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R 300801Z JAN 08
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 6833
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASH DC
RUEAIIA/CIA WASHDC
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UNCLAS SECTION 01 OF 03 GUANGZHOU 000052 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR CHINA OFFICE 
 
 
E.O. 12958: N/A 
TAGS: EFIN SENV ECON PGOV CH
SUBJECT: SHENZHEN STOCK MARKET LAMENTS LACK OF AUTONOMY 
 
REF: A) GUANGZHOU 0001, B) 2007 GUANGZHOU 1267 
 
(U) This document is sensitive but unclassified.  Please protect 
accordingly. Not for release outside U.S. government channels. Not 
for internet publication. 
 
¶1. (SBU) Summary:  Managers at the Shenzhen Stock Exchange (SSE) are 
frustrated that excessive regulation and limited market access for 
foreign investment banks stymie financial innovation, SSE officials 
told Embassy Beijing's Financial Attache and Congenoffs.  As a large 
institutional investor, Shenzhen fund management executives also 
support greater competition in China's brokerage sector, including 
from foreign investment.  Executives at China's only two domestic 
banks with substantial foreign managerial influence hope the 
successes they've achieved in financial restructuring will allay 
concerns of regulators and open opportunities for more foreign 
investment in the banking sector.  They also noted that high reserve 
requirements have a larger impact in restraining credit growth in 
small and medium-sized banks with fewer deposits.  The appreciation 
of the renminbi against the U.S. dollar (albeit a modest one in 
trade-weighted terms) is nevertheless adding to rising cost 
pressures on exporters and thus beginning to promote a rebalancing 
of China's economy.  End summary. 
 
Shenzhen Stock Exchange Wants More Autonomy 
------------------------------------------- 
 
¶2. (SBU) SSE Officials expressed frustration that excessive 
regulation stymies financial innovation.  Vice Director for Strategy 
and International Relations Jane Wu complained that all new listings 
must be approved by the Chinese Securities Regulatory Commission 
(CSRC), which has frozen initial public offerings (IPOs) for 
companies that meet the SSE's listing requirements.  In addition, Wu 
lamented the long delay in the CSRC's approval of trading in stock 
index futures on the Shanghai Financial Futures Exchange.  Approval 
would increase market liquidity by allowing investors to take both 
short and long positions.  Similarly, the Shenzhen Stock Exchange 
has been waiting more than six months for approval of a new board 
that would focus on start-up and other young companies.  New product 
development also suffers from the lack of access for international 
investment banks, according to Wu. 
 
Investors Need Financial Product Diversification 
--------------------------------------------- --- 
 
¶3. (SBU) Top management at Shenzhen's Bosera Asset Management 
Company also wants to see greater opening of China's financial 
products market.  While the firm has grown significantly, with 13 
different fund products, with over USD 18 billion under management, 
company president Xiao Feng said foreign assets were still too small 
a share of Chinese investors' portfolios, preventing effective 
diversification.  Xiao supports further expansion of the Qualified 
Domestic Institutional Investor (QDII) program, which allows 
domestic investors to invest overseas, and the Qualified Foreign 
Institutional Investors (QFII) program, which allows foreign 
investors to invest in China, stating that both programs benefit his 
firm and other local fund managers.  As a large institutional 
investor, Xiao noted the benefits of increased foreign investment in 
the securities sector as it uses Gaohua Securities as its broker 
(Note: Goldman Sachs effectively controls Gaohua) and would welcome 
more foreign firms providing research and brokerage services. 
 
¶4. (SBU) Investor education is a major priority at Bosera, 
especially as the firm's customer base has ballooned from 1 million 
investors to 10 million in 2007 alone. Bosera officials admitted 
that many of these customers are new to stocks and may not 
understand the risks. In addition to establishing a customer 
information hotline and distributing a pamphlet of frequently asked 
questions to customers, the company published a best-selling 
investment book and hosted 200 investor information sessions at 
hotels and other venues throughout China. 
 
¶5. (SBU) Nevertheless, the meeting with Xiao raised doubts about how 
customers would react to a sudden downturn in the market and whether 
Chinese mutual fund companies have adequate contingency plans to 
handle large-scale redemptions.  Xiao pointed out that Bosera's 
website had been able to handle up to 70,000 inquiries at a time 
(Comment: Inquiries could be in the millions during periods of 
market stress.  End comment).  When asked how Bosera would respond 
to a surge in redemptions, Xiao said the firm had the authority to 
delay filling redemption orders of more than 10 per cent of a 
shareholder's investment.  He expressed confidence that most clients 
are aware of this policy, but admitted that few customers actually 
have read the details in the prospectus. (Comment: Xiao notably did 
not mention efforts to establish bank lines of credit to meet 
 
GUANGZHOU 00000052  002 OF 003 
 
 
redemptions.  End comment). 
 
Foreign Control Does Not Break the Bank 
--------------------------------------- 
 
¶6. (SBU) Executives at Shenzhen Development Bank (SDB) and Guangdong 
Development Bank (GDB) described dramatic turnarounds at both banks 
within one year of assuming control over day-to-day operations. 
Shenzhen Development Bank has run a substantial profit for over half 
of the 28-month period since American investors took over in 2005. 
Guangdong Development Bank will soon announce profits exceeding 
internal targets by more than 100 per cent for the second half of 
2007 -- only 16 months after taking control.  In both cases, 
officials stressed that the large spread between deposit and lending 
rates (resulting from a ceiling on the former and floor on the 
latter) makes Chinese banking highly profitable with even modest 
efforts to rationalize costs and improve the quality of lending. 
These include holding branch managers accountable for collection of 
non-performing loans (NPLs) and improving customer service through 
increased bank tellers and ATMs.  GDB's Zink noted the long-term 
importance of cutting costs and developing non-interest sources of 
revenue as interest rate controls would eventually be phased out and 
NPLs will follow a cyclical downturn. 
 
¶7. (SBU) Executives at both banks are cautiously optimistic that the 
results of a survey conducted by the Chinese Banking Regulatory 
Commission (CBRC) on market conditions for foreign banks in the 
country will lead to further opening.  Survey results are expected 
in the spring and will likely form the basis of CBRC recommendations 
to the State Council on future banking reform.  As the only two 
domestic joint-venture banks in China with substantial foreign 
managerial control, SDB and GDB hope their success will help allay 
concerns among regulators and open opportunities for more foreign 
investors to take control of Chinese banks. 
 
Non-Performing Loans Falling Rapidly 
------------------------------------ 
 
¶8. (SBU) Non-performing loans at Shenzhen Development Bank peaked at 
11.3 per cent in mid 2005, not long after Newbridge Capital 
purchased its controlling stake in the struggling bank.  Chief 
Credit Officer Li Wenhuo said the NPL ratio dropped by almost half 
in two and a half years (ref A) as lending expanded under more sound 
risk management policies.  However, the decline in the ratio was due 
mainly to an expansion in loans.  The absolute value of NPLs did not 
substantially decline until the second half of 2007 when the bank's 
collection efforts began to yield positive results.  SDB formed 
teams with legal, prosecution, and police experience to press 
borrowers in arrears to turn over assets.  Li hopes that continued 
collections on legacy loans combined with SDB's continued track 
record of only 0.2 percent of new loans becoming non-performing will 
lead to a double decline in both ratio and absolute total of NPLs in 
¶2008. 
 
¶9. (SBU) Michael Zink, President of Guangdong Development Bank, 
described a similar decline in NPLs by holding branch managers and 
loan officers accountable for the collection of bad loans.  Only one 
case required a court judgment to assist in resolution.  Zink said 
Communist Party officials within the bank occasionally warned of 
potentially sensitive loans.  In those cases, management allowed 
Party officials to lead collection efforts. 
 
¶10. (SBU) Both SDB and GDB officials explained how monetary 
authorities' efforts to limit credit expansion through 
sterilization, increased reserve requirements, and asymmetric 
increases in administered interest rates (with deposit rates rising 
more than lending rates) had impacted their income.  SDB officials 
noted that the PBOC's most recent rate hike, which raised deposit 
rates more than lending rates (to limit the transfer of assets to 
equity markets) but lowered the interest rates on demand deposits, 
would in fact increase the bank's net interest income, given that 40 
percent of SDB's deposits were demand deposits.  Officials of both 
banks told how the increase in reserve requirements constrained 
their lending more than the big state-banks given that their retail 
deposits, and thus excess reserve holdings with the central bank, 
are smaller.  Neither SDB nor GDB officials were excessively 
concerned about efforts to limit credit growth through enhanced and 
quarterly enforcement of tighter lending quotas as both institutions 
intended to increase income by improving the  profitability of their 
loan portfolio, not just by loan growth.  SDB had sold off some NPLs 
and GDB is reducing its participation in lending syndicates to large 
credit-worthy SOEs to make rooms for more profitable lending (such 
as commercial real estate) under existing quotas. 
 
¶11. (SBU) According to Zink, relations among shareholders and 
 
GUANGZHOU 00000052  003 OF 003 
 
 
stakeholders remain the biggest managerial challenge at GDB (ref B). 
 Both China Life and Citibank hold an equal share of equity (20 
percent) and, given GDB's profitable outlook, both want to assume 
control.  Moreover, the Communist Party continues to play a major 
role in the appointments of senior management, which makes it 
difficult to hold senior management accountable to meeting financial 
targets.  This differed significantly from the Party's much less 
operational role in Citibank (China). 
 
RMB Appreciation helping to shift China economy 
--------------------------------------------- -- 
 
¶12. (SBU) Executives at Nike and Guoguang Electric (audio speakers) 
highlighted the challenges caused by the recent appreciation of the 
renminbi against the U.S. dollar (USD) for China-based 
manufacturers.  Nike does not bear currency risk because all of its 
purchasing contracts with factories in China are USD-denominated. 
Instead, Nike works closely with its contracted factories to help 
them find ways to cope with currency appreciation, mainly by cutting 
costs.  While the recent tight market for skilled workers may ease 
in the short term given the closure of several neighboring low-end 
assembly operations, worker retention continues to be the area of 
highest cost for Nike's contract factories.  While Nike continues 
procurement from Chinese firms in apparel and footwear, it has 
shifted orders for equipment towards Vietnamese suppliers.  At the 
same time, Nike China is looking to expand its sales to China's 
domestic market. 
 
¶13. (SBU) Guoguang produces audio speaker components.  Less than 
five percent of its product is sold in China, and currency-related 
losses were 10 per cent of total revenue in 2007.  Guoguang's export 
prices are all USD-denominated in inflexible one-year agreements. 
Given the cost of long term foreign currency hedging in China, 
Guoguang tries to roll out new products at a faster rate to replace 
old export contracts with new ones at current exchange rates.  Mr. 
Zheng Yamin estimated that his company will become unprofitable at 
RMB/USD 6.5, at which point Guoguang will have to either move 
operations to a cheaper location (they have begun to look in China's 
west) or invest heavily to increase labor productivity.  The 
reduction of the value-added tax (VAT) refund also raised costs, and 
Zheng complained about the lack of advance warning on reductions in 
VAT rebates.  He pointed out that Guoguang primarily competes 
against other manufactures in Taiwan and Korea, so RMB appreciation 
tilts the advantage to his overseas competitors.  (Comment:  Though 
to date most other Asian currencies have appreciated more against 
the USD than the RMB.  End comment). 
 
¶14. (SBU) In response to higher wages, taxes and a more appreciated 
exchange rate Nike, Guoguang, and South China AmCham have all 
observed a shift of manufacturing toward China's center and west. 
Guangzhou AmCham cited estimates of some 5-6000 factory closings in 
the Pearl River Delta (PRD). 
 
¶15. (SBU) Comment: The discussions with SSE and Bosera highlighted 
the importance of stressing to Chinese officials and the Chinese 
public how barriers to foreign investment erected by regulators to 
protect some Chinese firms (i.e. underwriters and brokerages) can 
harm other constituents of the same regulators.  The Communist 
Party's continued influential role in Chinese financial 
institutions, and the tension it creates with foreign investors 
trying to import commercially-oriented managerial practices, may 
account for some of the political opposition to foreign acquisitions 
of large Chinese companies. End comment. 
 
GOLDBERG