Investors drawn to China despite risks

Investors drawn to China despite risks

By Guy de Jonquieres, FT.Com

January 31 2005

If the quality of corporate governance was measured by published regulations and good intentions, China would be a model of probity. Its authorities churn out such injunctions almost weekly. But recent scandals and murky dealings at China Aviation Oil, the soon-to-be privatised Bank of China and a string of other companies are pointed reminders of the wide gulf between official pronouncements and commercial reality.

To be fair, China's regulators recognise what needs to be done and are trying their best to do it. They know systematic corporate misconduct undermines economic development and could scare off the foreign capital on which it depends. In that respect, at least, they are faster learners than authorities in Japan and South Korea.

Progress has undoubtedly been made, albeit from a very low level. The outlines of a clearer regulatory and legal framework are emerging, corporate boards are being established and some companies have begun to clean up their act. Jamie Allen of the Asia Corporate Governance Association, an activist group, argues that, when judged by the opaque cronyism and weak corporate accountability prevalent in much of Asia, China does not look quite so bad.

Yet even optimists expect just curbing rampant abuses to take a decade or more - and the path ahead is strewn with obstacles. They start with weak enforcement. The state-owned Assets and Supervision and Administration Commission, which oversees big state-owned enterprises, is still finding its feet. The China Securities Regulatory Commission, which supervises listed companies, lacks resources and sustained high-level political backing. Many regulations have no clear basis in law and are at the mercy of courts more disposed to favour powerful local interests than to dispense justice.

Those deficiencies are rooted in the intrinsic weakness and dubious legitimacy of the Chinese state. Its failure to develop strong independent institutions has left the Communist party as a central instrument for implementing policy. Sometimes, SOE heads also chair local party committees. In many SOEs, these enjoy a status superior to that of the board, assuming there is one. Independent directors, many with few qualifications for the job, are often kept in the dark.

Though capable of ruthless effectiveness, the party, by definition, is ruled by a political, rather than a commercial, agenda. In a system where all important jobs carry government grades, some heads of big SOEs out-rank their regulators, while their companies' performance may be only incidental to their career prospects.

Exposure to capital markets through public equity offerings has been scarcely more effective in imposing disciplines on managers. Many so-called privatisations so far have simply parcelled out dominant shareholdings to different arms of government, leaving only minority stakes for private investors.

Although ministries' direct interference in day-to-day management is being curbed, companies still face pressure to fulfil sometimes conflicting social and industrial policy priorities. That helps explain why studies have repeatedly found that many Chinese companies perform worse after privatisation than before.

For foreign investors, all this should amount to a large sign flashing caveat emptor in bright lights - all the more so as China prepares to sell off minority stakes in its large banks. Although they have been re-capitalised, the quality of their recent loans is unclear and they have still to undergo restructuring.

Yet where China is concerned, there is a long history of foreigners shedding their normal caution and being transported by heady visions of limitless gain.

Where else, after all, offers so many opportunities to participate in such a phenomenal growth story? And whatever the risks of plunging in, how much greater are the risks of being left out?

Few would dispute either China's economic potential or the country's capacity to harness it: only now are the implications starting to dawn on the world. However, China's ability to grow and prosper is one thing. For outsiders to reap dividends from it is quite another. Much more must be done to instil order in the country's turbulent corporate sector before those two interests are clearly aligned.