U.S.-China Economic and Security Review Commission, "Hearing: China's Presence in the Global Capital Markets," April 16, 2004

April 16, 2004
SD-138 Dirksen Senate Office Building
Washington, DC

Prepared Statement of Chairman Roger W. Robinson, Jr.

On behalf of the U.S.-China Economic and Security Review Commission, I would like to welcome you to today’s public hearing, the Commission’s final hearing of its 2003–2004 reporting cycle. During the past 10 months, the Commission has convened ten hearings, including field hearings in Columbia, South Carolina and San Diego, California. We are currently in the process of compiling the findings and recommendations related to our work over the past year in our Annual Report to the Congress, which will be released next month.

Our focus today is on the cutting-edge issue of China’s presence in the global capital markets, and the implications for U.S. investors, market regulators and, more broadly, U.S. security interests.

In setting out our mandate, the Congress took a broad view of the economic and security issues associated with the U.S.-China relationship. Our charge to examine, ‘‘Chinese access to, and use of United States capital markets,’’ demonstrates Congress’ recognition that U.S. investor funding of Chinese firms through our capital markets has become a substantial component of the U.S.-China economic relationship. Moreover, our mandated requirement to evaluate whether existing capital market disclosure and transparency rules are adequate to identify for investors any Chinese firms conducting, or involved in, activities harmful to U.S. security interests demonstrates Congressional concern about the identities and operations of certain Chinese firms accessing our markets.

As China’s economy has grown and restructured, the Chinese government has recognized the importance of reaching out to the international capital markets. These listings open the door to an important pool of capital for Chinese enterprises, enhance the reputation of the firms involved, and could serve to advance economic reforms by subjecting listing firms to intensified financial scrutiny and discipline. The Chinese government has the final say over which Chinese enterprises will be permitted to list on international capital markets, and to date has reserved this privilege almost exclusively for state-owned companies. The number of Chinese initial public offerings (IPOs) in international capital markets is sharply on the rise this year, with some market analysts forecasting the volume for 2004 to exceed $23 billion.

This development has important implications for U.S. interests. Chinese state-owned enterprises listing on international capital markets generally remain under the control of the Chinese government and play by corporate governance and transparency rules vastly different from U.S. norms. With billions of dollars in U.S. investor funds being attracted by these firms, it is vital to understand whether U.S. investors are being provided adequate information about their governance and financial performance, and whether U.S. regulatory requirements are sufficient to capture this concern.

As reflected in our Congressional mandate, the Commission also continues to be concerned about the potential linkages between listed Chinese firms and China’s defense-industrial complex and weapons proliferation activities. At a minimum, U.S. investors should be given adequate information about such activities in order to make more informed decisions as to whether they want to fund such companies. Such security-sensitive activities could also constitute a material risk to investors because of the possible negative impact on the share value and reputations of these enterprises. More fundamentally, the Commission is concerned about whether the U.S. Government is sufficiently monitoring this nexus and focused on the potential security implications.

The goal of today’s inquiry is to hear a variety of perspectives on the goals, methods and implications of Chinese firms’ use of global debt and equity markets to raise capital, particularly our own. This hearing takes place at a time of growing concerns over the governance and transparency of Chinese enterprises in the wake of several high-profile listings that have come under scrutiny. For example, the U.S. Securities and Exchange Commission recently announced a probe into New York Stock Exchange (NYSE)-listed China Life’s accounting irregularities and a trade secret theft and patent infringement suit has been brought in U.S. courts against NYSE-listed Semiconductor Manufacturing International Corp. (SMIC). These cases appear to have cooled investors’ appetite for Chinese IPOs, at least in the short-term.

Our opening panel will provide the Commission with an assessment of the trajectory of China’s presence in the global capital markets. We will hear from Professor Pieter Bottelier, Adjunct Professor at Johns Hopkins School of Advanced International Studies and Georgetown, and William Gamble, author of ‘‘Investing in China: Legal, Financial and Regulatory Risk,’’ who will discuss China’s capital needs and the role the U.S. and international capital markets have played—and are likely to play in the future—in addressing these needs. Tim Halter, of USX China Index, and Amit Tandon, of New York Global Securities will round out the panel with an explanation of what criteria are most often used when selecting Chinese enterprises for listings in global capital markets, how the performance of Chinese companies is quantified and which key Chinese IPO’s are on the horizon.

During our second panel, we will explore in-depth the corporate governance and other investor concerns that arise in the context of Chinese firms accessing our capital markets. Thomas Byrne, a Vice President and Senior Analyst on China at Moody’s, will explain the unique aspects and challenges of rating Chinese equity and bond issues. Nell Minow, Founder and Editor of The Corporate Library, and Jeffrey Fieder, President of the Food and Allied Service Trades Department (FAST) at the AFL–CIO, will discuss China’s corporate governance and accounting standards, how they compare to U.S. standards, and what the implications are for U.S. investors. Norman Bailey is a Senior Fellow for the Potomac Foundation and served as Senior Director of International Economic Affairs at the National Security Council during the Reagan Administration from 1981 to 1983. Mr. Bailey will share his views on some of the national security implications of China’s presence in global capital markets.

When the Commission held its first hearing on this topic in December 2001, it was, to my knowledge, the first time that a U.S. Government body had publicly examined this emerging area of security risk. The Commission recognizes its leadership responsibility in this issue portfolio and will continue to evaluate this crucial component of U.S.-China relations for the benefit of the Congress and the American people. With that introduction, I would like to turn to our first panel.

Prepared Statement of Vice Chairman C. Richard D’Amato

I would like to thank Chairman Robinson for focusing the Commission’s attention on the important topic before us, and today’s panelists for offering their informed perspectives on this issue. As the Chairman discussed, the economic and security challenges for the United States stemming from China’s incursion to the global capital markets is certainly one of the most unique issues in our mandate from Congress.

The vast majority of U.S.-listed Chinese enterprises—92 percent—are owned and operated by the Chinese state. Questionable corporate governance, accounting practices, and minority shareholder rights make this a subject of particular concern to the Congress. These issues have significant implications for U.S. investors looking to purchase stock in Chinese firms, as well as financial analysts tasked with unraveling Chinese companies’ complex web of relationships and finances. These facts raise questions about the suitability of Chinese debt and equity listings in the U.S. markets, and so called ‘‘China funds’’—mutual funds focused on investing in China securities. I am concerned that U.S. investors may not have sufficient information to make informed decisions about the risk of these investments. Furthermore, the possible links between listed state-run firms and China’s military industrial complex has here-to-for lacked comprehensive examination.

Is China using access to U.S. capital markets as a supplemental budget mechanism? Do investors in the U.S. know they are being lured into mutual fund positions that amount to financing the government of China? What are SOE’s? They are state-owned enterprises, economic units of the Chinese government.

Mr. Chairman, in a perverse way, this is genius. Here is a real suggestion to our Congressional Budget Committees, here is an idea for our Appropriations Committees. Here is a way to get at our budget deficit. Senator Byrd will be fascinated. Let’s float stock in the U.S. Defense Department on the Shanghai stock exchange, lets say an IPO for $10 billion. There goes two months of spending to keep us in Iraq. How much can we get for the dredging program at EPA? How about 10 percent of our Veterans hospitals? How about 15 percent of the Brooklyn Bridge?

Mr. Chairman, SOE’s are not transparent or accountable. It is nearly impossible to perform proper due diligence for investors. It gets worse when the due diligence for mutual funds, which pack in more and more SOE’s, is done by unknown consulting firms in Hong Kong, paid by the mutual funds. Is the SEC protecting the average grocer from Des Moines who buys into the new ‘‘Asia fund’’ or ‘‘China Buckaroo fund’’ and gets shoddy due diligence on nontransparent economic units of the Chinese government? Are they fattening their cash accounts at our expense? This trainload of new big IPO’s of Chinese SOE’s is heading over a rickety bridge.

I resist the idea of U.S. investors buying pieces of Chinese Brooklyn Bridges, and who knows what else, because of Wall Street broker hype. I fear the Wall Street crowd that brought us the hi-tech bubble is now fast creating a new China bubble.

We need to, at a minimum, shine a big new spotlight on how to perform proper due diligence on Chinese SOE’s, and fast. I would ask whether a pause in this process is advisable before we have yet another financial scandal in our markets.

Taken together, all this suggests that China’s need to finance its economic expansion and support its state-owned enterprises with U.S. investors money demands the full attention of the U.S. Government.

I would also join the Chairman in noting that today marks the end of what has been a diverse and prolific public hearing schedule for the Commission over the past year of our 2003–2004 reporting cycle. We held 10 hearings touching on a variety of economic and security related topics as mandated in our Congressional charter. Security issues ranged from China’s military modernization efforts, cross-Strait relations, and China’s involvement in the North Korea nuclear crisis. On the economic side, we examined issues such as China’s industrial, investment and exchange rate policies, its progress in meeting its WTO commitments, and the implications of all this for the U.S. economy, particularly the hard hit U.S. manufacturing sector. Today, we are continuing our discussion of China’s economic policies, specifically, China’s presence in global capital markets. Taken together we believe these activities have established a solid foundation upon which to transmit our second Annual Report to Congress, due out next month.

OPENING REMARKS
OPENING STATEMENT BY CHAIRMAN ROGER W. ROBINSON, JR.
OPENING STATEMENT BY CHAIRMAN RICHARD D’AMATO

Panel I: Trends and Key IPOs
Professor Pieter Bottelier, Adjunct Professor, Johns Hopkins University (SAIS) and Georgetown University
William Gamble, Founder and President, Emerging Market Strategies Company
Tim Halter, Managing Director, USX China Index
Amit Tandon, Managing Director, New York Global Securities

Panel II: Corporate Governance and Investor Concerns
Thomas Byrne, Vice President, Moody’s Investor Service
Nell Minow , Founder and Editor, The Corporate Library
Jeffrey Fiedler , President, FAST, AFL-CIO Dr.
Norman Bailey, Senior Fellow, Potomac Foundation