China Said to Study IBM Servers for Bank Security Risks

May 27 (Bloomberg) -- The Chinese government is reviewing whether domestic banks’ reliance on high-end servers from IBM compromises the nation’s financial security, people familiar with the matter said, in an escalation of the dispute with the U.S. over spying claims. Betty Liu reports on “Mover & Shakers” on Bloomberg Television’s “In The Loop.”

The Chinese government is reviewing whether domestic banks’ reliance on high-end servers from International Business Machines Corp. (IBM) compromises the nation’s financial security, people familiar with the matter said, in an escalation of the dispute with the U.S. over spying claims.

Government agencies, including the People’s Bank of China and the Ministry of Finance, are asking banks to remove the IBM servers and replace them with a local brand as part of a trial program, said the four people, who asked not to be identified because the review hasn’t been made public.

The review comes a week after American prosecutors indicted five Chinese military officers for allegedly hacking into the computers of U.S. companies and stealing secrets, while former contractor Edward Snowden’s revelations last June of a National Security Agency spying program already hurt U.S. technology sales in China. Last week, China’s government said it will vet technology companies operating in the country, while the Financial Times reported May 25 that China ordered state-owned companies to cut ties with U.S. consulting firms.

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“IBM is not aware of any Chinese government policy recommending against the use of IBM servers within the country’s banking industry,” Jeff Cross, a spokesman for IBM, said in an e-mailed statement. “In fact, news reports now state that China’s National Development and Reform Commission has not heard of any alleged directive to that effect. IBM is a trusted partner in China and has been for more than 30 years.”

Photographer: Ben Torres/Bloomberg

Public, private, and management data wires lead to servers on one of the cloud racks inside pod two of International Business Machines Corp.'s Softlayer data center in Dallas on Jan. 16, 2014. Close

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Public, private, and management data wires lead to servers on one of the cloud racks inside pod two of International Business Machines Corp.'s Softlayer data center in Dallas on Jan. 16, 2014.

The results of the government review will be submitted to a working group on Internet security led by President Xi Jinping, two of the people said.

Security Trumps

“Security trumps everything,” said Duncan Clark, chairman of BDA China Ltd., a Beijing-based consultant to technology companies. “China doesn’t need the U.S. companies in the way it did for the last few decades.”

Spokesmen for Bank of China Ltd., China Construction Bank Corp. and Industrial & Commercial Bank of China Ltd. declined to comment. Three phone calls to Agricultural Bank of China Ltd.’s Beijing press office weren’t returned.

U.S. technology sales in China have come under increasing threat following Snowden’s revelations last year of an NSA spying program.

Then, last week the Justice Department accused five Chinese military officials of hacking computers of American companies such as U.S. Steel Corp. and Alcoa Inc. to steal trade secrets, and casting them as an economic threat.

Photographer: Scott Eells/Bloomberg

Pedestrians walk past International Business Machines Corp. (IBM) offices in New York. Close

Pedestrians walk past International Business Machines Corp. (IBM) offices in New York.

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Photographer: Scott Eells/Bloomberg

Pedestrians walk past International Business Machines Corp. (IBM) offices in New York.

Not Justified

The U.S. State Department doesn’t feel that China’s reaction was justified, said spokeswoman Jen Psaki.

The U.S. expects “the Chinese government to understand that the Department of Justice’s May 19th announcement relates to a law enforcement investigation of individuals who have allegedly stolen intellectual property from U.S. businesses,” Psaki said. It “doesn’t provide, in our view, any justification for retaliation against U.S. businesses or the U.S. government.”

China is now vetting technology companies operating in the country for potential national-security breaches, which may put U.S. sales at risk for companies such as Microsoft Corp. (MSFT) in the world’s largest market for personal computers. Forrester Research Inc. estimates purchases of information-technology products in China will rise 11 percent this year to $125 billion.

Microsoft Exclusion

Microsoft said this month it was “surprised” to learn that the China Central Government Procurement Center excluded its Windows 8 operating system from a purchase of energy-efficient computers. The official Xinhua News Agency called it “a move to ensure computer security.”

Photographer: David Paul Morris/Bloomberg

Edward Snowden, the former National Security Agency contractor, speaks on screen during a virtual conversation at the South By Southwest (SXSW) Interactive Festival in Austin, Texas. U.S. technology sales in China have come under increasing threat following Edward Snowden’s revelations last June of a National Security Agency spying program. Close

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Photographer: David Paul Morris/Bloomberg

Edward Snowden, the former National Security Agency contractor, speaks on screen during a virtual conversation at the South By Southwest (SXSW) Interactive Festival in Austin, Texas. U.S. technology sales in China have come under increasing threat following Edward Snowden’s revelations last June of a National Security Agency spying program.

“China’s government is in a strong position given Snowden’s disclosures,” Clark said. “If you give them an excuse, they will aggressively promote domestic brands.”

The review would be a further blow to IBM’s business in China, where spending on server technology may grow 8.4 percent a year through 2017, compared with 2.2 percent globally, according to data compiled by IDC.

“It’s a challenging market, for sure,” Craig Stice, an analyst at IHS Technology, said in a phone interview. “It’s still an important piece because China is considered a growth market.”

The company said its China revenue fell 20 percent in the first quarter after a 23 percent decline in the fourth quarter. Chief Financial Officer Martin Schroeter said on a conference call this month that the challenges were cyclical because half of its sales in the country come from its struggling hardware business, compared with 15 percent of worldwide sales coming from that unit. IBM also has a “very heavy concentration” in state-owned enterprises, he said.

China Investment

“We are investing with the idea that China, like the rest of the growth markets, they’re absolutely going to come back and they’re going to be fine,” Schroeter said at an investor conference. “Now you can’t predict when that’s going to happen, but we continue to invest in China because we still see very good long-term opportunity there.”

While IBM doesn’t break out revenue figures by country, 14 percent of its 2013 revenue of $99.8 billion came from the Asia-Pacific region excluding Japan, according to data compiled by Bloomberg. About 9.7 percent of total revenue came from its server business, the data show.

Toni Sacconaghi, an analyst at Sanford C. Bernstein & Co., estimates that about 4 percent of IBM’s revenue comes from China, or almost $4 billion.

Lenovo Deal

IBM shares fell 0.6 percent to $184.78 yesterday, the lowest closing price since March 19. Through last week, the stock was down 0.9 percent this year, compared with a 2.8 percent gain for the Standard & Poor’s 500 Index.

IBM announced in January it would sell its low-end server computer business to Beijing-based Lenovo Group Ltd. (992) for $2.3 billion. That transaction faces regulatory scrutiny including a U.S. national security review. Angela Lee, a Hong Kong-based spokeswoman for Lenovo, said she couldn’t immediately comment.

Under the proposed deal with Lenovo, IBM will keep its higher-end hardware, including System z mainframes and Power servers. Lenovo would get IBM servers that use x86 processors, an industry-standard technology.

The transaction includes BladeCenter and Flex System blade-style servers -- slim devices that slide into racks -- along with switches that run corporate computer networks.

In addition to concern that Armonk, New York-based IBM’s equipment poses a security threat, China’s government also believes IBM servers are more expensive in China than in other regions, the people said.

Security Concerns

“Anytime you have an American company that is sold overseas to a Chinese company, there will be concerns over security as it changes hands,” Stice said.

China Postal Savings Bank Co. is using servers made by Jinan-based Inspur Group Ltd. as part of a trial program that began in March 2013, the people said. The government plans to expand that trial to other banks, they said.

The group’s Inspur International Ltd. (596) unit gained 9.4 percent, the most in almost a year, to close at HK$1.52 in Hong Kong trading yesterday. In Shenzhen, Inspur Electronic Information Industry Co. rose 4.7 percent yesterday.

Other agencies involved in the review include the National Development and Reform Commission, the China Banking Regulatory Commission, and the Ministry of Industry and Information Technology, the people said. The NDRC, the Finance Ministry, the central bank and the CBRC didn’t immediately respond to faxed requests for comment.

Chinese Retaliation

The U.S. indictment led China to suspend its involvement in a cybersecurity working group and drew formal protests from the ministries of defense and foreign affairs. The State Internet Information Office likened the U.S. actions to “a thief yelling ‘Catch the thief.’”

China’s IBM review may simply be a message to U.S. officials, said Richard Fichera, an analyst at Forrester.

“There’s obviously an element of political tit for tat going on here,” Fichera said in an interview. “Telling the Chinese banks to get off of it is one thing, but actually doing it is another.”

Last week, White House spokesman Jay Carney said President Barack Obama took the action because of “concerns over government-sponsored, cyber-enabled theft of trade secrets and other sensitive business issues -- business information for commercial gains.”

U.S. Victory

Carney didn’t say whether the U.S. had concerns about Chinese retaliation, which has been a pattern. During Obama’s administration, the two nations have disputed trade on issues including tires, chicken parts, autos, rare-earth minerals and credit-card payment services.

Two days after the U.S. imposed tariffs on tire imports from China in September 2009, China announced dumping and anti-subsidy investigations on imports of poultry and autos from the U.S.

The U.S. on May 23 claimed victory over China in a dispute at the World Trade Organization involving autos. The Geneva-based trade arbiter determined anti-subsidy and anti-dumping duties China imposed on the goods violated trade rules. The Beijing government lifted the measures at the end of last year.

To contact Bloomberg News staff for this story: Steven Yang in Beijing at kyang74@bloomberg.net; Edmond Lococo in Beijing at elococo@bloomberg.net

To contact the editors responsible for this story: Michael Tighe at mtighe4@bloomberg.net Sarah Rabil, Ben Livesey

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