Who should be considered as the “major shareholder” of China’s state-owned financial assets (SFA)? It is a question that is no longer theoretical. .

SFAs refer mainly to the assets held by the financial institutions directly or indirectly funded by the state and the rights and privileges that the state is entitled to as a shareholder. They are reflected in the equity and other rights and privileges that the state holds in banks, securities companies, insurance companies and other financial institutions.

At the end of 2007, the financial enterprises at the central level held a total of 1.2 trillion yuan (US ＄ 168 billion) of state-owned capital, more than 80 percent of their total amount of paid-in capital. The assets under management exceeded 40 trillion yuan (US ＄ 5.6 trillion), and this statistic does not take into account the state-owned capital at the local level enterprises.

However, the imbalance in the distribution of the state capital is startling. The state-owned banks have attracted over 80 percent of the 1.2 trillion yuan.

The next phase of SFA reform in breaking down blocks of vested interest and spreading the gains of reform hinge on the SFA investor taking up its responsibilities and asserting its rights, experts say.

MOF Flexing Its Muscles

The Ministry of Finance (MOF) has not always fully exercised its role as an investor. “From the legal point of view, the MOF is the investor of the SFA,” a financial expert told Caijing, “But it didn’t really assume its duty as such in the past.”

Sun Xiaoxia, Chief of the Financial Department under the MOF sought to clarify the remark in an interview with Caijing, saying “To be precise, the MOF has never been explicitly assigned the full duty of the investor of the SFA.”

Before 1998, the basic management of the SFA was left to the Bureau of State-Owned Asset Management, a vice-ministerial level agency reporting to the MOF.

During the institutional reform in 1998, the Bureau was dissolved with its functions taken over by the MOF. The Department of Finance and Department of Enterprises, both under the MOF, were given the responsibility of managing financial and non-financial state-owned assets respectively.

In the same year, the MOF became a sole state shareholder of the four big state-owned commercial banks – Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC) and Agriculture Bank of China (ABC) – after it issued special treasury bonds amounting to 270 billion yuan in order to fund the banks. The MOF later established four asset management companies to deal with 1.4 trillion yuan bad assets of the four banks.

However, the management of the SFA is fragmented. The human resources, compensation and social security, financing, business development and investment were all handled by different organizations under the State Council.

2003 marked the beginning of a major reform in the management of the non-financial state-owned assets. The State-owned Assets Supervision and Administration Commission (SASAC) of the State Council was formed to assume the responsibilities as an investor in non-financial state-owned enterprises.

The management of state-owned financial assets, however, continued to be the responsibility of the MOF, as stated in a document issued by State Commission Office of Public Sector Reform in 2003.

The document stipulates the MOF’s duties in three main points. The first is the basic management, which includes the registration of the state’s property right of the assets of the financial enterprises, the assessment, the transfer and the clearing and checking of the assets. The second duty is the construction of the system of the registration, assessment, transfer and examination of the SFA, aimed at the preservation and value increase of the SFA. The last responsibility is to guide the local SFA managing authorities.

Since 2003, the MOF has promulgated a series of regulations concerning the management of the SFA. “The purpose is to prevent the SFA from being drained away,” said Sun.

In 2004, the MOF began waking up to its role as a major investor, as the reform of the China Construction Bank and Bank of China got under way and the Central Huijin Investment, the central bank’s investment arm, was founded.

In April 2005, the Industrial and Commercial Bank of China (ICBC) embarked on a financial restructuring process. Unlike BOC and CCB, ICBC had only a half rather than all of its capital offset the bad debts. Its equity was equally shared by the MOF and Huijin.

In November 2007, Huijin invested 20 billion yuan in China Everbright Bank, the country's eighth-largest lender, in return for a 70.88 percent stake in the bank. Huijin injected another 20 billion yuan on the last day of 2007 into China Development Bank (CDB), taking a 50 percent stake (the MOF held the other 50 percent).

The MOF and Huijin are expected to complete the restructuring of the remaining big-four bank ABC this year. Huijin will likely invest 40 billion yuan into ABC, and the restructuring will follow the ICBC’s case.

With the restructuring of some 30 financial institutions at the central level coming to an end, the MOF and Huijin have emerged as the two major players in this circle.

Huijin’s Evolution

Huijin was founded on December 16, 2003 at the approval of the State Council, as an investment company fully owned by the state. The initial registered capital of US＄ 45 billion came from the country’s foreign exchange reserves.

Huijin made a spectacular debut at the end of 2003 when it injected capital into state-owned commercial banks as a part of a move by the state aimed at consolidating its position as an investor in state-owned financial enterprises. Just two weeks after its inception, Huijin injected 45 billion dollars into BOC and CCB and another US＄ 15 billion was put into ICBC in the next year.

On surface, Huijin may seem like no more than a Special Purpose Vehicle (SPV) through which the state invests its foreign exchange reserves.

However, the State Administration of Foreign Exchange has emphasized that the investment of the foreign exchange reserves is not a fiscal appropriation, but an injection of capital. Huijin, as a major investor, is responsible for supervising commercial banks to implement reform and restructuring, to improve their corporate governance, and to improve returns on investment and dividends on the equities.

Since September 2004, when former Chief of the Financial Stability Bureau under the central bank Xie Ping assumed the post of General Manager at Huijin, Huijin’s function has expanded beyond promotion of financial restructuring of state-owned banks. The oversight of the reform of corporate governance of state-owned financial enterprises became its most important mission.

Huijin’s approach has been quite progressive in that it fully embraces its role as “the investor of the state-owned commercial banks”. It assigned full-time shareholding directors to the banks to help the board of directors with supervision and governance.

By July 2005, Huijin had invested nearly 500 billion yuan, approximately a half of the total SFA under its umbrella. The proportion will only be greater after the investment in ABC and CDB.

Huijin has assumed another “policy task” in 2005. When the Chinese stock market was in the doldrums in the second half of 2005, acting on the instruction of the State Council, Huijin, together with its subsidiary China Jianyin Group, bought the shares of around ten state-owned or joint-stock securities firms directly or indirectly, and even provided them with short-term liquidity loans. The move cost Huijin a total of 12 billion yuan.

Although the investment came from Huijin’s own assets rather than the foreign exchange reserves, Huijin had to reconsider its role as a shareholder of over 30 major financial institutions.

Late 2006, the Financial Department under the MOF proposed that a commission of the supervision and administration of SAF be established based on the SASAC model to handle matters relating to personnel, operation and asset management. The proposal called for an integration of Huijin and its subsidiary China Jianyin into the commission.

The proposal was not approved, but instead, it was decided that a new entity China Investment Corporation (CIC) be set up with Huijin as a subsidiary.

CIC formally came into being in 2007. As an institution directly under the State Council, CIC is China’s first Sovereign Wealth Fund, whose current focus is to direct and manage China’s overseas investments.

Huijin, defined as the investor of the state-owned commercial banks, however, needs a new mandate. But before it finds one, Huijin executives and MOF officials both agree that its role has been reduced to only equity management. Huijin, it seems, is at least temporarily passive.

Difficulty With Exercising State Shareholder Rights

While major state-owned financial institutions have finished their restructuring and gone public, the problem of management control at those institutions is yet to be solved.

An executive from Huijin told Caijing that after the listing, the state-owned listed banks rejected supervision from the state shareholder, citing “equal rights among shareholders”. The shareholding directors sent by the state shareholder have no access to information other than that available in corporate reports.

Sun believes that the state shareholder is different in that it cannot “vote with feet” in the state-owned financial enterprises, but instead it must “vote with hands” on the board of directors to exercise its right as a shareholder.

But “voting with hands” is not as simple as it sounds. Although a basic structure of “the board of shareholders, the board of directors, the board of supervisors, and the management” has been set up, it does not clarify the corporate governance of the state-owned financial enterprises. “The biggest issue is whether the board of directors can genuinely exercise its entitled rights.” Lu Lei, a professor in Guangdong Finance Institute said.

For instance, a fundamental mechanism of the modern corporate governance is that the board of directors is in charge of the selection, supervision and assessment of the management.

However, the usual practice in major state-owned financial enterprises is that the board of directors only gives a symbolic vote, while the power resides in the Party committees. The party secretary is usually Chairman of the Board at the same time, with other party members occupying key posts in the management including executive directors, to the exclusion of non-party members..

Such a practice renders the board of directors impotent. It poses a stark contrast with the prevailing merit-based system of incentives to get the best out of the management in the fiercely competitive marketplace.

Interviews by Caijing reveal that the Department of Finance under the MOF and Huijin both share the view that it is necessary to adopt a market-based approach to the appointment of senior executives of state-owned financial enterprises and put in place a mechanism to guard against the management enjoying excessive perks without corresponding responsibilities.

In this context, the MOF discouraged a race among state-owned banks, insurance companies and securities companies to offer equity incentives. It has also begun drafting a regulation that is designed to integrate equity incentives into compensation schemes, with emphasis on incentives and restraints for the rank-and-file staff and compensation ceiling. The regulation may be rolled out this year.

Fundamental Questions Remain Unresolved

When major state-owned banks like Bank of Communications, CCB, BOC and ICBC embarked on restructuring and IPO in early 2003, some experts questioned if the break-neck pace was short-changing the reform as time was needed to assess the restructuring before going further forward.

Currently, various departments within the SFA management authorities are exercising the oversight. But their authority has increasingly been called into question to the extent, in the words of one official, “the state may have to increase the investment to maintain its status as a major shareholder in the event that the state shareholding is diluted.”

For the reform-minded experts, fundamental questions have to be addressed at this juncture:

Should maximizing profits be a goal of the future investor of the SFA? Should the state retreat from state-owned financial enterprises?  The policy-makers should examine closely the private share-holding mechanism which gradually encroaches up state-ownership before a solution for principal-agent problem is clarified.