Position Paper findings positive in 2005 for the Banking and Corporate Social Responsibility Working Groups

Banking & Securities

The Banking and Securities Working Group represents some 30 top European financial institutions, mainly active in commercial bank-ing and servicing long-standing multi-national clients and SMEs in China. It is one of stron-gest and most active Working Groups of the European Chamber. European banks have the largest share of foreign actors on the Chinese banking market, and last year saw the establish-ment of another four European banks and eight branches, taking the total to 59 and 122. The future could also see a number of large-scale investments ahead of the opening up of the retail market to foreign-invested financial institutions in December 2006.

Recent Progress

Chinese authorities have faced considerable challenges in moving from a centrally planned to a market economy, particularly over the past two years, and deserve praise for tackling banking reforms head-on. The emphasis on restructuring state-owned banks, improving solvency ratios, and addressing issues relating to corporate governance, are all steps in the right direction. Moreover, the China Banking Regulatory Commission (CBRC) has made strides in improving the supervision of foreign banking institutions by implementing new rat-ing systems more focused on risk. The Working Group takes note and recognizes the amount of new regulations that, as part of China's WTO commitments, have recently been introduced to facilitate foreign banking operations. Some of these achievements include:

Expansion of geographical scope for for-eign-funded financial institutions, in line with the WTO agreement, through the opening up of Kunming, Beijing and Xiamen to their activities. Two additional cities, Xi'an and Shenyang, were opened ahead of schedule.

Simpli.cation of the application process for foreign financial institutions wanting to set up representative offices in China.

Preferential review and approval procedures for the applications submitted by foreign banks to establish new entities or offer new lines of business in China's western and north-eastern regions.

Expediting of foreign bank applications for setting up intra-city sub-branches, engaging in RMB businesses or derivatives activities.

Banking & Securities

The Banking and Securities Working Group represents some 30 top European financial institutions, mainly active in commercial bank-ing and servicing long-standing multi-national clients and SMEs in China. It is one of stron-gest and most active Working Groups of the European Chamber. European banks have the largest share of foreign actors on the Chinese banking market, and last year saw the establish-ment of another four European banks and eight branches, taking the total to 59 and 122. The future could also see a number of large-scale investments ahead of the opening up of the retail market to foreign-invested financial institutions in December 2006.

Recent Progress

Chinese authorities have faced considerable challenges in moving from a centrally planned to a market economy, particularly over the past two years, and deserve praise for tackling banking reforms head-on. The emphasis on restructuring state-owned banks, improving solvency ratios, and addressing issues relating to corporate governance, are all steps in the right direction. Moreover, the China Banking Regulatory Commission (CBRC) has made strides in improving the supervision of foreign banking institutions by implementing new rat-ing systems more focused on risk. The Working Group takes note and recognizes the amount of new regulations that, as part of China's WTO commitments, have recently been introduced to facilitate foreign banking operations. Some of these achievements include:

Expansion of geographical scope for foreign funded financial institutions, in line with the WTO agreement, through the opening up of Kunming, Beijing and Xiamen to their activities. Two additional cities, Xi'an and Shenyang, were opened ahead of schedule.

Simpli.cation of the application process for foreign financial institutions wanting to set up representative offices in China.

Preferential review and approval procedures for the applications submitted by foreign banks to establish new entities or offer new lines of business in China's western and north-eastern regions.

Expediting of foreign bank applications for setting up intra-city sub-branches, engaging in RMB businesses or derivatives activities.

Despite such improvements, on other issues key to for-eign financial institutions the regulatory environment has not translated into greater business opportunities. According to some Working Group members, it is even more dif.cult doing business today than before China's accession to the WTO. The market share of foreign financial institutions is reported to have decreased from 2 percent in 2001 to 1.4 percent in 2004.

The Working Group expresses reservations on the following points:

The new foreign debt control regulations, plus those on short-term guarantees, working capital .nancing and ratio calculation, serve to limit the ability of European banks to do business in China. Moreover, financing through overseas guarantees is still not permitted, unless the FIE has a borrowing quota available.

Although foreign currency business with any customer, foreign or domestic, is now freely permitted, only a limited number of Chinese banks are allowed to do forward foreign exchange contracts, thus minimizing the ability to protect clients from the effects of currency .uctuations.

Prudential ratios are still being calculated according to the capital of foreign bank branches rather than according to the global capital base of the bank (notwithstanding the more lenient rules applied in the western and north-eastern regions).

If China is to realize its ambitions of becoming an international financial center in its own right, reducing investment risk and attracting viable strategic investors to partner with Chinese institutions at the same time, then Chinese regulators will be compelled to do more to prove they are serious about adopting and implementing international banking standards. The Working Group is con.dent that it could play a key role in sharing techni-cal know-how and resources with the regulators through more systematic consultation.

Key Recommendations - Banking

Capital Requirements

The Working Group suggests further reducing excessive capital requirements and eliminating the mandatory 30 percent deposit of working capital. High capital requirements do not provide additional guarantees, and instead result in inef.cient allocation of resources, reducing returns on equity and lowering levels of investment.

Liquidity Ratios

De.ne liquidity ratios on a consolidated basis for each legal en-tity according to international practice. The current calculation exacerbates operating costs, reduces pro.tability and frustrates collection of tax revenues.

Foreign Debt Policy

The conversion of onshore currency loans into RMB should be reinstated as a means to increase access to and reduce the costs of credit for FIEs. Tightened foreign ex-change regulations, on the other hand, could result in increased credit risk in China.

Business Scope of Representative offices

Representative offices are still unclear as to which activities they are authorized to under-take and those which they are not. A "checklist" should be issued without further delay containing detailed indications. It would be sensible to allow representative offices to conduct all activities short of "Banking business",as de.ned in line with international practice, and eradicate vague notions of "Business operation activity".

Waiting Period for RMB Licenses

Abolish the waiting period for RMB licenses, as all banks with a license to conduct foreign currency business should be entitled to conduct RMB business as well. This overly prudent stance has become out-dated given a maturing Chinese banking market.

Key Recommendations - Securities

Capital Guarantee Products Distribution

Capital guarantee products should be treated as off balance sheet business. A coordination mechanism for the regulation of equity and com-modity-linked capital products should be set up between the CBRC and CSRC (China Securities Regulatory Commission).

Owner Restrictions

Foreign financial institutions should be allowed to hold majority stakes in JVs. This would fa-cilitate the transfer of know-how essential to the development of the Chinese capital market, while at the same time limiting the risk due to lack of experience in local securities companies.

Derivative Licenses

Equity, index and commodity-linked products should be treated in the same manner as insurance policies. The current regulation, which requires financial institutions engaged in derivative ac-tivities to comply with the rules and regulations applicable to the underlying assets is mislead-ing, as the distribution banks are not exposed to the risk.

Corporate Social Responsibility

The Corporate Social Responsibility (CSR) Working Group represents over 30 members in various sectors. Working Group members have engaged in constructive dialogues covering a wide range of topics ranging from NGO reg-istration, HIV/AIDS, environmentally friendly practices in the corporate world and other issues concerning the supply chain. Task forces have also been established to deal with specific is-sues such as the Clean Development Mechanism (CDM).

Due to China's rapidly changing economic and social environment, European companies and their local counterparts are significantly contributing to China's social development through a wide variety of CSR programs. The Working Group welcomes the Chinese authori-ties. recognition of companies. added value in addressing societal needs at the local level, helping to bridge the gap in government welfare and community programs.

A key concern for the CSR Working Group is that the current legal and regulatory environment in China still poses many challenges. Unlike in Europe, there are no tax incentives for companies to engage in CSR and grass root organizations cannot register as NGOs and are forced to register as business organizations, robbing them of their le-gitimacy as civil society organizations. Moreover, although Chinese labor laws are compatible with international standards, the lack of implementation at a local level raises much concern.

CDM Task Force

The CDM (Clean Development Mechanism) task force represents 11 European compa-nies, mostly in the energy sector, who have a genuine interest in conducting CDM projects in China. The task force was established in April 2005 with the aim to engage members in a constructive and fruitful dialogue with relevant Chinese authorities concerning the possibility of allowing foreign companies to engage in CDM projects in China. Key concerns for the task force include the issue of HFC 23 and the 51 percent Chinese ownership requirement. HFC 23 is a potential greenhouse gas if emitted in the atmosphere. It is a byproduct of HCFC 22 production, and its GWP (Global Warming Power) is es-timated at 11,700 times that of CO2. An HFC 23 reduction project is a typical and financially efficient greenhouse gas improvement project. The development of HFC 23 incinera-tion CDM projects through technology transfer will contrib-ute considerably to greenhouse gas improvement in China and bring to China considerable CERs, which will contribute to China's sustainable development.

Members of the task force are very interested in developing CDM projects for their HCFC 22 operation in China and contrib-ute to greenhouse reduction once Chinese CDM project interim measures allow.

For the time being and according to article 11 of the CDM Interim Measures, only Chinese enterprises and enterprises with a majority Chinese share of 51 percent are eligible for CDM project development in China, which is not usually the case for multinational industrial investors. This interim measure ensures that Chinese eq-uity ownership of CDM projects is sufficient to enable the Chinese shareholder to manage the enterprise. Members of the task force are extremely concerned with this requirement due to the fact that Chinese entities lack the adequate know-how and experience to manage a CDM project. Members of the task force are reluctant to invest in a project that prohibits them to retain control of their investment and contribute their management expertise.

Banking Working Group gains ground Chairman of the Banking Working Group Marc Poirier on last year, next year and the position paper:

What will be the main issues in the coming year?

The main issue in 2006 will be whether the Chinese government is really going to open the market as it is stated in the WTO agreement. But the question is, by the end of 2006 the Chinese economy should be fully open, but is it going to be true? And what does "Open" mean? They will open the market, or, on paper foreign banks will be allowed to do whatever they want, but practically, maybe they will still have a lot of constraint.

What does "Open" mean to the Banking Working Group?

It means being allowed to do any type of activities without requiring specific licenses.

Will the authorities meet WTO requirements?

On paper they will meet the requirements, I think, but in practice probably not, nor in the spirit. They will .nd new rules to stop foreign banks from coming into China.

How does the Banking Working Group go about lobbying to the Chinese government?

When we have an issue we write directly to the banking regulator, which is CBRC [China Banking Regulatory Commission], or we write to SAFE, which is the State Administration of Foreign Exchange, or we write to the PBOC [People's Bank of China] directly. We also try to meet them on a regular basis - there's a very dynamic interaction between what we do and what the regulators are doing, and, generally speaking, it is not a confrontational relationship, but a very direct and very easy relationship.

How do you use the position paper in your lobbying efforts?

When we meet the regulator, we have a copy of the position paper that we give to them. We also have a yearly meeting with Liu Mingkang, who is the chairman of the CBRC, and we explain our position.

How does this help your efforts?

We haven't seen any results yet. One day it will pay. You have to live for the long term and you have to also understand the problems of the regulators, but yet, we expect some of the rules to change.

Taking Initiative

Corporate Social Responsibility (CSR) Working Group Chairman William Valentino on this years advancements and issues:

What were the major changes in CSR last year?

In 2005 the CPC and the central government put building a "harmonious society" on the country's top work agenda. This caused attention to become more focused on the increasing number of social challenges that China is facing as a result of its rapid economic transformation.

Sustainable development also became a household word last year as preparations for the Olympics highlighted China's environmental problems and the need for better enforcement of regulations to protect the environment, as well as the need to achieve sustainability for future generations.

The private sector increased the scope of CSR programs to include not just social and environmental issues but also labor conditions and issues not only in their own workplaces, but also in their supply chains. MNCs continue to be encouraged by China's engagement to alleviate its social and environmental problems by allowing MNCs to actively pursue CSR programs on both the local and national levels.

What do you think the main issues will be this year?

I expect that this year CSR will continue to be a key issue not only for foreign com-panies in China but also a key focus for large domestic Chinese enterprises. I anticipate that they will initially embrace it in terms of corporate branding and as a means to create competitive advantages, but CSR will gradually begin to weave social concerns into overall Chinese business strategies. This will follow the pattern of western companies who have been doing this by viewing business and society as being interwoven rather than distinct entities.

In the public health sector, the looming threat of a major avian .u outbreak will force the private sector to create response plans for their own workplaces and employees with the memory of SARS still very vivid in their minds.

What significant strides have Chinese com-panies made in the area of CSR this year?

Chinese companies have begun to recognize that doing well (bottom line success) and doing good (CSR initiatives) are not mutually exclusive and that they need to weave these into their business strategies to create sustainable busi-ness models and to remain competitive.

Chinese companies are becoming more and more active with their own CSR initiatives which I believe will make them strong role models for small and medium size Chinese enterprises who have yet to detect CSR on their own radar screens. The smaller enterprises will gradually follow the example of the larger Chinese enterprises who are increasingly beginning to use CSR more for corporate branding and for building better trust relationships with their stakeholders such as customers, employees, suppliers, regulatory authorities and communities.

What are the CSR Working Group's main lobbying platforms?

In my opinion the main lobbying platforms for the CSR WG are the boardrooms of our own individual companies. For many years, community development goals were philan-thropic activities that were seen as separate from business objectives, not fundamental to them. The lobbying task for many companies is to bring CSR into their boardrooms and demonstrate that cutting edge innovation and competitive advantage can result from weav-ing social and environmental considerations into their business strategies.

In addition, there are lobbying initiatives that the private sector can and should under take to address issues regarding tax incentives for CSR initiatives, as well as support for easier registration and establishment of domestic NGO's and civil society organizations. But I believe that it is equally, if not more important for the time being, for managers entrusted with handling CSR matters in WG companies, to lobby their managements to identify their roles in public-private partnerships and to undertake individual CSR initiatives. These initiatives should aim at bringing about real change in conditions and allow for the private sector to contribute to progress in achieving a better social, economic, business and stable political environment.