The Chinalco dilemma

The biggest investment ever made by China in a foreign company was aluminium giant Chinalco's 2007 acquisition (along a minority share from Alcoa) of a 12% stake in Rio Tinto plc, which it recently said it wants to increase to 14.99% .

However, the shares are held through a nominee (custody) account, operated by none othr than Lehman Brother's - the global bank which spectaculary collapsed last month, precipitating the current meltdown in financial markets.

Not surprisingly, the Chinese are keen to recover the value of their shares which could end up being sold as part of the settlement of Lehman's debts.

But who - just a few weeks back - would have thought that the US government may (effectively) no have to bail out China, bearing the cost through drawing on yet more US taxpayer's funds? It was more likely that the boot would be on the other foot, as indeed it has been with recent Chinese part-rescues of US banks themselves.

We may ask where this now leaves Chinalco's investment in Rio Tinto - specifically made as a blocking strategy to forestall BHP Billiton's takeover of the UK mining company? Indeed, where does it leave Rio Tinto itself which, just two weeks ago, set out grandiose plans for further expansion (notably in the Indian alumininum industry) along with the likely sale of some of its "non-core" assets?

Another intriguing question has to be whether investors will now recognise the increased risks of making custody arrangements with banks which may then fail. Virtually all of them offer such nominee accounts (including Barclays, HSBC, Morgan Stanley, UBS, Credit Suisse and others).

Among corporate campaigners, there's been growing concern that the identity of shareholders in dubious companies are concealed in this fashion, while the banks themselves shrug off their responsiblity for facilitating unacceptable investment, under the cloak of commercial confidentiality.

[Comment by Nostromo Research]

"The Lehman debacle could alter the way China invests in the future"

China's Lehman Problem

Tina Wang

Forbes.com

17th October 2008-10-17

Lehman Brothers Holdings' bankruptcy filing has left many victims in its wake, but one may have the muscle to push to the front of the line of creditors--the Chinese government.

Lehman's collapse may have put into jeopardy the $14 billion stake Beijing-controlled Aluminum Corp. of China, or Chinalco, bought in tandem with Alcoa. The London-listed Rio shares are held in a Lehman account that is believed to have been frozen as bankruptcy courts work on how to dispose of the Wall Street firm's assets. Chinalco is reportedly holding discussions with liquidators handling Lehman's assets in Hong Kong and is seeking to have the shares transferred to another account. Beijing won't be content to sit back and let the biggest overseas investment made by a Chinese company just evaporate, some analysts say. China's Lehman headache may also prompt the country to rethink the way it makes acquisitions abroad.

"There is no basis on which Chinalco's ownership of the shares could be validly challenged or on which its shares could form part of the general assets of [Lehman Brothers]," Chinalco said in a terse statement after a report surfaced in Britain's Daily Telegraph speculating that the Chinese company would not be made whole.

The Rio shares were held in a "separate designated account pursuant to a custody arrangement" with Lehman, the company said. But some analysts still wonder if the shares may be in danger of being sold by liquidators to pay off Lehman's debts.

Liquidators may decide that Chinalco needs to step in line with all the other creditors trying to salvage what they can from Lehman. That would incur steep losses for Chinalco, which bought 12% of Rio's London-listed shares with Alcoa in February for $14.1 billion, or 9% of the overall company--a record overseas stake for a Chinese enterprise . But since Chinalco is backed by Beijing, international politics may play a greater role here. "This is really a Chinese-government stake. I'm not sure the Chinese government is going take very kindly to losing all their money," said an analyst who asked to remain anonymous due to the sensitivity of the issue. "This could be quite a political hot potato." Given all its recent bank bailouts and the importance of ties with China, the U.S. government could hand the stake to Chinalco to avoid angering Beijing and pay out the difference to the liquidators, he added. The issue "will be debated between the two countries. It's a tough one."

The Lehman debacle could alter the way China invests in the future. State companies may prefer to invest directly abroad, instead of through the stock market and Wall Street banks, said Beijing-based analyst Cherry Chen for Core Pacific-Yamaichi International. "The management says they'll get back all the shares. I don't know if they can get back all the shares," she said, adding that she had not seen a problem like this before. Chinalco got approval in August from Australian regulators for the Rio purchase. Chinalco's move into the company has been interpreted as a Chinese attempt to derail the hostile bid by BHP Billiton for Rio, which Chinese steel producers are loath to allow given that it would give the resulting goliath broad pricing power in the iron ore market.

In Hong Kong midday trading, Chinalco shares fell 6 Hong Kong cents (1 cent), or 1.8%, to 3.24 Hong Kong dollars (42 cents). In Sydney trading, Rio shares fell 2.93 Australian dollars ($2.00), or 4.4%, to 63.08 Australian dollars ($43.11).