Annual Conference 2013, Boao Forum for Asia

Annual Conference 2014, Boao Forum for Asia Session Summary

Session 21 April 11, 2014 Slow and Painstaking Global Financial Reform

Moderator:

 Christopher HARVEY, Managing Director and Global Industry Leader of Financial Services, Deloitte

Panelist:

 Daniel L. DOCTOROFF, CEO, Bloomberg L.P.

 Gerry GRIMSTONE, Chairman, Standard Life, UK

 Fred HU Zuliu, Chairman, Primavera Capital Group

 Juan RODRIGUEZ INCIARTE,Executive Member of the Board of Directors, Group Senior Executive Vice President for Strategy & Asia, Banco Santander

 Bill OWENS, Vice Chairman of the New York Stock Exchange (NYSE) for Asia; Chairman of AEA Investors ASIA

 Gary PARR, Vice Chairman, Lazard

Key points:

 The adoption by Chinese banks of the stress test which has been undertaken by US banks and which is being undertaken by Eurozone banks, would generate a strong boost for consumer confidence and result in greater capital investment.

 Many Chinese consumers think that the double digit returns on trust products are as safe as deposits at ICBC. The biggest threat is consumer protection, and lack of disclosure.  There is an estimated RMB 10 trillion in off-balance sheet amounts in trusts and other shadow banking in China, which has increased four fold over the past 3-4 years. A very high percentage of new lending is being done by these entities.

 In the past there was not enough capacity for the Shanghai index to absorb a multi-billion dollar IPO, but the newly announced Shanghai- Hong Kong cooperation could potentially absorb even the largest of IPO's.

Chris HARVEY gave his view that the global financial reform had not only been slow and painstaking, but painful. He suggested that the panel first consider the status of reform as a direct response to the global financial crisis, then consider the implications of recent trends and new initiatives. Consideration of global financial reform would inevitably necessitate a look at China as a major influence.

Lessons from the Global Financial Crisis The US began to recover from the global financial crisis by implementing a serious stress test in 2009 to build investor confidence. The Euro zone also plans to conduct its own similar stress test by the end of this year. If Chinese banks were able to undergo a transparent stress test, it would generate a strong boost for consumer confidence and result in greater capital investment.

The US has also implemented major financial reforms, which have resulted in a drop in margin and loss of corporate profits for some companies. Even now, the laws are still far from being completely implemented, with only 40% having been translated into enacted regulation.

Shadow banking and liquidity risk in China The panel discussed the risks of the shadow banking system, specifically trust products in China. Recently, questions have been raised about shadow banking and the housing bubble in China, and whether China may be able to apply some of the lessons of the global financial crisis to these issues.

Fred Hu, Chairman of Primavera Capital Group, acknowledged that transparency for these products is clearly a big area of concern, considering the interconnectedness of local government and state owned enterprises. Because of a lack of transparency, people do not feel confident that they know what is happening and are bearish. He also raised the issue that unfortunately many Chinese consumers think that the double digit returns are as safe as deposits at China's major banks such as ICBC. The biggest threats are lack of disclosure and lack of consumer protection. Gerry Grimstone, Chairman of Standard Life, UK, observed that no other nation has these types of trust products. There is an estimated RMB 10 trillion in off-balance sheet amounts held in trusts and other shadow banking in China, an amount that has increased four-fold over the past 3-4 years. A very high percentage of new lending is being done by these entities. Fred Hu countered that shadow banking does not represent a systemic risk for China, partly because there are no derivatives in China so it is highly unlikely for risk to migrate from one asset to class to another. Since most SME's in China face hurdles in access to capital, shadow banking plays a legitimate function in the economy. Without shadow banking, the situation for SME's would be worse.

Nevertheless, Daniel Doctoroff, CEO of Bloomberg, perceived that Chinese regulators were probably beginning to take a deeper look into this situation, and there was a belief among some panelists that the Chinese authorities are sensitive to the situation and they may use the Free Trade Zone and the opportunity to use the concept to introduce new measures in a contained area, to experiment ways to bring the situation back into balance.

New measure to connect Shanghai and Hong Kong stock exchanges for cross trading The panel considered the announcement made earlier in the week by Premier Li Keqiang that the Chinese government will actively create conditions to establish a Shanghai-Hong Kong stock exchanges connectivity mechanism, and further promote two-way opening-up and healthy development of the capital markets on the mainland and Hong Kong. The panel discussed whether this combination would impact listing decisions for companies preparing to go public. Bill Owens recognized that Hong Kong is a lot closer to home whereas New York is much further away. Although there are people questioning the corporate governance of these listed Chinese companies, some of it arises from misunderstanding of how the companies are set up. The US has a more restrictive regulatory system, and it can be difficult to be associated with a foreign company that the SEC investigates for years. Gerry Grimstone pointed out that in contrast to the West where such measures would only be announced after the whole implementation model had been thoroughly studied and discussed, the announcement made by Premier Li Keqiang was likely a statement of intent with the detailed development work to follow. In the past there was not enough capacity for the Shanghai index to absorb a multi- billion dollar IPO, but a Shanghai-Hong Kong cooperation could potentially absorb even the largest of IPO's. Fred Hu noted that for Chinese companies with international aspirations, Hong Kong is a very good place to list, in contrast to some struggles perceived on US roadshows for Tencent and QQ. Except for market leaders, the US is a difficult market. Hong Kong offers greater potential for success to smaller cap companies. International expansion of Chinese banks Managing a financial service company outside of one's home country is an extremely difficult task. One determining factor of success is the quality of local management. Japan had similar expansion plans as China does today, but a look at history shows that the results are extraordinarily mixed at best, despite a long-term focus on planning. In fact, a country does not have to expand internationally to be incredibly global and successful. Take for example Wells Fargo, which is the largest bank in the US but also the most localized with modest international expansion. Gary Parr observed that when expanding abroad, the logical growth path is for banks to follow their clients. He further commented that as it stands now, there is one bank in China with US$22 billion of lending exposure in Venezuela, and there is another bank with US$17 billion in lending exposure just in the New York City area construction projects. These Chinese banks are lending to their already existing Chinese client base as their clients expand globally. In this way, Chinese banks can naturally expand internationally. China may benefit from creating a culture of great corporate governance. The west learned from Enron, whose directors were not sufficiently involved in the financial side of the business. Bill Owens noted that the board must be deeply involved in strategy, by understanding the risk factors and becoming involved in next steps, and in implementing regulations.