It was a painful lesson. In May – months before the words credit crunch
became common currency – China’s fledgling sovereign wealth fund, China
Investment Corporation (CIC), backed the flotation of the Blackstone
private-equity group to the tune of $3 billion (£1.5 billion). The
investment bought it a stake of almost 10%.
The timing was disastrous. As the summer unfolded and the credit crunch took
hold, the value of private-equity funds slumped. Blackstone’s share price
tumbled. CIC has made a paper loss of more than 20%.
But last week, the news that CIC is putting $5 billion into Morgan Stanley
gave a new perspective to Chinese involvement in the West’s largest
financial institutions. The sheer scale of the Morgan Stanley deal was
striking. And over the past few months, investment from the Far East has
become almost commonplace.
China Development Bank and Temasek of Singapore pumped $4.4 billion into
Barc-lays, securing a 5.2% stake. Citic Securities put $1 billion into Bear
Stearns. The deal with Morgan Stanley is only the most recent of agreements
to be struck. The Chinese dragon has become a familiar – and surprisingly
welcome – presence on Wall Street.
In contrast to the protectionist fervour that forced a Dubai company to sell
several American ports that it acquired through the takeover of Britain’s P&O,
there has been barely a murmur of opposition to this trend.
But as America’s stance on foreign money has changed, so has that of the
Chinese. Since the embarrassment of Blackstone, the Chinese appear to have
learnt their lesson. The Blackstone deal was a risky investment; now they
are after solid returns.
Morgan Stanley was in a weak position when it negotiated with the Chinese:
news of the CIC investment came alongside the disclosure that the American
investment bank was writing off a $9 billion slug of its exposure to
sub-prime debt.
Chief executive John Mack bent over backwards last week to emphasise that the
bank’s regulatory capital position was never in jeopardy. But, he said,
Morgan Stanley’s self-imposed targets made it necessary to raise capital.
Details of the Chinese investment show that CIC is to receive 9% on its money,
plus the right to buy a 9.9% stake in the bank – a meaty return by anyone’s
standards, and an indication of Morgan Stanley’s desperation to raise funds.
The deal illustrates perfectly the confluence of two driving forces. On the
one hand, investment banks that have been hit hard by losses on sub-prime
exposure need the cash to repair their balance sheets. And on the other,
China is brimming with foreign-exchange funds to invest, the product of its
huge current-account surplus with the rest of the world.
China is not alone, of course, in having money to spray around – and not alone
in showing interest in buying stakes in investment banks. Singapore has put
$11 billion into UBS. The Abu Dhabi Investment Authority has put $7.5
billion into Citi. Money from Dubai has gone into Standard Chartered and
HSBC. Only two days ago came news that Singapore’s Temasek is in talks to
take a stake in Merrill Lynch.
IN many ways, this is a good time to buy in – bank shares are heavily
depressed. But investors are still making Wall Street pay through the nose
for capital. Abu Dhabi’s $7.5 billion injection into Citi comes with an 11%
coupon – even higher than CIC’s return on its Morgan Stanley stake.
Nobody – least of all a bank whose balance sheet is in tatters – would deny
that $5 billion is serious money. But the funds put into Morgan Stanley are
small beer in the context of the $200 billion that CIC has to invest.
“These are relatively small stakes and they are going to be passive
investors,” said Richard Portes, professor of economics at London Business
School.
However, the politics of such investments are sensitive. UBS’s investors have
voiced concerns that Singapore has become one of the bank’s backers:
Singapore is a competitor to Switzer-land as a financial centre.
But Portes pinpoints the crucial issue for the banks that have been so willing
to accept money from sovereign wealth funds: “Can America really afford to
be too snooty about what sort of investment it accepts?” Put bluntly,
beggars cannot afford to be choosers. And in the present climate, banks
really are beggars.
The list of international banks swallowing write-offs has lengthened week by
week. And so has the list of international banks welcoming investment – from
China and elsewhere – with open arms.
But how much longer will it continue? Jon Peace, a banking analyst at Lehman
Brothers, said: “We are anticipating that some European banks will have to
take charges, but the size of them shouldn’t be so great that they have to
seek a partner. But, for the American banks, there is probably more in the
pipeline. It now seems certain that Merrill will announce a write-down and a
recapitalisation.
“And for Citi, it seems inevitable that they will need more write-downs and
probably more capital-raising.”
EAST-WEST ties are not purely a one-way street. China needs western expertise
to develop its financial services. Before cash became such a scarce
commodity, several British and American banks, including Bank of America and
Citi, took stakes in Chinese lenders. The idea was to tap into soaring
valuations but also get in on the ground floor of a liberalising,
fast-growing market with more than a billion customers.
Ser-Huang Poon, a professor of finance at Manchester Business School, said:
“China, being China, is very cautious. But they are keen to do joint
ventures.”
But Portes, at the London Business School, is sceptical about the speed with
which western banks will make headway in China. “The knowledge transfer has
been rather more limited than western banks had expected,” he said.
“They are very different culturally and the Chinese banks are subject to
political constraints in their lending. It is not so easy for a western bank
to introduce the credit evaluation and risk analysis that they are
accustomed to using.”
Peace, at Lehman Brothers, said: “The story that the banks are spinning is
that there are synergies to be had. But will that have any value in the
short term? Having said that, because China is such a closed market, Morgan
Stanley may gain from having a tie-up with the government.”
Royal Bank of Scotland has already established a foothold in China and shown
that it is possible for a western bank to make headway. It has issued 2m
credit cards in China through its two-year-old partnership with Bank of
China. Shareholders were initially fearful that the Bank of China deal was
little more than hubristic empire-building, but RBS won over the doubters.
The value of its £900m investment in Bank of China – in return for a 5% stake,
since diluted to 4.2% – has increased to £4 billion.
But chief executive Sir Fred Goodwin is eyeing a bigger prize. From his
position on the board of Bank of China, still more than 70%-owned by the
Chinese government, he hopes to influence how China develops its banking
market.
RBS has at least made a good start, advising on everything from marketing of
financial products to running the back office. Beyond credit cards, RBS has
set up ventures alongside Bank of China covering wealth management and
corporate lending, where $2 billion of transactions have been financed so
far.
And government links can bring advantages. Bank of China has struck a deal
which, in effect, out-sources the job of chasing up credit-card customers
who fall behind with repayment. The people who do the chasing are the
Chinese police.
For RBS, the Chinese connection is interesting, but not a matter of life and
death. For Wall Street banks desperate for funds, the Chinese connection has
been crucial to their recovery.
CIC WANTS TO BE A STABILISING FORCE IN WORLD MARKETS
IT may have made two multi-billion dollar overseas investments, but the China
Investment Corporation (CIC) is “just a newborn baby”, according to its
chairman.
The latest sovereign wealth fund to splash its cash in the West was
inaugurated only at the end of September. It is still advertising for
managers to run four global portfolios.
Internationally, however, CIC has been treated as an adult from the start.
Chairman Lou Jiwei, a former vice-minister of finance, has already been
drawn into the tense battle between Rio Tinto and BHP Billiton – only for
CIC to deny that it intended to act as a white knight for Rio.
CIC has $200 billion (£100 billion) to spend, its first slice of China’s $1.5
trillion of foreign-exchange reserves that have so far been tucked into
low-risk, low-return assets such as US treasury bills.
Of its initial capital, only a third has been earmarked for overseas
investments. Another third will be used to take over Central Huijin, a
government holding company that has controlling stakes in many of China’s
largest banks and brokerages. The rest will be spent at home, recapitalising
some of the remaining state banks and looking at other assets. CIC invested
$10m in the Hong Kong flotation of China Railway.
Jiwei has not been slow to set out his stall. At a City of London dinner this
month, he said that CIC wanted to be a stabilising factor in world financial
markets.
But he warned foreign governments not to use national security fears as an
excuse for protectionism to block deals.
Increasing CIC’s disclosure is not on the cards, though. Jiwei said: “If we
are transparent on everything, the wolves will eat us up.”
