The Bloom Comes Off the Rose of ‘China, Inc.’

(Washington, D.C.): In recent days, investors have become leery of China’s
state-owned and
state-affiliated companies — many of which have close ties to the People’s Liberation Army
and/or Chinese intelligence services. This new “China flu” has begun to infect the Hong Kong
market, as well, just as its stock exchange is seeking to establish unprecedented “co-listing”
arrangements with the U.S. NASDAQ exchange.

According to an article headlined “Investors to Tread Warily in China Oilfields” that
appeared
in the 23 December edition of the Financial Times:

[A proposed listing on the New York Stock Exchange] of PetroChina, a unit of
the
China National Petroleum Corporation…estimated to be worth $7 billion…is hardly a
crown jewel, despite implied promises that the company would improve following an
IPO, some observers said….

Many investors may soon be alarmed to find that PetroChina has earmarked the
bulk of its IPO proceeds for “debt repayment and severance compensation,”as
stated in the company’s preliminary listing prospectus. [N.B. Ironically, CNPC
felt compelled to create this new holding company and seek to circumscribe the
uses of investor proceeds in response to growing international criticism about
the company’s extensive involvement in oil exploration and exploitation in
terrorist- and slavery-sponsoring Sudan.]

“What CNPC is saying is: ‘We are big and we are lousy but we will get better
with your money,’ said one banker. ‘That is not the way to enter the
international markets. Investors are not a bunch of simpletons.'” (Emphasis
added.)

In fact, investors have begun to vote with their feet on a major
partner of CNPC in
Sudan’s principal oil consortium — Canada’s largest private petroleum firm, Talisman
Energy,
Inc. According to ABCNews.com on 10 January, “Leading U.S.-based pension funds
[i.e.,
TIAA-CREF, CalPERS and the Texas Teachers Retirement System] have dropped their shares in
a stock allegedly linked to slave-trading in Sudan, after protests and complaints about ownership
of the shares.”

Similar complaints from members of the human rights and national security
communities are
bound to prove no-less-problematic for CNPC and certain other state-owned or -associated
Chinese firms that are trying to attract billions of dollars in the United States capital markets,
even as these firms are engaged in global activities — in Sudan and elsewhere — which are
contrary to prized American values and security interests. Early evidence of this trend is to be
found in the following, important article that appeared in Investor’s Business Daily on 4
January.

Investor’s Business Daily, January 4, 2000

Are ‘Red Chips’ a Trojan Horse?
As China’s Firms List On U.S. Exchanges, Who’ll Profit?

By John Berlau

Of all the global business mergers and alliances, none is likely to have more
impact — or
create more controversy — than the new alliance between the Nasdaq stock market and the
Stock Exchange of Hong Kong.

The Nasdaq and Hong Kong’s exchange plan to have dual listings on each other’s markets.

Seven American companies, including Microsoft Corp., Cisco Systems Inc. and Dell
Computer
Corp., are expected to list in Hong Kong in February.

It hasn’t been announced yet what companies from the Hong Kong exchange will be listed in
America.

But the co-listing would mean that millions of American investors could buy foreign stocks
once available only to large institutions such as pension funds.

“In an environment when alliances and partnerships are truly becoming the norm for
business,
this is probably the first of many of these types of business partnerships (among international
exchanges),” said James P. Donovan, head of emerging markets for Citibank’s worldwide
securities services.

“I think the more you expose investors to good companies, and the more good companies
investors can access, the better off the overall capital market will be.”

But as the partnership goes forward, a host of issues may come into play — from
disclosure of
information to investors to national security concerns over the growing influence of the
People’s Republic of China.

The Hong Kong exchange’s “set of ties, both direct and indirect, to the Chinese government
may
require additional due diligence,” said consultant Roger Robinson, a former vice president at
Chase Manhattan Bank.

China, which took control of Hong Kong from Britain in 1997, said in June that it has the
right to
overturn all Hong Kong laws — reversing an earlier decision of Hong Kong’s highest court.
Observers such as Robinson fear this means China will exert more control over Hong Kong’s
economy in the future, including its financial markets.

Already, the Chinese government has a growing prescence on Hong Kong’s stock exchange.
Forty-three of the exchange’s 940 firms are incorporated on the mainland.

There are even more companies traders call “red chips” — offshoots of China’s state-owned
firms
that incorporate in Hong Kong or other countries to raise money for their parents.

Another big worry: the accounting practices of state-owned firms.

Britain’s Financial Times reported last week that a Chinese government
audit of 100 firms
showed that 81 had falsified their accounts.

“The poor quality of accounting in China has undermined the credibility of the stock market
and
made it more difficult for banks to judge the creditworthiness of prospective clients,” the
newspaper said.

If banks can’t judge Chinese state companies, can American investors?

“Disclosure and transparency represent important questions,” said Robinson. “It’s my
impression that the threshold of listing in Hong Kong is somewhat lower than the requirements
for listing” in the U.S.

Indeed, SEHK Chief Executive Alec Tsui said the U.S. has much tougher disclosure rules
than
his own exchange, according to a recent article in Hong Kong’s South China Morning
Post.

Will the listings from Hong Kong have to comply with disclosure and other rules foreign
stocks
now have to follow on American exchanges?

The Securities and Exchange Commission said it didn’t know yet.

“It’s entirely speculative at this point,” said SEC spokesman Chris Ullman. “They (the
Nasdaq
and the Hong Kong exchange) have to come to us and lay out in rule-making form what they
want to do.”

Nasdaq spokesman Scott Peterson said the companies from the Hong Kong exchange will
register with the SEC and “be subject to U.S. listing requirements.”

The SEC is being urged by some to let foreign companies list using standards of the
International
Accounting Standards Committee (IASC).

Right now, the SEC requires foreign companies to use U.S. Generally Accepted Accounting
Principles for core figures.

“The U,S. GAAP generally requires a lot more detailed information” than the IASC and
other
standards, said Carrie Bloomer, a project manager for the Financial Accounting Standards Board,
the private group that sets the GAAP standards.

The Hong Kong exchange accepts IASC standards for companies from China and other
countries. Exchange spokeswoman Lorraine Chan said whether its firms would conform to the
GAAP standards to list on Nasdaq is “still under discussion.”

If the SEC lets Hong Kong’s companies use the international standards, stock tables would
list
companies side by side that use different accounting measures. Bloomer said there are key
differences between GAAP and IASC standards that investors need to know in order to “have the
red flags when you need them.”

For instance, the IASC doesn’t require companies to list executive pay in stock. Some
spending
for research and development can also be listed as an asset instead of an expense. And
companies can revalue old equipment on financial reports rather than sticking to a strict
depreciation schedule.

As a result of these differences, companies using IASC can sometimes report higher values
for
assets, net income and earnings per share than they can using GAAP, Bloomer said.

But if red chips are listed on the Nasdaq, accounting standards would be just one problem.

“Most of the key decisions (of red chips) are still made in accordance with the
wishes of
controlling (Chinese) government bodies,” according to “Red Chips and the
Globalisation of
China’s Enterprises,” a 1998 book written by a group of Hong Kong financial analysts.

The book refers to red chips as “something as a midwife for the parent” whose main
assets
are usually “injections” from the parent company.

But when it comes to disclosure rules, the Hong Kong exchange treats red chips just like
other
companies.

“Only the listed company has an obligation to disclose information to the exchange, and the
parent company is not the listed company,” said Henry Law, the Hong Kong exchange’s director
of corporate communications.

Because the state-owned parent is considered a “shareholder,” Law said the red chip
has to
list only the percentage of shares the parent owns, and “not the financial situation of the
parent company” unless “there are any significant implications on the listed company’s
share price.”

Investors need to know this, says Citibank’s Donovan.

‘If a company is not required to disclose an important affiliation with another company who
may
be subject to a wholly different set of risks, then you need to know that,” he said.

Robinson, a former senior official in President Reagan’s National Security Council,
noted
some of the Beijing parent companies of red chips have been implicated as possible U.S.
security threats.

Hong Kong’s South China Morning Post found in 1998 that nearly 200
Hong Kong
corporations were linked to the Chinese military or China’s defense industries.

At least two companies on the Hong Kong exchange, Continental Mariner Investment Co.
and
Poly Investment Holdings, were described by the paper as “arms of (China’s) People’s
Liberation Army.”

Even some innocent-sounding state companies such as the China Ocean Shipping
Company (Cosco) and China Resources, both of which have red chips listed in Hong Kong,
have been linked to the Chinese military or spying in congressional reports.

The China National Petroleum Corp., which wants to list on the New York Stock Exchange
as
early as February, is creating a stir because of its dealing in three countries — Sudan, Iran and
Iraq — that the U.S. believes are involved in terrorism and has banned most trade with.

In October, after IBD reported concerns about an oil pipeline CNPC was
building in partnership
with Sudan’s government which the State Department says is providing safe haven to terrorists
and sanctioning slavery, CNPC reportedly decided to list a stripped-down surrogate in the U.S.
that no longer includes the Sudanese assets.

But some 200 religious and civic leaders, including former Treasury Secretary
William
Simon and former Assistant Secretary of State Elliott Abrams, still worry that U.S. money
will end up funding Sudan’s regime.

“I don’t think that there has been the kind of continuing disclosure that allows anyone to say
with
assurance that funds raised by the China National Petroleum (Corp.) Will in no way assist the
Sudan pipeline,” Abrams said.

The company shows no “inclination toward transparency, routinely refusing media
interviews and even denying lawyers preparing for the flotation access to key company
accounts,” the Financial Times reported. CNPC and its reported issuer
Goldman Sachs
declined comment to IBD for the record.