Note: this was a sponsored report and not editorially independent, but is included here as a resource

SECTION 1 – interview with Alisher Ali, Chairman, Eurasia Capital

EM: Set the scene: what is the opportunity in Mongolia today?

AA: Mongolia has so many things going for it. It is physically located next to China, which has become the de facto engine of growth in the global economy. It has been blessed with natural resources. And you have the government and political system: the country is a true democracy, so as a result there is a good chance of the country being able to manage effectively not only its mineral wealth but the economic growth that will come with the development of those mineral resources.

So we have been early believers in Mongolia. We opened our office in 2008 in the same week as the Lehman disaster, and even though the timing may not have been perfect, we are still proud of the fact that we saw the opportunity for Mongolia’s growth potential and investment opportunities much earlier than many others. We built the infrastructure, we focused on building relationships with government entities, and with the corporate sector and international investors. Now we have the largest investment bank in the country, well positioned to capitalize on opportunities. The mission for Eurasia Capital is to provide a bridge between Mongolia and the international markets: to give international investors access to Mongolia growth, and to facilitate the entrance of Mongolian companies and banks to raise capital internationally.

EM: What shifts have you seen in the business climate since 2008?

I’ve appeared at least 20 times in studios for interviews with Bloomberg, CNBC, Al Jazeera and others to talk about Mongolia. And I always get the question: why haven’t we heard about Mongolia before, with its massive resources? The reason was that for years, the Mongolian government, parliament and public in general have had intense debates about how to develop those resources. It took a long time and was frustrating for foreign investors trying to bring big mining projects into production. The big example was Ivanhoe Mines, which discovered the Oyu Tolgoi deposit a decade ago yet only signed the landmark agreement allowing it to develop it in October 2009. But when we set up here there was no doubt in our mind that the government would decide to develop its strategic projects and large mines. The question was when.

The 2008 crisis hit Mongolia very hard: by the first quarter of 2009 the government was running out of money, foreign exchange reserves were depleted and investors were fleeing. It led to a bailout with support from the IMF and a number of bilateral agreements. But that crisis, in my view, had a silver lining, because it helped the government and public to focus on the key need to develop mineral resources. It became clear they had no luxury to wait and debate further. So we were all relieved when, on October 6 2009, they finally came to agreement with Ivanhoe and Rio Tinto. That was a turning point. It was a big sign: this country is ready for business. It was a crucial milestone and the catalyst for a change in investment sentiment towards Mongolia. The country has never looked back since then.

EM: Where are the opportunities in investment? Everyone knows about the mining, but how about the knock-on effects in the economy?

One of the main reasons for us spotting the opportunity in Mongolia early on was our early experience in Central Asia, especially Kazakhstan. Our time in frontier markets and Eurasian countries allowed me to see the parallels: that once you have momentum, and the development of world class resources, you are going to see knock-on effects. Yes, mining is going to be the largest and most important sector for Mongolia, but there will be other sectors and the opportunity is not going to be confined only to mining.

In January 2010 we produced a report called Mongolia Outlook 2010 – a historical document in the development of our firm. It was positive and optimistic about Mongolia at a time when the turnaround wasn’t obvious, but we said that Mongolia was going to go through a multi-year bull market: that there would be growth in GDP and in FDI. Beyond that macro vision, we made two important calls which were – this is important – executable investment recommendations for international investors. The first was that the Mongolian tugrik was going to appreciate and influence FDI. There is no derivative or spot market, so investors had to initiate bank deposits with Mongolian banks, which at that time were offering 16% in tugrik local currency deposits. Those investors who followed our advice made over 25% return after subtracting all costs, a combination of high deposit rates and the appreciation of the currency.

The second important call was that we recommended investors start investing in local equities. In January 2010, this was considered an optimistic call: the local market collapsed in 2008 and was also negative in 2009 in dollar terms. But we were confident the worst was behind us and estimated the market would gain 70% that year. In fact, it went up almost double that amount. In 2010 the tugrik was the second best performing currency globally, and the stock market was the best in the world.

From the beginning I have trained our research team to think in a way so as to come up with actionable recommendations. We look at opportunities in the currency markets, in fixed income, in public equities – domestic and international – in private equity, infrastructure and property, then tailor recommendations around them. We have built indices allowing investors to track performance of Mongolia-related companies listed in countries around the world.

EM: What funds and businesses have you built to do this?

Eurasia Capital Management is a Central Asian investment and fund management business. Silk Road Management, which started in 2008 as a wealth management advisory firm, is now being transformed into a Mongolia-focused investment management firm. We aim to build the largest such institution in the country. Our first product was the first ever venture capital and private equity fund focused on Mongolia, the Mongolia Human Capital Fund, which raised US$30 million from investors. The idea of this fund is to focus on non-resource sectors where human capital is going to be crucial in the success of the business: areas such as media, healthcare, education, professional services industries and information technology. These are industries in their infancy stage that are going to benefit from strong economic growth.

We have plans to launch funds across different asset classes. We intend to launch a publicly-listed Mongolia-dedicated fund. And we have teamed up with a Korean group, Goran Capital Partners, to launch a Mongolia-Korea resources fund and to tap the interest of Korean institutional investors looking for investments in Mongolia. We tailor investment products around the interests of investors.

Eurasia Capital itself has been recognized by several international publications; this year it was named the best investment bank in Mongolia by Euromoney magazine.

SECTION 2 – interview with Ganhuyang Chuluun Hutagt, Vice Minister of Finance, Mongolia

Euromoney: At a time when the rest of the world is struggling, economic projections for Mongolia are extremely positive. Is the outlook realistic?

Minister: The outlook will be as good as the demand for what we are producing. In recent years what we possess in terms of minerals has attracted a lot of investor interest, based on global demand for these commodities: copper, uranium, gold, coal, iron. There will be demand for our products despite what happens with Chinese inflation, the American budget and debt ceiling, and European defaults.

EM: What is a realistic expectation for GDP growth?

Minister: It will depend on what’s going to happen in the US and how it will affect production in China, and what appetite China will have for Mongolian commodities. I don’t think the Mongolian government can become too arrogant: I advocate we watch out for negative trends, and manage risks. Consecutive crises have shown that they do have an impact on the Mongolian economy.

Despite that, the outlook that is being projected by the international community, our development partners and ourselves is pretty positive. We will have tremendous growth in our economy based on mining and the building of physical infrastructure to make our products more available to international markets: border ports, railways, roads, airports. We are going to need to build new cities in the new mining areas, currently mostly in the Gobi. Most of the business will happen around the mines and in the value chain. We need new power plants, new houses, and even here [Ulaanbaatar] with growing incomes we have a minimum of 200,000 people who will need houses and apartments. You don’t need too much imagination to think of the investments behind these numbers in terms of water, sewage, energy, roads, schools and hospitals. It entails huge business opportunities, but mining can support it only through steady and growing cashflows.

What will be the role of the state in all this investment?

The role of the state is going to not diminish in the near future. At this stage of development the government needs to take a leading role, creating not only the environment and good opportunities for foreign investors, but also intervening in managing the economy, supporting our traditional industries such as agriculture, as we did today [in an issue of bonds to support agricultural producers and SMEs]. We need to help our industries in this tough environment with foreign competitors coming in and cheap imports, aggravated by the impact of the strong tugrik. We will need to continue direct involvement such as the development bank, to build public services. This year we budgeted MNT627 billion for capital investments, and the number will go above 1 trillion this year. Altogether in the past 20 years put together, the capital expenditures were only MNT1.6 trillion; in two years we are doing what was done in 20.

What will be the role of the private sector in this?

The private sector has plenty on its plate already. Almost all of the banking sector is in private hands: out of 70,000 registered companies, only 100 are state-owned, although they include the champions.

How do you rate ease of doing business in Mongolia?

We have fared pretty well. Mongolia is one of the friendlier environments in which to do business. Because we are latecomers we can implement some systems immediately: for example we rank one of the top countries in terms of extractive industries transparency. If you compare us with some Eastern European countries, we are pretty similar; if you compare us to former Soviet Republics, we are way better.

And what still needs to be done?

Last year the government announced the year of Business Environmental Enabling Reform, or BEER. The results of it are yet to be fully reflected, but the government made an important decision to continue with reform here in 2011.

Can you explain the mandate of the new Development Bank? For example will it fund small business as well as long-term infrastructure?

It’s not for small business, it is to support large national projects and to help the government invest in energy, infrastructure and to help us utilize our mines more efficiently. It is specifically stated in the law what sort of projects will be funded, and they will include housing. The bank is operational – it has not yet funded projects, but we have given them the guarantee to issue MNT800 billion of bonds. They are working hard to issue those bonds, get the funding and start financing projects.

Are you considering a sovereign wealth fund?

We have set up a stabilization fund, which by the end of the year will have MNT180 billion. When it hits 5% of GDP we will start investing it actively; in the meantime it’s in cash. I will do my utmost to make sure the government makes the right decisions and does not have incentives to spend it all right now. It is a big responsibility for our future.

What are its sources of funding?

Any income that is in excess of certain fixed prices for coal and copper. We also have the Human Development Fund; we put revenues from the mines in that fund and will start investing this money outside of the country to protect our economy and insulate it from foreign currencies, as well as preserving wealth to share with future generations.

You said Mongolia is dependent on demand for commodities. What is being done to diversify the economy away from such reliance on mining?

Traditionally Mongolia has been an agrarian economy: livestock and anything related to it like meat, pelt, felt, wool and cashmere. They are all industries of high potential. Food security is a big concern for us; Mongolia has become self-sufficient in terms of wheat, which is a success. We could focus on and develop other industries: our increasingly educated workforce will be able to drive industries such as tourism and financial services to become major contributors to the economy.

The financial services industry had a rough time in 2009. How is its health today?

Over 95% of the financial industry is commercial banks. The system is doing well: it is growing, NPLs are decreasing on the back of the economic boom, and the stock market has consistently outperformed most others. But we start from a low base and there is a need for reforms. We need to approve the draft law on securities – hopefully this year – and reform in the pensions system will need to happen. We need to overhaul our insurance sector. And with this we will create local institutional investors who will help us create robust, dynamically growing local stock markets.

The world is watching the forthcoming Erdenes Tavan Tolgoi IPO. How transformative will it be for Mongolian markets?

The current capitalization of the local stock exchange is $2 billion; we are talking about $10 billion in an IPO of one company. That’s the magnitude, and if we decide to float some percentage locally it will have a huge impact. Right now 10% is owned by the Mongolian people and another 10% will be sold to Mongolia-based companies. This will provide a strong incentive for international investors to come in early and take part in the trading of those securities.

What is the idea behind giving shares in it to every Mongolian citizen?

It gives people a feeling that they are benefiting from the big national treasure directly. It’s a good lesson to all Mongolian citizens in terms of managing capital, really understanding what a stock market is and how it works, and what being a shareholder entails. It brings accountability to the person, whereas if the state was to manage the wealth for our own citizens, it is more indirect. Tavan Tolgoi will be a better governed organization because it is owned by individuals, not just the faceless state.

With the US and Europe in turmoil, what is your resilience to external shocks?

I don’t think we have been particularly resilient at any time in history. We depend on our buyers; we have one rail line. Economically we are dependent on two neighbours: we import all of our gas from Russia, we export most of our coal to China.

What message do you want to give to foreign investors about Mongolia?

It makes sense to get exposed to Mongolia. It is the top opportunity globally in terms of our mineral resources. We possess almost all the elements in the periodic table. We are tripling coal exports this year. The ambition with our partnership with the London Stock Exchange is that one day Asian investors can trade on the Mongolian exchange with their stocks listed in London, on the same platform, the same systems.

Cashflows are exploding, the budget is in surplus and we have record high cash levels in our treasury. We will one day make a decision on sovereign bonds: we are issuing local currency and giving a very good return to our investors. Debt to GDP is just 17%, so we can borrow, and I think we want to borrow to make investments and increase the capacity of the economy.

SECTION 3: ECONOMY

Economy

Mongolia has experienced rapid economic growth since the global financial crisis. Eurasia Capital, an Ulaanbaatar-headquartered investment bank, estimates that Mongolia became the world’s second fastest growing economy in 2010 in terms of US$ GDP growth rate at current prices, with a 44% year-on-year increase, driven by the 12.9% appreciation of the Mongolian tugrik (MNT), the national currency, against the dollar over that period. This means that Mongolia outperformed the BRIC emerging economies as well as all other leading frontier and high-growth economies globally. Fueled by investment in the mining sector and a significant increase in exports, real GDP growth reached 6.1% last year, according to official data, versus 2.7% in developed and 7.1% in emerging and developing economies. And it is getting better still: in the first half 2011 it was up 14.3%, or in nominal terms 29.1%. The second quarter, with 17.3% year on year growth, was the fastest expansion since 2005.

Significant investments and demand from China, the major market for Mongolian products, have allowed Mongolia to double coal output to more than 25Mt in 2010, up from 13Mt a year earlier. Coal exports increased 2.9 times in 2010, overtaking copper for the first time, and in 1H2011 Mongolia overtook flood-hit Australia as the largest coal exporter to China. Crude oil production rose 17% to 2.2MMbbl, and iron ore output more than doubled to over 3.2Mt. Major manufacturing industries, such as food and beverages, grew 24% in 2010.

Mongolian foreign trade surpassed its historical high in 2010. Trade turnover surged 53.5% year-on-year to US$6.2bn. 2010 was a record year for exports, reaching US$2.9 billion, with a 53.8% annual expansion driven primarily by Chinese demand (it bought 85% of Mongolia’s exports), commodity price increases and volume expansion. Record level exports have been the primary driver of Mongolia’s impressive economic growth. And they are getting better still: Mineral exports jumped 72% year-on-year in the first half of 2011, with coal up 135% and iron ore exports 122%.

Increases in international prices for Mongolia’s major export commodities boosted already substantial export earnings. The price of coal, the largest 2010 export earner for Mongolia, rose more than 14% over 2010, with copper, gold, iron ore and crude oil gaining 28%, 26%, 52% and 8%, respectively.

Eurasia Capital expects Mongolian foreign trade to grow at an even faster rate in 2011. A positive outlook on commodity prices, increased output from existing operations, the launching of new mines, and strong growth prospects in major trading partner markets – particularly resource-hungry China – should fuel increased exports from Mongolia. Eurasia now believes that Mongolian economic growth should beat its original projection of 10% GDP growth for 2011.

Foreign direct investment (FDI), which was considered frozen until as recently as 2008, hit a record high of US$1.6bn in 2010, according to official data, further underpinning the economy. The mining sector was the major destination for FDI.

China was for many years the only major FDI player into Mongolia, accounting for US$2.5 billion between 1990 and 2010. That is changing. Canadian FDI, the second biggest in Mongolia, increased more than 140 times in 2010 to US$147.8 million. Investment from Hong Kong is also climbing.

By sector, geology and mining have attracted US$3.15bn in FDI – 65.3% of the total – since 1990. The majority of this investment has come since 2008, when the mining industry began to entice resources giants around the world. Hong Kong and Canada’s FDI focus is mainly on mining and related activities, while South Korean and Japanese investments have targeted trade and service, engineering construction, and financial sectors. The biggest investor, China, has followed varied targets covering almost every sector. Infrastructure is likely to attract more FDI in coming years, with 1100km of Mongolian railways planned, for example.

Remarkably, Mongolia is thriving with limited inflation. Prices rose around 13% last year, and there were concerns from the World Bank that an expenditure plan – including major increases in salaries – could push inflation over the 25% mark. Yet according to N Zoljargal, deputy governor of Bank of Mongolia, the central bank, inflation has instead declined to around 6.5% year on year in June. In any case, he says, Mongolia is an exceptional case when it comes to considering inflation. “Mongolia has for so long been under-invested,” he says. “So when you see a flow of new cash wealth, how much of it do you sterilize and how much do you let trickle into the economy? That is the challenge we faced in 2010, we are facing it now and we will probably live like this for the next few decades.” Last year the bank sterilized around 30% of net inflows in foreign exchange, feeling that it was short-term and speculative; this year, it has sterilized far less.  “Yes inflation is a worry, with banks over-extending credit in the good days; people argue the economy is getting too hot,” he says. “I say we are nowhere near to that: we are just warming up. Everybody has their own temperature.”

Indeed, some argue inflation should actually be higher, and monetary policy looser. “Economists say that if there is inflation, just take out money from the economy,” says Sambuu Demberel, Chairman and CEO of the Mongolian National Chamber of Commerce & Industry, and a key economic advisor to Mongolia’s president and prime minister. “It’s nonsense. We need money in circulation: the more money the better. People in real sectors want money to create business and profit, but the majority of SMEs don’t have access to lending. We need decisive action to change our monetary environment to drive the economy.”

Rich mineral resources

Mongolia hosts world-class mining deposits, including estimated coal resources of over 160Bt, ranking fourth in the world after the USA, Russia and China. Erdenes Tavan Tolgoi, one of the world’s largest untapped coking coal mines, is a vivid example of a world class resource: it is estimated to contain 6.4Bt of thermal and coking coal worth approximately US$390bn. The Government of Mongolia is in the process of finalizing the deal with international bidders.

Another world class mine is Oyu Tolgoi, which is one of the world’s largest undeveloped copper-gold deposits, rivaling Escondida and Grasberg. Oyu Tolgoi contains approximately 37Mt of copper and 1,300 tonnes of gold, with a project cost of US$5.9bn. Based on conservative calculations, the monetary value of the Oyu Tolgoi project is approximately US$252bn. It may become as much as US$424bn if measured, indicated and inferred resources are taken into account.

Balanced Political Environment

Mongolia is to hold parliamentary elections in the summer of 2012. The newly elected parliament will oversee the implementation of major mining, infrastructure and industrialization projects, which will define Mongolian politics, economy and society for years to come.

The parliamentary election in 2008 saw a brief period of turmoil, but the formation of a coalition government between the two main political parties, the Mongolia People’s Party (MPP) and the Democratic Party (DP), has resulted in a stable functioning government. Domestically, the coalition government has focused on expanding investments in Mongolia’s vast natural resource wealth, diversifying the economy, job creation and improving living standards. Internationally, the government has maintained good relations with Mongolia’s traditional partners, Russia and China, as well as expanding relations with countries beyond its traditional partners.

In June 2011, Mongolia and China agreed to upgrade bilateral ties to a strategic partnership level and to bolster economic ties. The agreement is expected to bring more Chinese investments and financial support into resource and non-resource sectors and infrastructure development. Mongolia also enjoys strategic partnership status with Russia. In terms of “third neighbor” relations, Mongolia has held high-level meetings with Japan, the USA, Korea and India, among others: it expects to sign an Economic Partnership Agreement, roughly equal to a free trade agreement, with Japan in 2012. During the visit of Mongolian President Tsakhia Elbegdorj to the USA in June 2011, the Obama Administration stated that it was committed to developing a broader, deeper and more strategic relationship with Mongolia, including expanded commercial, political and cultural ties. India is actively pursuing cooperation with Mongolia in nuclear energy and mining.

With upcoming elections, the coalition government is eager to start the Tavan Tolgoi coking coal project in partnership with major international mining players. Large mining deals, infrastructure development and poverty reduction will remain recurring themes of parliamentary elections in 2012. There is a wide political consensus among major political parties about the development needs of Mongolia. Therefore, regardless of the election results, the country should be expected to stay on its current course of resource-driven growth.

SECTION 4: CAPITAL MARKETS

Public equities: Best Performing Market Globally

Despite its relative tiny size in global market terms, the Mongolian Stock Exchange (MSE) is increasingly gaining importance for local and international investors intending to gain exposure to the Mongolian market. Naturally, most of the market is resource-related.

Mongolia has so far this year maintained its title as the world’s best performing equity market. Having gained 138.4% (173.7% in US$ terms) last year, the MSE Top-20 Index has continued its global outperformance in 2011 at +43.8% at the time of writing. By comparison, the MSCI Frontier index gained 16.6% in 2010 and is down 11.6% so far in 2011; the MSCI EM Asia index gained 12.9% in 2010 and is down 0.7% year to date; and the Shanghai Composite Index fell 14.3% and 5% respectively.

After the Mongolian Stock Exchange benchmark surged 123.3% within the first two months of the year, hitting 32,954.97 on February 25, it went through a significant correction, losing 43.8% by the end of May. This volatility is a function of speculation, low liquidity, a small free float in listed companies, and unrealistic and uninformed investor expectations. Improved investor sentiment driven by the expected launch of Tavan Tolgoi coal mining operations and proposed IPO, the strategic partnership agreement between the MSE and the London Stock Exchange (see box), and a strong outlook for commodities, contributed to the surge and underpin further growth.

The MSE market capitalization grew 2.5 times in 2010, passing the landmark US$1bn in November 2010  and reaching US$1.7 billion by July 2011. The top five stocks (Coal groups Baganuur, Tavan Tolgoi, Shivee Ovoo and Sharyn Gol, and beverage group APU) contributed 82.1% of this growth. The combination of expected double-digit economic growth, and the experience of other commodity-linked emerging markets, suggests that the momentum has just begun: Kazakhstan Stock Exchange’s market capitalization grew 100-fold to US$100 billion between 2000 and 2008, while the Qatar Stock Exchange grew 31 times from 1997 to 2007 to US$95 billion. Stock market penetration – total market cap representing just 20% of GDP – is relatively low compared to other emerging and even frontier markets, underlining the growth potential.

The MSE, with its huge gains, is still challenged by companies with small free floats and low trading volume. Average daily trading volumes were US$234,000 from January to February 25, and US$33,000 from then to May 30. It is likely that the lack of liquidity will remain a concern in the short term.

The Mongolian government has approved a list of state-owned enterprises that are slated for privatization starting from 2011. These SOEs are in mining, mineral processing, construction materials, power distribution and generation, telecommunications and airline industries. Many will pursue a listing locally on the MSE to serve as a vehicle for privatization and then seek additional listings in regional or international markets to raise capital for expansion and modernization.

The leader among these expected privatizations is the highly anticipated IPO of Erdenes Tavan Tolgoi, expected early next year, and potentially worth over US$10 billion. This government-owned company holds the licence for Tavan Tolgoi, the world’s largest undeveloped coking coal mine. The government has distributed 10% of the company’s shares to Mongolian citizens, with a lock-up period that has not yet been decided, and plans to sell another 10% to Mongolian companies and offer 30% on a combination of domestic and international markets. It should substantially boost MSE market capitalization and liquidity while also enfranchising citizens in the capital markets. “The entire population of Mongolia will become shareholders,” says Munkhtushig Dul, Deputy Director and head of finance and logistics at the MSE. “When that happens, new brokerages will have to develop, as will the capital markets themselves.”

“There are several separate pipelines of new listings,” he adds. “First there are the big strategic mineral deposits, which by law should have no less than 10% listed on the MSE. Then there are many companies with huge assets in Mongolia who are not listed here: we are hoping to repatriate them to create more involvement in the Mongolian markets. And then there are local privately held companies: cell phone companies, food companies, very strong businesses that will need more money.”

There have been no new IPOs on the MSE in the last two years, but it is expected this will change dramatically in the coming years as a number of leading domestic private companies are expected to launch IPOs first internationally and later on MSE. Mongolian private business groups that are expected to launch IPOs at a group or subsidiary level include MCS Holding, Petrovis Corp, Bodi Group, Newcom Group and Monnis Group. New IPOs, whether from state or private sources, should ease liquidity concerns and therefore volatility.

Many Mongolian companies – now over 20 – have listed overseas, often instead of domestically, in locations including Toronto, London, Hong Kong and Australia. But Mongolian authorities do not see this as capital fleeing the country. “I don’t see it as a bad sign,” says Bayarsaikhan D, chairman of the Financial Regulatory Commission of Mongolia. “Companies are using the opportunity to raise funding in large amounts.” The hope is that companies that have listed overseas will come to list more of their stock domestically as the Mongolian market gains in scale and sophistication.

Eurasia Capital believes the outlook for Mongolian equities in the short to long term is very positive. This year, it expects the MSE to retain its title among the top three equity markets, if not the best.

BOX: The LSE partnership

Mongolia took a historically important step to develop its capital markets when MSE and London Stock Exchange (LSE) signed the landmark Master Service Agreement to manage the MSE on April 7 2011.

Through this agreement the MSE will be modernized with the LSE’s support over the next three years. LSE will introduce an integrated securities trading system, create an effective legal and regulatory environment, and will bring infrastructure, technology and human resources capability in line with international standards. LSE has appointed a management team at the MSE to oversee its development and privatization, and has brought in Millennium IT, the leading global exchange technology provider, to assist with trading, surveillance and post-trading infrastructure.

The partnership should bring modern market rules, procedures and operations, as well as broadening tradable asset classes to derivatives and ETFs. The ultimate aim is for MSE to become a regional resources hub for international investors. In future it may even attract resources listings from neighbouring countries.

“The main purpose of the agreement is to bring the stock exchange to international standards,” says Bayarsaikhan. “A lot of work has been done so far on the legal framework, on IT, and in corporate governance and transparency. The future is bright and all the professional players in the market are working hard.”

In Eurasia Capital’s view, this partnership should accelerate the process of MSE becoming a viable source of capital for Mongolian companies and an efficient channel for wealth distribution from mineral resources among the Mongolian population.

Private equity

Flurry of M&A Activity

In recent years Mongolia has seen a flurry of M&A activity, particularly in the resources sector. M&A volumes doubled from 2009 to 2010 to a record level of over US$1bn, most of it in mining, and chiefly coal; international interest has grown dramatically since the investment agreement on the Oyu Tolgoi (OT) mine was signed in late 2009. The origins of acquiring companies were diverse but Hong Kong and Australia led the charge: Hong Kong was involved in US$473mn worth of M&A deals through injections of resource assets into existing publicly listed companies.  Australian companies have not only bought assets but held IPOs.

This year M&A activity is more vibrant still. Total deal value for the first half of 2011 increased 45% year on year to US$636mn, and had reached US$690mn by July 27; Eurasia Capital expects another record year. Close to 50% of the announced deals were reached in participation with Australian companies, suggesting Mongolia will continue to be on the radar of cash-rich mining companies that have strengthened their cash positions through improved operational efficiencies and high commodity prices. The Erdenes Tavan Tolgoi deal will impact this year’s numbers: some bankers estimate the overall worth of the asset at US$15-20bn.

Fixed income: Bond Market Kicking off

Until very recently, not many people knew of the existence of the bond market in Mongolia. But it is becoming more active. The market has been waiting for the right time and conditions while building knowledge, experience, and infrastructure. News about bond issues is not on-and-off anymore; the market is underway.

The Mongolian Government is being cautious in approving new issues, knowing the damage any default would cause to the reputation and credit rating of the market. Government issues have focused on national benefit: for example, in September 2010 it issued a MNT60bn bond, half of which was offered to the public, to fund the “4000 Apartments for Public Servants” project. So far, offers worth MNT69.6bn out of a planned MNT72bn have been launched for project funding.

Backed by confidence in Mongolia’s expected growth, the government is planning another offering to support the cashmere and wool sectors, and small-to-medium enterprises.

Through the Development Bank, established in 2010, big industrial, infrastructure and mining projects will be funded and the government will issue MNT800bn bonds for necessary funding as new projects come up. The Bank also supports those projects by providing guarantees to the loans. Both domestic and international investors can participate.

Corporate bonds will become an interesting area for investors. For most of the companies who intend to tap the debt markets, it is a testing period: they need models to follow, but there have been only 12 issues since 2001. But by waiting, they risk losing out to competitors. Just Agro has made the first move this year to attract bond investors with a MNT30bn bond offering. If successful, other companies may follow.

Trade and Development Bank (TDB) is the only bank in Mongolia to tap the international bond markets so far, with a US$75mn deal in 2009 (successfully repaid), and two new bonds in 2010. Other banks, Khan Bank and XacBank, have followed suit and announced smaller debt issues. But bank deposits, offering more than 11% returns in MNT, remain favoured by many local investors.

BOX: Currency

After an impressive 12.9% appreciation in 2010, the Mongolia tugrik (MNT) has been relatively volatile this year, appreciating 1.6% year to date by August 4. Eurasia Capital believes it will remain a strong currency to hold. This confidence comes from expected capital flows to the large projects in the mining industry and infrastructure: FDI was US$1.5bn in 2010. The revenues from the two mega-projects of Tavan Tolgoi (coal) and Oyu Tolgoi (copper and gold), both under development, will consolidate the MNT for many years to come. Mongolia’s exports of mineral resources will dramatically increase when the necessary infrastructure, including the rail lines, become ready.

The currency is comparable to other resource driven currencies, such as the Australian dollar or Brazilian Real, which have experienced large appreciation. The MNT has emerged as a new resource currency and is increasingly correlated to the export commodities. It represents an excellent carry trade opportunity.

SECTION 5: PROPERTY, INFRASTRUCTURE AND FINANCIAL SERVICES

Property

As mining has brought wealth to Mongolia, the property market has experienced speculation and rapid expansion. After the highest ever price for a luxury residential apartment was registered at US$8000/sqm in the new Blue Sky Tower, an April Fool’s joke by a local broker about Donald Trump’s plans to build 120-storey “Trump Tower” for US$1bn in the center of Ulaanbaatar was picked up and distributed by some respected online sources.

Although Mr. Trump is not planning to build a tower in the capital city of Mongolia, the property market is poised to benefit from the country’s mining-led economic growth. Already, the residential, office, retail and hospitality property segments have consistently grown over the last few years, with supply struggling to meet demand. The market in Ulaanbaatar stabilized in 2010 following the turmoil of 2008-2009, and has benefited from increased inflows of foreign capital. Industry experts expect a period of accelerated growth.

Residential property prices in Ulaanbaatar have nearly quadrupled since 2002, although the global financial crisis corrected the steep market growth up to 3Q2008. The past year’s strong economic growth, national currency appreciation and speculative inflows of foreign capital for Mongolia have driven residential property prices up nearly 20% in the capital; the average residential property prices in 2010 was around US$900 per square meter, although much of that can be attributed to the 12.9% MNT appreciation.

Although foreign investors have an impact, the growing number of wealthy Mongolians is also significant, boosted by successful capital raising by mining companies. Fundamental demand for housing in Ulaanbaatar and nationwide will be a key driver of near-term growth. Since 2005, the population of Ulaanbaatar has increased 22% to 1.16 million, which represents over 40% of the total Mongolian population. More than half of Ulaanbaatar’s inhabitants live in traditional “ger” settlements, whilst the others live in old buildings that are deteriorating fast. Facing the need to accommodate its population, the Mongolian Government has initiated several measures that stipulate construction of mid-budget accommodation through government support. These initiatives include programmes such as the “100,000 Apartments Project” which aims to alleviate the strains on infrastructure services, social services and pollution.

Despite the newfound wealth, more than one third of the Mongolian population lives below the poverty line. Increasing prices might deter low income earners from buying property. However, 2010 was marked by a revival in the mortgage market as major Mongolian banks have started providing loans to the population, albeit at high rates – currently from 11% to 28.8%, with required downpayments as high as 50% (but more commonly 30% and sometimes 10% if the construction company takes on some of the risk).

Ulaanbaatar is again crowded with construction cranes, just as before the 2008 crisis. Maybe Mr Trump will really build a Trump Tower in Ulaanbaatar during the next few years.

Infrastructure

Mongolia’s mining boom may stutter if the country cannot solve its infrastructure problems. Infrastructure is regularly listed among the major inhibitors of Mongolian growth, and vast investment is needed, probably in excess of the current GDP of the country.

The Concession Law, adopted in 2010, sets the legal framework for private sector participation in the development of infrastructure projects. The Mongolian government has approved a list of 121 projects in road and railroad construction, power generation and transmission, industrial development, urban development, telecommunications, education and healthcare, inviting private sector investments. Both foreign and domestic companies can participate in the projects individually or jointly. Concessions can be gained via open tender, competitive bidding or direct contract.

The development and expansion of railroad infrastructure is one of the most pressing issues in the Mongolian economy. To support its mining sector, Mongolia is currently focusing on extending its railroads to major mining areas within the country, as well as on opening trade corridors and export routes to neighbouring countries. In the next five to ten years, the country is planning to build about 5,700km of new railroads, providing easier access to Mongolian minerals and exports to neighbouring and international markets. The railroads will be constructed in three stages. The first stage, which has already started, envisages construction of a new 1,100km main rail line from the Tavan Tolgoi coal deposit to Choibalsan, the town connected to Russia by the existing railroad. The new main line will intersect the existing Trans-Mongolian Railway in Sainshand station in Gobi region. Mongolian Railways was selected to implement the project. The project is in feasibility study stage. It is expected to be completed in the next 4-5 years.

In the near future, major infrastructure projects in Mongolia may offer numerous investment opportunities. Construction of new railroads would create opportunities for investors, construction and operating companies. A new US$10 billion development, the Sainshand Industrial Complex near the Chinese border, will be a hub to process Mongolian raw materials for export, and should spur investor interest. A number of other government-priority projects will be open for private bidding in the coming year.

Financial services

Mongolia’s banking industry endured a difficult financial crisis in which two banks failed. But there is a sense that it has returned to health on the back of the growing economy. N Zoljargal, Deputy Governor of The Bank of Mongolia, the central bank, says the banking system has “never been better than it is today. It is very healthy.” Those banks that survived the crisis are now strong. “During the crisis our banks were well managed, beefed up their liquidity, and since then have seen high growth in assets.” Non-performing loans, which at one stage topped 20%, are now around the 6% mark, he says, and “coming down dramatically” as previously troubled businesses in construction and other areas pay back their loans. As Zoljargal says: “It the economy is growing 10%, it’s hard to produce NPLs. You have to be doing something very wrong.”

Some local banks with distinct strategies look healthier still. Xac Bank’s NPLs peaked around 7% and today stand at 1.7%, according to CEO Bat-Ochir Dugersuren, because its portfolios are well diversified. Xac Bank is an interesting study: founded in 1998 under a UNDP program, it is fundamentally a microfinance institution, with a governance and shareholder structure unique in Mongolia (EBRD and IFC are stakeholders, and the board is independent). Today, SMEs are very much a focus for expansion. “We have big corporates in this country but I don’t believe they are going to expand and carry the country’s growth forward,” says Bat-Ochir. “We need a broad base of promising SMEs to allow double-digit growth to take place in our economy.” Xac Bank, like most, gets around 90% of its income from interest, and accepts that growth in other business lines will have to take place to diversify earnings.

Another example of an unusual strategy is Chinggis Khaan Bank. Chairman Sergey Gromov – a pioneer investor in Mongolia whose holdings also including the leading brewery APU and the insurer Mongol Daatgal, discussed below – says the bank focuses on areas like agriculture and building materials, but not mining. “Agriculture has huge potential,” he says, pointing to the sheer scale of land and the as yet limited use of fertilizer or other techniques.

International players such as ING and Standard Chartered have started to appear in Mongolia, though chiefly with representative offices rather than significant on-the-ground commitment so far. PricewaterhouseCoopers, KPMG and Ernst & Young are also represented.

Eurasia Capital is the nation’s leading investment bank today, and it is likely that this will be a growing part of the market in future. “There will be more of a focus on long term investment funds and institutional investors in future,” says Bayarsaikhan D, Chairman of the Financial Regulatory Commission of Mongolia. As the finance ministry interview explains, two quasi-sovereign wealth funds – the Stabilization Fund and Human Development Fund – are being developed, while a development bank focused on long-term infrastructure has been formed and will soon start lending. The development of new investment, capital markets and securities laws, in varying states of readiness, will help growth.

Another area ready for dramatic growth is the insurance industry. Mongol Daatgal, the country’s first insurer, dates from 1924, but the industry is still in its infancy; only one company provides life insurance, while a handful of others provide property and commercial cover. “It is a very virgin market,” says Batzul Tumur-Ochir, Mongol Daatgal’s CEO. “It only holds 7.4% of GDP, and total premium income in 2010 was just US$30 million for the whole industry. People have not understood insurance, or have seen it as a cost in the past; but now the economy is growing because of the mining industry, people have more money from wages and may spend some on insurance.”

On top of general economic growth, legislation will drive the industry too. Mongolia today does not have mandatory insurance for drivers, but this year a new law is likely to change that. “That will automatically give a 30 or 40% increase to the market,” Batzul says. Professional liability insurance will also become mandatory in the near future, while the growth of the mortgage market is also going to feed through to insurance – through corporates and banks, and through individuals. Batzul plans to enter life insurance too within three years, as he also sees momentum for growth there.

There’s a common goal in Chinese private equity: going local. Raising billions of dollars in offshore vehicles is old hat. Today, the money that goes furthest in private equity is denominated in renminbi.

Foreign private equity houses have known this for years. “Structurally, it’s a totally different opportunity set,” says Stephen Peel, managing partner and group head of Greater China, Eurasia, India and southeast Asia at TPG Capital. “There are deals offshore money can invest in, and deals RMB money can invest in, and the two rarely cross.”

But it’s only recently that foreigners have been permitted to chase that domestic opportunity, and only in the last few months that real progress has been made.

Early last year, China allowed domestic, RMB-denominated private equity funds to be largely foreign-owned and managed for the first time, provided they were set up in partnership with a local institution. Two of the heavyweights of global private equity, Blackstone and Carlyle, quickly announced they would develop new funds, each aiming to raise RMB5 billion.  First, in August 2009, Blackstone announced a partnership with the government of Shanghai’s Pudong district, to launch a vehicle called the Blackstone Zhonghua Development Investment Fund, with priority for investments in and around Shanghai. Then in January Carlyle signed an MoU to launch an RMB-denominated fund in Beijing, the Carlyle Asia Partners RMB Fund, with full backing from the Beijing Municipal Government.

Little then happened until July 30 this year, when Carlyle announced the first closing of its fund after raising RMB2.4 billion. The fund will be run by an investment management joint venture owned by Carlyle (80%) and by one of the fund’s main investors, Beijing State-owned Capital Operation and Management Center (BOSCOMC), a holding company owned by the city government with interests from transport to coal mining and steel. Apart from BOSCOMC, key investors include Beijing Equity Investment Development Fund and several other large SOEs, private companies and individuals.

Then, in August, TPG announced its own plans to launch two RMB funds, again worth RMB5 billion apiece. TPG too has tied up with major municipalities: like Blackstone, it is in partnership with the local government of Shanghai’s Pudong district, and in its other fund it has teamed up with Chongqing for a product that will focus on Western China. TPG Western China Growth Partners I will set up in the Liangjiang New Area of Chongqing, an economic development zone in the style of Pudong in Shanghai or Binhai in Tianjin, and is expected to involve the Chongqing government as a limited partner investor. The Shanghai-based fund, TPG China Partners I, will make onshore investments to support medium and large companies nationwide.

For its part, Blackstone is still out there; Peter Rose in the manager’s New York headquarters says “we are still raising our fund and have not had a final close,” so declined further comment. But in the meantime it remains active as ever from its offshore bases, making its first major investment in Chinese housing in late August in a deal with Hong Kong developer Great Eagle. It doesn’t hurt that China Investment Corporation, China’s sovereign wealth fund, owns 10% of Blackstone; those in the industry expect a formal first close of the Blackstone RMB fund within the next few months.

It’s a time of great opportunity and expectation for foreigners looking at the local picture. “A key set of changes is coming,” says one private equity professional. “Legislation has been developing over the last 12 months and it is now sufficiently certain how these partnership structures owned by overseas entities will work: how they will be taxed, how they will be regulated.”

Why go local?

Why take this road? It’s not as if groups like Blackstone, Carlyle and TPG weren’t making plenty out of China already. TPG (originally through its Newbridge incarnation) is believed to have made than US$2 billion for its investors when it sold its stake in Shenzhen Development Bank to Ping An Insurance – that’s about a 16-fold return, and when it sells its stake in car dealership China Grand Auto, it might do better still. Carlyle, which has already put more than US$3 billion into 50 China deals, will probably make even more in dollar terms from its exit from China Pacific Life.

But going local opens a whole other set of options. “In the past two to three years we have increasingly realized that, given the establishment of the sovereign wealth fund, social security fund and other institutional investors in China, this country should not just be a recipient of foreign private equity investment,” says Yi Luo, managing director for China at Carlyle. “The country itself has tremendous potential to cultivate a private equity culture with a very strong LP base. And, obviously, with the convertibility issue of the currency, if you want to develop LPs in China right now it has to be through a local currency fund.

“Increasingly,” he adds, “We think China will be a country that is going to supply capital to the domestic industry and even invest outside of China.”

That’s the big picture. More pragmatically, there are a host of practical reasons a local fund has a lot to recommend it. Most obviously, there’s approvals: getting a foreign-led private equity purchase over the line in dollars has been known to take 18 months (and others have taken longer and still never reached final approval). It’s true that new regulations, allowing any investment below $300 million to get approval at the provincial rather than the state government level, ought to make this a little easier, since central government approvals alone can take three to six months. But there’s no question that a locally incorporated business, buying an asset in RMB, should get an easier ride.

Additionally, taking dollar investments is not always appealing for a Chinese company. “In some deals we look at, the investee company will tell us they may not want dollar investment because once they take it, they become a foreign invested company, and then face some regulatory issues,” says Yi. “In that situation, if we have an RMB vehicle we should be able to do an investment. If we only have a dollar vehicle, we would lose that opportunity.”

Partnership with a local municipality obviously has a lot to recommend it too. The principle reason Carlyle got from announcement to first close in six months – and it expects to get to the full RMB5 billion close by the end of the year – is the support of the Beijing government. “They were the biggest anchoring investor in the first closing,” Yi says. Being alongside a local brings cash, acceptance, credo with the regulators – and presumably opportunity. One can imagine how many juicy deals come up when one is the preferred investment partner of the People’s Government of Shanghai Pudong New Area, for example, as Blackstone and TPG will be; elsewhere, the Carlyle fund will be entitled to preferential policies from Beijing Municipal Government. BSCOMC already had RMB760 billion by the end of 2009 and is tasked, among other things, “to make investments according to government’s strategic plans, raise funds from capital markets, promote SOE reform, orderly consolidate investments and exits of state-owned assets, promote investments in pioneering and technologically-innovative industries, manage equity holdings in companies that are listed or partially listed, restructure debts for enterprises and solve historical corporate issues.” With a mandate that broad, it’s clearly going to throw up a few opportunities.

There is, though, a question of just how forceful these municipalities will be in suggesting deals. Yi says in the Carlyle fund: “The Beijing government has committed that they will not be involved in the investment decision-making process at all. They will let us decide how to make investments. They will probably recommend good deals from time to time, but whether or not we make that investment is entirely up to our professionals.”

No longer off limits?

This combination of local incorporation and strong state partners ought, in theory, to allow these vehicles into industries that have previously been off limits. Fundamentally, going local is about looking more Chinese: the industry is rife with stories about foreign purchases being brought down because of local competitors trying to derail them, often successfully, on the grounds of national security. It is tempting, for example, to wonder if Carlyle’s bid for Xugong Machinery – surely the gold standard of Chinese private equity intransigence and frustration, abandoned after years of expensive effort and negotiation – might have received a different reception had it come from a locally incorporated fund.

“Some industries that may be off limits to foreign funds may be available to this fund,” Yi says, who won’t be drawn on Xugong. The hope is that it combines local appearance with international expertise. “If companies want an international brand name to invest to give them credibility, but their hands are tied about taking US dollar funding, we can use our RMB fund to invest and our global network to add value.”

For Yi to be right, a central question must be answered in his favour: will these vehicles operate on a level playing field with local competitors? This question covers a host of elements from access to tax, but the foreign firms active in setting up local vehicles believe they will not be disadvantaged.

It is to be hoped that they are right, because the local competitive landscape is becoming more powerful by the day.

Homegrown power

In January, for example, Citic Private Equity Funds Management closed what is believed to be the largest local currency private equity fund in China – RMB9 billion, a sign of the growing strength of the homegrown private equity industry. At the time of the launch, RMB2.4 billion of it had already been invested in 10 deals, through its formidable 60-strong team of investment professionals. Groups like this can be exceptionally powerful both in scale and connections. Bohai Industrial Investment Fund, for example, which was launched in 2007 as part of Tianjin’s economic development push, is approved to go up to RMB20 billion and has an enviable roster of fund-holders including the National Council for Social Security Fund, China Development Bank, Bank of China and China Life. Or consider New Horizon Capital: its co-founder is Winston Wen – son of Chinese premier Wen Jiabao.

Some see a distinction between two types of local competitor: private companies in the style of a foreign house, or funds that look a lot like government departments. Wu Yibing, the Citic PE president and former Legend Holdings chief, said at the time of his fund launch that “we have a strong institutional affiliation but in terms of how we run the company we may as well be Blackstone”. The difference is, even if target companies still see a local Blackstone fund as having a foreign shine to it, they’re not going to have any such qualms about a fund from what is chiefly still a state-owned entity.

Are local vehicles the future? Citic PE’s chairman, Liu Lefei, was quoted at the fund launch as saying: “Local funds will replace foreign investors in the future; that is the obvious trend.” Foreigners, for their part, expect a mixed bag of successes and failures from the homegrown industry. “What you have is a lot of managers with two or three years of experience who are doing their first funds,” says one observer. “There will be those that raise funds successfully and grow into large managers, and many who will not get beyond a first fund.”

The truth is probably that the two sides will move closer to one another. “We have a view that, over the long term, the China private equity market will be comprised of managers providing onshore and offshore capital, using a platform that manages both,” says Peel. “That includes those starting from an onshore heritage who have gone on to raise money onshore, and those like us whose heritage is offshore but have then raised money onshore.”

Foreigners may be helped by the fact that municipal partners appear to be using their deals to support their own claims to be leading financial centres. Certainly, the new foreign-owned funds appear to be enthusiastically backed by their municipalities. Lin Xu, standing member of the Shanghai Party Committee and Party Secretary of the Pudong New Area, lent his words to the Blackstone announcement last year, seeing Blackstone’s engagement as illustrative of Shanghai’s growing role as an international financial centre. Lin Xu was present again at the TPG announcement. JI Lin, the executive vice mayor of the Beijing Municipal Government, turned up on Carlyle’s announcement, again hoping to use the news of the fund closing to illustrate Beijing’s own strength as a financial hub. “By working with global firms such as Carlyle, we will leverage private equity investments to grow local enterprises and structurally transform local industries,” he said. “We also view this as an important step to solidify the foundation for rapid and healthy development of the private equity industry and the broader financial industry in Beijing.”

For there to be room for both local and foreign-spawned RMB funds to survive, there needs to be a refinement of the existing domestic investor base. It’s the belief that this is happening that has prompted groups like TPG to engage. “Our long term interest is in seeing an institutional domestic LP market in China, and it’s only very recently that what we think will be a key set of institutional investors – the insurance companies – have been permitted to invest directly in private equity,” says Peel.

Those who have watched the development of the industry have seen gradual progress in the availability of capital. “The initial pools of capital were high net worth individuals and the social security fund [the NCSSF],” says one person familiar with both local and international private equity in China. “That then broadened into SOEs and a number of other quasi-development capital organizations. What you would hope to see next is a broader institutionalization of the market.”

In Carlyle’s case, there already appears to be evidence of that. While the Beijing city government anchored the first close, “to our pleasant surprise we also raised funds from other LPs including private entrepreneurs, high net worth individuals, private enterprises, and state owned enterprises,” says Yi. “They all committed a huge amount of capital to us and enabled us to raise the fund in three or four months. We’re surprised and encouraged.”

BOX: Bankers next?

Both Goldman Sachs and UBS have been reported as considering private equity ventures; both declined to comment, although it’s already clear that their existing China vehicles, the Goldman Sachs Gao Hua and UBS Securities entities, wouldn’t be practical for use as private equity funds anyway. “The establishment of an RMB fund in China requires a separate JV arrangement so our existing JV platform is not particularly relevant,” says one Goldman insider. Nevertheless both houses are believed to be looking in to the idea, and it is likely they will consider using their global asset management businesses as the foreign partners in local funds.

In the meantime, one can barely move for senior Chinese investment bankers leaping from their employers to try to launch new private equity funds. Take a look at Hopu Investment, the impeccably connected Chinese private equity group that has been turning up alongside Temasek on Chinese deals: its founders include Fang Fenglei, who used to be Goldman’s key man in China, Richard Ong, also ex-Goldman Gao Hua, and Guy Cui, formerly of Morgan Stanley.

Australia’s market for new initial public offerings, already moribund, has been further dented by an Australian Taxation Office (ATO) attempt to levy a tax on foreign private equity exits.

 The transaction that triggered the ATO’s stance, and has rattled potential issuers, was the IPO of Myer in November 2009, which raised A$2.4 billion in a deal led by Credit Suisse, Goldman Sachs JBWere and Macquarie Bank. One of the groups that sold its stake in the IPO was the foreign private equity group TPG, which alongside minority partner Blum Capital owned Myer through a Cayman Islands-based entity called TPG Newbridge Myer. The partners gained A$1.58 billion from the IPO.

Shortly after the IPO, the ATO said it was pursuing TPG for a A$452 million tax bill related to the cash from the float – it went so far as to freeze a National Australia Bank account TPG held in Australia in expectation that the money was going to flee offshore (which, indeed, it reportedly already had).

 At issue is where tax on income should be paid. The ATO believes the gains TPG made from the Myer listing constituted Australian-generated income, and that income tax should therefore be paid in Australia by TPG Newbridge Myer (and another offshore TPG company, NB Queen). It is understood to be pursuing TPG for a further A$226 million in penalties for tax avoidance.

At the time of writing, the ATO had not published its final conclusions on the TPG tax situation, and was expecting to do so in late May along with final rulings on tax proceeds of private equity sales generally. The resolution of the case one way or another will have a big impact on foreign private equity appetite for Australia, and in turn for IPO volumes.

“I speak to a lot of private equity majors who are looking at Australia but I can tell you for a fact this is bothering them,” says one M&A banker at an Australian institution. “At the moment, it’s not just the question of the tax, it’s the uncertainty they really don’t like.”

Quite apart from the tax issues, the performance of recent IPOs has been miserable. After announcing an uninspiring third quarter sales result in May, the Myer share price was down more than 25% from its IPO. Another IPO late last year, for outdoor supplies retailer Kathmandu, has also fared badly. The only major IPO in Australia this year has been a A$516 million float from Miclyn Express, the marine services group; at the time of writing that was down 10% from its listing price.

Consequently private equity firms in Australia seeking an exit are believed to be looking for trade sales instead of IPOs. For example Study Group, a university programme provider owned by CHAMP and expected to raise A$600 million, and pallet maker Loscam, owned by Affinity Equity Partners and expected to raise up to A$700 million, have been reported to be heading for trade sales rather than floats. Since the real boom in private equity activity in Australia began in 2006, and firms normally hope to hold their companies for three to five years, there ought to be a host of forthcoming exits. But in this stock market environment, a number of expected floats may never happen.

Nevertheless there is a reasonably robust pipeline of equity capital markets deals expected in Australia when conditions suit, among them listings for Ascendia Retail, which operates the Rebel Sports chain of sporting equipment shops, and is believed to have appointed Bank of America Merrill Lynch, Goldman Sachs JB Were and UBS; the coal and freight business of Queensland Rail, which has been valued at A$7 billion; and Bilfinger Berger’s Australian operations.

The Myer situation fits within the context of a broader conflict in Australian commerce today: a desire to increase tax revenues (also evident in the proposed super-tax to be levied on exceptional earnings by miners in Australia) while also appearing to be business friendly and attractive for foreign investment. “The tax office and the markets don’t always appear to be coming from the same direction,” says an ECM banker in Sydney.

Nevertheless, there are already signs that foreign private equity interest in Australia will persist even if there is uncertainty about where they will be taxed on the proceeds. TPG itself, alongside Carlyle, launched a A$1.7 billion bid for Healthscope in May.

The Middle East has emerged as the fourth world centre for private equity after North America, Europe and Asia.

The numbers are indisputable. A study by the Gulf Venture Capital Association, KPMG and research group Zawya put the total funds raised in the region in the three years to the end of 2007 at US$13.4 billion, from 76 separate funds. Everything is climbing: the $6 billion raised in 2007 is more than double the $2.4 billion of 2005; the number of funds closed in 2007 – 22 – is up by a similar degree, from 12 in 2005; and the average fund size is climbing too, from US$204 million in 2005 to US$274 million in 2007. Last year saw the first billion dollar private equity deal in the region (Abraaj Capital’s $1.41 billion purchase of Egyptian Fertilizers) and the raising of the first billion dollar fund (Abraaj again, with its Infrastructure and Growth Capital Fund).

But it’s not just the figures. Everywhere you look you see new entrants coming in. Abraaj’s name keeps cropping up because it was a first mover (see box): when it set up in its current form in 2001, it had the market to itself. But these days there is competition from local funds, from the direct investment of local banks, from increasing international attention, and from the growing wealth (and newfound willingness to invest locally) of the vast sovereign wealth funds in the region.

What’s the attraction? One obvious reason is the oil price. There is great and growing wealth here at both an institutional and an individual level, and it needs to go somewhere. For any business seeking to get started or grow, liquidity is abundant – and that can’t be said for many world markets today. In particular, the region needs infrastructure. “After more than a decade of underinvestment, the Middle East is going through a huge construction phase, with more than a trillion dollars worth of projects underway,” says Imad Ghandour, principal in the investment team at Gulf Capital, a private equity specialist in Abu Dhabi. “All sectors related to real estate and infrastructure are booming. Soon after, a consumption cycle will begin, supported by an efficient economy liberated from the public sector and significantly higher disposable incomes.”

On top of that, there are interesting demographic changes taking place. According to Faisal Belhoul, the managing partner of Dubai-based Ithmar Capital, over 90% of all commercial activity and non-oil-related GDP in the Gulf is controlled by family firms. He says there are 5000 of these family firms with combined assets of more than US$500 billion, employing 70% of the region’s workforce.

Traditionally, this has been an impediment to investment: people don’t want to sell. But there is also a sense that things are beginning to change. “Often you’ll find that one or two generations of a family build up a business, but when it comes to the next generation, they don’t necessarily want to take it on,” says one private banker in Dubai. That creates an opportunity: either businesses consider listing for the first time in order to give family members an exit if they want it; or it gives private equity players a way in.

“It’s changing for a lot of reasons, not just the generational lead,” says Chuck Pieper, vice chairman of Credit Suisse Alternative Investments, speaking to Asiamoney between company visits in Abu Dhabi. “As many of the families have acquired a portfolio of interests over time, they’re finding that the cash requirement for growing a broad base is larger than the ability they have to generate it. We were reviewing a deal today with three different arms of a family company, and within each of them, two or three different businesses: a mini-conglomerate. They would like to monetise some of them to get the cash required to build others.”

Ghandour adds: “Family businesses eyeing an IPO understand that private equity is a good intermediary step towards public listing, as it proves to the wider investor audience that the company is ready for outsiders and at the same time it infuses new expertise into the company.”

One could also argue that the thinness of Gulf stock markets supports private equity. Many markets in the region – in the UAE and Qatar, for example – are barely a decade old. Saudi Arabia, by a distance the most powerful economic force in the region, has only 123 stocks listed on its stock exchange. In a market like that, with very few small caps to speak of, the stage is set for pre-IPO investment, by private equity or venture capital firms.

And, locally, the financial services sector is growing in sophistication by the day. And it’s here, on the ground, that the broadening of the field is taking place. As local banks have announced their latest results, the words “private equity” are cropping up ever more frequently.

For example, take a look at the 2007 results announcements from Bahrain’s banks, all of them announced in the last few months. Investcorp, which focuses on alternative investments, recorded strong growth in both its private equity and Gulf growth capital businesses. Unicorn Investment Bank completed an initial $150 million capital raising for the Unicorn Strategic Acquisition Fund, which it hopes will become a $1 billion fund in due course. (One of its existing funds, Unicorn Global Private Equity Fund I, bought 55% of Gulf Strategic Partners, a Bahraini engineering services firm, in March to go with four previous investments.) Ithmaar Bank achieved a $200 million first close on its Aldar Private Equity Fund in November. Capivest, formerly known as Khaleej Finance & Investment, confirmed a private equity fund worth $110 million focusing on India. Gulf Finance House told its February AGM that its focus for expansion is on asset management and private equity. And other banks are active as acquirers in their own right, whether as principal finance or to build their franchises; an example is Ahli United Bank, which bought 35% of Oman’s Alliance Housing Bank in 2007.

Several of these banks are relatively new themselves. Ithmaar (not to be confused with Dubai’s Ithmar Capital) is only in its second full year of operation as an investment bank but has embraced the private equity opportunity as a strategic business, launching funds not only for the Gulf but the world. “We take a global view of private equity opportunities,” says Andrew Pocock, who heads the bank’s private equity team; examples have included an investment program for Australia, stakes in  funds investing in China (Ithmaar owns 20% of CITIC International Asset Management), and funds related to Africa, Latin America and CIS’s energy sector.

Big new funds are springing up all the time. Kuwait’s Global Investment House, Dubai Islamic Bank and Millennium Capital (part of Dubai Islamic) announced in March the Global DIB Millennium Islamic Buyout Fund, a private equity vehicle targeting $500 million of commitments, which will invest in buyouts of Shariah-compliant companies. The fund followed an earlier Global Buyout Fund, which had an initial close in November 2007 after raising $550 million and has already committed more than one third of it. Global itself says it manages around $1.6 billion in private equity; at the fund’s launch, Global’s executive vice president, Omar El-Quqa, said: “We believe strongly that this asset class will dominate the region in the coming years as it is well-suited for the region’s macroeconomic factors, such as sustained economic growth, implementation of reforms that facilitate foreign direct investment, and an increased willingness of governments to privatize state-owned entities in a variety of sectors.”

Internationally, too, groups have taken notice of the possibilities in the Middle East. In November 2006, Carlyle Group announced it had established a team for the Middle East and North Africa (MENA) region, headed by Walid Musallam. It was quite a coup: one of Musallam’s previous roles was chief executive officer of the Abu Dhabi Investment Company, a multi-billion dollar investment group backed by the Emirate itself (he’s also worked at Lehman Brothers and the IFC). Firas Nasir subsequently joined from UBS and is based in Dubai; other key hires include Hassan El-Khatib,  a managing partner of EFG-Hermes Private Equity, part of the leading investment bank in the Middle East. Carlyle has yet to make public any investments by its new MENA Buyout Fund, nor its size.

Carlyle is the foreign private equity name everyone talks about in the Middle East, but others are building up too. 3i is invested in a fund from Dubai’s Ithmar Capital, and in a Bahrain-based infrastructure fund run by Manara Equity Partners. Both Ripplewood and Actis have made purchases in Egypt. Blackstone worked alongside Dubai International Capital on the Merlin Entertainments/Tussauds merger in 2007.

Among the foreign investment banks, the clearest sign of renewed enthusiasm comes with their recent movements of personnel. David Law was until recently head of the financial sponsors group internationally (that is, outside the US) for Morgan Stanley, with close relationships with major private equity firms; in February he was appointed chairman of investing banking for Middle East and North Africa out of Dubai, supposedly with a mandate to target sovereign wealth funds. In April, Lehman Brothers created a new role of global head of sovereign wealth funds in Dubai, to be filled by Makram Azar, previously head of the media, consumer and retail investment banking business in Europe and the Middle East.

Aside from the seniority, there are interesting tie-ups too. Credit Suisse announced in March that it would create a strategic alliance with Gulf Capital. “Even when oil was at $20 or 40 a barrel, we thought the Middle East had a lot of potential for private equity,” recalls Chuck Pieper, vice chairman of Credit Suisse Alternative Investments. “It was still early on, but it was developing a real infrastructure that was not just about carbon exports of oil or gas, but real businesses developing here. We spent a couple of years looking for partners.” Gulf Capital proved a good fit: of the four managing partners, one used to work at DLJ (now part of Credit Suisse) and the other had worked for Pieper during his time at GE. The partners have been reported to be raising a fund of around $750 million.

Pieper thinks the time is right for international institutions to play a bigger role. “Something in the order of $12 billion of private equity has been raised for the Middle East and the vast majority of that is done with local firms,” he says. “Less than 20% has been from international names.”

But there is a big difference between the amount of money ready to be invested and the amount of money that actually is. And there’s an even bigger difference between the amount that is invested and the amount that comes out again in exits.

The KPMG report says $13.4 billion has been raised for private equity in the last three years – but only $12 billion has been invested in the last 10. Also, during all that time, just $900 million has been realised in exits: just 7.7% of total investments. And that’s a dramatic improvement: of the 49 investments sold in the last decade, 36 were in 2006 and 2007, although not all exits are reported publicly.

“With a few conspicuous exceptions, there has to date been a lot more success in raising investment capital than in deploying that investment capital,” says Pocock at Ithmaar, “and one consequence of this is that returns are being constrained by the prices being paid.” There are western-style deals occasionally – the Abraaj purchase of Egyptian Fertiliser is one – but “what you find is a lot of the private equity is actually going into what are, in effect, start-up businesses. You get a relatively high level of green field investment, which can mean quite a long lead time before you start generating cash. In pure green field, at least in capital intensive industries, you’re probably not talking about cash generation for three to four years and dividends for five.” That, in turn, leads to a longer holding period than is traditionally seen in the west. “We’re looking at a project now which probably won’t close until next year, and then the equity is drawn down over the next three. That approach is still going to give investors an attractive return, but they have to have confidence and be willing to allocate capital to Ithmaar’s fund for the duration.”

Pieper notes a key difference between the Middle East and other emerging markets, notably China. “You’d probably say 90% of the exits in China are IPOs,” he says. “I would bet in the Middle East we will see at least half of the exits being strategic acquirers.”

There are other challenges for private equity too. It’s true that the nature of family business is changing, but it’s still very much there, and change takes time. “The economic backdrop that makes for a very active private equity market like in the US and Europe generally speaking does not exist in the Gulf,” says Pocock. “One of the reasons for that is that a lot of the enterprises here are family-owned, and while many have made a lot of progress in corporatizing themselves, some are still run in their old-fashioned form as a sole proprietorship or family partnership. In these cases there’s a reluctance, particularly if the patriarch remains alive, to dispose of any division, no matter how poorly it may be performing.”

And it creates some doubtful arrangements too. In May, The National Investor, an Abu Dhabi-based investment group, calculated that 75% of businesses in the GCC region have at least two board members from the same family. In Kuwait, one family can occupy the whole of a board, and in Saudi Arabia, 75%.

And underpinning any boom market is a perennial challenge: people. Pieper says he spends one third of his time on people matters. “The whole private equity industry is people dependent,” he says.

“Many individuals and institutions seeking to enter this business underestimate the issues involved,” says Pocock. “There is a significant shortage, not of able people, not of talented people, but appropriately experienced people trying to make their way in this business.”

BOX ONE: SOVEREIGNS

As everyone knows, the really big money in the Middle East is with the sovereign wealth funds. Nobody knows the precise figures, but the Abu Dhabi Investment Authority may have as much as $1 trillion under management. Of the estimated $3 trillion in sovereign funds internationally, probably almost half is run out of the Gulf. A recent report by Private Equity Intelligence estimated that 60% of the world’s sovereigns are invested in private equity, with between $120 and $150 billion committed to the sector, so if the Gulf accounts for about half that figure, it’s clear there are some huge funds to be deployed – and the money just keeps coming out of the ground.

Traditionally, though, the sovereigns have focused on investments outside the Gulf, in order to diversify. The investments that get the most coverage are, for example, Saudi Arabia’s Prince Alwaleed or Abu Dhabi’s ADIA buying chunks of Citigroup, or the Kuwait Investment Authority taking holdings in DaimlerChrysler and Merrill Lynch.

But recently, sovereigns have started to show a willingness to invest in the region as well, if not in their own name then through subsidiaries, or for other groups mandated or supported by the state. Take Dubai Holdings, owned by Dubai’s ruler, Sheikh Mohammed bin Rashid Al Maktoum. Its financial services holding company arm, Dubai Group, was launched in 2000 and holds a wide range of direct and indirect investments worldwide. These include American, European and Asian interests, but also stakes in numerous Middle East groups such as EFG-Hermes, Global Investments House, TAIB Bank in Bahrain, Dubai Bank, and Emirates Cement Company. Dubai Investments is a separate entity again, the largest investment holding company listed in the UAE; it has a private equity and venture capital division called M’Sharie, whose investments include a range of local companies from rubber to driving centres, cooling machinery and lab technology. Also in Dubai is Ithmar Capital, another GCC-focused private equity fund. Its first two funds raised $70 million and $250 million respectively, and a third raising later this year is rumoured to be targeting as much as a billion dollars. While not part of a sovereign, its partners in its funds do include sovereign wealth funds, as well as international funds and institutions, among them 3i. An example of a recent investment was Panceltica, a Qatar-based provider of fast track housing, in which Ithmar was a pre-IPO investor.

Ninety minutes up the road in Abu Dhabi, ADIA, the heavyweight of sovereign funds, does not invest locally. But Abu Dhabi Investment Company, a sister company of sorts to ADIA, includes a private equity division focused on the MENA region. It is, for example, developing the Queen Alia Airport project in Amman, Jordan. Then there’s Mubadala Development Company, a wholly owned investment vehicle of the Abu Dhabi government, established in 2002. Mubadala’s mandate is to establish new companies and acquire strategic holdings in existing ones, locally and overseas. While some of its holdings are in the West – most notably, stakes in Ferrari and Carlyle – most are in the Gulf, such as stakes in Abu Dhabi Ship Building, Emirates Aluminium and a host of healthcare businesses. (Mubadala is not the only example of this interesting twist of Gulf funds owning stakes in American private equity firms: ADIA has a stake in Walden Capital.)

Still, many in the industry do not see sovereigns as direct competitors. “In reality, the private equity houses competing for deals are less than a dozen,” says Imad Ghandour at Gulf Capital. “Sovereign wealth funds usually have a different agenda compared to private equity firms, and rarely compete head to head with private equity houses.”

 BOX: ABRAAJ

Abraaj Capital is enjoying the benefits of being a first mover. While other funds and enterprises grapple for opportunities, Abraaj has around US$5.25 billion under management already, across five funds.

“We had the advantage of being the early birds,” says Omar Lodhi, executive director at Abraaj in Dubai. “We entered this space as principals in 1995, and in our formal structure as Abraaj in 2001, when nobody knew what private equity was, leave alone sensing any opportunity. We’ve grown in tandem with the opportunities around us in the region.”

From the outset, Abraaj has not limited itself to the Gulf, but to a region it calls Menasa, for Middle East, North Africa and South Asia. “That’s some 1.8 billion people, $3.2 billion in GDP, and a region that has historically had a lot of cultural and economic ties that are now being rekindled,” he says. Taking this approach benefits from the synergies between resource rich and population light countries in the GCC, and those with the reverse demographics in south Asia and Africa. Much of the region is also now benefiting from an agenda of business reform.

With its scale, Abraaj tends to appear on the landmark private equity deals in the region, such as the acquisition and exit of Aramex International, and the region’s biggest ever private equity-led buyout, the purchase of Egyptian Fertilizers. Other deals, worth at least $100 million apiece, have included investments in Acibadem Healthcare Services in Turkey, Air Arabia in the UAE, and GEMS Schools across the region. Access is helped by a remarkable roster of shareholders and executives, among them Saudi Arabia’s Sheikh Abdulrahman Ali Al Turki, Kuwait’s Public Institution for Social Security, the Qatar Pension Fund, Citicorp, and numerous other regional business or political figures. “They’re all very influential institutions and people who permeate the fabric of society, of business and corporates and government within the region,” says Lodhi. “They are extremely useful throughout the value chain of private equity we practise, in terms of deal sourcing, post-acquisition management, and helping companies grow.”

Apart from being one of the few businesses around to be able to demonstrate a full-cycle track record, Abraaj really now stands out for its size. “The need for larger funds arises because corporates around us now are growing,” he says. “Aramex when we bought them were $70 million, and when we exited, $300 million. Today they’re close to a billion. That’s the kind of growth we are seeing in this region.”

Liquid Real Estate, Euromoney magazine, June 2008

 As the market for big IPOs dries up, Indian real estate is becoming more and more the preserve of the private equity industry.

An example of the momentum is Red Fort Capital, a Mauritius and Delhi-based investment management firm specialising in real estate. A new offshore fund, its second, is expected to close this month [JUNE] with a corpus of Rs35 billion (US$800 million) to invest in the sector in India.

Red Fort India Real Estate Fund II targets everything from individual investors and pension funds to foundations and governments in Europe, the US and elsewhere. Its investment remit is similarly broad, covering residential, commercial, retail and hospitality sectors, provided they are compliant with foreign direct investment rules. In June the manager also expects to close a Rs10 billion domestic fund.

 Red Fund’s first fund allocated $400 million to Indian property, including projects of Bangalore’s Prestige Group and a township being developed by the Indu Group, from Hyderabad. Red Fort says that fund has generated 55% returns to international investors.

While Red Fort is a specialist, India’s bigger banks are raising capital too. In May ICICI Bank began raising $1.5 billion for a private equity fund and announced it was considering raising $1.1 billion, which could rise to $1.5 billion, for a real estate vehicle alongside , to invest in residential and commercial projects in India’s major cities. This fund, like the Red Fort fund, plans to raise most of its funds from overseas, with the US, Europe, Japan, China and the Middle East targeted.

Also in May, Kotak Mahindra Bank announced plans to raise about $1.2 billion for two new funds for India. Although it appears this will chiefly invest in infrastructure rather than other real estate, Kotak already runs an $800 million real estate fund and may raise more.

It’s not just local houses who see the opportunity. At the end of April Blackstone Group’s real estate arm, Blackstone Real Estate Partners, announced it would invest approximately $18 million in a minority stake in Synergy Property Development Services, a project and construction management company based in Bangalore and founded in 2003. The stake, though modest in investment size, comes with board representation.

Synergy manages over 100 million square feet of office, retail, residential, hotel and hospital property, and plans to expand into infrastructure. Blackstone, whose Real Estate Partner VI reached capital commitments of $10.9 billion to become the largest real estate opportunity fund ever raised, has a dedicated Mumbai office for its real estate group.

 Indeed, Blackstone and others realised some time ago that real estate was one of the best ways to put money to work in India. Partly, it’s because property represents an obvious growth area in India: there is not of enough of any quality real estate in India to match its growth, whether it be houses, shopping centres, offices or airports. Also, it’s an easier way to get in than to try to purchase meaningful stakes in India’s growing companies, many of which have no need or inclination to give up much control.

 Citigroup Property Investors, for example, closed a US$1.29 billion Asian real estate vehicle, CPI Capital Partners Asia Pacific, in February 2007, with India as part of its focus. The previous month it launched a partnership with Bangalore real estate developer Nitesh Estates to build a 250-room luxury hotel in Bangalore, and even that followed $250 million of previous investments in India’s residential and hospitality sectors. Earlier still, in 2006, Morgan Stanley Real Estate announced an investment in New Delhi-based real estate management company Alpha G:Corp Development, following it up the next January with a US$152 million investment in Oberoi Constructions, a real estate developer. Even further back, Tishman Speyer announced in 2005 a joint venture with ICICI Venture Funds Management to develop real estate projects in India.

More recently, Morgan Stanley has confirmed plans to start a private equity unit in India, with property expected to be part of its remit; and Deutsche Bank’s RREEF Unit has said it plans to invest over $1 billion in the next three years in Indian real estate and infrastructure. Warburg Pincus has also taken a stake in a local developer, while 3i Group raised $1.2 billion for Indian private equity investment in April, albeit not specifically for real estate.

In the meantime, the performance of Reliance Power – the world’s largest ever private sector IPO, but well below its issue price at the time of writing – has helped to put issuers off seeking new money from the public markets for the time being. The weak post-listing performance of DLF, considered the landmark real estate listing in India in recent times, has not helped, while there is still no sign of legislation emerging to allow for the formation of real estate investment trusts in India.

Euromoney magazine, May 2008

Interview with Cui Jindu, Vice Mayor, Tianjin Municipal People’s Government

Tianjin is perhaps the most exciting area for growth in mainland China, backed by the national government as the country’s next engine of economic development. Where once Shenzhen was the focus of attention for reform and growth, and then Shanghai’s Pudong area, Tianjin is now set to take up the mantle.

China’s State Council first confirmed this important national vision for Tianjin and the Tianjin Binhai New Area in 2006, and the municipality received a further boost in March of this year, when the State Council approved the launch of an ambitious pilot program for financial and commercial reform.

“This document is of great significant for reform and innovation,” explains Cui Jindu, the Vice Mayor of the Tianjin Municipal People’s Government. “Just as the government made the decision to open up Shenzhen n the 1980s, and Pudong in the 1990s, in the early 21^st century it has decided to develop the Binhai New Area. These three new areas have been developed in different stages and different economic backgrounds. But all of them have had – and will have – great influence on the development of the economy of the whole nation.”

The Tianjin story involves the city itself – a city that has boasted 600 years of industrial development, and is a thriving commercial location in its own right – and the Tianjin Binhai New Area. Much more can be read on this exciting venture in the later pages of this guide, but it has been building rapidly since its inception in 1994 and embraces the largest port in Northern China, a new economic development area, ecologically sound cities and hubs for IT, technology and outsourcing, among other things. “The central government attaches great support to the Binhai New Area, not only in terms of finance and tax, but in its organisation and implementation,” says vice-mayor Cui. And it is an outstanding time in China’s development to receive such support. “When Shanghai and Shenzhen opened up, China had just entered economic globalisation,” he says. “But as Binhai New Area is opening up, China has passed the transfer period of entering WTO. It has already entered globalisation.”

Tianjin and the Binhai New Area will be a testing ground for widespread financial reform, also explained in more detail in the later pages of this guide. “The central government has urged Tianjin to speed up reform, especially in finance,” he says. “It will allow innovation with an attitude of: ‘Go and try first’, so we can develop, collect experience, and provide a working model.”

The development of this pilot scheme will serve all of China, and it will also act as a spur to growth and innovation in the Tianjin area itself. Among other things, it will be a focal point for attempts to increase the proportion of direct finance in China, by becoming a centre for private equity, for example. It will attempt to combine all financial services, including banking, insurance and securities, within a single body, to establish whether a comprehensive financial services approach is a better model for China. It will be a testing ground for foreign exchange reform, with some local banks permitted to conduct trading business never previously permitted. It will be home to China’s first international over-the-counter securities market, and to its first national emissions exchange, as well as to a property rights exchange. And it will be home to an economic and financial arbitration centre quite different to anything previously attempted in China.

All of this will be done in the spirit of learning and cooperation. “We welcome  enterprises, banking and other financial institutions, to join our progress,” says Vice-mayor Cui. It will be fascinating to watch this ambitious plan take shape. As he says: “The trend is upwards.”

TIANJIN

Tianjin has centuries of history as a centre of commerce and trade, and is ideally located to serve the growth of the North of China. It was once known as the Wall Street of North China – and it could become so once again.

Tianjin, one of the four municipalities directly under the central government of China, is located 137 kilometres southeast of Beijing. Its trading port was opened in 1860 and by 1930 it was the largest industrial and commercial city, and the key financial centre, in the north of China. Today it hosts a population of 10.43 million permanent residents.

Its location is one of its principal assets: not just its proximity to the national capital, which will soon become a 30-minute train ride when a new high-speed rail link opens before the Olympic Games, but also to Bohai Bay, where its port already links with 300 other locations worldwide, and is ideally located for trade with Korea, among other places. Tianjin is at the heart of the Circum-Bohai area, which covers the land surrounding Bohai Bay from Dalian in the north round to Yantai in the south.

Openness and innovation is part of its psyche. It was one of the first of China’s coastal cities to open up to the outside world in the late 1970s. “We were one of the first gates to open to the world,” says Zhang Xiaoguang, director at the Tianjin Municipal Development and Reform Commission. Since then, it has become recognised as a national leader with its advanced technology, favourable environment, and strong supply of human resources.

Tianjin, unlike most cities, is blessed with natural resources, most notably oil and gas: its Bohai and Dagang oil fields are among the country’s key developments, producing 17.83 million tons of crude oil and 880 million cubic metres of natural gas in 2005. Its coastline naturally gives it sea salt resources – its Changlu Salt Field produced 2.3 million tons of salt in 2005, 10% of the national output – and more than a dozen metal minerals are found there. Plentiful warm underground water is another asset, as is the sheer scale of available land – Tianjin accounts for over 1.1 million hectares, 37.4% of it arable; soil is fertile and the cost of development is generally low.

These natural assets have been reflected in exceptional growth in recent years. Tianjin’s total GDP was RMB501.8 billion in 2007; its total industrial output topped RMB1 trillion. Between 1993 and 2006, Tianjin enjoyed double digit growth in gross production value each year. Tianjin has attracted investment from over 110 countries and regions, with almost 18,000 foreign-funded enterprises having established branches there. Total investment so far is over US$55billion, and a remarkable 128 of the top 500 enterprises in the world have invested in Tianjin.

Human resources has long been a key to Tianjin’s success. It is home to the first institution of higher learning in China’s modern history: Tianjin Beiyang University of Western Studies (now Tianjin University), established in 1895. There are over 40 institutes of higher learning in Tianjin, serving 300,000 registered students; there are also 1000 scientific and technological research institutes, and over 600,000 technicians. The Tianjin Hi-Tech Industrial Park, founded in 1988, was one of the first national new and high tech industrial development zones established with the approval of the State Council of China. Tianjin is considered one of the top three regions of China in terms of educational ability, and was among the first locations to provide nine-year compulsory education.

Tianjin has combined all this with a reputation as a liveable city. It has great historical and cultural significance, and is known in particular for its opera and quyi performances. Its museums and memorials are nationally renowned, and it is recognised as a prestigious area for sports: it will hold football matches during the Beijing Olympics in an outstanding new building, the Tianjin Olympic Central Stadium.

Tianjin is undergoing a major redevelopment of its financial district, quite separate from the developments going on in the Tianjin Binhai New Area. The city’s North Jiefang Road was considered the region’s financial centre as long as a century ago: HSBC opened its first business here in 1882, the Qing dynasty established the first ever state-run financial organisation, the Official Exchange Bank of Zhili, here in 1920, and by 1935 21 foreign banks had been set up by institutions from eight countries, alongside 29 banks invested by Chinese.

Even today, one can see fine buildings characteristic of the area, and it remains home to landmark institutions including the Tianjin municipal government, the most important national government departments, the development and reform commission, and major local and international banks. Accoring to Du Qiang, deputy director general of the Financial Affairs Office within the Tianjin Municipal People’s Government, there are 178 financial institutions in Tianjin, with RMB946 billion of assets between them, including RMB834.2 billion of deposits.

North Jiefang Road will be the focal point of the redevelopment of Tianjin Financial Town, which will cover 113 hectares, including a total built up area of 2.3 million square metres, bordering the Haihe River. An estimated RMB26 billion will be invested in this redevelopment, which will be 10 years in the making.  A strict division of enterprises will help to make the area efficient and focused.

A financial landmark area will host the headquarters of the recently-formed Bohai Bank, and also potentially the office of the OTC market soon to be established in Tianjin (see the article on financial reform for more on Bohai Bank and the OTC market). This will be the area for securities transactions. A financial auxiliary service area will cover a construction area of 700,000 square metres, including the Tianjin Tower skyscraper; this area will accommodate service industries. Another area will cover intermediary services and facilities for auction; there will be designated sections for hotels and offices; and two other areas cater for financial and business enterprises, including the offices of major state-owned banks.

“Jiefang Road has had 60 years of industrial development,” says Zhao Feng, president of the Financial City of Tianjin Development Company, a state-owned company approved by Tianjin Municipal government to be responsible for the overall development of Tianjin’s downtown financial projects. “More than 100 years ago we had more than 50 banks and financial organisations locating their office buildings here. It is a historic place for the finance sector’s development.”

Feng believes Tianjin has many advantages in its development of the new financial town. “We understand the transportation network for a finance city is key,” he says. “Our new train station [set to open before the Olympics] connects with Beijing and South China; the high speed train will take just 30 minutes to Beijing; we have new bridges crossing the river; and although we already have Tianjin airport we are considering setting up a small airport within the finance city.” An underground transport system is another key part of the city’s convenience as a financial location.

Feng says several projects are underway, while land collection and redevelopment is also well advanced. The financial town in Tianjin downturn will work in partnership with the other financial ventures underway, such as the Tianjin Economic Development Area within the Tianjin Binhai New Area.

In short, Tianjin is well placed to reclaim its historical importance as a centre for financial services. Its ambition as a city is impressive, and when combined with the developments in the Binhai New Area, its momentum looks unstoppable.

TIANJIN BINHAI NEW AREA AND TEDA

The Tianjin Binhai New Area is one of the most exciting commercial developments in China. It is a key part of national policy thinking for the future growth of China, and its development has the backing of the central government.

The Binhai New Area covers a 2270 square kilometre area on the coast near Tianjin itself, with a 153 kilometre coastline and a population today of around 1.5 million. It covers three functional areas – the Tianjin Port, a free trade zone, and the TEDA, described below – as well as three complete districts (Tanggu, An’gu and Dagang) and parts of two more. Viewed from above, it can be visualised as a combination of a high-tech axis and a marine belt, embracing three ecologically sound urban areas and eight industrial zones, covering areas including technology, advanced manufacturing, chemicals, seaport logistics, an airport-based industrial zone, coastal leisure and tourism, the port and the finance-based CBD.

TBNA was first envisaged by Tianjin’s municipal government at the end of 1993, and has grown tremendously since its formal launch the following year. “In 17 years, it has achieved amazing things in terms of economic development,” says Chen Fang, chief of financial and investment development bureau on the administrative committee of Tianjin Binhai New Area. “In early 1994, at the beginning of this new area, its GDP was around RMB11.2 billion. In 2007 it was RMB236.4 billion – an average annual growth rate of more than 20%.” Per capita GDP is US$19,200 – very high by Chinese standards – and other indicators demonstrate the area’s progress too. Local government fiscal revenue has gone from RMB2.36 billion to RMB48.1 billion between 1994 and 2007, while the export value of foreign trade has jumped from US$500 million to US$24.5 billion over the same period – a 50-fold increase. “The Binhai New Area’s industrial output is RMB630 billion,” says Fang. “That is higher than in Pudong.”

So the achievements have already been impressive. But the area’s future looks brighter still, and was mapped out in the Outline of the 11^th Five-Year Plan for the Development of National Economy and Society in the People’s Republic of China. This landmark policy document, released in 2006, includes this passage: “Efforts shall be made… to push forward the development and opening of Tianjin Binhai New Area, so as to accelerate the development of the regional economy.” A detailed briefing from the State Council of the People’s Republic of China on the new area says: “Promoting the development and opening up of the Tianjin Binhai New Area is an important strategic arrangement made by the central committee of the CPC and the State Council, based on the overall situation of China’s economic and social development at the new stage of the new century.” It adds: “Promoting the development and opening up of the TBNA will be beneficial for strengthening the international competitiveness of the Beijing-Tianjin-Hebei region as well as the circum-Bohai region… the TBNA is the gateway to China’s vast hinterland and boasts outstanding geographic advantages, profound industrial foundation, and great potential for growth. The TBNA is an important window for China’s participation in economic globalization and regional economic integration.”

This clear policy support, which in March was followed by state council approval for the new area to serve as a location for pilot financial reform (see next article), has made a huge difference to the TBNA: it is no longer just striving to support Tianjin but is part of the national development strategy, and a key part of the development of the whole of northern China.

Even before these welcome national directives, TBNA’s performance had been outstanding. Already, 80 of the world’s top 500 enterprises have invested in the new area, including Motorola, Airbus, Toyota and Samsung. More than US$20 billion of foreign direct investment has been utilised so far. There are 28,000 companies established here, and the area contributes more than 45% of the entire GDP of Tianjin municipality despite having only one sixth of its land mass and one eighth of its population. “For foreign invested companies, this is now regarded as the area with the highest investment returns and the highest margins in the whole of China,” says Fang.

So with the might of the national government behind it, it’s not hard to imagine how dramatic the growth will be from now on. “If you look at Shenzhen, the first big opening up of China to the world, the whole economic capacity of the Pearl River Delta has been amazingly improved,” says Fang. The same is clearly true of the Yangtze river delta ever since Shanghai’s Pudong district was given similar support. “Now, you can see the focus shifts from the south to the Tianjin Binhai New Area.”

The idea is that TBNA serves to spur development of a much bigger region, including Beijing, Hebei Province, and what is known as the Circum Bohai Region, which covers the land area around the Bohai Sea. Its coastal location gives it advantages for both inward attraction and outward export; Tianjin Port, for example, has trade with more than 300 ports in 170 countries and regions worldwide (see the infrastructure article on page xx for more on the port and other transport infrastructure). “By 2015,” says Fang, “The Tianjin Binhai New Area will take its turn to be the third growth engine for China’s economic development.”

A key part of the TBNA is the Tianjin Economic-technological Development Area, known as TEDA. This is a national economic zone and is located at heart of the TBNA, five kilometres from the port, 45 kilometres from Tianjin’s downtown and 120 kilometres from Beijing. Originally approved by the central government in 1984, it is already a well-established manufacturing base, and for 10 years in a row it topped a list compiled by the Ministry of Commerce on the investment environment of national development zones. By the end of 2007 TEDA had approved 4,485 overseas projects from 74 countries and regions, with a total investment of US$40.33 billion; electronics and information are two leading industries here, with the biomedicine industry also logging exceptional annual growth of 30% in recent years.

Like the rest of the new area, TEDA’s role gained importance when the Eleventh Five-Year Plan boosted the areas profile in 2006. It will be here that the pilot financial reform scheme will be implemented and tested, giving the area a historic place in China’s development.

The administrative committee responsible for TEDA’s development and planning have been fastidious in making sure that it is a desirable place to live as well as a centre for commerce. There are designated residential areas for senior staff and management, and for general residential use; a lake, with carefully considered construction around it; there is impressive medical and educational infrastructure, including two hospitals and two international schools; there are areas for shopping malls and hotels, with two five star hotels already built and several more under construction; there will be a theatre and a museum; and there is a light railway that is already operational.

“According to our master plan, we will have very comprehensive infrastructure to support the finance sector’s development, including entertainment, residential, parks, hotels, medical and education,” says Qiao Wei, deputy director of the Investment Promotion Bureau at TEDA.  “We aim to set up a complete, dynamic area, a first class international CBD.” Top consultants such as CBRE have been involved in the development of this area.

Already it is proving popular: almost 90% of the finished office buildings in what is known as Finance Street, and in other areas of TEDA, are occupied already. “More and more investors are interested in our area, so we would like to speed up the whole CBD development and construction,” says Wei. Most of the foreign banks in Tianjin are represented within TEDA, with some banks already considering it a suitable place for a national centre (see next article).

TEDA is also a key location for service outsourcing, having been recognised as one of the country’s 11 key service outsourcing base cities by the Ministry of Commerce in 2006. There is a dedicated park for this business.

The Tianjin Binhai New Area and its TEDA zone exemplify why observers are so excited about the potential for growth in this area. The performance has already been extraordinary for years – and now it will be combined with national support and drive. The future looks bright.

FINANCIAL REFORM

In March, the State Council took a landmark step when it approved Tianjin Binhai New Area as the location for pilot financial reform in China. This cements Tianjin as the third growth engine for China after Shenzhen and Pudong; it also ensures that the area will be closely watched by observers worldwide as some of the most dynamic areas of Chinese finance are tested and perfected. As Zong-Sheng Chen, vice secretary-general of the Tianjin Municipal People’s Government, puts it: “Within this area, we can go and try first.”

There are six key elements to this reform. The first is to attempt to increase the proportion that direct finance occupies in Chinese companies. “The present situation is that indirect finance covers 90%,” explains Cui Jindu, the Vice Mayor of Tianjin. “That doesn’t go well with economic development.”

Improving the role of direct finance will involve some very interesting projects. Tianjin will be a centre for the development of domestic private equity. Although 10 private equity funds have been approved domestically, the only one that is fully operational is in Tianjin: the Bohai Industrial Investment Fund Management Company, which was approved at the end of 2006 and is approved to raise RMB20 billion, having raised a RMB6.1 billion first tranche so far. The fund’s major sponsors include the Bank of China Group, the National Council for Social Security Fund of China, the Postal Savings Bank of China, China Life Insurance, and two state-owned Tianjin companies. The management group is majority owned by Bank of China. 

This fund has already put more than RMB2 billion of funds to work, starting with its first purchase, of a steel tube manufacturer called Tianjin Pipe, in November 2007. “We have made breakthroughs in creating the fund,” says Au Ngai, CEO, a former partner at global private equity giant Newbridge. “At the time of our launch there was not even a partnership law. So the Tianjin government, working closely with the National Development and Reform Commission, has been a major force behind that breakthrough. There is a major effort by the government to position Tianjin as a hub for launching private equity funds.”

Local funds do have something of an edge, in that purchases made in renminbi create no pressure on foreign exchange reserves, and in fact make money for social security funds. “Secondly, our state-owned nature allows us an advantage on winning trust with businesses,” says Ngai.

Why does China, with all its liquidity, need a private equity industry? “Right now most of China’s company financing is done through indirect, secondary financing, which is unhealthy,” Ngai explains. “Our fund is a project within a much larger scheme to help with direct financing. This kind of professionally managed fund investment entity provides a different venue for investors to allocate assets, and for investee companies to receive financing.” Ngai says the fund is “95% similar to any [commercial private equity] fund”: it has a 15 year maturity, and generally looks at exiting investments after a three to five year exit. It has 30 people on staff, including 18 investment professionals.

Investing the full RMB20 billion it is permitted to raise should by straightforward. “From the speed of our investment during last year, I don’t think that should pose any problem,” Ngai says. “We’ve been cautious last year because of valuations; now in a more normalised market we should be able to do more.” A vibrant industry should develop: with 10 approved funds in China, likely to be allowed to raise RMB10 billion each on average, that already means an approved pool of private equity capital of RMB100 billion in domestic funds.

Another effort Tianjin has made to be home to this emerging industry is by hosting the country’s first national private equity conference, which will hold its second annual event in June. Last year 223 funds and institutions joined the forum, and a total of 5000 participants; this year the forum has been expanded to include some funds in Europe and the US, and a total of 500 funds are expected to attend, with at least 6000 overall participants. A national private equity association is being established, and a partnership law has been developed.

Additionally, a dedicated funds centre is being established within the Binhai New Area to attract private equity funds, while tax and registration policies are being designed to be more appealing to the industry. And outside of private equity, other efforts are being made to improve direct equity participation, including promotion of IPOs, and a study into the potential development of a real estate investment trusts market.

The second area of reform is to establish a comprehensive financial services business. In China, there has always been strict separation between commercial banks, securities houses and insurers; the idea now is to find out in Tianjin how a combined entity might work. The first step towards this was taken in October with the formation of Teda International Holding Company, which will encompass business in banking, securities, insurance and funds. (It is also one of the shareholders in the new private equity fund). “It covers every area of financial services,” says Vice Mayor Cui.

A third area involves the development of new specialist areas of the financial system. One example is lease finance, where Tianjin is already the clear leader in the development of this new sector. “Already Tianjin has four financial leasing companies,” says Du Qiang, deputy director general of the Financial Affairs Office within the Tianjin Municipal People’s Government. “It has made Tianjin a centre for lease finance.”

One of the early entrants into this industry has been ICBC Leasing. Fan Ergang, vice chairman of the board, explains what prompted ICBC to pick Tianjin as the centre for its new business – after all, its 10,000-strong target customer base in aircraft and ship leasing covers most of China so it could have chosen anywhere. “The decision was made to locate the company in Tianjin mainly because of the boom and pilot reform happening here in the Binhai New Area,” he says.

In particular, financial reform is appealing to ICBC because of the move towards mixed operations in the finance sector and because of the possibilities for the development of risk management policies. The pilot foreign exchange liberalisation, discussed below, should also be useful for a leasing company so as to avoid currency fluctuations.  “We believe we will have a brighter future, with a more comfortable operating environment and more flexible inspection policies and regulations,” Fan says. “There is also more potential.”

The outlook for lease finance is exceptional in China. Today, the ratio of lease finance is just 3% in China, compared to 30% in the US – which means that after products are manufactured, only 3% of them are sold or financed to their next users through a lease in China. That shows the potential of this area. 60% of aircraft globally are purchased by leasing companies, and then leased to operating companies for the airlines. “Most Chinese airlines just lease the aircraft from overseas finance leasing companies, because there’s been no such leasing company to handle these activities in China until now,” Fan says. He says domestic airlines leased 992 aircraft from overseas companies by the end of 2007, and that 3000 more planes will be needed in China in the next 10 years. “You can see through these numbers how large the potential of the leasing market is in China,” he says. It’s a similar story for ships, trains and even power.

Another appeal for ICBC choosing the Tianjin area is the neighbours. With zones dedicated to manufacturing and high technology, “that means the complete supply chain for certain sectors will occur in the Binhai New Area.” For example, Airbus has built a major manufacturing base in the new area: there is now a complete aviation supply chain present including machinery, engines and even seats manufacturing.  “With these two accumulating effects, one financial and one manufacturing, we believe an ideal economic base and environment will be created.”

There are other specialist institutions being built too. The Sino-German Home Savings Bank, or Bausparkasse, began operations last year. It offers home loans and was jointly set up by Construction Bank of China and Bausparkasse Schwaebische Hall. Another institution, Binhai Rural Commercial Bank, also opened in 2007, aimed at building the financial service system in rural areas around Tianjin.

One of the most significant new institutions is Bohai Bank, which officially opened in February 2006 – the only nationwide join-stock domestic commercial bank approved by the government since 1996, it was launched in part to promote the financial innovation enshrined in the State Council’s ambitions for Tianjin. It has seven major shareholders, including both state-owned enterprises and private companies; among them is Standard Chartered. The diversity of its structure is unusual, and is designed to help with decision making. It is considered a leader in corporate governance, has an excellent independent audit and risk management system, and has its own internal five-year development plan which includes a unique remuneration and welfare system aided by an external remuneration advisory company.

Already, despite its short history, Bohai Bank has launched 25 new products in areas such as wealth management, loans, trade settlement and custody. It has researched financing products using bond, trust and derivative structures, and has launched a highly regarded loan mortgage service, advancing 427 loans worth RMB300 million in its first six months. It founded an investment banking department in April 2007 and is at the heart of foreign exchange reform in the new area, discussed below. It has also already participated in 11 underwriting groups for commercial paper issues. Total assets had reached RMB32.49 billion by the end of 2007, with a deposits balance of RMB25.84 billion and loans or RMB18.12 billion; after-tax profit was RMB45.66 million, well ahead of the break-even target the board had set.

In the insurance sector, Bohai Property Insurance Company commenced operations in 2005, and is also primed to take advantage of financial reform. According to Wang Jiandong, general manager, Tianjin and the Tinjain Binhai New Area boast the highest potential growth rate for insurance anywhere in China. The insurer has already grown rapidly: it now has 19 sub-offices across China and achieved RMB740 million in insurance fee income last year. “Insurance will be a key area in these comprehensive reforms, and Bohai Insurance will take advantage of its pilot status,” says Wang.

Specifically, the insurer may be able to take advantage of the cross-disciplinary approach being tried in the pilot scheme, and so venture into life insurance and asset management. It may also be permitted to use its capital in a way that insurers have not previously been allowed to do: suggestions from the State Council suggest insurers may be permitted to invest in the equity of financial organisations, industrial investment funds, and infrastructure projects. It is also likely to foster innovation in products, in customer services, and in distribution, with the company planning to try telemarketing and web sales among other things. Many other areas of financial reform – foreign exchange, mixed operations, the OTC market (see below) – should bring with them opportunities for new insurance products while the vibrancy in the manufacturing sector with the arrival of foreign manufacturers like Airbus is also good news for an insurer. “All these investors bring us the chance to provide services,” Wang says.

Another exciting development is a new arbitration centre. “This has significance in two aspects,” says vice mayor Cui. “The service this arbitration centre provides is focused not only on Tianjin, but the region around Tianjin. And it will work not only according to domestic laws but international laws.” The centre, which will have a higher status than the court and local arbitration institutes in China, will “provide the development of a complete legislative environment,” he says.

A fourth item of reform concerns foreign exchange, with some special policies to be tried out in Tianjin. The State Administration of Foreign Exchange has approved the trial of these measures – and with foreign exchange being one of the areas that foreigners watch most closely in China, it represents another example of Tianjin’s growing status.

Specifically, controls will be loosened over foreign exchange under the capital account, and ways will be explored to allow renminbi capital account convertibility in certain areas and within set amounts. The management of foreign exchange under the current account will also be improved, and in time residents and enterprises may be able to buy and sell foreign exchange voluntarily.

As part of these measures, banks will be allowed to develop offshore finance in Binhai, which should facilitate exchange between foreign lenders, borrowers and investors. It will mean there is no limit to the amount of foreign exchange that can be transferred between bank headquarters and branches, while the threshold for individuals to hold shares in foreign listed companies will be lowered. Announcing these measures in 2006, the then mayor, Dai Xianglong, referred to Tianjin as “the icebreaker for the country’s financial reforms.” In theory, these reforms should stimulate foreign trade and held to boost the coastal areas around Tianjin.

The fifth area of financial reform will involve the establishment of financial markets. In particular, Tianjin will host the first national over the counter (OTC) market in the country. It will also be home to a climate exchange, along the lines of the Chicago Climate Exchange – unquestionably, a landmark development which will be closely watched worldwide. Du says the government has been in extensive dialogues with China National Petroleum Corp [PLEASE CHECK – TRANSLATOR WAS NOT SURE]and CCX to help develop this exchange; “We have worked on this draft plan for over a year, so I think this market will soon be established,” he says. It is a vitally important market for China and the world. As Vice Secretary-General Chen says: “We work for the whole nation to reduce pollution, clean the air and provide a good environment for the market.” A third new market, for the exchange of property rights, is also envisaged.

The sixth and final area of reform concerns the environment for a financial services centre. “To give support to the financial sector we have issued policies in finance, tax, commerce and registration,” says Du. This includes background support for financial institutions, domestically and internationally. As things stand there are already three financial services areas in Tianjin – downtown in the city itself, Finance Street in TEDA, and a district called Yujiapu financial area, which is under development and aims to serve the whole of the Binhai New Area. But in order to ensure financial services businesses have the right support, a fourth area will be established, to serve entities like funds and leasing businesses, between the city and the New Area.

The TBNA is already home to an active financial services industry. By the end of 2007 there were 26 banks located in the area, with 6,300 employees, and with seven foreign banks among them. Their assets grew 29.7% in 2007 alone. There are 447 bank offices and connecting points, alongside non-banking organisations and 68 insurance organisations with a further 3,200 employees. There are 10 operational offices of securities companies.

It is interesting to note that the banks in the Binhai new area have on average a lower non-performing loan rate than is the case in the rest of the country. The national figure is 5.6%; in the new area, just 2.4%, according to Chen Fang, chief of the financial and investment development bureau at the administrative committee for TBNA.

Factors like these are attracting more and more foreign enterprises. All told, within TBNA or the city of Tianjin, foreign branches include Standard Chartered, BNP Paribas, HSBC, Credit Lyonnais, Societe Generale, OCBC (from Singapore), Chase Manhattan Bank, and Japan’s Sanwa and Sakura Banks.

Also very prominent are Korean banks, drawn by the proximity of Tianjin’s port to Korea. One, Korea Exchange Bank, decided in January 2008 to put its national headquarters for China in Tianjin.

Why? “We believe, in this new century, the economic development of China is happening here in Tianjin and the Circum Bohai area,” says Kwang Hyun Lee, general manager of the Tianjin branch of Korea Exchange Bank. “It is the engine for the whole of northeast China’s economic development.”

KEB considered Shanghai and Beijing as national headquarters, which are more commonly used as national headquarters. But Lee recalled the days when people knew of only one tall building in Shanghai, the Pearl Tower, and wondered why they should bother to invest there. “After 10 years development we can see how mature it is. The same story and miracle will definitely happen here in the Binhai New Area. We should grow together with it.”

In fact, KEB first set up in Tianjin in 1993, because so many of its Korean clients had chosen the city as a location. Many of these clients are engaged in logistics and the chemical and oil sectors, which makes Tianjin a natural home for them. Other Korean institutions have had the same experience, such as Industrial Bank of Korea, a policy-oriented bank mandated to support small and medium sized enterprises – many of whom have gone to Tianjin as suppliers to bigger multinationals like Samsung or Hyundai. “Tianjin was our first step to invest in China,” says Moon Ho Sung, general manager of the Tianjin branch. “We have more than 10 years history here.” The pilot reform programme will give it opportunities to grow from its core SME business into other areas, perhaps including securities, insurance or offshore financial services.

In the future, people are likely to look back at the pioneering efforts taking place in Tianjin as some of most visionary and influential reforms affecting Chinese business and finance. The city and new area have been given an outstanding opportunity to help China move forward in financial innovation, and they are determined to seize that chance.

 INFRASTRUCTURE

A vital part of Tianjin’s attraction is the outstanding transport infrastructure linking it with the country and the world. “Tianjin is one of the cities under direct management of the central government,” says Zhang Xiaoguang at the Tianjin Municipal Development and Reform Commission. “So we have a complete transportation and infrastructure system.”

The port is perhaps the most visible part of this, having been a mainstay of Tianjin’s development for over 150 years. Today, it is the largest cargo port in North China, with an annual handling capacity of more than 310 million tons and 7.1 million TEUs, with the latter figure expected to pass 10 million by 2010. It is already linked with more than 300 ports from 170 countries and regions worldwide, and is the subject of ambitious expansion plans, growing from its original 40 to 100 square kilometres. Construction is underway on a 250,000 ton deep water channel and a 300,000 ton crude oil dock. The emergence of the Tianjin Port Free Trade Zone, the largest free trade area in northern China, will help it to grow. Ten square kilometres of the port are given over to Dongjiang Bonded Port, the largest bonded port zone in North China.

Although the city is easily reached through Beijing Airport, Tianjin Binhai has its own landmark international airport, which will have a 5.6 million passenger capacity and a 500,000 ton cargo capacity by 2010. This is envisaged as the air freight centre for north China.

Before the Olympic Games, Tianjin’s heavily redeveloped railway station will open, featuring a high-speed train that will carry passengers to and from Beijing in just 30 minutes – an extraordinary feat of engineering. This is only part of a major railway network through Tianjin; there are six major railways in all directions, as well as an inter-province metro. A high speed train is also envisaged to link Beijing with Shanghai, passing through Tianjin. The Beijing train will extend to join a commuter line between TEDA and Tianjin by 2009.

Tianjin is at the heart of one of the country’s best networks of roads, including nine expressways, six inter-province highways, and with a further two expressways between Beijing and Tianjin near completion to complement the existing one. Zhang says the combined total of expressways, at 700 kilometres, is the highest of any Chinese city.

This transport infrastructure makes it easier to do business with and through Tianjin, and cements the area’s standing as a hub both for the development of North China, and for trade with the rest of the world.