HSBC and its rebel shareholder Knight Vinke were engaged in a fresh squabble yesterday over whether the bank makes any money from its efforts in the plum strategic market of mainland China.

Although total Chinese profits at HSBC reached $903 million (£440 million) last year, $986 million was attributable to associates – stakes in local banks accumulated by HSBC – according to Knight Vinke, with HSBC-managed businesses posting an $83 million loss.

Eric Knight, the founder of Knight Vinke, said: “Company-managed businesses in China are losing money across the board. The profits in China come from businesses they don’t manage themselves.” HSBC denied the suggestion. “Eric Knight is wrong,” a spokesman for the bank said, asserting that 20 per cent to 30 per cent of 2005 and 2006 profits came from HSBC’s own branches in China, when they were investing heavily through the profit and loss account.

The performance of HSBC-built businesses in China is a key test of HSBC’s emerging-markets credentials and of whether it has, as Mr Knight claims, “squandered” its Chinese birthright. HSBC’s Chinese associates include stakes in the local Bank of Communications, Ping An, Industrial Bank and Bank of Shanghai. Local banks have a huge advantage because of tight restrictions on what foreign-controlled banks can do.

Mr Knight, who is pushing for strategic and boardroom reforms at HSBC, is lobbying for the legal headquarters of HSBC to be moved from London to Hong Kong or Shanghai so that it qualifies for local bank status. Alternatively, he suggests spinning off the Hong Kong and Chinese businesses into a Shanghai listed and headquartered business. This would create instant value for shareholders, because successful local banks trade on 30 times earnings instead of the ten times that HSBC typically trades on.

Although there could be regulatory and tax issues from such moves, Mr Knight argues that these are the kinds of bold ideas that the bank should be grappling with through an independent strategic review. Although HSBC is the biggest foreign bank in China, with 15.5 per cent market share, it is tiny by Chinese standards. Total foreign banks account for only 1.4 per cent of the overall loan market. Knight Vinke argues that the bigger opportunity for HSBC in China is in investment banking, which has lighter restrictions. Here HSBC has been falling down the rankings in areas such as bond issues and flotations.

Restrictions on foreign-controlled banks will not be lifted until the local players can compete on an equal footing, Mr Knight argues. “If HSBC waits for this to happen, it risks missing the boat and its Hong Kong business will also be at risk,” he said.

One source close to HSBC said that it was ridiculous to expect organically grown and start-up operations in China to make big profits immediately. HSBC, like many other Western firms experiencing losses in China, was “investing for the long term”. On Friday, HSBC gave greater emphasis to its Asian and emerging-markets roots, saying that it aimed to generate 60 per cent of profits from these higher-growth economies and 40 per cent from developed economies, such as Europe and North America. Previously, it had said that its target was 50-50.

In a Knight Vinke briefing note seen by The Times, the activist investor is also questioning the independence of many of the HSBC nonexecutive directors. Although HSBC considers eight of its 15-strong board to be independent, as defined by the Combined Code on corporate governance, Knight Vinke said that the figure could be as low as four.

Cross-directorships indicate a lack of independence, Knight Vinke says. Simon Robertson, the senior independent director, shares a boardroom post at The Economist with Rona Fairhead, a fellow HSBC director, and James Hughes-Hallett and Baroness Dunn both sit on the board of John Swire & Sons. “If these directors were regarded as not being independent, then the independent directors would comprise only a minority of the board at present,” Knight Vinke said.

Knight Vinke, which has the backing of the Californian pension funds CalPERS and CalSTRS, renewed its two-month assault on HSBC last week, accusing it of misleading shareholders when it presented a planned executive bonus scheme to them in 2005. HSBC denies any misrepresentation, and its supporters argue that the Knight Vinke campaign is gaining little or no City traction. None of the investors and analysts at Friday’s presentation asked about Knight Vinke’s allegations.

Divergence

What HSBC makes in China – according to its critic

— Owned subsidiaries: loss of $83 million
— Partly owned businesses (Ping An, Bocom, Industrial Bank and Bank of Shanghai): $986 million

Source: Knight Vinke

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