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P 231016Z JUN 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 7428
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RHEHNSC/NSC WASHDC

C O N F I D E N T I A L SECTION 01 OF 04 HONG KONG 002606 
 
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E.O. 12958: DECL: 06/23/2031 
TAGS: ECON EFIN PGOV HK CH
SUBJECT: COULD A "CHINA ENRON" HAPPEN IN HONG KONG? 
 
Classified By: EP Section Chief Simon Schuchat; Reasons: 1.4 (b/d) 
 
 
SUMMARY/COMMENT 
--------------- 
 
¶1. (C) The expanding role of Hong Kong's stock market, now 
Asia's top location for raising new equity, underscores the 
importance of Hong Kong effectively vetting which firms list 
here and then regulating those companies in a manner that 
protects investor interests while also advancing China's 
economic liberalization and promoting regional financial 
stability.  The contemplated listing by the Macau firm SJM -- 
associated with tycoon Stanley Ho, as well as allegations of 
money laundering -- demonstrates how events on Hong Kong's 
exchange, which to a significant degree is privately 
regulated, might potentially be of concern to U.S. policy 
makers.  The Consul General recently held separate meetings 
with the head of Hong Kong's Security and Futures Commission 
(SFC) and Hong Kong Exchanges and Clearing (HKEx), the 
company that runs the stock exchange.  He emphasized the 
importance of listing scrutiny to Hong Kong's reputation as a 
finance center, noting the pending SJM listing in this 
context.  Both interlocutors described the thorough vetting 
required to go public here and emphasized the self-interest 
of Hong Kong and the mainland in preserving the exchange's 
strong reputation so that it can continue to serve as a 
catalyst for mainland firms to restructure and adopt global 
practices. 
 
¶2. (C) There is no doubt that Hong Kong's exchange plays a 
positive role in promoting better corporate governance among 
mainland firms.  However, the positive comments made to the 
CG by SFC and HKEx are not the whole story.  The head of the 
Asian Corporate Governance Association told us of "Faustian 
bargains" made by HKEx to let mainland firms in the door, and 
he assessed that most mainland companies listing here would 
not dare go to New York, where they could be exposed to class 
action suits.  Hong Kong's SFC lacks jurisdictional authority 
in China, and the SFC Chairman himself recognizes this as a 
pressing matter, given that most new listing business for the 
exchange comes from the mainland.  Also of note is that many 
of the companies that list here represent China's shaky 
financial system or volatile sectors like energy and 
telecommunications.  A significant downturn in China's 
economy might well lead to diminishing business prospects for 
these firms, and investor losses coupled with reports of 
malfeasance could well dent the exchange's ability to 
maintain its reputation as a center of quality geared to 
matching emerging mainland firms with global investors.  END 
SUMMARY/COMMENT 
 
BACKGROUND -- A BOOMING EXCHANGE, THANKS TO CHINA 
--------------------------------------------- ---- 
 
¶3. (U) Hong Kong's stock market is eighth in the world by 
market capitalization, fourth in the world for equity raising 
(after New York, Toronto, and the Spanish Exchanges), and the 
top location in Asia for companies raising money through 
initial public offerings (IPOs) or follow-on fund raising 
activities.  The world's top two IPOs over the past year both 
took place here: Bank of China and China Construction Bank, 
which together raised approximately USD 20 billion.  New 
business for Hong Kong's stock exchange is overwhelmingly 
driven by listings from the mainland. 
 
¶4. (U) "Going public" for mainland firms in Hong Kong 
involves issuing two kinds of shares, both well known to 
China-oriented investors: "H-shares" are stocks of 
Chinese-incorporated firms that trade in Hong Kong, such as 
PetroChina, China Life Insurance, and Air China; Red Chips 
are stocks of Hong Kong-based corporations that are 
substantially owned by entities affiliated with the Chinese 
government, including Lenovo and China Mobile.  The Bank of 
China is an H-share; the Bank of China Hong Kong subsidiary 
(BOCHK) is a Red Chip. 
 
¶5. (U) The issuance of shares by Red Chip and H-share 
companies has, since 1993, raised approximately USD 150 
billion in funds and created USD 460 billion of market 
capitalization, 39 percent of the Hong Kong stock market's 
total, representing a range of key sectors.  This in turn has 
provided significant volumes of cash to refine or expand the 
 
HONG KONG 00002606  002 OF 004 
 
 
business operations of major Chinese corporations (whose 
activities, depending on the firm, are both domestic and 
foreign) by attracting portfolio investment from foreign 
shareholders via Hong Kong. 
 
REGULATOR: TOP CONCERN IS JURISDICTION 
-------------------------------------- 
 
¶6. (C) In a meeting with the Consul General, Securities and 
Futures Commission (SFC) Chairman Martin Wheatley lamented 
that the Hong Kong's stock exchange's expansion is almost 
entirely reliant on companies that are resident in locations 
outside of local jurisdiction.  This poses an enforcement 
challenge.  Except for London and New York, other exchanges 
primarily serve companies in their geographical proximity. 
In Wheatley's assessment, mainland authorities are keen to 
ensure nothing goes wrong.  All that said, Wheatley sees a 
new and riskier stage coming in regulating mainland firms; 
new companies from the mainland will increasingly be private 
in nature rather than state-owned enterprises (SOE).  He 
explained that the Chinese government has actually done Hong 
Kong a favor by vetting SOEs before they even seek to list 
here.  Such controls will not be in place for privately held 
firms, he said. 
 
¶7. (C) Wheatley was less concerned about the ability of 
listing rules and procedures to filter out poor quality 
companies in the first place.  He acknowledged that Hong Kong 
faces competitive pressure from aggressive exchanges like 
Singapore, and that there is some tension with the mainland 
exchanges (Shanghai, Shenzhen) that would like to start 
attracting new listings from China's blue chips.  However, 
this does not translate into compromising the vetting process 
for the sake of getting new business, Wheatley asserted. 
 
EXCHANGE: HIGH STANDARDS MEAN TURNING AWAY BUSINESS 
--------------------------------------------- ------ 
 
¶8. (C) Like Wheatley, HKEx Chief Executive Paul Chow 
underscored the pressure on Hong Kong from competing 
exchanges.  He had harsh words for Singapore, which in the 
last year has reached agreements with Shandong and Zhejiang 
provinces in China to set up what has been termed a 
"systematic channel" for listings of companies from those 
provinces.  "We would never do that," he said while 
criticizing other exchanges for lowering their standards to 
get new business. 
 
¶9. (C) Chow said Hong Kong's listing standards and vetting 
procedures are so lengthy that he fields numerous complaints 
from corporations frustrated by them.  He criticized 
investment banks that put forward questionable firms that are 
unprepared to go public, leaving it to the exchange to play 
the unpleasant role of refusing them.  Chow spoke almost 
enviously of Sarbanes-Oxley legislation (commonly referred to 
as SOX) in the U.S., assessing Hong Kong as not as tight on 
listing and regulation as the U.S.  He is watching with 
interest the implications of SOX for U.S. exchanges and 
thinks all quality exchanges will ultimately have to move 
towards SOX-like regulation. 
 
¶10. (C) In Chow's view, HKEx needs to emphasize quality at 
the expense of new business.  This is key to China's economic 
development, since SOE restructuring cannot otherwise move 
forward successfully.  HKEx could easily lower standards, but 
any event along the lines of Enron, Parmalat, or China 
Aviation Oil (a mainland firm whose collapse after 
undisclosed derivatives trading posed a major challenge last 
year to Singapore's exchange) would be a major setback.  The 
proportion of individual investors in Hong Kong is higher 
than other places and HKEx's customers are critical by nature 
-- they expect protection because they are not professionals, 
he said. 
 
¶11. (C) Chow said HKEx was branding itself in terms of 
quality and integrity.  China will ultimately lift controls 
on its capital account, and many believe this will open the 
floodgates for listings in Shanghai that are geared to 
foreigners as well as locals, perhaps at Hong Kong's expense. 
 But Chow is preparing for another scenario: cautioning that 
he could never say this publicly, he told the CG that capital 
account liberalization will actually mean that mainlanders 
will choose to put their money abroad, not in China, and they 
 
HONG KONG 00002606  003 OF 004 
 
 
will be particularly interested in investing in Hong Kong, 
based on the exchange's reputation as a host for premium 
Chinese companies, relative to Shanghai or Shenzhen. 
 
MACAU'S SJM: A LISTING OF POTENTIAL CONCERN 
------------------------------------------- 
 
¶12. (U) Macau tycoon Stanley Ho's monopoly on gambling in 
Macau came to in end in 2002, after 40 years.  Facing new 
competition, Ho proceeded to carve a subsidiary out of his 
holdings called Sociedade de Jogos de Macau (SJM).  Ho 
intends to list SJM publicly in Hong Kong, but in pursuing 
the listing, he has become embroiled in a dispute with 
minority shareholder (and sister) Winnie Ho; she has 
subsequently filed suit against her brother to block the 
listing. 
 
¶13. (C) SJM's listing has subsequently been delayed.  A local 
media report said the delay is tied to SFC's concerns about 
money laundering issues.  VIP rooms in Ho's casinos have over 
time been associated with criminal activity, including money 
laundering.  (Also of note: Ho also has a casino in North 
Korea.)  The money laundering is best summed up by the 2006 
International Narcotics Control Strategy Report, which 
states: "Under the old monopoly framework, organized crime 
groups were, and continue to be, associated with the gaming 
industry through their control of VIP gaming rooms and 
activities such as racketeering, loan sharking, and 
prostitution.  The VIP rooms catered to clients seeking 
anonymity within Macau's gambling establishments and were 
removed from official scrutiny.  As a result, the gaming 
industry provided an avenue for the laundering of illicit 
funds and served as a conduit for the unmonitored transfer of 
funds out of China.  Unlike SJM and new entrant Galaxy, the 
Sands (new American entrant to Macau) does not cede control 
of its VIP gaming facilities to outside organizations.  This 
approach impedes organized crime's ability to penetrate the 
Sands operation." 
 
¶14. (C) In his meetings with the SFC's Wheatley and HKEx's 
Chow, the CG noted concerns raised in hearings held by the 
U.S.-China Economic and Security Review Commission about 
firms going to Hong Kong instead of New York, allegedly 
because it is easier to list here.  He noted the pending SJM 
IPO and emphasized the importance of rigorous listing 
procedures to Hong Kong's future role as a finance center. 
Both the SFC and HKEx said that local vetting standards are 
very high here and that Hong Kong is not sacrificing listing 
procedures to accommodate new business. 
 
¶15. (C) Hong Kong already has one listed gaming company, 
Galaxy Entertainment (also named in the INCSR report quoted 
above).  A Cambodian casino operator owned by Malaysian 
tycoon Chen Kip Keong, NagaCorp, also has plans to float 
shares in Hong Kong.  Singapore and Hong Kong have previously 
rejected attempts by NagaCorp to list on their exchanges. 
 
CONCERNS ABOUT HONG KONG'S EXCHANGE 
----------------------------------- 
 
¶16. (C) The Asian Corporate Governance Association (ACGA), 
based in Hong Kong, has made a name for itself regionally 
with its highly critical analysis and scorecards concerning 
corporate behavior throughout the region.  ACGA Secretary 
General Jamie Allen gave us a generally positive assessment 
of Hong Kong's stock market, describing it as highly 
professional and not corrupt.  Although Allen termed the 
exchange as the best in the region, specifically placing it 
above Singapore, he did express significant reservations 
about listing practices with regard to mainland firms that 
hold IPOs in Hong Kong. 
 
¶17. (C) According to Allen, HKEx has over time adjusted its 
rules to accommodate mainland firms, entering into a series 
of "Faustian bargains."  The exchange is motivated by a 
desire for new business, he said, and its officials do not 
really understand the corporate governance issues embedded in 
some of the firms that have listed here.  The problem is 
exacerbated by second-tier investment banks -- specifically 
not the well-known U.S. houses operating here, he said -- 
that represent some of the more questionable firms that wish 
to issue stock in Hong Kong.  These companies' managers have 
little idea of what listing requirements mean.  In general, 
 
HONG KONG 00002606  004 OF 004 
 
 
however, the overall impact of preparing to list here is 
positive for the conduct of the mainland firms that do so, he 
said. 
 
¶18. (C) Allen was critical of HKEx for bending or weakening 
numerous listing rules in recent years in order to 
accommodate mainland candidates.  HKEx no longer has a profit 
requirement -- they now allow firms to qualify through market 
capitalization or revenue thresholds.  HKEx has repeatedly 
offered waivers on compliance with important listing issues; 
for example, they have waived requirements that a certain 
number of directors be based in Hong Kong, thus opening the 
door to a situation where it may be difficult to field an 
investigation should something go wrong later on.  There have 
also been numerous waivers issued with regard to disclosures 
of connected transactions (which occur when a public firm 
conducts significant business with a parent holding company; 
such business may affect the fortunes of minority 
shareholders).  Disciplinary action is also very slow, 
lowering its deterrent value, said Allen; a firm that 
violated disclosure rules in 2003 is only now being 
sanctioned. 
 
¶19. (U) ACGA in general has a mixed view of Hong Kong.  Their 
snapshot report on the city notes that new listing rules 
implemented in 2004 are still lax with regard to the 
reporting of corporate results.  ACGA assesses Hong Kong as 
having sound securities regulation, strong disclosure 
requirements on ownership, and detailed rules on the 
disclosure of connected transactions.  However, despite Hong 
Kong's rule of law tradition, class action suits are not 
permitted.  ACGA evaluates the SFC as independent and 
increasingly powerful and the anti-corruption commission 
(ICAC) as strong.  They suggest, however, that the stock 
exchange is not robust in terms of enforcing its own rules. 
Private enforcement by shareholders is termed as weak, and 
high costs and unfavorable legal rules mean that minority 
shareholders see little to be gained from suing companies and 
directors in court. 
 
WHY THEY DON'T GO TO NEW YORK 
----------------------------- 
 
¶20. (C) We have on numerous occasions encountered contacts or 
seen media stories suggesting that recent listings by the 
Bank of China and China Construction Bank took place here and 
not in New York because of SOX.  ACGA's Allen said this is 
only partially true and that SOX is really a subset of a 
larger issue: the right of U.S. shareholders to initiate 
class-action suits, something that cannot be done in Hong 
Kong.  Allen said that top managers and directors of mainland 
SOEs know very well that their management structures are not 
under full control -- just look at all the malfeasance that 
has been reported at local branches of the large Chinese 
banks.  Further, the mainland firms all watched China Life, 
which listed on the NYSE in 2003, become embroiled in 
shareholder suits.  Some of these concerns have been 
aggravated by SOX, but the fundamental issue is that no top 
figure at an SOE wants to put himself in a position where a 
shareholder can hold him liable by bringing a class-action 
suit, said Allen. 
Cunningham