VZCZCXRO8589
RR RUEHCN RUEHGH
DE RUEHGH #0120/01 0721053
ZNR UUUUU ZZH
R 131053Z MAR 09
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7729
INFO RUEHBJ/AMEMBASSY BEIJING 2603
RUEHCN/AMCONSUL CHENGDU 1823
RUEHGZ/AMCONSUL GUANGZHOU 0279
RUEHHK/AMCONSUL HONG KONG 1990
RUEHML/AMEMBASSY MANILA 0057
RUEHUL/AMEMBASSY SEOUL 0404
RUEHGH/AMCONSUL SHANGHAI 8364
RUEHSH/AMCONSUL SHENYANG 1814
RUEHGP/AMEMBASSY SINGAPORE 0238
RUEHIN/AIT TAIPEI 1611
RUEHKO/AMEMBASSY TOKYO 0584
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 05 SHANGHAI 000120 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM, DAS DAVIES 
TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP 
TREASURY FOR IMFP -- SOBEL/CUSHMAN 
USDOC FOR ITA DAS KASOFF, MELCHER, MAC/OCEA 
NSC FOR LOI 
STATE PASS CEA FOR BLOCK 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN 
STATE PASS CFTC FOR OIA/GORLICK 
 
E.O. 12958: N/A 
TAGS: CH ECON EFIN PGOV PREL
SUBJECT: (SBU) SHANGHAI UNSURE OF NEXT STEPS IN THE WAKE OF THE 
FINANCIAL CRISIS 
 
REF: SHANGHAI 119 
 
¶1.  (SBU) Summary.  Foreign banks have largely been able to 
regain access to the renminbi interbank market after Chinese 
banks pulled credit lines this past fall in the wake of the 
Lehman Brothers collapse, Shanghai interlocutors told a Treasury 
delegation on February 19-20.  The financial sector in East 
China is now working through follow-on impacts of the financial 
crisis:  cross-border foreign exchange flows are being 
scrutinized; customers are reluctant to use derivative products; 
and officials are seeking new ways to regulate complex financial 
products.  In the longer term, our interlocutors report that 
officials are reassessing the goals of financial reforms, given 
that the previously emulated U.S. model looks broken to them. 
One factor that may bolster the U.S. model in East China is the 
potential arrival of Wall Street refugees.  End summary. 
 
¶2.  (U) This is the second of two reports based on Beijing 
Finatt's February 19-20 meetings in Shanghai. It covers 
financial service sector trends; the initial report covered 
macroeconomic issues. 
 
============================ 
Short-Term Liquidity No Longer a Problem 
============================ 
 
¶3.  (SBU) Foreign banks have largely overcome their difficulties 
in obtaining short-term renminbi funding from Chinese banks, our 
interlocutors told a Treasury delegation February 19-20.  Citi 
China CEO Andrew Au and John Tan, a Shanghai-based managing 
director of Standard Chartered Bank, separately noted that 
overnight, 7-day, and 30-day borrowing is now possible, although 
not for longer terms.  While People's Bank of China (PBOC) has 
now established an emergency liquidity facility, Tan believes 
that any bank using the facility will be put on a blacklist--he 
said that only Bank of East Asia has asked for such assistance. 
While Deutsche Bank Executive Director Gao Feng also said that 
liquidity is not currently a problem, he said some Chinese banks 
consider his firm "too small to lend to." 
 
¶4.  (SBU) Moving forward, critics of foreign investment in the 
Chinese financial sector have been strengthened as many Chinese 
have begun to doubt the trustworthiness of foreign partners. 
Royal Bank of Scotland's (RBS's) sale of its holdings in Bank of 
China after the shares were unlocked in January was "a big loss 
of face" for the Chinese, said Deutsche Bank's Gao.  Ding 
Guorong, chairman of Shenyin & Wanguo Securities, one of China's 
largest securities firms, said Chinese see the recent sales of 
strategic stakes by foreign investors--including RBS, Temasek, 
and Bank of America--as irresponsible. 
 
¶5.  (SBU) The Chinese Government may be considering other relief 
for foreign banks.  Standard Chartered's Tan said his bank in 
October made two suggestions to help alleviate foreign bank's 
funding shortfalls:  1) SAFE should temporarily increase foreign 
debt quotas.  (Comment: This was subsequently agreed to in the 
December Strategic Economic Dialogue (SED), though foreign 
bankers report that SAFE remains reluctant to approve 
applications.  End comment.)  2) Banks should be allowed to use 
other foreign assets as collateral.  The assets could be posted 
overseas--for instance, with the Hong Kong Monetary 
Authority--and then the PBOC would issue renminbi to the company 
in China.  (Comment: PBOC officials have noted that they are 
working on such a facility.  End comment.)  Citi's Au mentioned 
that the PBOC, along with the China Bank Regulatory Commission 
and the State Administration of Foreign Exchange (SAFE), at a 
meeting in late 2008 said that foreign financials firms would be 
allowed to issue renminbi-denominated bonds to avert liquidity 
problems, and that rules would be unveiled in January.  However, 
there is still no action on this, said Au. 
 
 
SHANGHAI 00000120  002 OF 005 
 
 
============================ 
Customers Avoiding Derivatives 
============================ 
 
¶6.  (SBU) Chinese insurance companies and state-owned companies 
do not want to be seen with derivatives on their books, said our 
interlocutors.  Standard Chartered's Tan said that Chinese 
customers were turned off to derivatives by the case of Nansha 
Power, which bought hedges against oil price increases from 
Goldman Sachs, but is now disputing the contract after heavy 
losses.  In addition, said Tan, regulators are looking into the 
books of state-owned enterprises to find out what derivatives 
they may hold.  Shenyin & Wanguo's Ding agrees, saying Chinese 
regulators are slowing the approval of new financial products, 
particularly derivatives.  Chinese securities firms will return 
to their core businesses--such as underwriting, corporate 
finance, and brokerage services--and will emphasize innovation 
less, said Ding.  Gao Hao's Yin said that clients are cautious 
and want to buy only "plain vanilla" stocks or bonds. 
 
¶7.  (SBU) Several interlocutors mentioned the need to develop 
new ways to regulate and rate complex financial products.  Luo 
Yang, People's Bank of China (PBOC) Shanghai Head Office 
International Department Director General, noted that some 
Chinese banks bought products rated AAA, but recently have seen 
these investments lose money.  Luo commented that the United 
States needs to fix its regulatory system, and that credit 
rating agencies need to be better supervised.  Shenyin & 
Wanguo's Ding said that securities firms will emphasize 
strengthening internal risk controls. 
 
============================ 
Regulators Concerned About Foreign Exchange Flows 
============================ 
 
¶8.  (SBU) Most of our interlocutors said that SAFE appears to be 
slowing the flows of foreign currency into and out of China. 
Citi's Au said that SAFE has been scrutinizing Citi's forex 
activities, and recently SAFE director general-level 
officials--a much higher rank than previously-- have questioned 
transactions.  Citi Country Treasurer Paulus Mok said a SAFE 
official recently for the first time called him before the bank 
hit its forex trading limit. 
 
¶9.  (SBU) SAFE has stopped approving new quotas for companies 
under the Qualified Domestic Institutional Investor (QDII--a 
mechanism for Chinese investors to invest in overseas capital 
markets) program since the third quarter of last year, said 
Steve Lee, CEO of HSBC Jintrust Fund Management Co.  As for 
overseas companies seeking to invest in China's stock market 
through the Qualified Foreign Institutional Investor (QFII) 
program, the China Securities Regulatory Commission has been 
active in approving new licenses--a total value of US$2.8 
billion in 2008--but SAFE has left some twenty licensees with no 
quotas, said Lee.  In the latter case, SAFE is not moved by the 
logic that expanding the QFII program would support the Chinese 
stock market, said Lee.  Gao Hua's Yin had a different take, 
saying that QFIIs are being quietly approved, including quotas, 
and that his firm is helping clients to start investing in 
China.  China has committed to raise the QFII quota to US$30 
billion, noted Yin.  (Comment:  This was an SED commitment.  End 
comment.) 
 
¶10.  (SBU) Regarding the depreciation of the RMB in early 
December 2008,  Standard Chartered's Tan speculated that PBOC 
tested the dollar-yuan exchange market to see if it would remain 
stable without PBOC intervention, and determined that it would 
not.  On December 1, the PBOC stopped selling dollars, said Tan, 
and since no other market participants wanted to sell, the yuan 
ended at the bottom of the +/- .5 percent daily trading band. 
 
SHANGHAI 00000120  003 OF 005 
 
 
The PBOC concluded that it needed to continue to intervene 
heavily to avoid a sharp depreciation of the renminbi, said Tan. 
 Lian Ping, chief economist of Shanghai-based Bank of 
Communications, one of China's top five banks, said that, in his 
view, the renminbi exchange rate will remain stable--this is the 
responsible thing to do, and it is good for China's medium and 
long-term growth. 
 
============================ 
Chinese Officials Reassessing Financial Reforms . . . 
============================ 
 
¶11.  (SBU) Several interlocutors noted that the model of the 
U.S. financial system now looks broken.  Shenyin & Wanguo's Ding 
said that China's financial sector reforms over the past few 
years were patterned after the U.S. model, but that 
unfortunately the pace of reforms in the financial sector has 
stalled in the wake of the U.S. financial crisis.  Ding said 
that Chinese officials and financial firms are now also unsure 
how to proceed on improving corporate governance, internal risk 
controls, transparency, and disclosure.  Nonetheless, Ding said 
he was sure that the U.S. model would rise again after this 
"lesson." "No one has said to reject the U.S. system," said 
Ding. 
 
¶12.  (SBU) As a result, some reforms are being put on hold.  For 
instance, said Gao Hua's Yin, stock market index futures will 
not be rolled out this year, since officials are concerned about 
the problems Chinese companies had speculating with derivatives 
in 2008.  In addition, the government wants to protect the 
welfare of retail investors with limited financial literacy, who 
would be large users of stock futures trading, said Yin. 
Regarding the eventual futures trading system, Chinese officials 
are putting a "ring fence" between securities and futures 
brokers, said Yin, even though this leads to highly inefficient 
duplication of back offices.  On a separate issue, Shanghai 
Financial Services Office Director General Fang Xinghai said 
emphatically that the Central Government had rejected 
decentralization of regulatory approval to the Shanghai offices 
of CBRC, CSRC, and other regulators--a measure bolstering 
financial innovation in Shanghai that Fang had expected to be 
approved last September. 
 
============================ 
. . . While Unveiling Some Innovations, and Considering Others 
============================ 
 
¶13.  (SBU) Our interlocutors cited several welcome measures 
recently introduced: 
  -- Permitting foreign-invested banks to trade and underwrite 
corporate bonds on the interbank market--begun in December. 
(Comment: Allowing foreign banks to trade bonds was an SED V 
commitment.  End comment.) 
 -- Allowing the Shanghai Interbank Offered Rate (SHIBOR) to 
better reflect market conditions.  According to Standard 
Chartered's Tan, the PBOC--upon Standard Charter's prodding in 
mid 2008--has stepped away from moral suasion on SHIBOR 
participants to limit their quotes from what PBOC views as 
excessively low or high interest rates. 
 -- Allowing securities firms to handle block trades--started in 
late 2008.  Gao Hua's Yin said that firms are allowed to control 
pricing and allocation, making the process similar to a 
secondary offering.  No licensing is required.  However, Gao Hua 
has not carried out a trade, since the market is too volatile. 
 
¶14.  (SBU) Interlocutors cited other measures that could be 
unveiled this year, including: 
-- Licensing commodities brokers to trade on overseas markets, 
to allow arbitrage with the London Metal Exchange. 
 -- Allowing foreign trade to be settled in renminbi.  Fang said 
 
SHANGHAI 00000120  004 OF 005 
 
 
that China needs to be cautious, but that Hong Kong already 
holds adequate renminbi to start trade settlement. It will 
subsequently be expanded to other nearby countries, such as 
Thailand. 
 -- Approving a forex options market.  Standard Chartered's Tan 
and Citi's Au agreed that SAFE has made all necessary 
preparations, but had held off for fear it would add to 
appreciation pressure; now that depreciation is also a concern, 
it is a good time to renew lobbying for this. 
 -- Permitting exchange traded funds (ETFs) on the Shanghai 
stock exchange.  Fang and HSBC Jintrust's Lee both said that the 
first ETF would be based on the Hong Kong Heng Seng index. 
 
============================ 
New Blood Arriving from Wall Street? 
============================ 
 
¶15.  (SBU) Financial sector professionals laid off in developed 
countries are eager to work in Shanghai, said our interlocutors. 
 Standard Chartered is receiving "loads" of resumes from 
prospective candidates willing to take 30-40 percent pay cuts, 
said Tan.  Shanghai in December sent a delegation to the West to 
recruit professionals, said Fang, and about 10 percent were 
non-overseas Chinese.  Fang said that these non-Chinese view a 
few years in China as an addition to their careers.  (Note:  One 
draw for these applicants may be that, according to Citi's Au, 
China has overtaken Japan as East Asia's biggest banking market. 
 End note.) 
 
¶16.  (SBU) However, interlocutors also pointed out that 
Shanghai's financial sector is not at its most robust. 
Multinationals are pulling back and remitting profits out of 
China, said Standard Chartered's Tan.  He added that the work 
atmosphere in Beijing is much better than in Shanghai--in 
Shanghai "you can feel the pain," but in Beijing there are "no 
salary cuts, no bonus cuts." 
 
============================ 
Leadership Notes 
============================ 
 
¶17.  (SBU) Regarding financial sector leaders, our interlocutors 
had the following observations: 
 -- Liu Mingkang is "on the rise," said Citi's Au.  Au said that 
Premier Wen Jiabao is happy with Liu's performance during the 
financial crisis, including the high-profile efforts Liu made to 
clamp down on mortgage lending a year-and-a-half ago.  Liu now 
accompanies Wen on the Premier's trips, said Au. 
 -- Wang Qishan, who has now been in office for more than a 
year, has assembled a team that he is ready to move into place 
in the financial regulatory bureaucracy, said HSBC Jintrust's 
Lee, citing some vice ministerial level vacancies that will soon 
be filled in the CSRC. 
 -- Shanghai Stock Exchange President Zhang Yujun, former 
president of the Shenzhen exchange, in recent years has given 
quotas to each of his direct reports to attract business, 
including new companies and product innovations, said Lee. 
  -- Fang Xinghai said that, after the financial system was 
rattled in mid September, leaders began a lengthy internal 
reassessment.  He has tried to convince them China is at a 
different stage of development than the United States, and that 
China has an "undersupply" of financial services. Fang has 
argued that this is an unprecedented opportunity for financial 
reforms--developing the bond market, for instance, since it is 
the best source of long-term finance for infrastructure. 
 
============================ 
Comment 
============================ 
 
 
SHANGHAI 00000120  005 OF 005 
 
 
¶18.  (SBU) Our Shanghai-based interlocutors generally mark the 
end of the previous financial era as September 15, 2008, when 
they awoke to find that two seemingly unshakable pillars of the 
U.S. financial system had failed:  Lehman Brothers was bankrupt 
and AIG was essentially nationalized.  Their first reaction was 
to shed without discrimination possible counterparty risk with 
foreign financial institutions, thereby subjecting foreign 
banks, insurance companies, and securities companies with solid 
operations in East China--many locally incorporated, and having 
met high capitalization requirements--to the equivalent of bank 
runs.  While the PBOC created several avenues for foreign banks 
to obtain renminbi financing, it has been reluctant to allow 
banks to use them, out of apparent fear that it could signal 
that the global financial crisis was spilling into China's 
financial sector.  In the end, Chinese regulators relied on the 
tool they know best, moral suasion on the large state banks to 
provide financing to foreign banks.  Some foreign bankers feel 
bitter after this experience; after years of developing 
relationships with Chinese regulators and financial 
institutions, they were left feeling abandoned in a crisis. 
Many wholesale foreign banks are now rethinking their business 
model of relying on short-term loans from their Chinese 
competitors to finance their renminbi lending.  In addition, 
AIG's problems and foreign banks' sales of strategic stakes in 
Chinese banks has strengthened the position of vested interests 
who now argue that foreign investment in the financial sector is 
a source of systemic risk rather than strength.  As a result, 
foreign financial services firms believe it has become 
increasingly difficult to get regulatory approval to expand 
their operations. 
 
¶19.  That said, reform and opening up of the financial sector 
has not stopped.  The need for macroeconomic stimulus appears to 
have catalyzed reform of the bond market, including allowing 
foreign banks to underwrite and trade corporate bonds.  In 
addition, the PBOC's efforts to promote trade settlement in 
renminbi have accelerated, even if part of this is to capture in 
the formal sector transactions that were occurring in the black 
market.  In terms of staffing, financial professionals arriving 
from overseas to give new impetus to financial sector reforms is 
another potential bright spot. 
 
¶20.  (U) Beijing Financial Attache David Loevinger has cleared 
on this cable. 
CAMP