May June August October October Berkeley Center for Law, Business and the Economy, November 1, 2011 • The “Standard Opinion” gave legal basis to corporatization and legally defined share classes • Created non-tradable shares • Cooperation with Stock Exchange of Hong Kong provided access to a large and mature market • Put domestic market development in a subordinate position 10

  6. 1993 – 1997: SOE Reform via public listings Two track listings Creating legal basis Oct. 92—1st overseas listing July 93—1st HK listing Aug. 94—1st NYSE listing Oct. 97—China Telecom IPO July 93— Exchange Regulations July 93— Accounting standards July 94— Company Law July 99— Securities Law Berkeley Center for Law, Business and the Economy, November 1, 2011 • The Company Law affirmed corporatization as the basis of SOE reform • Securities Law affirmed CSRC as sole regulator 11

  7. Standard Opinion—corporatization method 1 Govt Ministry Gov’t Ministry Oversight 100% ownership SOE Berkeley Center for Law, Business and the Economy, November 1, 2011 Selected net assets State shares SOE NewCo NewCo becomes a fully incorporated company wholly-owned by its Ministry in the form of State Shares 14

  8. SOE #1 SOE #2 Standard opinion—fund raising method 2 What if Multiple SOEs under the same Ministry are involved? Non-State Investors Gov’t Ministry LP shares or A/B/H shares Berkeley Center for Law, Business and the Economy, November 1, 2011 Domestic LP shares SOE#1 and #2 end upreceiving State Legal Person shares inreturn for their net assetcontributions. Public investors get A shares in return for cash. NewCo 15

  9. The type of share depends on who invested Shanghai and Shenzhen Exchanges market structure Berkeley Center for Law, Business and the Economy, November 1, 2011

  10. SOEs—big and complete, small and complete Roads and Infrastructure Hotels Schools Hospitals Farms Worker Housing Courts Police & Fire Dept. Berkeley Center for Law, Business and the Economy, November 1, 2011 Trading Company Travel Agency Factory #1 Factory #2 Factory #3 How do you take THAT and create a modern corporation? 3

  11. Roads and Infrastructure Hotels Schools Hospitals Farms Worker Housing Courts Police & Fire Dept. Trading Company Travel Agency In ??? Factory #1 Factory #2 Factory #3 Slicing and dicing: a thorough restructuring Out Berkeley Center for Law, Business and the Economy, November 1, 2011 17

  12. A thorough restructuring 2 Comparative Companies plus draft audits are the critical report card Cash Receivables Fixed Assets LT Receivables LT Investments Intangibles ST Debt Payables LT Debt Verify with bank statements Verify payment schedule Identify ownership, conduct asset appraisal What are these? Who owes them? What are these? What are these? Berkeley Center for Law, Business and the Economy, November 1, 2011 Whose debt, can it be gotten rid off? Whose payables, ditto Whose debt, ditto Does the proto-NewCo have a positive net worth? Is it too much? 18

  13. The goal of restructuring: Valuation, one fundamental problem • Profitability both in absolute and in marginal terms • Sustainable growth prospects: what are the industry’s prospects • Strong balance sheet • Competitive products • Sound management • Management oversight through a Board of Directors The NewCo is designed to resemble as much as possible an existing listed company in the same industry The problem is: even if all the above goals are achieved, the NewCo remains an untested company with no operating track record. It is fundamentally not comparable with existing listed companies operating in market economies Berkeley Center for Law, Business and the Economy, November 1, 2011 19

  14. A single unrestructured Chinese enterprise: another problem The cash generated by the productive assets and labor supports everything and everyone else in the SOE Retirees Berkeley Center for Law, Business and the Economy, November 1, 2011 Non-productive assets Productive assets and workers In China the SOE is the country’s social security program 20

  15. The post-IPO cashflow crunch The cash generated by the productive assets and labor can no longer flow directly to the rest of the SOE, except a trickle as dividends. Berkeley Center for Law, Business and the Economy, November 1, 2011 How can the Parent now support itself and its staff? 24

  16. Post-offering overall Group corporate structure ADRS Parent Co. (SOE) H shares Berkeley Center for Law, Business and the Economy, November 1, 2011 A shares Listed Co. 21

  17. Unrestructured industry: a third problem Ministry Berkeley Center for Law, Business and the Economy, November 1, 2011 Individual enterprises 22

  18. The creation of National Champions Ministry Berkeley Center for Law, Business and the Economy, November 1, 2011 Parent SOE companies Holding Co. Ltd. New company 23

  19. The China Telecom IPO, 1997US$4.5 billion dual listing Ministry of Posts and Telecommunications China Mobile Communications Corporation 100% US$6.6 bn = appraised Net Asset Value contributed China Mobile Hong Kong Group 100% China Mobile BVI 75% NYSE/HKSE Listed Shares Berkeley Center for Law, Business and the Economy, November 1, 2011 100% China Mobile (HK) Co. Ltd. 25% Guangdong BVI Zhejiang BVI Jiangsu BVI Fujian BVI Henan BVI Hainan BVI 100% US$4.5 bn= cash contributed for shares 100% Guangdong Mobile Zhejiang Mobile Jiangsu Mobile Fujian Mobile Henan Mobile Hainan Mobile

  20. 1998: government streamlining eliminates industrial ministries 1950-1998 1998-2003 Ministry of Finance Ministry of Finance Ministry X Ministry X State Asset Management Bureau State Asset Management Bureau Berkeley Center for Law, Business and the Economy, November 1, 2011 SOE Y Group Company ListCo ListCo Who “owns” the group company?

  21. 2003: SASAC is established: yet another problem State Administration of State Assets Commission (SASAC) SOE Group SOE Group SOE Group SOE Group Berkeley Center for Law, Business and the Economy, November 1, 2011 50%+ 50%+ 50%+ 50%+ Board of Directors Board of Directors Board of Directors Board of Directors ListCo 4 ListCo 1 ListCo 2 ListCo 3 Supervisory relationship Equity ownership

  22. Who is the beneficiary of SOE profits? Berkeley Center for Law, Business and the Economy, November 1, 2011

  23. What to do with the money? Berkeley Center for Law, Business and the Economy, November 1, 2011

  24. Invest in brother and sister SOE listings Berkeley Center for Law, Business and the Economy, November 1, 2011 * denotes overseas returnee issuer

  25. Who profits? Your brother and sister SOEs Berkeley Center for Law, Business and the Economy, November 1, 2011

  26. Original Huijin investments pre-2005 Post-2005 Huijin investments An alternative to SASAC: Central SAFE Investments MOF PBOC Huijin 100% 48.7% 50% 50% 85% Board of Directors Board of Directors Board of Directors Board of Directors Board of Directors Berkeley Center for Law, Business and the Economy, November 1, 2011 Industrial and Commercial Bank of China Agricultural Bank of China China Development Bank China Construction Bank Bank of China

  27. The Big 4 banks: from 2004-2010 paid US$84 billion in cash dividends Berkeley Center for Law, Business and the Economy, November 1, 2011 Source: bank H-share annual reports for the Big 4 banks The four banks raised US$106 billion in IPO proceeds = ABC 2010 IPO of US$22 billion + US$84 billion in cash dividends 21

  28. Final comments The adoption of shares and stock markets led to the creation of a national capital market, China first The corporatization of SOEs turned them into property which could be “owned” - the process enhanced the independence and power of SOE management Experience with markets and corporatization led to a more sophisticated restructuring approach for the banks - but this approach put banks into play Overall, corporatization and shares created property that the State could monetize if desired - could be used to fund a social security program - could be used to pay down state obligations Created the infrastructure for true privatization Berkeley Center for Law, Business and the Economy, November 1, 2011

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