Morgan Stanley's Chinese Coup

For more than two years, Morgan Stanley & Co. has been cultivating its Chinese connections to help create China's first joint-venture investment bank. On Oct. 24, at a Beijing villa surrounded by lakes and gardens, the effort paid off. With Morgan Stanley Group President John J. Mack looking on, Chinese Vice-Premier Zhu Rongji launched the new bank, China International Capital Corp. (CICC). Alongside Mack were his partners in the bank, some of the most powerful stars in the Chinese business world (table).

The deal and the prolonged negotiations that preceded it demonstrate how Zhu is making fitful progress toward upgrading China's outmoded banking system. CICC could be an important element in Beijing's efforts to raise the estimated $500 billion needed to modernize China's infrastructure. It also illustrates the Chinese strategy for key industries such as banking, insurance, and autos. By allowing no more than a few foreign companies to enter at a time, Beijing's leaders want to prevent local officials from cutting their own deals. And by admitting only a select few, Beijing helps ensure the ventures' success--and keeps those on the outside interested.

LATECOMER. If CICC works, it could serve as a model for other investment banks in China. The bank, capitalized at $100 million, is designed to help Chinese companies raise funds in international markets and advise local enterprises on restructuring and project financing. The bank will also make some direct investments of its own.

The new bank could prove a useful vehicle for easing Morgan Stanley into China's domestic capital markets, which remain off-limits to foreigners. About 40 foreign banks have applied to become partners in joint-venture financial institutions. Until CICC is up and running, though, no others are likely to win permission from Beijing to compete with it. So Morgan Stanley is getting a big headstart on rivals such as Goldman Sachs and Merrill Lynch. "CICC will get a lion's share of deals," says Tony Larkin, a bank analyst with Smith New Court Far East Ltd. in Hong Kong.

Morgan Stanley was a latecomer to the deal, which had its origins in 1974. That's when two of its principal partners first met in Nigeria. Payson Cha, the son of Hong Kong tycoon Cha Chi Ming, was overseeing his father's textile factories in Lagos, while Edwin R. Lim, an overseas Chinese from the Philippines, was working as a World Bank economist. Over the years, Lim rose in the World Bank, opening its China office in 1985. Cha became managing director of Mingly Corp., a multibillion-dollar holding company.

DEVASTATING MOVE. Last fall, the two men bumped into each other again in Beijing. Cha had concluded that it was time to set up an investment bank to help China gain access to international financial markets. Acting independently, Lim had explored the same idea with Vice-Premier Zhu, whom he had first met in 1980. Cha and Lim decided to work together to see if they could make it work.

Lim had ready access to top bankers and officials thanks to his World Bank experience. In the discussions, Beijing officials made it clear that they would only accept a deal including players from several countries. So Lim brought in Government of Singapore Investment Corp. (GSIC), headed by former Prime Minister Lee Kuan Yew. The group manages a significant portion of Singapore's foreign assets.

Soon after, Cha and Lim met to decide which foreign investment bank to bring in. Although Salomon Brothers Inc. and Goldman, Sachs & Co. had built reputations in China as preeminent American investment banks, Cha insisted on Morgan Stanley. He had recently worked with the firm, which had successfully placed a $100 million convertible bond in 1993 for Cha's HKR International Ltd., an $840 million Hong Kong property developer.

Morgan Stanley had been exploring the idea of a joint-venture investment bank on its own. In June, 1992, John S. Wadsworth Jr., chairman of Morgan Stanley Asia Ltd., had suggested the idea to Wang Qishan, vice-president of People's Construction Bank of China (PCBC). With $122 billion in assets, PCBC has long been the most important local player in financing Chinese infrastructure projects. Wadsworth spent a year cultivating Wang. Then, in June, 1993, Wang was suddenly promoted to deputy chief of the central bank. The move was devastating to Morgan. "Our major advocate was off to another project," says Wadsworth.

A CLASH OF CULTURES. As discussions died with PCBC, Wadsworth scrambled to resurrect the deal. A former colleague of Wadsworth turned out to be friendly with Lim and suggested that they get in touch. In October, Wadsworth called Lim at his World Bank office in Washington. A month later, the two of them met over a lunch of soft-shell crabs at Maison Blanche restaurant, not far from the White House. They showed each other the proposals they had sent to the Chinese. "My letter and his could really have come out of the same typewriter," says Wadsworth. Since Cha was leaning toward Morgan Stanley anyway, the team was formed.

With the overseas partners lined up, Lim in early 1994 left the World Bank to pursue the effort full-time. Shuttling from Hong Kong to Beijing, Lim managed to win approvals from PCBC and the Finance Ministry. But getting the nod from conservatives on the State Council, China's Cabinet, proved more difficult. That's when the group called in its biggest chit. Cha's father, Cha Chi Ming, had recently donated $20 million for a new science and technology foundation in China. On Deng Xiaoping's birthday last August, he handed out 10 awards of $116,000 each to Chinese scientists. That led Premier Li Peng, a leading conservative, to express his "thankfulness." Now, to smooth the way for the banking deal, the elder Cha made the rounds in Beijing, securing the necessary approvals from conservative officials.

That clinched it. On Sept. 20, PCBC notified its partners that the deal was on. Soon, everyone gathered in Hong Kong to hammer out the details. Cultural differences flared between the Americans and the Chinese. "For Americans, confrontation is a daily routine," says Payson Cha. "But it will take time to transplant that idea in China."

Morgan Stanley, for example, wanted an agreement that management issues would be settled by a simple vote. The Chinese, however, wanted to resolve differences through discussion. The two sides agreed finally to settle issues through discussion but set a deadline for how long these talks could last. After nearly a week meetings in Morgan Stanley and Mingly offices in Hong Kong's Central district and the Ritz-Carlton Hotel, where the Chinese were staying, Cha helped secure the final agreement.

PLENTY OF RISKS. Although the Americans have only a 35% stake in the bank, Morgan Stanley did gain a de facto veto over CICC moves. That's because all shareholders will have to sign off on a deal before it can proceed. "If the shareholders don't agree, then the deal doesn't get done," says one Morgan Stanley executive. In another reassuring move, Wang Qishan, Morgan Stanley's old PCBC connection who went on to the central bank of China, will be CICC's chairman of the board.

But plenty of risks remain. PCBC has extremely close ties with the State Council, and might, therefore, feel pressure to make funds available to help bail out ailing state enterprises. Moreover, if Beijing leaders suddenly open the market to outsiders, Morgan Stanley could find itself saddled with a venture in which it has less than 100% control. Morgan Stanley, however, is betting that such a development is at least several years off. In the meantime, it's busy conducting business the Chinese way.

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