Capital Markets Transparency and
Security: The Nexus Between U.S.-China Security Relations and
America's Capital Markets
China's Recapitalization
There exist a number of ways China might attempt to "recapitalize" its
economy. Domestically, the government can seek to expand its revenue stream
by strengthening tax collection and eliminating corruption and graft at the
provincial level. It can similarly stimulate domestic demand to reduce the
country's reliance on export-generated revenues as well as encourage investment
in -- and lending to -- capital-producing projects. Moreover, China could strengthen
its rule of law and improve its business environment to attract more foreign
direct investment.49 While worthy objectives,
the effects of these measurers, if successful, would likely have little impact
on Beijing's more immediate hard currency requirements.50
Two more promising funding venues, however, could yield the sustained, multi-billion-dollar
capital streams China requires annually: 1) the PRC's domestic capital markets;
and 2) the international capital markets.
Domestic Chinese Markets
China dedicated significant resources in the 1990's to developing its nascent
capital markets. Although it has advanced the process -- and could become the
third largest financial center in Asia by the end of this decade -- its domestic
markets remain inefficient, thin and, compared to those in the West, relatively
underdeveloped. Even when viewed optimistically by international analysts and
market players, it is difficult to envision China's markets as a decisive source
of capital for the government in the coming years.
China's most pressing domestic capital market concern is its underdeveloped
bond market. This limitation makes it difficult for the government to issue
sovereign debt in order to help fund stimulus measures and the above-referenced
capital requirements. According to a 1998 Financial Times article, "Perhaps
the most important reform for the government is the creation of a liquid bond
market that would facilitate the issuance of government debt." 51 Central
government policies, however, continue to hamper progress. Specifically, China's
central bank controls interest rates, thereby disrupting the fluidity of the
market and undermining its vitality.52
China's equity markets have faired little better. Irrespective of impressive
figures regarding the market's capitalization, rate of listings and active
trading, its domestic stock market fails to inspire confidence. Of principal
concern are artificially high prices, insider trading, market manipulation
and a dearth of transparency and disclosure.53 In
addition to these challenges, Nicholas Lardy of Brookings Institution raises
doubt with respect to the empirical strength of China's equity markets, pointing
out that "the market's huge capitalization wildly overstates their importance
because it reflects the total value of listed companies, not the tiny number
of shares traded."54
Far from serving as a primary recapitalizing vehicle for the central government,
China's burgeoning markets could potentially become a net financial drain.
Currently, some 34 million Chinese -- many of whom are unemployed -- actively
trade in China's equity markets.55 China's
own National Bureau of Statistics emphasized recently that "immense risk
could be lurking in the markets," likely due to what China Online News
terms "an under-regulated stock market, low-quality public companies and
investor irrationality."56
Three prominent Chinese economists came to a more dramatic conclusion in a
recent letter to China's National People's Congress. According to China Reform
Monitor, the correspondence stated, "Rampant market speculation and a
massive drain of capital from floundering state-owned enterprises, combined
with a lack of regulation in China's mushrooming securities markets, could
lead to a 1929-style stock market crash."57 While
Beijing's control over its domestic markets makes such a scenario improbable,
any financial implosion of this type could cripple the government financially
and possibly result in significant social backlash.
International Financial Markets
China's most realistic -- and near-term -- venue for meeting its large-scale
capital requirements is the international debt and equity markets. Statistics
reflecting the country's increasing presence in these markets attest to the
efficacy of this strategy. Between 1980, which marked China's return to the
global debt markets, and 1999, China issued some 195 global debt offerings,
netting some $24 billion.58 Roughly $14 billion
of these funds were raised through U.S. dollar-denominated debt offerings.
During this same period, some 23 Chinese firms were listed on U.S. stock exchanges
-- a number of which are no longer actively traded. Dozens more created off-shore
subsidiaries that were then listed on Hong Kong's Hang Seng and marketed to
international investors.
Prior to 1998, the primary funding vehicles for China were international sovereign
bonds and debt offerings by the country's "big four" banks and a
number of "ITIC's," or international trust and investment corporations.
ITIC's are "vehicles through which Chinese government agencies and local
authorities raise money abroad for investments at home."59 From
1980 through 1998, the PRC raised some $4.2 billion in dollar-denominated bonds
under its own name.60 The Bank of China and
People's Construction Bank attracted an additional $3.5 billion. China International
Trust and Investment Corporation (CITIC) and other ITIC's offered some $2 billion
in dollar-denominated debt.61 Each of these
entities attracted billions more in deutschmark- and yen-denominated bonds
during the same period.
Beginning in 1998, Chinese activity in the international markets increased
significantly, accompanied by a diversification strategy designed to expand
the number and types of PRC-owned or -controlled entities seeking global funds.
The Financial Times provided an accurate, if understated, confirmation of this
trend: "China is set to rely more on...international capital markets next
year as the government continues its fast-growing debt issuance program to
finance infrastructure spending and boost economic growth."62
The centerpiece of this strategy to expand access to global capital markets
is the "privatization" of state-owned enterprises. By listing these
companies on international exchanges, the PRC is able to raise billions of
dollars from a diversified funding base. In addition to providing critical
capital and helping underwrite both healthy and faltering SOE's, the listings
provide legitimacy for China's largely centrally-controlled economy and create
global constituencies with vested financial interests in seeing that these
companies not only survive, but prosper.
"Privatization" through overseas listings rarely strays from two established
patterns. State firms, for example, can simply list in Hong Kong or elsewhere
to acquire shareholders and capital (i.e., so-called "H-shares"). More
often than not, however, China's SOE's prefer to construct a Hong Kong-domiciled
subsidiary and transfer profit-generating projects, divisions or other assets
to the subsidiary to bolster share value. In addition to helping attract international
investors, this step provides the impression that the listed firms are independent,
autonomous entities whose primary mission is to strengthen the company's bottom
line.63 More importantly, it preserves the
parent company's ability to forego a number of transparency and disclosure requirements
with respect to its operations, management structure or finances. These so-called "red
chips" then raise capital through an initial public offering and listing
on the Hang Seng and/or other global exchanges.64
Unlike U.S. and other Western firms, which often float a majority of their
stock when "going public" (thereby creating shareholder-owned companies),
China's SOE's tend to offer between 10 and 30 percent of the company. In the
case of "red chips," the parent company usually maintains a controlling
interest in the subsidiary. According to a 1997 Credit Lyonnais Securities
Asia (CLSA) report, ì...most red chip parents have maintained a large
majority shareholding in their listed vehicles." The report goes on to
state that "Many red-chip parents exercise strong control over the 'family'
of companies in their groups."65
Dominant control (both in terms of management and ownership percentage) by
the mainland has given rise to investor-related concerns. Specifically, as
primary owners, mainland parent companies control the "red chips" use
of profits and dividends, management structure and, if deemed warranted, can
directly intervene in corporate decision-making. If the parent chooses to divert
revenues to its own operations, for example, minority shareholders would have
few avenues of recourse. While not prevalent, there have been cases in the
past when parent companies have diverted the resources of "red chips" to
benefit mainland operations.66 Put simply, "red
chips" should not be viewed as entirely independent, irrespective of their
Hong Kong headquartering.67
Although U.S. capital markets remain the "prize" for China's funding
strategists due to the depth, prestige and unimpeded access to American institutional
investors that accompanies U.S. listings, Hong Kong presently remains the primary
venue for the "privatization" of Chinese SOE's. In 2000 alone, some
65 PRC-controlled or -affiliated firms were listed on the Hang Seng, attracting
in the range of $9 billion.68 These listings
accounted for approximately 75 percent of the exchange's initial public offerings
that year.69 (It should be noted that only
about one-third of these firms were trading at a level which exceeded the IPO
price by year's end.)70
The move away from Hang Seng listings, however, has begun in earnest. In the
past few years, Chinese firms and their subsidiaries have accelerated their
preparation to list on U.S. and other international exchanges. The primary
impetus for this strategy is tapping deeper volume markets that are more capable
of absorbing large amounts of "China risk" over time. For example,
although PetroChina, a subsidiary of China National Petroleum Company, raised
$2.89 billion in a "global listing" last year (New York and Hong
Kong), the company attracted only about $350 million from the Hang Seng listing
(roughly 15 percent of total proceeds).71 Equally
important is the successful launch of Chinese firms to pave the way for hundreds
of SOE's to be listed in the coming years.
The PetroChina example underscores the need for China to expand its access
to the U.S. debt and equity markets to help attract the large sums of capital
required annually by the PRC and its network of enterprises. It also validates
the views of many Wall Street and other analysts that the New York Stock Exchange
listings of PetroChina and Sinopec (the country's second largest energy concern)
in 2000 were preludes to a veritable convoy of Chinese SOE's that will seek
to attract funds in the U.S. capital markets over the next decade. Indeed,
according to a recent Reuters report, "Hoping to capitalize on [the IPO
success of 2000], the State Economic and Trade Commission has said it intends
to 'cultivate' 30 to 50 large state-owned enterprises over the next five years,
culminating with overseas listings."72
Conclusion
China's most reliable and expedient route to meeting massive capital demands
is accessing global capital markets. Despite efforts to bolster the development
of its domestic markets, China's debt and equity markets remain thin, under-regulated
and incapable of generating the large-scale capital infusions China needs to "keep
the dragon roaring." An alternative venue is the global -- and most importantly,
the U.S. -- capital markets. It can be expected that Chinese SOE's will list
on these exchanges with greater frequency and scale in the coming years. Regrettably,
certain of these firms will likely be "bad actors," (i.e., PLA-affiliated
entities, companies that aid and abet terrorist-sponsoring governments, etc.)
seeking funds from unwitting Americans to finance dubious activities.