Emerging Markets, October 2007

Putrajaya is a curious place. Though few outside of Malaysia have heard of it, it is the country’s federal administrative centre, founded in 1995 to take the government departments out of nearby Kuala Lumpur. It’s a place of resplendent architectural daring: mosques, palaces, convention centres, and five extraordinary bridges over a 650-hectare man-made lake. But the most striking thing about it is this: there’s no-one there.

Arriving on the train from a gridlocked rush-hour in Kuala Lumpur, it’s common to see perhaps half a dozen cars on the wide boulevards that link the station and the town centre. It is an infernal place to try to find a cup of coffee. Nobody walks the streets.

 And in a particularly isolated corner of Putrajaya, reached by taking a road past an uncompleted bridge opposite an uncompleted Mosque, one finds the Perdana Leadership Foundation, “dedicated to leadership and national development by studying Malaysia’s past leaders.” And upstairs in this building sits the past leader who commissioned this pristine, empty city, and who ran Malaysia for 22 years, half its modern history: Tun Dr Mahathir bin Mohamad.

Now 82 and with several heart attacks behind him, Mahathir is a frail figure in person, but with none of his mental sharpness lost. In fact, what impresses about Mahathir is the sheer range of issues he is simultaneously angry about. He is angry about the removal of capital controls he put in place during the Asian financial crisis. He is angry about the handling of national car manufacturer Proton – an iconic venture whose creation he was initially responsible for. He is angry about the behaviour of Khazanah, the state agency tasked with improving the performance of government-linked companies; about gradual shifts away from affirmative action policies to protect ethic Malays; about the return of his former deputy and now nemesis, Anwar Ibrahim, into Malaysian political life. And in particular he is cross about the failure to pursue the so-called mega-projects that characterised his time in office. 

Which makes Putrajaya, the ultimate mega-project, a suitable place to be meeting him, since the place’s apparent redundancy reflects his malaise at a government (led by a man he appointed but has since turned against, Abdullah Ahmad Badawi) that has taken some quite different directions to those he had hoped for. They are the first thing he mentions when asked what his successor has done wrong.

“The initial thing he did was to stop what they called the mega-projects,” he says, although he doesn’t like the term, considering the projects perfectly ordinary. “But when the government stops spending money, lots of people suffer: contractors will suffer, subcontractors will suffer, suppliers, the chap who peddles food on the roadside. You will slow down the economy.” Badawi’s Ninth Malaysian Plan does appear to be putting many big infrastructure plans back on the agenda, notably the Iskander Development Region in Johor, in Malaysia’s south, but it hasn’t appeased Mahathir. “Now they have changed their minds and decided we must have these mega-projects again, but to start them is very difficult: you have to acquire land, go through legal processes, pay out compensation, there will be protests. You have a five year plan which gives out a very beautiful picture of what we are going to do. But after three of the five years nothing is done.”

Mahathir’s influence is stamped all over the country through these projects, from icons like Putrajaya and the Petronas Towers to key infrastructure like the North South Highway, the vast (and underused) Kuala Lumpur International Airport and the Multimedia Super Corridor, to say nothing of the nation’s educational, media and even judicial institutions, for better or worse. Critics say Malaysia under Mahathir grew at the expense of freedom of speech, independent judiciary and true democracy. But grow it most certainly did, particularly in the pre-crisis golden era from 1988 to 1997 when growth averaged over 10 per cent and standards of living improved considerably, for most citizens at least.

Today there is regret at what has happened since. “It has regressed a bit, I’m afraid,” he says. “Before, foreign direct investment into Malaysia was always bigger than to most other Asean countries. I was shocked to find Indonesia attracted more foreign direct investment than Malaysia. We need to reposition ourselves in the context of China and Vietnam, and other developing countries, India for example. Unless you do that, you are going to go backwards.”

Outside of Malaysia, Mahathir will always be known best for his response to the Asian financial crisis. This was, depending on your perspective, Mahathir at his absolute best or worst: bloody-minded, facing down a crisis, shouting at the world and doing what he thought was right no matter how many people were telling him it was wrong (and pretty much everyone was). This was the era of blaming the ringgit’s devaluation on a Jewish conspiracy, with George Soros coming in for especial contempt.

A decade on, there doesn’t appear to be a thing he would have done differently. “I learned a lot, because I knew nothing about finance,” he recalls. “I had to read up, I got people to brief me. I had to understand how banks work, how their accounts are kept, so it was a good learning experience.” And was his approach – characterised by a peg to the dollar and a range of capital controls – the right one? “Yes, I think it was. It still is.”

Today, almost all of those restrictions are gone: even short selling has been introduced, in a limited sense, to Bursa Malaysia, and foreign exchange restrictions were axed in March. “I still believe there is a role for fixed exchange rates,” he says now. “When we allow it to float, today the ringgit is stronger but we are not getting any benefit from that… we have no means of ensuring the strengthening of the ringgit benefits people.” He adds: “Floating is all right provided you restrict these people who manipulate the market.” Short selling, he still says, “is manipulation. It is something that, because you have power and a lot of money, you can go in and buy and buy and push up the value of shares and then dump them.” And even today he considers Asian countries in danger. “They are more sophisticated, more knowledgeable, but still if there is another concerted attack against their currencies some of these countries could go down again, and that may happen to Malaysia even.”

Another of Mahathir’s lasting effects on his country is the New Economic Policy, the controversial affirmative action approach that sought to put 30 per cent of the national economy in the hands of Bumiputras, or ethnic Malays. This was passed in 1971 so was not Mahathir’s policy, but he was around to keep it in place and to oversee the implementation of the similar National Development Policy that succeeded it in 1990. Badawi appears to have made the first steps away from the policy by saying that it will not apply in the Iskander development, and this too has drawn Mahathir’s ire.

“We have not achieved the target we set for ourselves,” he says. “I believe the NEP target of affirmative action needs to be restudied. But if you want to do away, you can do away after proper study.” Mahathir points out that he did repeal several previous NEP decisions, notably quotas on admissions to universities, where he eventually concluded that admission should be based on merit rather than race. “But there are other areas where there is a role to be played by Bumiputras, and you have to give them consideration. You can’t just say I don’t care.”

It is widely argued, even by some Malays, that the approach has created an uncompetitive Malaysia, a generation that hasn’t needed to be competitive because it knows it will be helped, thus impeding the group it was intended to protect. “There is some truth,” says Mahathir. “Like all plans to improve anything, it’s not 100 per cent perfect. [But] Bumiputras are much better off than they were before NEP.” Notably, the percentage of Bumiputra doctors has gone from 2 to 40 through the policy. “I always believe that when you want to get a thing up straight, you overstretch, and then when it rebounds it comes to the correct position… Affirmative action notwithstanding, we can still perform.”

There are many other things on Mahathir’s list of grievances. At Proton, which at the time of interview was clearly in crisis and becoming more and more likely to need a foreign acquiror to survive, he bemoans the removal of a successful CEO where “they put in an accountant who apparently couldn’t understand the automotive business, and his idea of running an automotive industry is to have meetings every day.” He believes foreigners can come in to Proton, but not control it. “Otherwise it will not be a national car. A national car must be owned by the nation.” He complains about the expansion of Khazanah’s role into corporate life. “Khazanah was set up to be a repository of shares. It’s not supposed to be involved in management.” He calls for more transparency in all GLCs and even takes on the one great success story of GLC reform, Malaysian Airlines: “I know some routes where they were carrying full loads but they stopped. So why were they stopped?” He sees little need for the new free trade agreement signed between the US and Malaysia.

Asked about Anwar, who fell from being Mahathir’s most likely successor to being incarcerated on corruption and (subsequently overturned) sodomy charges before being released and recently making a tentative return to politics, Mahathir is curt. “There will be some people who might be entranced by him. His party might pick up a few seats. But he’s not going to become prime minister of Malaysia.” Does he feel he dealt with Anwar fairly? “I dealt with him very fairly. In fact I restrained myself quite a lot, until I reached a stage where I cannot put up with it anymore. It’s not because of politics, it’s his personal behaviour.”

It is time to go, and in concluding Mahathir returns to his concerns about the leader who he appointed to continue his visions but who has failed to follow the plan. “Any new government will want to start its own policy and be recognised for what it is doing. But the idea that you should take a 180 degree turn in order not to be identified with previous governments, that idea is wrong. If you have new ideas that are going to yield better results, by all means. But so far I have not seen any.”

He gestures towards the window, to this custom-built city that wouldn’t exist without him, and one is struck by the opportunity that must be presented by running the same country for 22 unbroken years. “Everything we do, the intention is long term,” he says, the present tense still firmly in use. “We never do things only for tomorrow. We built an airport for 100 years. One has to be able to see quite far ahead.”

Euromoney magazine, part of cover story, September 2007

China is well known for its opportunism, but it takes a special kind of entrepreneurial zest to make money out of your own pollution. In the curious world of carbon trading, China accounts for perhaps half of all credits traded with the west, as unseen utilities half a world away effectively pay to build windfarms and clean up freon plants the length and breadth of China.

 China is at the heart of the clean development mechanism, or CDM. This is one of the key initiatives that came out of the Kyoto protocol, and is aimed at reducing greenhouse gas emissions while encouraging sustainable development in emerging markets. The idea is that any company or institution can invest in greenhouse gas-reducing projects in the developing world, for which they earn credits that can be used to offset their own emissions, or indeed sold in the open market. These credits are formally known as certified emissions reductions, and are often called carbon credits.

 In essence: build something environmentally beneficial in China, offset your own pollution in Britain or America. And while it might sound odd, it does make sense. A greenhouse gas emission hurts the environment just the same no matter where it comes from, and reducing pollution in industrialising new economies is obviously to the greater good. If that creates a market in which some people, whether developers or brokers or banks, get rich, then so be it. And for Chinese businesses, it’s a bonanza: the rest of the world is paying them to clean up their act.

 They have not passed up this opportunity. Today, estimates of the proportion of the CDM market that China accounts for vary between 40 to 60 per cent, partly a reflection of the amount of emissions the country produces in the first place (officially second in the world, and well on track for the top spot, probably by 2009), and consequently the many ways of achieving reductions. In particular, China produces and uses more coal than anywhere else in the world. “If you build a windmill in China you can generate a lot of carbon credits because what would have happened otherwise is they’d build a coal plant,” says Roger Raufer, director of engineering services at International Environmental Trading Group. “You could build a windmill in Costa Rica too, but the carbon credit is going to be much smaller.”

 “At first, [Chinese] project owners were in complete disbelief,” recalls Leigh Fitzgerald, a senior specialist at Arreon Carbon, part of a growing private sector industry of project developers and brokers that has grown up in China to match buyers and sellers. “They said: ‘People are going to pay us money to do this, are you kidding?’ They were almost suspicious.” That initial bafflement was quickly replaced by a voracious appetite, then sophisticated opportunism.

 It would be churlish, though, to call it a scam. Even if Kyoto were all to fall apart, and no carbon credits ever traded again under this mechanism, there is a great deal of renewable energy infrastructure in China that otherwise would not be there. More to the point, despite looking from a distance like a sure-fire recipe for an easy buck and a bit of manipulation, the system is in fact rigorously policed, by the United Nations Framework for Conventional Climate Change.

 “The registration process is lengthy. It’s onerous. It’s not trivial by any stretch,” says Paul Ezekiel, head of global carbon trading at Credit Suisse in New York, and formerly the president and co-founder of a specialist merchant bank and advisory firm in the environmental industry, called Antipodean Partners. “Some people view it as potentially having a random construct behind it: I plant a tree and generate a credit. It’s nothing of the sort. It’s an environmentally rigorous market. And without that, there’s no way a financial institution like Credit Suisse would invest one dollar.”

 Getting from signing a contract to seeing a credit takes 18 months to two years (which has already created a vibrant forward market). When a group like Arreon Carbon takes a look at a potential CDM project, it first asks its technical department to assess if it has a strong chance of UN approval. If it does, the technical department writes a brief called a product development document in English and Chinese. The Chinese one goes to the government, which then has to approve it for submission to the UN, and provides a letter of authorisation. Whichever foreign party is lined up to buy the credit has to do the same with its own government. There also has to be a third party validator – designated by the UN – which goes in and writes a report on the project assessing its viability. The whole lot goes back to the UN who, having approved it as being eligible for carbon credits, then goes back every year to check on it. (Arreon, active in this business for several years, is only now getting its first projects registered.)

 Consequently, if there’s a criticism of the system it’s that it is overly strict, expensive and inefficient, not that it is laissez-faire or opaque. “From a liquidity provider’s perspective it is far more important for it to be very onerous than for it to be very lax,” says Ezekiel. “It’s good that it’s strict. I’d like to see it more streamlined, of course, but if it’s going to go one way or the other it’s better to be more strict than less.”

 Raufer adds: “One thing Kyoto has done is take all the compliance and put it outside of the host countries. You can do a project anywhere in the world, Asia or Africa, and [the verification] will be issued by an agency in Bonn. It’s obviously more expensive to do transactions that way, but it does mean there is internationalised compliance.”

 The projects themselves can cover all sorts of areas: the creation of renewable energy projects such as wind farms, solar or biomass, which qualify for carbon credits because they displace energy that would otherwise have been generated by coal; the implementation of technologies to reduce emissions in existing plants; even methods of improving energy efficiency in buildings or transportation.

 There are, though, anomalies. One of the problems with the CDM is that there is a sense that some people play the market, creating an effect quite contrary to what Kyoto intended.

 A clear example of this came in China with the pollutant HFC-23. This is a by-product of the manufacture of a refrigerant called HCFC-22, and is the most potent gas covered under Kyoto. Under the protocols established at that treaty, different emissions are considered to be equivalent to set amounts of carbon dioxide, and so lethal is HFC-23 that it is considered to be worth 11,700 times more than a tonne of CO2.

 Getting rid of this stuff is clearly a good thing, and it’s pretty easy to do, too, with a straightforward revamping of facilities. But here’s the thing: the tradable value of HFC-23 so dramatically outweighs the cost of fixing the problem, that it makes economic sense to develop these plants just in order to fix their own pollution and pocket the revenue. Stanford University Professor Thomas Heller told a forum in Hong Kong in July that the market price of HFC-23 is nine euros per ton, and the cost of abatement, just 10 euro cents – with the difference between the two mainly being profit for the company doing the polluting in the first place.

 Seeing this, China intervened to stop new plants being built by levying a 65 per cent tax. (Where this money goes is a moot point, but the United Nations Development Programme says it goes into a new CDM Fund launched by the Ministry of Finance. Kishan Khoday, assistant country director and team leader for the energy and environment team at the UNDP in Beijing, says his organisation has been approached by the ministry “to help analyse how to make use of this new fund. It’s an innovative model whereby China could use tax revenues from CDM credit sales to do broader sustainable development projects,” achieving not only emission reductions but broader development goals.)

 Besides, markets aren’t supposed to be ethical, just efficient. “These markets are artificially designed,” says Raufer. “In this case the market did what markets are supposed to do: found the easiest, fastest way to generate credits.”

 HFC may just be a teething problem necessary in an evolving market. “Most of the developers in CDM feel that HFC is done: there are no projects left and it was the low hanging fruit that got snatched up first,” says Fitzgerald. “The projects being developed now tend to cost more and there’s a lot more renewable energy projects. There are about 8 to 10 HFC projects and 250 renewable energy.”

 Now, China is on track to move from this system of bilateral trades to a more formal exchange. The UNDP, which since 2002 has provided capacity building support to China in building its CDM markets, launched a new initiative in February to advise the Chinese government on how climate exchanges operate and whether one would be beneficial in China. Specifically, the Ministry of Science and Technology  – a key member of China’s National CDM Board – will implement the project, and has spent the time since the launch identifying experts to undertake research, which will now get underway.

 Officially there is no plan for the Chinese government to establish a climate exchange system. The research “is meant to explore how such exchanges work in the west, and explore the value such a mechanism could have in the future for expanding China’s role as a major supplier of carbon credits to the global market,” says Khoday. China has no commitment to reduce emissions under Kyoto, and “such a mechanism would not involve the type of domestic cap-and-trade systems present in Europe and other western countries,” says Khoday. It would instead focus on a more effective supply of credits from China to the west.

 Broadly, the benefits of a formal exchange are likely to be that it brings market efficiencies, makes it easier to match buyers and sellers, and to keep a balance between different project types. It facilitates the availability of information too. The challenge is that the entire global market is only really a couple of years old, and as the European experience has shown (so much supply that credits have dropped to a value where it becomes economically sensible to pollute) there is plenty of learning and experimentation to be done.

 If it launches one, it may well be beaten to it by Hong Kong. On July 18 Hong Kong Exchanges and Clearing appointed Australian law firm Mallesons Stephen Jaques, and consultants International Environmental Trading Group and Climate Focus, to study the trading of emissions-related products, expecting the study to take four months. “The US has developed sophisticated markets on pollutants; Europe has a large and aggressive market. It’s pretty clear Asia’s going to be next,” says Raufer at IETG. “The question is how do you evolve into that, and deal with development issues and pollution problems.”

 Key to it will be the regulatory framework. “You need an institutional basis for structuring these markets,” says Raufer. “They are artificial markets created by government requirements. They’re not like widgets or cellphones where people want to buy them. You buy them because you have to. So you need that regulatory infrastructure, and it takes a while to establish.”

 Even before an exchange has been launched in the region there’s a slight sense of overkill. “I have had conversations with six up and coming regional exchanges for carbon,” says Ezekiel. “It begs the question, what’s the role of a futures exchange in any up and coming commodities market? There’s a role for a local exchange but I’m not sure if every country needs a carbon exchange.”

 Moving China forward on this or any other climate change decision is complicated by the fact that Kyoto, under which China (like all developing countries) has no obligations to reduce emissions, is coming to an end, and that nobody really knows what the successor agreement will look like from 2012. If the establishment of an emissions exchange were to be interpreted as a willingness to accept an emissions cap, that might not be in China’s immediate interests.

 Anyone involved in carbon trading with China also has to think about issues of enforcement. As projects and credits get rolling, and as the Kyoto protocol enters into what is called its “compliance period” from 2008 when developed world countries with emission commitments will have to start reporting to the UN on how they have done, this is going to be very important. “The next big issue which the international community will be dealing with in the near future is that of compliance under the UN Kyoto protocol,” says Khoday.

 China does not have the rule of law, and previous local pilot projects in China (see box) have been criticised for placing far more emphasis on written laws than is appropriate in a country that does not hold them as sacrosanct. Also relevant are the great power of local government, and the power of contract.

 “In the US, the information flow and legal process is well understood between the parties trading,” says Christine Loh of Hong Kong-based NGO Civic Exchange. “In China, it is much less so, which is why there is a heavy administrative component to Chinese schemes.” Fitzgerald says Arreon puts all its contracts under English or Hong Kong law.

 Would they be enforceable in China? “We’ll see. For the most part everyone seems to think it’s the best we can do.”

 BOX: TAIYUAN, AN UNLIKELY PIONEER

The industrial town of Taiyuan doesn’t look much of a place for landmarks. True, the capital of Shanxi province is often compared in environmental literature to Los Angeles, but only because it is surrounded on three sides by mountains to create a similar trap for smog. But this coal mining city, largely unknown to the west despite having the same population as Rome, has a claim to fame: it is the birthplace of emissions trading in China.

 In 1998 the World Bank gave Taiyuan the unhappy accolade of being one of the world’s most polluted cities. China was sufficiently concerned about this to put in to its 10^th Five Year Plan, for 2000 to 2005, a call for sulphur dioxide emissions in the city to be halved over that timeframe. Shanxi’s provincial government applied to the Asian Development Bank for a loan and technical assistance, aiming at bringing in the use of market-based instruments for air quality management, and strengthening the ability of provincial agencies to implement them.

 Sulphur dioxide trading is very different to carbon trading, for a simple reason: carbon emissions create a global issue, sulphur dioxide local. The whole premise for carbon trading is that a greenhouse gas wrecks the environment just as much if it is emitted in Beijing or Bradford. That’s why it is considered legitimate to offset your own emissions by supporting clean energy development on a completely different continent, the idea that underpins the Kyoto protocol’s clean development mechanism (see main story).

 Sulphur dioxide, on the other hand, causes problems locally but not elsewhere in the world. Sure, there are environmental and political issues when wind blows Chinese fumes across to Korea and Japan, but in essence measures to curb these sorts of emissions rely upon fixing the problem in a local area. And since China is the world’s largest producer and user of coal, whose principle by-product is sulphur dioxide, this is a big challenge indeed.

 There is a useful role model for sulphur dioxide reduction: the US Acid Rain Program, set up in 1990 to reduce SO2 and nitrogen oxides from power plants. It involved demanding cuts in emissions from industry, and giving allowances to plants for a certain amount of those emissions, with these allowances able to be bought, sold or banked. A power plant able to cut more emissions than required was able to profit by selling the additional allowances; a plant unable to cut the emissions was able to buy those allowances, thus staying on the right side of the law but incurring a clear financial penalty. It has been considered a great success.

 The ADB elected to follow a similar model, known as “cap and trade”, in Taiyuan, whose municipal government passed a new regulation for emission trading in 2002.  Twenty-six enterprises became involved in the scheme, with the first trade of credits going through between two industrial enterprises in December 2003. Although other trading projects in Nantong, in Jiangsu province, and Benxi, in Liaoning province, kicked off earlier, Taiyuan is considered the most ambitious and instructive of the pilots.

 “It was successful to a degree,” says Anthony Maxwell, environment specialist at the Asian Development Bank in Manila, who became involved in the project late in the day and formally closed it in January 2005 after the conclusion of its mandate. “It was too small to be self-fulfilling for a long period, because it required very strong advocacy from the government to push the trading. But it was a useful tool for learning, and for the national scheme.” Following other pilot projects in China, government enterprises including the National Development and Reform Commission and the State Environmental Protection Agency are believed to be looking at a national scheme.

 The Taiyuan project did, however, come under strident criticism from Ruth Greenspan Bell, a noted scholar on the environment, who took it to task in an address to the OECD Global Forum on Sustainable Development. She credited it with enacting a regulation providing the legal basis for emission trading, and enabling an allowance and emission tracking system, but called the emission reduction targets unrealistic and said that the lack of any serious efforts to pursue compliance and enact enforcement reduced any motivation for industry to set up the scheme. In large part, Bell’s complaint was about the relative meaninglessness of written law in China, which is hardly within the remit of an ADB technical assistance program on acid rain, but is an important point when considering any emissions market development on the mainland.

 A new emissions trading scheme underway in Hong Kong also takes the local approach. That’s natural: Hong Kong’s air quality has deteriorated appallingly over recent years, and much of the blame is aimed at factories in neighbouring Guangzhou.

 The new Emissions Trading Pilot Scheme provides a platform for thermal power plants in the Pearl River Delta to trade emissions for sulphur dioxide, nitrogen oxides and respirable suspended particulates pollutants. It is a voluntary programme “based on the power companies’ own commercial considerations,” says a spokesperson for Hong Kong’s Environmental Protection Department.

 It will work like this. Power plants can propose emission reduction plans – use of cleaner fuels, perhaps, or better energy efficiency – to the local government environmental protection authorities. If those authorities approve the emission reduction projects, and the reductions are verified by both governments, then the reductions can be transferred between a buyer and a seller under a trading contract. The spokesperson says the programme is intended to “promote the use of market based tools in the region, to enable both Hong Kong and Guangdong governments to gain experience in the implementation and management of emissions trading schemes, and to lay the foundation for the further development of emissions trading systems in the future.”

 Anything that reduces pollution in the area is welcome, but the project clearly faces many challenges, among them persuading industry to take part in a voluntary scheme. A seminar was held in Guangzhou in May to promote the scheme to local power companies. “The general responses are positive towards the introduction of the pilot scheme,” says the spokesperson, though as yet none has formally joined it. “I think they [companies] are cautious, and you would expect that,” says Raufer. “It’s a normal corporate response, especially from electric utilities.” Christine Loh at Civic Exchange adds: “I am frankly not sure how this will be develop. There have been meetings between Hong Kong and Guangdong where the various utilities had apparently participated but I am not sensing a lot of speed on progress.”

 In the meantime, the Hong Kong and Guangdong authorities are trying to raise awareness of the scheme, promote it as an attractive option for industry, and Hong Kong is putting through legislative amendments to facilitate it. On the Hong Kong side of the border at the very least, there is consensus that something has to be done: more and more people are leaving the city with their families for the cleaner air of cities like Singapore, taking their business with them. And from Hong Kong’s perspective, few things hurt more than that.

 In the fluid and competitive world of China investment banking, new hires come and go, but occasionally one comes along that really rattles the market. One such came in February when Merrill Lynch hired Margaret Ren, the former Citigroup China chief, as its chairwoman of China investment banking.

 This is a bold and surprising hire. Ren is arguably the ultimate rainmaker: bankers with such exceptional relationships that they can bring in big mandates for houses that might otherwise have no right to expect them. The daughter-in-law of former premier Zhao Ziyang, Ren proved her contacts and persuasiveness time and again at Bear Stearns and Citigroup. Her successes in getting Bear Stearns on to IPO and secondary issues for names like China Telecom and Guangshen Railway in the late 1990s, when the bank had no meaningful China investment banking presence to speak of, are widely considered the most extraordinary examples of leveraging relationships the China market has ever seen.

 But she left under a cloud when sacked by Citi in 2004 over her behaviour in the IPO of China Life Insurance, a departure that has never been explained but is believed to have centred around allocation of shares in the IPO and a manipulated document submitted to the US Securities and Exchange Commission. Although subsequently cleared of wrong-doing by the SEC itself, her reputation was damaged severely.

 The hire, like Ren herself, divides opinion. “Bizarre”, says a rival China head. “Excellent hire,” says a leading headhunter, not involved in her move. One banker: “Margaret without that family connection would have zero value in China.” Another:  “She is without question the most effective China banker of her type the market has seen.”

 The disparity in view, and the ferocity of attention, is because Ren’s move is about more than her past behaviour or ethical probity. It’s also because to many people, it represents a return to a style of China banking from a past and less sophisticated era: the rainmaker, or princeling, model.

 The fashion these days is for banks to say they eschew the cult of the individual: that mandates are only won by houses with demonstrable excellence not just in coverage but execution, with industry expertise and a host of other skills beyond a well-positioned father-in-law or an ability to get a big meeting in Beijing.

 Big China privatisations today are decided by committees with a far higher level of sophistication and transparency than has ever been the case before (see box). And besides, those elephant deals are running out, with Agricultural Bank of China the only landmark on the horizon; the big story today is private sector listings, as the companies born of China’s burgeoning entrepreneurialism seek capital. The people who run those companies couldn’t care less about government connections because they don’t have to.

 Rivals look at Merrill’s hire – swiftly followed by a less controversial poaching, the recruitment of a rising China star, Rodney Tsang, from Credit Suisse – with some bemusement, seeing it as a step backwards, and wondering just how the bank can accommodate so many stars in one team. It already boasts Ehrfei Liu, one of the outstanding China bankers of his generation, as chairman of Merrill Lynch China; one market old-timer recalls him fondly as “leading the listing of China Southern Airlines when it was just a plane.” There is also already a China investment banking chairman, Wilson Feng, himself a well-connected individual (his father-in-law is Wu Bangguo, chairman of the National People’s Congress, who was in charge of state-owned enterprises under Zhu Rongji.)

 Feng and Ren will work alongside one another and report both to Liu and to Sheldon Trainor, the head of Asian investment banking, a driven and strong-minded figure in his own right. They will have the further supervision of the man who led the hires, Pacific Rim investment banking head Damian Chunilal, who is also COO for Merrill Lynch Pacific Rim. As one banker puts it: “There’s an awful lot of egos in that place.” Another: “I don’t think Sheldon knows what he’s taken on.”

 But Merrill is a bank enjoying great success in China, lead managing the record-breaking US$21.9 billion Industrial & Commercial Bank of China IPO late last year alongside a host of other transactions both lucrative and interesting. So these are not the hires of a desperate institution hoping to make up lost ground. So has Merrill, in taking a chance on what some see as damaged goods, just smarter and bolder than the herd? Or is it going to mess up a successful franchise with a hire that looks backwards rather than forwards?

 To answer that, let’s first take a look at what the competition is doing with its staffing models. Because for all their protests of building teams not individuals, the fact is that the same dozen or so key figures, many of them best known for their connections rather than their execution skills, have been bouncing around different investment banks for years, with little new talent rising to the top. “Some say all the princelings are dead,” says a top Chinese headhunter. “I don’t think so. You’re just relying on smarter princelings.”

 One perennially popular hire is Wei Christianson. Formerly at Morgan Stanley, she followed John Mack to Credit Suisse, then moved on to Citigroup to replace Margaret Ren, before being rehired by Mack barely a year into her stint at Citi to come back and run Morgan Stanley’s China team. This followed the departure of previous China head Jonathan Zhu to private equity firm Bain Capital.

 Christianson prides herself on not only being adept at coverage and relationships, but at execution too. And like all big names in China, she denies being a rainmaker, a term that these days has clearly come to have negative connotations of ego and lack of franchise support. “I never considered myself a rainmaker, though I do think I have the capacity to bring in business and interact and make connections with senior officials and senior clients,” she says. “But I have that power because of the platform and because of the support the firm gives me.” Mainland-born, and a law graduate from Columbia University, Christianson also spent time at the Hong Kong Securities and Futures Commission before entering investment banking.

 She argues that political connections are no more relevant in China than in London or New York, but recognises that in the mid-1990s “that was the only thing that was relevant. But this trend is changing. Firms are focusing on capable, very effective bankers who can build a relationship with clients quickly and sustain them. Those people don’t have to be the children of someone as was the case in the past.”

 Morgan Stanley is clearly a force in China, topping ECM league tables in 2005 with lead arranging roles on the China Construction Bank and Agile Property IPOs before a more fallow year in 2006, but like all houses it does face challenges. One, a whole separate subject, is whether the bank must sell its stake in mainland investment bank CICC in order to build a domestic platform that gives it access to mainland securities. Another is the staff turmoil that accompanied Christianson’s return, with 12 departures from the broader China team, although Euromoney understands three were internal moves and three more at the bank’s behest. Jing Zhao, who moved to Citigroup as Christianson’s replacement, was the biggest name to leave. “The most important thing is we are hiring,” says Christianson. “We are a powerhouse, especially in capital markets transactions.”

 When Zhao moved to Citigroup to replace Christianson, she moved to a house with surely the most troubled recent history of all foreign banks that hope to engage with China. Citi has found itself in strife three times: first back in 1999 when its handling of a pulled IPO for CNOOC effectively got it kicked off similar mandates for years; second when Ren, who was hired alongside Hong Kong’s own rainmaker Francis Leung in 2001 to correct that situation, left under such curious circumstances after having got Citi back into the field for big deals; and finally when, after reneging on a commitment to make a strategic investment in China Construction Bank, Citi found itself removed from the team to lead a share issue for the bank.

 Citi’s most recent attempt to repair the business involves notably more low-key hires than Ren or Christianson. The bank has two MDs in China, both of them hired within the last year or so: Zhao, as head of China investment banking; Zhang Wendong, hired from UBS; and a third due to join from a rival in April. (Albert Ng was hired from PricewaterhouseCoopers but has already left again; numerous other MDs have at least some involvement in China.) People like Zhao and Zhang are admired individuals but neither are in the rainmaker mould of either of Zhao’s two predecessors.

 Does this represent a difference in approach? Mark Renton, head of investment banking for Asia at Citigroup, says the model now “focuses on a team of senior bankers and plays to the strengths of the Citi platform.” He adds: “The marketplace is changing, and our sense is that relationships alone are not sufficient to deliver mandates. The client base in China is maturing very rapidly and becoming more sophisticated. Therefore you need to be able to front to those clients people who are very skilled bankers and relationship managers.” It is understood that Renton and Citi have tired of the star banker culture.

 Citi ought to be a powerhouse in China investment banking because it has so much else going for it in terms of its broader China platform. When it opens in Hangzhou this year it will be Citi’s seventh mainland branch alongside 16 consumer bank outlets. It employs 3000 people on the mainland and is a market leader in areas such as forex, cash management, trade finance and securities services. It led a consortium that took control of the 502-branch Guangdong Development Bank, and it holds 5 per cent of Shanghai Pudong Development Bank. It is the only bank in this story to have been approved for local incorporation. Renton describes a multi-layered model combining the coverage team, industry specialists, the corporate banking platform, relationships through the local bank ownerships, and principal investment.

 That’s quite a platform and Zhao, like her predecessors no doubt, believes it can be exploited. “The growing corporate footprint in China is being leveraged fully to complement the investment banking business,” she says. Citi believes its lead manager role on the almost US$2 billion China Coal Energy IPO in December demonstrates that it has again been rehabilitated; it also points with pride to its role on the first Sino-Indian JV last year as an M&A advisor.

 It all ought to work, but then it ought to have been working for the last 10 years, and if Citi is ever to be successful it must be able to make this disparate range of talent work together. “You can’t judge a China team for at least three years,” says one headhunter. “They have hired very good people but are in the rebuilding stage.” Again.

 Another house with a vast transactional platform and a modest recent history in investment banking is JP Morgan. By late 2005 JP Morgan’s lukewarm performance was drawing widespread criticism and is thought to be partly responsible for the removal of Asia chairman Ralph Parks last year.

 If Parks did lose his job for a flaccid China practice, the timing was unfortunate, because 2006 turned out to be a record year for overall revenue in China, both in investment banking and more broadly. “We consider it to be a banner year, a watershed,” says Charles Li, chairman and CEO for China at JP Morgan, whose intriguing CV includes stints working as an offshore driller for CNOOC and a reporter at the China Daily. “China, for the first time on the investment banking front, was the biggest market in Asia Pacific – bigger than Japan, bigger than Australia.” The bank got onto the US$2.66 billion IPO for China Merchants Bank and a $1.98 billion follow-on for CNOOC. “People used to think: JP Morgan, great brand, great firm, but they somehow haven’t been able to pull it together in China. Now we have.”

 Like Citi, JP Morgan’s franchise draws revenues from institutional broking, derivatives, and a host of wholesale banking services such as treasury, securities services, settlement and clearing. “It’s very significant fee generation business,” says Li. “They are almost like annuities. Once you have the mandate they’re there almost forever, so revenues are going to come in anyway regardless of having IPOs or not.”

 JP Morgan doesn’t really have rainmakers, with its most well known name Fang Fang, the former CEO of Beijing Enterprises and now head of China investment banking. The house has a problem, though, with the loss of rising star Leon Meng, formerly Fang’s co-head, who like Morgan Stanley’s Jonathan Zhu has found the allure of private equity irresistible and moved to DE Shaw Group.

 “It’s a very unfortunate loss for us,” concedes Li. “He is one of the strongest M&A bankers there is. Somebody with that combination of skills and experience and overall confidence is very hard to come by. But replacing people is not like it was 10 years ago when losing a top guy could shut you down for two years. The pool of candidates is much bigger now.”

 Li, though, doesn’t think the market has moved as far as some do. “We are long gone from the model of magic children who can single-handedly make the rain fall,” he says. “It was bad for business, bad for China and bad for the people involved. But people who say we are completely out of that era are getting ahead of themselves. When you have very big [SOE privatisations] that still matters. Between a few giants [investment banks] the differentiation between them is so small that someone who has a special relationship or special child can still make the difference.”

 One bank that has made a point of slamming the rainmaker idea whenever possible is Credit Suisse, whose departing Asia CEO, Paul Calello, has spoken frequently about his contempt for that idea. It’s worth noting, though, that Credit Suisse does have on its books Janice Hu, the grand-daughter of former party leader Hu Yaobang. Hu (junior)’s presence is believed to have done no harm to the bank’s success in getting on to the ICBC mandate. In fairness, those who have worked with Hu describe her as a capable banker regardless of family relationships, strong both in coverage and execution.

 Hu is not the China chief, a role that is held by Zhang Liping (both are Merrill alumni), who was coaxed back to investment banking in 2004 after several years in the private sector. He oversees business lines including private banking and asset management – where the bank has a joint venture with ICBC – but in practice spends most of his time in investment banking.

 A former Ministry of Communications staffer, Zhang was one of the first wave of China bankers. “I was called a rainmaker during the early 90s,” he says. “I was in the first group of pioneers working in China and have experienced the whole change of the approach to investment banking in this country. I don’t think I’m a rainmaker, at the end of the day business will be down to a team.” When Euromoney calls he has just seen a list of supposed rainmakers in another publication. “It was quite ridiculous. Some of the names listed had nothing to do with the transactions.” But, tellingly, he doesn’t think their role has gone forever. “In exceptional cases a person’s individual relationship may make a difference. I would say there is a 10 per cent chance for a mandate to be down to an individual’s relationship. The majority are awarded on institutional relationships.”

 To put it in perspective, Zhang reckons that work on getting the mandate to joint lead manage the ICBC float last year began “four or five years ago. According to our memos we were one of the earliest banks pitching for the international IPO.” He sees every involvement with the bank since – including handling ICBC’s landmark NPL securitisation in 2004, then appointing ICBC as a custodian, and finally setting up the asset management joint venture – as part of the process of pitching for that mandate.

 Like Deutsche (see box), Credit Suisse is a house perceived to be punching above its usual weight in China. Apart from ICBC, the bank joint led the US$9.2 billion China Construction Bank IPO in 2005, and, the same year, the largest sole-books IPO from the country to date, the US$648 million Shanghai Electric IPO. But the loss of private sector specialist Rodney Tsang to Merrill is a blow.

 That leaves two houses of note, the heavyweights of China investment banking: UBS and Goldman Sachs. These stand apart from the herd not only for their recent dominance of league tables, but also because they are the only two houses able to get involved in A share listings, Goldman through its venture with Gao Hua, and UBS through its partial ownership of Beijing Securities. Goldman is ahead in this respect – it will rarely have been more proud of a domestic transaction than in its joint lead role on mainland insurer Ping An’s $5 billion Shanghai listing earlier this year – but UBS is now understood to have the approval to pitch for similar deals, up against domestic competitors like CICC, Citic Securities and Galaxy. To many banks, this is the future. “I see bankers in Hong Kong looking worried because their lunch is just being taken away from them,” one banker says. It will also dominate the way hiring selections are made in future.

 Unquestionably successful over the long term, both houses scoff at the idea of rainmakers or any disproportionate contribution from the individual. But here, too, there are stars. At UBS, which recently lost Zhang Wendong to Citigroup, a recent heavyweight hire was Henry Cai (see ELIOT’S profile) as chairman of investment banking for China, who was certainly considered a relationship-based rainmaker in his previous role at BNP Paribas as co-head of investment banking for Asia. There, he had a focus on small and mid-cap sectors, but arguably lacked the franchise around him to make the best of it; the theory is that UBS gives him the platform to boost the bank’s participation in private sector transactions. He brought his team too, and it is notable that BNP’s joint venture with Changjiang Securities has fallen through since his departure.

 “Rainmakers are always going to be important,” says Matthew Koder, joint head of equity capital markets for UBS globally, “but they’re going to be significantly less effective unless they’ve got people around them to support them and execute deals properly.” UBS has also previously hired George Li, son of former politburo member Li Ruihuan, suggesting it has as much respect for connections as anyone else. But whatever the rationale, it’s working: UBS ranked top of the ECM league tables last year despite playing no role in ICBC, quite an achievement.

 Goldman, also not present in ICBC, ranked second, reflecting another success story. Goldman was the only major house to refuse Euromoney an interview, but it is known the bank sets great store on the 100 people it has on the ground in China, the track record it has established over time and now the opportunities afforded by its domestic venture.

 But for a house that espouses the team message, it has given Fang Fenglei, who heads the Gao Hua venture, extraordinary power. Goldman had to use a complex structure to get its venture away, creating two separate entities: Beijing Gao Hua Securities (GH) and Goldman Sachs Gao Hua Securities (GSGH), each with different domestic licences. GSGH is owned 67 per cent by GH, and 33 per cent by Goldman; GS is owned 75 per cent by Fang and 25 per cent by the mainland large cap Legend Holdings. This means Goldman legally speaking holds no equity in GH, and instead has funded Fang with a $97.5 million loan. There are naturally believed to be suitably iron-clad covenants in place to protect Goldman’s interest but it’s hard to recall a greater display of trust in an individual than this.

 So that’s the field: built on institutional strength, for sure, but still as full of big hitter individuals as it ever was. So is Merrill’s strategy out of step with the rest of what’s out there? Some think it is.

 “It’s [Ren’s hire] basically reverting to how banking was done by these guys years ago,” says one observer. “One, she’s damaged goods, whether or not she was a scapegoat for broader problems at the China Life IPO. And two, the bulk of work is shifting into the private sector anyway. It doesn’t matter who you know, unless you know the chairman of the company.”

 Damian Chunilal argues China affords a fourfold opportunity: government owned companies approaching IPO, listed clients that still have substantial state ownership, private sector entrepreneurs, and government or municipality clients. “You need different bankers for different clients,” he says. Ren will focus on state-owned clients, and Rodney Tsang on the private sector, where he was gaining acclaim at Credit Suisse.

 But it’s not as if Merrill was short of personnel. One wonders what Ehrfei Liu and Wilson Feng thought of a hire that must surely imply they didn’t have sufficient connections themselves. Chunilal says Ehrfei Liu is to focus more and more on principal finance and private equity, and much less on day-to-day client coverage. “As he’s moved across, I needed to hire somebody, and Margaret was the right person to hire,” says Chunilal. And although Merrill has Catherine Cai doing coverage on the private sector side, Chunilal says that wasn’t enough for what he calls “the once in a lifetime event” of Chinese private sector wealth generation; hence Tsang’s appointment, and “we’re still understaffed in my opinion.” Private sector business already contributes more than half of overall China revenues, he says.

 “I hired Margaret pure and simple because I liked her, I thought she was capable, I thought she had the right energy and content and would succeed,” he says. He met her two and a half years ago and decided quickly he wanted her on the staff; if the circumstances of her departure from Citigroup had any bearing on her appearance at Merrill, it was purely in delaying the hire because of the due diligence involved (on the way she was reputedly very close to joining Macquarie Bank, but that fell through). Chunilal says he “doesn’t see anyone as a rainmaker. This is about having a strong team in place.”

 But there’s no question Merrill has a track record hiring a certain type of person. It has now had three senior people with family ties to Chinese political big hitters past and present: Janice Hu (now at Credit Suisse), Wilson Feng and Ren. One of the problems many people see with the hire is working out how she and Feng can work together, with their roles appropriately delineated; each has the same title. “We’ve always had more than one person cover the different areas of business in China,” says Chunilal. “The opportunity is big enough for more than one person to focus on each part of the business.” To many, the hire makes more sense if rumours that Feng has resigned are true (Merrill insiders deny them).

 And the management challenge? “That’s my job, to lead and manage a team, and I like to think I’ve done a good job in doing that. With every hire you take a risk, there’s no question about it. But in the last three years we’ve got 90 per cent of our hires spot on.”

 While nobody expects Ren to be a leader in the technicalities of deal execution, if she originates a few deals she will have done her job. And while family relationships have no doubt helped, there must be something more to her than that. Every profile of Ren mentions her father-in-law, but rather fewer point out that he spent the last 16 years of his life under house arrest, or precisely how that helps generate a mandate for a state bank or telco.

 Whatever one thinks of the wit of the hire, there’s no denying Merrill has become a force in China. Recent successes include taking lead manager roles on state IPOs like ICBC, Shenhua Coal and China Power, private sector deals like Nine Dragons, M&A advisories like Lenovo/IBM and some quirkier transactions like the Asia Aluminium MBO, where Merrill took the company private, and financed the deal through a mixture of principal investment and a syndication of risk to sophisticated investors. It has done so with a stable team. “Stability of key personnel is essential. We haven’t had the merry-go-round some of our competitors have had,” he says.  “Our China team has been rock solid and that stands in stark contrast to many of our competitors.” He’s right. But it remains to be seen whether the latest hires, perhaps the boldest of Chunilal’s time in charge, bolster that team or fragment it.

 BOX: DEUTSCHE

Deutsche has promoted a mainland Chinese national to the highest level of responsibility of any foreign bank. Lee Zhang is head of global banking for Asia Pacific and chairman of Deutsche Bank for China. That means he not only oversees all of the bank’s operations for China but M&A advisory, equity capital markets (in an internal JV with the global markets team) and transactional banking in 16 countries.

 When he was given the promotion, some saw it as an elevation in name but not in substance, expecting he would continue to focus on China and leave it to co-head Jonathan Paul to cover the rest of the region. But with Paul now retired, Zhang has the empire to himself, matching the great ambition he is said to have (some expect him to enter politics). Zhang says he spends one third of his time in China, one third in Hong Kong and one third in the rest of the region; he had been in Australia the week before Euromoney’s call and was due on a major pitch in southeast Asia the following week.

 “Guys like Lee Zhang, China’s not enough for them,” says one headhunter. “They want to go global.”

 Zhang is a fascinating figure. A charismatic and tough banker from China’s north, he took a curious route to banking, taking a Masters degree in plant science from the University of Alberta and working for Hewlett Packard in Palo Alto before moving to Schroders, then Goldman Sachs as chief representative for China, and on to Deutsche in 2001. A member of National Committee of the Chinese People’s Political Consultative Conference – and one of only three members to work for a foreign corporation – he’s clearly connected, but Deutsche insiders cringe at any description of him as a mainland rainmaker. “It devalues his role a bit to say he’s a door opener in China,” says one, who also says Zhang is a stickler for deal execution rather than just being the coverage heavyweight he is depicted as being by rival banks.

 Deutsche’s arrival on the China investment banking stage coincides directly with his arrival (although, to put it in context, Deutsche wasn’t really an investment bank anywhere until 1997). It’s an ascendancy that has perplexed competitors, wondering how it can be that a bank with no discernible presence a few years ago can have been lead manager on three of the five largest equity transactions in China since 2005 (ICBC, China Shenhua Energy and a Petrochina follow-on). Some complain that Deutsche has been particularly quick to play the national card, enlisting the Chancellor to lobby for mandates for the bank in the broader name of cross-border trade, but that’s a claim that enrages Deutsche insiders, seeing no difference between their leverage of the politics of nationality and Citigroup’s hiring Robert Rubin, or UBS Leon Brittan.

 “When we first started my pitch was: we may not have a track record in China, that means we will work harder than everyone else, it’s important for us,” says Zhang. While it’s tempting to see Deutsche as a one man band given the synchronicity between Zhang’s arrival and the bank’s growth in presence, Zhang himself says: “I don’t think it’s ever been a case of: one individual delivers. At the end of the day it’s the firm, it’s the platform, it’s the team. Clients are not going to award a mandate to a bank that can’t execute it.” Deutsche has three top-level MDs below Zhang in China (Charles Wang, Amanda Lu and Yunfei Chen); one headhunter describes as “absolute rubbish” the suggestion that Deutsche lacks strength in depth in China, but does speak of Zhang’s “incredible presence. He’s well plugged in to the bank, too.”

 BOX: MANDATE HUNTING

One of the biggest reasons people argue the rainmaker era has run its course is because of the growth in sophistication in Chinese mandate processes, especially in the big state-owned-enterprise mandates.

 It would be a stretch to say the decision-making process is transparent, but many feel that it stands comparison with privatisation beauty parades elsewhere in the world. In at least two bake-offs, for ICBC and Bank of Beijing, people who pitched say they heard back from the selection committees with detailed feedback on their performance – in some cases down to their precise rank among the bidding banks, or the score they were given in particular areas of the pitch.

 “When you see clients now making a big decision it looks like a real panel, with people sitting there doing the scoring,” says one senior banker. “They not only inform us if we’re in, they also give us the score.”

 Wei Christianson at Morgan Stanley adds: “Rarely do you do a bakeoff anymore without knowing what’s actually going on. Clients will have a committee, often including regulators, and often academics, who are relatively objective since they have no political ambition. There is an argument that the real decisions are made behind the scenes, but I think the fact that more people are involved in the decision is progress.”

 An environment like that makes it less likely that a relationship-driven outlier will turn up on the final ticket. “We are very infrequently surprised by the outcome on any deal,” says Matthew Koder, joint global head of equity capital markets at UBS. “We have a very good understanding of where we stand in any pitching or competitive process. I can’t remember the last time I was genuinely surprised at the outcome.”

 Not everyone shares this view, though. “What we see, which concerns us, is we are lined up to do a sole lead role on an offering and suddenly another bank is there,” says one banker. “You say: what are you doing here? Then you find out one of their people is the daughter of the chairman of the issuing company. That’s a problem.”

 And one oddity in the scoring system comes when a bank outside the top rank turns up on a mandate. Years ago it was reported that banks including Deutsche were going to make a formal complaint about the conduct of the Bank of China bake-off, but Lee Zhang denies that emphatically. “I am a great believer people should celebrate success but also be able to accept failure sometimes. Clients make decisions, there is a process, and we accept that.”

 Acceptance can be begrudging, though, or just pragmatic. “The bake-off continues to be a sham,” says one senior banker. “That doesn’t mean it’s corrupt. It simply means that decisions are generally not decided at the bake-off. They are made before the bake-off, and the bake-off is there to provide the appearance of fairness and openness.”

To see this article in its published form, click here:http://www.euromoney.com/Article/1320801/BackIssue/51463/Why-the-China-rainmaker-just-wont-go-away.html

Shaukat Aziz became Pakistan’s prime minister in 2004. A Karachi-born career banker and a Citibank executive for 30 years, he entered public life when invited to become finance minister by General Musharraf following the General’s assumption of power in 1999. He has found out the hard way about the perils of public service – he survived a suicide bombing that killed his driver – but is credited for bringing about much of the financial reform which has underpinned Pakistan’s economic revival. Smooth and charismatic – and, to private sector eyes, an agreeable counterpart to the military-uniformed President – he spent half an hour with Institutional Investor’s Chris Wright in Islamabad. 

II: We’re speaking at a time of very strong economic growth in Pakistan. Is it sustainable?

Our medium term outlook is based on a growth target of 6 to 8 per cent. This financial year will be the fourth in a row we will be within that range. The reason these are sustainable growth rates is the transformation and transition of the Pakistan economy over the seven years since President Musharraf came in and all of us joined the team and started the reform agenda.

It was a two-track approach: one, address the macroeconomic issues; two, a structural agenda covered a very holistic menu from the justice system to security, agriculture, manufacturing, banking and so on. A fundamental philosophy drives everything: deregulation, liberalisation, privatisation, accompanied by governance, transparency and stability. If you have these ingredients you will have sustainable growth.

They stand out as one of the more pronounced reforms of any developing country in the recent past. We’ve made a lot of headway. Tax reform has increased tax collection dramatically and reduced corruption; the financial sector is totally deregulated with a level playing field, consistency of policy and a strong regulator; the economy in every area is growing, and has more than doubled in seven years, per capita; and Pakistanis are arriving on the global capital market scene for the first time [through government bonds and corporate GDR issues in London]. The Pakistan story is being heard louder and louder.

Like any country we have our challenges too: we have to sustain the path of reform, we have to show consistency and continuity of policy, we have to have total transparency and improve the quality of governance.

Last year total foreign direct investment was US$3.52 billion. And this year in the first quarter it is a record, over a billion. It all points to an economy which has a lot of promise.

 II: Those FDI numbers are vital given your trade balance and current account deficit.

Oil prices have been a big challenge and the FDI numbers have helped a lot. More than that, it is a vote of confidence by people who have a choice, they don’t have to come to Pakistan.

 II: You mentioned privatisation as a key initiative, and for a long time it has been seen as a success. Would it be fair to say progress has stalled with the situation at Pakistan Steel Mill [see privatisation article]?

No. We have had one, only one transaction which the honourable Supreme Court will not agree to. We have of course appealed. But the momentum of privatisation will continue unabated. We have a whole calendar, we have the Pakistan State Oil company [after the interview the deadline for bidders on to complete statements of qualifications on this sale was extended to January]. We have lots of entities on the list. That reform will not stop, because it is a cornerstone.

 II: How damaging do you think the Pakistan Steel Mill decision was in terms of Pakistan’s perception in this regard?

 Obviously it impacted our program but we have to look ahead. Since the attractiveness of the privatisation program in Pakistan is based on reform, strong growth and the prospect of strong returns to investors we think we will ride over it.

 II: Is it chiefly strategic sales you are looking for in these programs or sell-downs into the market?

 We have both. We are looking at strategic sales which take longer, and selldowns through domestic and international equity markets. We have this month a very important GDR for Oil and Gas Development Corporation [it raised US$813 million at the end of November].

 II: That’s foreign stock markets rather than domestic. Do any of your current privatisation initiatives involve the domestic market?

Yes, this particular company already has a listing. When we do a GDR we do it only when there is a domestic listing. We allocated a little chunk here.

[We then discussed the National Savings Scheme; see asset management article for his comments on this theme.]

 II: When people talk about impediments to future growth in Pakistan they focus on infrastructure and power. Are you on top of those needs?

Absolutely. There is remarkable growth in electricity demand: 8 to 10 per cent a year, very high by international standards. We have encouraged the private sector and the public sector to come in and install new capacity, and several thousand megawatts are being planned. The power needs of course are seasonal, so in the peak season, the height of the summer, we will face some pressure at peak times. At the same time many companies have gone for self-generation and we are introducing more efficiency into our production. We have massive investment in power, lots of foreign interest, lots of local interest.

Then on infrastructure we have a major program of improving our logistics chain from Karachi, our major port, up to the north. We have plans to build more major motorways, we will have by end of next year one from Peshawar to Lahore, and are now starting one from Lahore to Multan. The ports are being made more efficient, they are being outsourced and managed by companies like Hutchison and Dubai Ports. We have good airports in Karachi and Lahore and have started work on a new airport in Islamabad. The railway system is being revamped: we are getting new rolling stock, improving the tracks. Then for oil movement in the country we have pipelines. This is all part of a logistics chain we are looking at comprehensively with the help of the World Bank, and I personally chair this committee.

We are also exploring oil and gas exploration domestically, and import of LNG, and a pipeline from Iran to Pakistan…

II: Is that ever going to happen?

 We reman optimistic but there’s a lot of work to be done. Then we are offering energy corridors, trade corridors, transportation corridors for the central Asian countries through Pakistan on to the Arabian Sea. Western China is very close to the Karachi port, and we have a road which is being improved jointly by Chinese and Pakistani governments. If you look at Pakistan in the next decade or so we see ourselves as leveraging our position by linking more to China, central Asia and Afghanistan, using these corridors to create economic activity.

 II: As someone who has lived widely overseas [he has lived in 10 countries and was based in New York when called back to Pakistan to become finance minister] do you consider the world’s expectations of Pakistan to be realistic?

The perception of Pakistan does not necessarily reflect reality, so we have work to do. People who have lived here, worked here and invested here are very comfortable. But people who do not know Pakistan are influenced by events in the region. We need to get the relevant people to come here and see for themselves what this place is all about. Pakistan is a moderate nation with tremendous human capital, playing a stabilising role in this part of the world, managed transparently where the leaders have a no-nonsense approach. The perception of security gets highlighted in the press, but you can see our biggest problem today is finding hotel rooms. The flights coming in are jam-packed.

 II: Do you feel the perception is damaged by the fact that the country’s president is also head of the military, and leads an administration did not come to power through conventional democratic methods?

 Actually him having dual office is a unique phenomenon which was necessary at the time for facing the challenges which occurred due to the situation in the region, particularly Pakistan. Pakistan is an evolving democracy. We have a very active political process, vociferous opposition, media which is very free, with almost 50 TV channels. We are a functioning democracy where the people have a voice, and we are also very conscious of gender involvement. We are a very tolerant society, everyone is allowed to practise their faith freely. I’m elected, I fought a direct election, so did the entire parliament.

 II: So given that progress, why is it still necessary to have a dual role as head of the military?

 As I said, it’s evolving.

 II: Do you feel that the renewed prosperity of Pakistan is flowing down far enough?

 In the last seven years almost 14 to 15 million people have come out of poverty. Poverty levels have come down in Pakistan from almost 34 per cent of the population to 24 per cent. We have to work harder and that is exactly what we are focusing on now, to transfer the benefits of economic growth to the masses. You can see the emergence of a larger middle class. Sales of consumer goods like motorcycles and cellular phones in the rural areas going up. People’s expectations are rising and they are meeting some of those expectations.

 II: You left a successful and presumably well-paid career at Citibank for a job which has very directly threatened your life. How do you feel about the move you made?

 It was a very good move for the country, for me personally, because any time you get the opportunity to serve your nation, you can influence things, take policy decisions, implement them, make a change. We brought a professional government which is chasing a multitude of challenges and creating many opportunities for its people. I feel very privileged that I’ve got this opportunity, it’s an opportunity of a lifetime, to help improve, enhance and build my country.

Author’s note: this interview was part of a 42 page report on Pakistan distributed with Institutional Investor in January 2007. Other articles will be added to the site in the near future.

Author’s note: the boxes containing the interviews with the scholars are embedded in this story beneath the main text

They are a rare mix: men of God, religious legal experts, multilingual, and market savvy enough to be able to discuss the ins and outs of a hedge fund or a project finance syndication with investment bankers. It’s quite a skill set. And the dearth of these shariah scholars – men entrusted to certify the suitability of products for Islamic investors – represents the biggest bottleneck in the world’s fastest growing financial industry.

 The speed of development in Islamic finance is extraordinary, if difficult to quantify. There are now at least 250 shariah compliant mutual funds managing over US$300 billion. Moody’s has estimated 300 Islamic institutions hold a further $250 billion in assets, and Islamic windows of conventional banks (in which assets are held separately and managed under Islamic principles) account for probably another $200 billion. Just four years after the issue of the first international Islamic sukuk (similar to a bond), issuance is now over US$15 billion. It’s close to a trillion dollar industry if it isn’t already.

 All over the world, Muslims are growing in wealth and are demanding the opportunity to invest that wealth in ways consistent with their theological code. It’s debatable whether Islamic products have yet become popular among non-Muslims – though product developers argue there’s no reason they shouldn’t in due course – but there’s no dismissing this as a fad: 44 per cent of the Malaysia’s domestic bond market is based on Islamic paper, according to Bank Negara, and some banks there report take-up of Islamic product now accounting for as much as 60 per cent of overall sales.

 But there is a challenge here. Every bank engaging in Islamic finance needs to have a shariah board, a committee of scholars who will say whether products are compliant with shariah, the values enshrined in the Quran. The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), a Bahrain-based group which says its written principles are now adhered to directly or indirectly by about 90 per cent of Islamic banks worldwide, insists that every bank must have such a board and recommends three scholars on each. Even if there were no such regulatory requirement, Muslim customers look to the names on a board to give them confidence to purchase: no shariah board, no sale.

 The problem is that there aren’t enough people with the right range of skills to fill all these boards. It’s a big ask. And among international institutions in particular, more and more of whom are seeing the potential in this field and moving in, there are at the most about a dozen individuals that appear on everybody’s board, and six men in particular. So Asiamoney set out to meet them; they’re interviewed on the following pages.

 Such a concentration of power and trust within a few people raises many issues. To western eyes, the most obvious of them is conflict of interest, though curiously that’s rarely raised as a problem in either Malaysia or the Gulf. Asked if he is concerned that some of his advisory board members also work for CitiIslamic, HSBC Amanah’s Kamal Mian, who oversees shariah issues, says: “It appears that it should but it doesn’t. Scholars are people of such a level of integrity and honesty that we do not have any doubt.

 “I hear this a lot in the media,” he continues, “but most of the time the people who are talking about it are not in the industry; they haven’t worked with the scholars one to one. For them, the biggest responsibility is they are acting in a capacity of interpreting a law that is divine.”

 Instead, a more common gripe is that people so heavily in demand can’t possibly give sufficient attention to all of their tasks. The most popular scholars appear on literally dozens of advisory boards and it is a frequent comment from bankers, albeit cheerfully made, that they are almost impossible to get hold of. Each of them, when reached, was generous with their time and open in their answers, but tracking them down for interview took months: between Dr Mohamed Elgari of Saudi Arabia agreeing to be interviewed, and the interview taking place, took 21 calls, emails and faxes to his Jeddah office to arrange a time and location. Another scholar has four mobile phones but is still tricky to reach; “your best bet is to call him at exactly ten past five,” says a helpful banker who employs him.

 Scholars don’t like to see themselves as holding any degree of power, instead considering themselves conduits for interpretation; the real power, they argue, is with the Quran. But it is surely not desirable, if only in appearance, for such a small number of people to hold the trust of global institutions. “You run a risk,” says one senior Malaysian Islamic banker, “if the same names keep coming up, that it starts to look like window dressing: I’ll have a guy from Saudi on my committee, a guy from Bahrain. If you want to get a product internationally respected you know these are the names you need to have.”

 Various measures have been tried to deal with the problem and to bring more people through. Among the most interesting, and controversial, is Malaysia.

 Malaysia has by some distance the most comprehensively documented legislative framework for Islamic finance and the closest supervisory approach (the only country to rival it, perhaps surprisingly, is Sudan). Last year, it adopted a new measure: no one scholar could serve on the boards of more than one Islamic bank. Bank Negara, the central bank, has its own shariah board, and nobody on that board can represent another bank either.

 Again, conflict of interest is rarely mentioned as a reason for this: instead, it is suggested as a method of broadening the pool of available expertise among scholars. There is no shortage of scholars in the world: qualifications in shariah or Islamic jurisprudence are offered all over the world, and there are highly regarded institutions everywhere from Kuala Lumpur to Karachi to Jeddah. The challenge is in finding people with expertise in financial instruments and experience of working with banks as well.

 The Malaysian approach has fostered an eclectic mix of people on supervisory boards. The CIMB Islamic Bank board in Malaysia, for example, boasts the former chief justice and minister of law of Sudan, and a Canadian national who wrote the constitution of Afghanistan for the UN. “We [the industry] do need more individuals that are highly qualified in shariah and able to interact effectively in the industry,” says CIMB Islamic’s head, Badlisyah Abdul Ghani.

 But in the Gulf especially, the Malaysian approach is seen as counterintuitive, even a restraint on trade. “Can you imagine if you said to a bank: you can only have one engineering company as a client, one trading company, one textile company? That’s not right,” says Majid Dawood, who heads Yasaar, a group banks can use for shariah advice on a case-by-case basis – sort of a shariah advisory outsourcing agency. “That’s restrictive practice under international labour laws and I think it’s wrong. I agree we want to encourage the growth of scholars, and this is one way of doing it, but don’t we then have a problem that it’s restricting one guy from earning a living?”

 The references to the language of mainstream trade practices is in keeping with a broader shift for shariah advisory to be considered an emerging discipline just like law or accountancy. It is commonplace for people to draw an analogy with law, especially when answering the conflict question: nobody tells lawyers they can’t advise more than one bank, so why should scholars be any different?

 But for that discipline to be universally respected, there are many things that will need to be dealt with. Law, for example, requires specific qualifications from its practitioners, although naturally they vary from jurisdiction to jurisdiction. Until the AAOIFI code was developed there was no requirement for there to be any minimum level of qualification among scholars, and even now, it is vague: its governance standards refer to “specialised jurists in fiqh almua’malat (Islamic commercial jurisprudence)” but add they don’t have to be a specialist in that field if they are “an expert in the field of Islamic financial institutions”.

 Some, AAOIFI among them, believe there ought to be a more appropriate minimum qualification for scholars, and various efforts are underway to develop them. AOOIFI, the Bahrain Monetary Authority and the Bahrain Institute of Banking and Finance, for example, are devising a program, as is the Dubai International Finance Centre and the Islamic Banking and Finance Institute Malaysia.

 But at the same time, the idea of a requirement does not meet with anything like universal appeal. “The minimum qualification is a proper understanding of Islamic finance,” says Khalid Hamad, executive director of banking supervision at the Bahrain Monetary Agency. “But we do not really spell out criteria to qualify for scholars. It will send a bad message if you say this scholar is not fit. We have not been facing any difficulties in this area in terms of the quality of shariah board members.”

 The touchiest subject in the development of shariah as a professional discipline, inevitably, is pay. How much scholars earn, and should earn, is a matter of considerable conjecture. The structure itself is fairly standard – a retainer which entitles the customer to a set number of board meetings, usually quarterly, and a certain quota of advice each year, then additional fees for further transactions, typically charged by the hour – but the quantum is not.

 The Egyptian scholar Sheikh Hussain Hamid Hassan, now the most prominent scholar in Dubai, made waves recently when he suggested that US$300,000 was not an unusual fee for advice on a complex transaction. Others suggest that the retainer for an international bank would be in the region of US$150,000 to $250,000, and one source says he was quoted US$100,000 just to get shariah approval on a fund, after all the product development had taken place.

 Others disagree with this appraisal. HSBC’s Kamal Mian recalls discovering an accounting glitch, prior to his involvement, through which none of his shariah board had been paid for six months. None of them had complained, and none has ever asked for more pay, he says.

 And in any event, it is wholly counterproductive, not to say unfair, to expect scholars to live up to the austere man-of-god image many would like them to have. “A lot of times people assume you’re a man of God: what do you want money for?” says Dawood at Yasaar. But if shariah truly is to emerge as a discipline, and it’s already clear it’s an essential plank of a multi-billion dollar industry, then if only for reasons of professional excellence it is natural to assume they will want to be paid like any other advisory profession. The only people who believe average shariah fees are on a par with legal fees are lawyers; everyone else considers them lower, although they’re unlikely to stay that way for long. “They will get there,” says Dawood. “And they will stay there. It’s like the oil price, it ain’t going down again.”

 It’s interesting that when people do gripe about scholar remuneration, it’s often not the money but the five star hotels and first class air travel scholars sometimes require that seems to rankle. Again, this suggests people find the ideas of professional remuneration and religious conviction difficult to reconcile. But it’s hard to generalise about rates or demands: pay scales are understood to vary dramatically regionally, with Malaysians generally earning much less than those in the Gulf. “People here aren’t being paid thousands of dollars a month,” says Daud Abdullah, chief executive officer at Hong Leong Islamic Bank in Kuala Lumpur. “I know a shariah board member on a Saudi financial institution is probably getting something like US$10,000 a month. In ringitt people could retire here on that. They’re getting nothing like that.”

 Some feel that shariah costs ought to be disclosed by banks, as they are for board directors. This proposal divides opinion, even among the most apparently like-minded of scholars: when Asiamoney puts the suggestion to Dr Elgari and Shaikh Nizam Yaquby, the two most well-known scholars in the Gulf, Elgari agrees (“The only reason they are not doing it now is maybe they’re ashamed: this is the amount we are paying our scholars”) and Yaquby reacts angrily (see interview). One advantage of greater disclosure in this field, though, would be that if it demonstrates people are well paid, it will prompt more people to enter the profession, which is desperately needed.

 The other major difference between law and shariah is the idea of accepted regulatory codes of conduct. The picture varies from the regulated (Malaysia) to the almost ignored (Saudi), but there is a certain uneasiness in the fact that the people with so much say in the direction of the industry report to nobody. Well, not quite nobody. It is frequently pointed out that scholars, holy men, consider themselves accountable to Allah and that the very idea of them drifting from shariah principles for the sake of monetary gain is inconceivable. AAOIFI requires that contracts avoid things like performance related pay or other enhancements anyway, but the variety of approach around the world does make it difficult to form a consistent view of how oversight is conducted.

 This is important because, in truth, the idea of Islamic finance still garners suspicion and cynicism in some parts of the west. These days most people in finance understand the basic ideas: that usury, or interest, cannot take place in Islam because money can’t become more money without serving another purpose. They understand, for example, that you can’t lend someone money to buy a house and charge interest, but you can buy that house for them and sell it to them at a profit, since that is classified as profit in trade rather than interest.

 But there are many who wonder how, for example, Shariah Funds Inc, a division of US-based investment manager Meyer Capital Partners, could possibly have found a way to get shariah approval (from Yaquby and Sheikh Yusuf DeLorenzo, among others) to launch a shariah compliant hedge fund. Short-selling is haram (prohibited), since it involves selling something you don’t own, a clear no-no in Islam. Others feel uneasy at the development of the reverse murabahah, a method of providing a return on customer bank deposits. Some non-Muslims who have built structured products that went through shariah compliance checks feel that all they changed to get approval was the words they used to describe the process rather than the process itself.

 Of course, opinion on these things is not homogenous, which is part of the point of having shariah advice in the first place: if these issues were straightforward advisory councils wouldn’t need to exist. Elgari recalls a bank that wanted to give prizes to its customers through a random draw. He was one of several scholars asked to endorse the program: some of the panel considered it gambling, others thought it was OK provided the prize was offered as a marketing tool with a clear assurance that fees would not be increased in order to finance the prize. The panel ended with an unresolved two-one split.

 But after some occasionally spirited debate, scholars almost always find common ground, and in practice very few things are refused outright, though modifications are often suggested. Khalid Yousaf, director of Islamic Finance at the Dubai International Financial Centre, recalls a study that found 96 per cent commonality in fatwas, or decisions, issued in the 10 years from 1995. Such a level of agreement has a positive and negative way of looking at it. The positive is the increasing convergence and consistency of approach, giving structure and stability to a complex field. The negative is to think it looks a bit like a cartel.

 There will never be complete consistency among shariah advice, which is part of the problem in understanding it outside of the Muslim world. The Sunni faith alone has four, arguably five core sects with different ideas on how to interpret their faith. That’s before one considers the Shia faith, which includes most of Iran, among other places. This has a bearing on finance too, with Malaysian systems generally seen to be less strict (or more progressive, depending on who’s describing it) than in the Gulf and particularly Saudi Arabia.

 For this reason, there are some things which cannot be included in AAOIFI’s shariah standards because it’s just not possible to produce one standard that all Muslims will agree upon. An example is what’s permitted on house financing, where Malaysian and Middle Eastern views differ.

 Nobody who knows them questions the probity of the handful of individuals who are so dominant in the provision of shariah advice, but for Islamic finance to be truly accepted by the global financial world these issues will have to be addressed.

Dr Mohamed Ali Bin Eid Elgari, Jeddah, Saudi Arabia

To the outsider, Dr Mohamed Elgari looks like a shariah scholar should look. In a red and white checked ghutra headdress and spotless white dishdasha, he has a piercing, heavy-browed stare and luxuriant greying beard. He looks, for want of a better word, learned. 

Elgari is based in Jeddah, where he is on the faculty of King Abdulaziz University as an associate professor and deputy director of the Centre for Research in Islamic Economics. As an advisor, too, he’s in considerable demand: Dow Jones, CitiIslamic, Islamic Development Bank, Saudi British Bank and numerous other institutions in Saudi Arabia and elsewhere.

“There’s no question that shariah advisory is becoming a bottleneck in the growth of Islamic finance,” he says at the Ritz-Carlton in Kuala Lumpur, a Saudi visa having proved prohibitively difficult for Asiamoney to acquire. “There isn’t a sufficient number of people who are qualified enough to really take this industry into the next stage of development. People are yet to recognise that advising financial institutions, and membership in shariah boards, is by itself a new discipline.

“Being a shariah scholar per se does not qualify you for this purpose,” he adds. “Being a banker will not qualify you. An economist will not qualify you. It’s a new multi-disciplinary approach we need to have, and very few people were lucky enough to have exposure to all these things.”

In his case, he started out teaching in Jeddah in the Centre for Islamic Economics, one of the few such specialised institutions in the world at the time. Teaching courses exposed him to institutions involved in Islamic banking both from an academic and practical point of view, and that got him started. Already linguistically capable, having got a PhD in economics from the University of California, he also became a regular participant at annual meetings of the Islamic Fiqh Academy in Saudia Arabia, and at conferences in Mecca and elsewhere. His first shariah advisory role was in 1991 for the National Commercial Bank in Jeddah.

Like all his peers, he sees no problem with conflict of interest in the small number of people holding so many high-profile board positions. “The question has been raised, but not very frequently,” he says. “Institutions definitely don’t want an advisor who can be a vehicle for moving information between banks, but confidentiality and secrecy are the cornerstone of success of any advisor. If you don’t keep secrets you will lose the confidence.” He recalls a situation in which two banks he was advising were, quite separately, developing almost exactly the same product. It took them nine months. “I was doing this without giving any hint that what you are doing is being done by someone else.”

He’s not a fan of the Malaysian approach in which a scholar can only serve one bank. Looking at the Saudi system, with no such impediments, he says: “I don’t remember there was any problem or complaint. So I don’t understand the approach here [in KL], expect from the angle of trying to encourage and produce sufficient number of shariah scholars.”

Elgari sees himself as part of the emergence of a new discipline but is quite open about the practical reasons for its existence. “One aspect which is important, though shariah scholars don’t like to emphasise it, is in the final analysis banks are commercial ventures,” he says. “They want to sell.” He has an unusual analogy. “Why have a shariah board? One purpose is to assure the market that this is what you want, in a way similar to the American Dental Association does on toothpaste. People want to make sure this toothpaste is healthy, does the job, really protects your teeth. The American Dental Association is an independent entity, with no direct interest in the profits. Shariah boards have a position like this.”

Elgari does not believe his profession is well remunerated, certainly compared to the legal and auditing fees he sees in transactions he advises on. “We envy them, actually.” If anything he describes a naivety in his own profession. “We are always accused, if that’s the right word, of not being commercially minded. We rarely negotiate a contract, and of course this is not the right way to maximise your fees. One good thing, and I am sure it will continue, is that although we are few in number we have never used our negotiating power collectively. The idea has never crossed the mind of any of us that we should have one stand vis-à-vis the banks.” That, he believes, kept scholars in good name, “but by the same token it did not create the incentives in the market to produce new scholars.” He’d be happy to see shariah costs disclosed by banks.

Like all his peers, Elgari is busy and spread thin. Should there be a limit on the number of boards you can serve efficiently? “Of course there has to be a maximum.” Could he take on more work? He smiles. “I think I reached my limit.”

DR MOHD DAUD BAKAR, KUALA LUMPUR

Dr Mohd Daud Bakar is the most prominent Malaysian shariah scholar, and also the youngest member of this top-ranked clique by about 20 years.

 Still in his early 40s, he is visibly more business-oriented than the others interviewed for this piece. He runs a group called International Institute of Islamic Finance from a Kuala Lumpur tower block opposite the Petronas Towers, which runs education and seminar programs alongside his advisory roles. Dressed smartly in a suit, he runs what seems a relaxed business; whereas our interview in Pakistan follows the call to prayer, on the tape of this one you can hear Duran Duran’s Dance Into The Fire on the radio in a neighbouring room.

Daud Bakar serves on the shariah scholar panel of Bank Negara Malaysia, and as such is no longer allowed to serve on other Malaysian bank boards, which he used to; his absence is lamented by some of them. “If we could clone Daud Bakar several thousand times,” says Daud Abdullah at Hong Leong Islamic Bank, “that would be extremely helpful.” Other advisory roles include Dow Jones, Invesco, Royal Bank of Scotland, Bank of Ireland, Societe Generale and HSBC Amanah. He’s also on the roster of Yasaar, a group which arranges shariah advice for organisations on an occasional basis as an alternative to them appointing shariah boards of their own.

As something of a spokesman for a new generation of scholars, he thinks there are plenty more coming through, but that they face headwinds. “There are scholars in the pipeline but as we go on to more sophisticated products they cannot catch up easily,” he says. “It takes years of experience and exposure to the industry. The bottom line is to be able to understand the meaning and interpretation of the sources of Islamic law, and be able to connect the texts and sources to the case before you.”

Like his more senior peers, he entered the profession having acquired a PhD outside the Islamic world – in his case, St Andrews in Edinburgh, following a first degree in Kuwait – and after a spell teaching. His first advisory role came in 1994.

Asked if there is a limit to the amount of work he can do, he says: “It depends on the nature of the advisory job. Some are routine in nature: you look through the prospectus, advise on the investment portfolio; that would be less time consuming.” Others, like new products, particularly sukuk or derivatives, take longer, and involve vetting the trust deed, prospectus and legal documentation. “A scholar has 24 hours a day: he has to measure his time. In some cases I have to say no because I don’t have the time.”

He has no problem with the self-regulatory stance of the industry. “The market will decide. If I am involved a product I could share that product with a third party. But if I was to do that people will know. We have to be bound by our own internal regulations.” And Malaysia has done more to avoid conflict issues than most. But even here there are issues that arise from the sheer range of his client base: Daud Bakar advises not only Dow Jones but also, through Yasaar, FTSE, which wants to bring an Islamic index to Malaysia, a decision which will have to be approved by Bank Negara – whom Daud Bakar also advises.

It’s common to state that there is a difference in approach and interpretation between Malaysia and the Middle East, but Daud Bakar doesn’t like this distinction. “That is a very general statement which is not correct from any standard,” he says. “We cannot simply put Malaysia and the Middle East in two baskets. A scholar is a scholar, not confined to any regional prescription. We use our intellectual capability to relate to the issue at hand. It’s not about the region, it’s about the individual scholar.”

One practical point he is alone in making is that shariah scholars face liabilities, and therefore ought to expect payment commensurate with that risk. “If we were negligent in our fatwas, if we haven’t checked thoroughly and the prospecuts has to be declared null and void from a shariah perspective, the company will suffer a loss and have recourse to the scholar for the indemnification of that loss,” he says. “You have two roles: shariah compliance and consumer protection. Consumers come in because they have seen your name so you have to protect their interests as well. Why did they buy the product? Because they believe you. You owe them a duty.”

SHEIKH NIZAM YAQUBY, MANAMA, BAHRAIN

It’s a tough call, but Nizam Yaquby might be the most in-demand shariah scholar of them all. An advisor to CitiIslamic, HSBC, Dow Jones, and the Arab, Bahrain and Dubai Islamic Banks, in addition to numerous others, he is perhaps the most widely recognised scholar in his industry. 

And he certainly operates from the most unlikely surroundings of any of them. Readers of Asiamoney may recall our first meeting with Sheikh Nizam in 2002, when we interviewed him at a desk at the back of an electronics and consumer goods store in Manama’s souq, or market. There’s no separate office; it’s not even a particularly big desk, wedged in between a wooden staircase and a large Oral B product display, and buried to a height of several feet in prospectuses, term sheets and text books. Four years on, one of the most important people in this multi-billion dollar industry is still working out of the same desk at the back of Yaquby Stores.

Dressed in white keffiyeh and dishdasha in the classic Arab style, Yaquby speaks with booming projection and a little irritation when the questioning turns to matters of pay. “Do the banks disclose what they pay for lawyers, or for auditors, or for high management?” he remarks when Asiamoney asks if he thinks banks should disclose what they pay for shariah advice. “If the law of the country says they must disclose everything they pay to everyone, then why not. But if these things are not there, why should we only insist on it when it comes to the shariah? It is a contractual matter between the bank and the shariah scholars. They should disclose there is a contract, that’s enough.” He also doesn’t seem impressed by a question on whether there is a wide range of attitudes between scholars, from progressive to conservative. “There is no such perception among scholars. These are terminologies used by outsiders. Different scholars reach different conclusions for different reasons.”

But he has the experience to be entitled to be brittle at misunderstandings of his field. He entered the Islamic banking movement in the late 1980s, having trained in shariah since childhood. His academic career had embraced modern economics, though a degree at McGill University in Montreal, which no doubt also helped his linguistic fluency. He worked under a range of leading scholars, some of them judges and teachers of 50 years standing, and eventually took on his first advisory role for Arab Islamic Bank in Bahrain.

Today Yaquby is at the cutting edge of Islamic finance, in that he is one of the scholars people turn to when they want to try something new. He is on the panel that approved Shariah Funds Inc’s new hedge fund product as shariah compliant, a decision some find perplexing. “Short selling is considered to be the sale of something that you do not own, so therefore is prohibited. But if someone can prove that no it is not, for example that lenders are not getting the money but the borrower, this turns the picture,” he says. “All these things are subject for research, very deep research. In a short sale, who owns the stock at that time? Who owns the voting right? These are depths scholars go to, it is not superficial levels.”

In principle, he says, “why not make all the tools that are available in the financial market available to Islamic institutions and investors, so long as we do not violate the rules of shariah? Islamic law is not what people think, a very stiff and undynamic law. It is very dynamic, it develops with time and situations of the communities, provided that it always keeps the principles.”

He doesn’t think the Malaysian model of limiting scholars advisory roles would work in most Islamic countries because of the lack of suitable graduates to fill the roles. And he is not a fan of the outsourcing approach practised by groups like Yasaar. “There are some scholars who are happy to work in such capacities. There are some like myself who have not favoured till now this approach. I prefer to work directly with the institutions to be more involved, to know what they want to do, to be in the picture.”

JUSTICE MUHAMMAD TAQI USMANI, KARACHI, PAKISTAN

Darul Uloom University looks unpromising from its surroundings, flanked by industrial developments on a cratered and untarred road in a suburb of Karachi. But through the gates is a scrubbed and bustling establishment, a new mosque taking shape in the centre, austere but proud. 

The opening line of the introductory literature the university provides, penned by its president, describes it as “a link from the hallowed chain of sanctuaries devoted to religious education established in this subcontinent by some right guided servants of Allah to brave through the dark night of British imperialism.” It describes an institution geared towards countering the “intellectual subjugation of Muslims”. And within a dark and modest office in this campus, where dormitories are segregated not by men and women (there are no women) but between the beardless and the bearded, works Justice Taqi Usmani, one of the most influential people in the development of Islamic finance over the last 30 years.

An ageing man now, with a distinctive red hennaed beard, Taqi Usmani is not as radical as the literature of his host institution might suggest. In fact, his contribution to the field has been to foster more understanding of it rather than less, and as a retired member of the Supreme Court his impact on his country has been immense. But he appears the most outwardly religious of the scholars interviewed for this piece, and seems to voice the clearest misgivings about where the profession might be headed.

Asked about the complexity of products that are now becoming certified as shariah compliant, he says: “There are two approaches. One is that whatever is available in conventional financial institutions should be available in Islamic institutions as well, with certain modifications. I do not adhere to that approach. The Islamic banking system has its own philosophy, and because of it we cannot bring about an alternative for all the products that are being used.” Asiamoney had mentioned the hedge fund product newly certified as shariah compliant. “I do not fully agree with the concept that the hedge funds must have some alternative in Islamic finance. Many things that are not fully compliant with the basic philosophy of Islamic economics, we do not need to bring about alternatives for. That’s the second approach. I subscribe to it.”

Taqi Usmani has been stepping aside from many advisory roles, among them CitiIslamic, in favour of research and teaching, though he still holds some advisory positions. “It comes only as a third activity that I advise some institutions,” he says. “But I am normally withdrawing myself from them.” One hugely important role he does still hold is as chairman of the shariah board of AAOIFI, the closest thing Islamic finance has to a universally recognised setter of common standards. He calls it “one of the big achievements” of Islamic finance.

His withdrawal from advisory roles increases the concentration of a handful of names among international boards. “Essentially [this concentration] should not be desirable, because of many reasons,” he says. “One is that the one who is good for all is good for nothing. Sometimes he cannot do justice to all of them. And secondly, there may be some conflict of interest.

“But it was due to necessity that it has been accepted,” he says. “There were no such scholars available.” He thinks Darul Uloom, which has a centre for Islamic economics training both professionals and scholars, is part of the hard work taking place to fix the problem.

Despite an occasionally negative tone, he is optimistic about the ability of Islamic finance to be harmonised despite the many different sects within Islam itself. “I hope with the passage of time we will be able to standardise all financial products despite these differences,” he says. At AAOIFI, the people he develops standards with include a shia scholar. “When we sit together our basic intention is to bring together a product or principle which is agreed upon by all, or at least to minimise the differences. I think we are successful so far.”

SHAYKH YUSUF TALAL DELORENZO, USA

 Yusuf DeLorenzo is the voice of shariah scholars in the United States. Along with Dr Nazih Hammad, the North Vancouver-based scholar whose roles include being president of CitiIslamic’s advisory board, and Rushdi Siddiqui, who heads the development of Islamic indices at Dow Jones, he is among the small group of people representing his profession in the relatively uncharted ground of North America.

Here, the main market of interest is the retail sector, mainly mutual funds and home finance. “Demand is growing as word gets out that Islamic finance is actually available and, most important, competitive,” DoLorenzo says.

Is Islamic finance understood or respected there? “It is spreading. After some baby steps in this direction in the 1990s, most of which were local or regional operations, there are now several companies doing business on a national basis,” he says. And, asked about whether US government attitudes towards the Middle East and the Islamic world have affected take-up in North America, DeLorenzo says he is encouraged to see that the US Federal Reserve has set up a working group on Islamic finance. “Our impression is that they have recognized Islamic finance as a legitimate financial sector, and that they are preparing themselves to deal with it.” He is hopeful he will soon see Islamic banks opening in the US and Canada.

DeLorenzo is one of Yasaar’s panel of scholars, and he disagrees with others who feel that some personal relationship is lost through this approach, since in effect Yasaar becomes the customer institution’s advisory board itself. “Nothing is lost,” he says. “The relationship is just the same. What is gained, however, is a further degree of credibility, like that of an outside auditor.”

He was also one of the panel that approved Shariah Capital Inc’s hedge fund recently, and offers a detailed explanation of how such a product came to be Islamically compliant.

“I like to explain this by saying simply that the method… replicates the economics of a conventional short sale, but is changes the mechanics,” he says. “In other words, it is decidedly not a conventional short sale, with the borrow of a security and then its sale, which is prohibited by Shariah rules. The actual process is very complex, as it not only has to comply with Shariah rules but with SEC and stock exchange regulations as well.

“It took our Shariah board months to come up with an acceptable Shariah solution, but this was only the beginning of the process. The really difficult piece was to fashion that solution in such a way as to satisfy all the regulations.”

Was it a unanimous decision among the board? “Most assuredly. Our goal was to create the product without straying from the strictest of standards for Shariah compliance. I’ve little doubt that any Shariah board anywhere in the world would have difficulty approving that product, provided that they had enough time to devote to understanding it. That’s the key.”

DeLorenzo has been a scholar for 30 years, serving on the boards of Dow Jones, the FTSE/SGX Islamic Asia 100 Index in Singapore, Wafra Investment Advisory, Sarawak Corporate Issuer, the Royal Bank of Scotland, Societe General and numerous others around the world. He studied shariah for eight years and taught it for 15, and made the leap to advice after he began collecting fatwa literature from shariah boards, translated them into English and published them. A widely published author in his field, his output has ranged from translations of religious and legal texts to much more basic material, such as the introduction to The Lightbulb Guide to Understanding Islamic Investing. His role as a respected and patient medium between a complex and misunderstood field, and a vast and sometimes suspicious potential market, is seen as a vital one.

He believes the patterns of scholarly undersupply are as true in the US as elsewhere. “The situation is the same in North America,” he says. “People seem to think that new scholars can somehow be manufactured, if only an institution with an appropriate curriculum was available for that purpose,” he says. “Nothing could be more fallacious.”

 As the dust settles on Singapore’s surprisingly acrimonious bout of banking consolidation, who has come out of the process unscathed and enhanced? Not DBS, with a failed bid and a public relations mess; not really UOB or OUB either, until complex integration issues are resolved. OCBC had the smoothest ride, but its acquisition of Keppel will not transform the bank, and it becomes the smallest of three competitors. No, the unquestioned winners fall into two camps: Singapore itself, with a more sensible banking environment, and the international investment banks who will pick up the fees. By Chris Wright.

After all the bids, counterbids, recriminations and apologies, Singapore’s new-look banking sector has finally found its shape. It’s not quite the two-bank duopoly that Singapore’s government had had in mind, but it is a less crowded market, and it looks like this: UOB/OUB, versus DBS, versus OCBC/Keppel.

The process of getting there provides us with many interesting lessons, not just about the new leaders of Singapore banking, but about the way M&A activity will be conducted in Singapore. And that matters a great deal, because the city-state is going to be one of the key drivers of M&A in this region.

 OCBC: first mover advantage

So who won? If we measure it by ease, by lack of disaster and damage to reputation, the answer is clearly OCBC. The bank’s decision to bid for Keppel Capital Holdings (KCH), spearheaded by CEO Alex Au and CFO Chris Matten, kicked off this whole situation in the first place. It shows the advantages of being the first mover (see box: “What might have been”) since, by setting events in motion, it ended up with no rival bid to contend with, across-the-board acceptance after a modest increase in the bid price, and first shot at tapping the market for funds. Offering an all-cash deal helped.

It also faces less integration issues than any other merger on the table, with some demonstrable synergies. “Keppel has two strong franchises that are really attractive, and they happen to be our weak franchises,” says Matten. OCBC covers the middle to large market, Keppel the small to medium; OCBC’s customers are older, Keppel’s are young and entrepreneurial.

“No integration is easy,” he adds. “There are always people issues to worry about. But it is relatively small and we don’t have too many potential political fights at a senior management level.” It helped, for example, that Keppel Capital only had an acting CEO (ex-Allied Irish man Walter Coakley) – so the top job there, one assumes, was decided automatically, and indeed was officially announced without complaint on August 17. “In our case the thorniest problem is solved before you begin,” says Robin Tomlin, managing director for corporate finance at OCBC’s advisor, UBS Warburg.

But there is a flip side to this assessment: the purchase of Keppel will not transform OCBC. In fact, once all acquisitions are complete, OCBC will be the smallest bank in Singapore. And given that the government has said it envisages a market with two banks rather than three, that suggests it will be vulnerable to takeover itself.

“We’re not hung up on rankings,” says Matten, a touch predictably. “The top three are relatively close to each other in terms of size – we will still be an organization with a S$85 billion (US$48.6 billion) balance sheet, which is pretty substantial.” Others question whether there is ever likely to be another wave of domestic consolidation. “I am a sceptic on whether there can be further consolidation,” says James von Moltke, head of the financial institutions group at Keppel’s advisor, JPMorgan. “It’s hard to envisage a situation where one of these three buys another, because you get into concentration issues. It was never obvious to me how you would get two big institutions out of the five that existed.”

The bank is also likely to acquire again before too long, with expansion in China a likely next step: OCBC has the rare distinction of having stayed open for business through the Cultural Revolution. The bank still has what Matten calls a “very lazy balance sheet” with billions of dollars of latent gains in property that could be put to work. In the meantime the bank has already raised everything it needs to fund the acquisition (see Deal mechanic).

 DBS: an image hangover

What about the others? You can’t help but think that DBS would look a lot better had it never entered the fray in the first place. By doing so, it has come out with terrible image problems and no obvious gain. The bank had already seen its share price take a battering after it offered more than three times book value for Dao Heng earlier this year, albeit in a deal that could create the first truly regional Asia-domiciled bank; the June 22 offer for OUB sent the price lower still.

Analysts had two chief concerns about the OUB bid: the bank’s ability to integrate major acquisitions in two markets simultaneously (although, as DBS president Jackson Tai points out, there was a time when they worked on integrations in three countries simultaneously – POSBank, Thai Danu and Kwong On), and the danger of a share overhang that would be caused by DBS’s mainly stock-based bid.

But in fact, the views of analysts or the financial press were only part of the problem. Far more evident was a grass-roots issue. To international investors, the slick and well-presented pitches of the DBS top brass were impressive, evidence of a bank with global ambitions and smart management. To Singaporeans, it seems, they smacked of arrogance. Terribly ill-advised advertisements run by DBS, depicting DBS as a father and OUB as a child, did not help matters and were swiftly withdrawn. It is said, but has been denied, that OUB founder Lien Ying Chow cried when he heard of the DBS bid; he was certainly upset enough to welcome the rival bid from UOB when it came.

Things were to get much worse when DBS’s advisors, Goldman Sachs, left a presentation that belittled the UOB/OUB proposal with European investors (see box: “Sorry!” ). By the time allegations arose of misleading biographical information about CEO Philippe Paillart on the company’s website – a very insignificant aberration, it must be said – it had become a turkey-shoot.

DBS undoubtedly made mistakes, but to understand fully the scale of this negative response, one has to look to history. DBS is a partly government-owned bank and has local responsibilities, yet at the same time has been trying to transform itself into a regional leader using expensive and experienced expatriate staff with abilities honed at international banks, particularly JPMorgan. At the heart of this ambition is a necessary conflict, and it has never been more amply demonstrated than in DBS’s acquisition in 1998 of POSBank – the Post Office Savings Bank.

More or less everyone in Singapore has a POSBank account. When you do your national service in Singapore, that’s where they pay you. And in taking over POSBank, DBS found itself with armies of customers with about 50 Singapore dollars in their account, doing nothing with it. For a modern bank those sorts of logistics are uneconomical, and so DBS set about downsizing, rationalizing, changing. “If you are trying to run a retail banking business this is probably not the client you want – that’s where you need a post office bank which is run as a national service and not a profit centre,” says Tomlin at UBS Warburg. “That inconsistency in mission wasn’t reconciled: it gave DBS scale but it didn’t deal with this service delivery issue for POSBank clients.”

Locally, it went down very badly. People didn’t like the closure of branches, the loss of personal service. It would appear that a lot of resentment from that process came out when DBS made its offer for OUB. “I don’t think the offer per se was anything exceptional, but there was a lot of residual feeling,” says one observer. “The little guy was feeling that he got screwed on the POSBank account, so this was a very good opportunity to voice his opinions. DBS made a perfectly sensible reaction to the market, they just had no idea of the depth of resentment. Well, they found out!”

On POSBank, Tai is diplomatic. “POSBank is an opportunity for us as well as a challenge,” he says. “Opportunity in that it gave us and gives us a connection with 92% of the population of Singapore. That gives us a wonderful connection to the marketplace. The challenge is that we have purchased what was the people’s bank, and they still have expectations of service quality which we must respond to. In some ways it is public service. But it is public service in the context of our being a commercial organization that has to get higher returns for our shareholders.”

And does Tai think DBS is arrogant? “I think there is always a danger when one makes an unsolicited bid that one comes out looking like the aggressor… and that is the risk we took when we decided it was best to put the offer [for OUB] on the table so that all shareholders could have a say in the matter. We were not making progress in convincing the principals and we decided it was appropriate to have the public at large decide.”

In a free market, there is nothing wrong with Tai’s thinking on that point. But the progress of the bid itself also stood out as unusual. There are very few examples in history of a company launching a bid for a rival, a bid that it knows will not be welcomed and which will almost certainly attract a counter-bid, and yet not being prepared to increase that bid. “In a situation like this you either make your original bid a knock-out or you are prepared to have it countered,” says one banker. It was sufficiently puzzling to generate a persistent, if unlikely, conspiracy theory that DBS had launched its bid knowing full well it wouldn’t win, at the behest of the government, to kick off other bids. (“We did not do this at the direction of the government. We are not doing national service,” says Tai. “This was well prepared on a commercial basis. If this was government-directed, why do we have such a food fight on our hands?”)

Speaking after the official apology but before DBS effectively withdrew from the competition for OUB by allowing its offer to expire, Tai explains the bid process like this. “When one puts out a bid, one has all kinds of other chess moves in mind. One has a playbook, and one should not enter into any bid without a treasure chest of options. We were fully aware of other potential bids and we were fully ready. But one has to look at the bid in the context of the stock price, public sentiment and the economic conditions going forward. Our view was that we were not prepared to get into a bidding contest. We were not going to let personal feelings, emotions or even ambitions cloud our view of what is the right thing to do.” DBS’s share price has risen markedly since it pulled out of the bidding.

DBS will not have enjoyed the last month but its regional scale should not be overlooked. “DBS does have the number one franchise today,” says Steven Sun at UBS Warburg. “In some ways there is strength in the fact that they have already gone through a number of the changes the other banks must now go through.” Although its track record in acquisitions is only average, and although the Dao Heng acquisition has been strongly criticized on price, DBS is still a bold bank with a very strong regional footprint. The fact that it is no longer the largest bank in Singapore is really not a huge issue; more than half of its revenues now come from outside the city state and in the international arena it has a lot to say for itself. “It has been the institutional darling for a while now,” says one banker. “Whereas with all respect to Mr Wee [of UOB] I think he made his first investor presentation ever just a few weeks ago.” But fixing its image at home will take longer.

OUB/UOB

So what of the new domestic leader by size? Well, that’s not straightforward either. The public apology embarrassed DBS, but it didn’t do OUB/UOB any favours either, getting every major criticism of the merger onto the front pages of Singapore’s newspapers. Those criticisms – valuing ‘face’ over shareholder value, creating a board made of friends and family, and the danger of a board so large that it would be impossible to make decisions – do raise questions worthy of discussion.

Most of it is bitchiness, but the point about decision-making is a valid one. The merged group will have co-deputy chairmen and co-presidents, and there aren’t many examples of that going smoothly. It is hard to move policy forward without a clear leader. The two banks face a long process of integration, much harder than OCBC/Keppel and arguably more difficult than DBS/Dao Heng, where there is zero overlap to consider. And as Asiamoney went to press the merger had not reached the 90% level required to allow UOB to delist OUB – absolutely essential to get the best synergies from the bank – although it did look likely that it would do so.

Besides, the mutual adulation that accompanied UOB’s June 29 bid was eye-catching. “I have always had the highest regard for Dr Lien Ying Chow as well as the management and operations of OUB,” said Wee Cho Yaw, group chairman and CEO of UOB. “I welcome UOB’s offer, and believe that it is good for shareholders, customers, employees and good for Singapore,” said OUB group chairman Lee Hee Seng. This affection was more important than it might seem given the level of ownership families had in both banks, with OUB founder Lien Ying Chow committing to accepting the offer for his own 15.7% stake from the outset, alongside two related companies, Overseas Union Enterprise and Overseas Union Insurance. Tellingly, those subsidiary companies felt obliged to issue a statement justifying the speed of their commitment, saying they took “detailed legal advice and carefully considered their fiduciary duties”. They must have worked quickly.

But perhaps we’re too cynical. Unlike OCBC/Keppel, this transforms the bank. According to UOB’s own data, the merger makes the bank a market leader on gross customer loans, domestic personal and corporate loans, total assets, credit cards and market capitalization. The strength of the UOB name is demonstrated by the success of its recent bond issue (see Deal digest). If cost savings can be realized – the offer document cites the figure at S$200 million-250 million per year pre-tax – then this does make for a market leader.

Thanks to the timing of the bid, the principals and advisors involved were unable to comment for this feature, but even those who work for its competitors can find praise for UOB’s approach and success. “I think they have played their cards brilliantly so far,” says Tomlin at UBS. “The resulting bank will be a very powerful combination. A very strong Malaysian franchise particularly, which one shouldn’t ignore.”

In general, Singapore’s banking sector itself will be stronger and more sensible now – five banks was always a crazy number for a place where you can’t drive for more than half an hour without falling into the sea. “You should see an environment where all three banks should be able to service their clients better, earn better returns, and be more ambitious from a regional perspective,” says Sun.

The real winners

And so for the real winners: UBS Warburg, Morgan Stanley, Merrill Lynch, JPMorgan, Salomon Smith Barney, ANZ and (yes, even them) Goldman Sachs, for a start. Each has gained lucrative advisory roles through this process and in many cases valuable capital markets work too – notably UBS Warburg on OCBC’s recent record-breaking three-currency bond issue (see Deal mechanic) and Merrill Lynch and JPMorgan for their capital raising roles for UOB (see Deal digest). And those that have displayed proficiency can look forward to plenty more where that came from (see box: “Tip of the iceberg”). Singapore doesn’t look altogether comfortable yet with the ins and outs of hostile takeovers. But they’re here to stay.

BOX 1: SORRY! THE QUESTIONS BEHIND THE APOLOGY

 What were they thinking? That has to be the first response to one of the worst PR moments in recent M&A history. It’s one thing to libel a rival bidder, even to pay it compensation. But to have to pay compensation and publicly apologize to the target of your own bid, while that bid is still open, is really something. But there’s more to it than meets the eye.

For those who have somehow missed the story, here’s what happened. Goldman Sachs, advisor to DBS on its bid for OUB, printed a presentation that, among other things, made several criticisms of the rival bid by UOB. This was shown to European investors and, unfortunately, was left with some of them. The presentation found its way to UOB and OUB, who threatened legal action on the grounds of defamation. With the rumoured behind-the-scenes involvement of the government, DBS publicly apologized, running a full-page advertisement in the Straits Times including the text of DBS chairman S Dhanabalan’s letter of apology to both his opposite numbers at OUB and UOB, and their responses; DBS also paid S$1 million to each bank, to be donated to charity. DBS made a point of shifting the blame to Goldman Sachs, claiming it had not cleared the document. “I am very angry and upset… What has happened is not reflective of the way DBS does things.” He must have choked on that apology: Dhanabalan is chairman of Temasek, the investment holding arm of the Singapore government, and a former cabinet minister of 16 years standing.

Beyond the scandal, there are three issues. One, the sensitivity of M&A involving Singapore. Comments like the ones Goldman distributed are nothing new in most parts of the world during a hostile takeover. It seems the bank badly misjudged the sensitivities of Singapore, where these things do not happen in the same way, and that there was an oversight in legal and compliance, if the text was seen by them at all. The furore will be closely noted by any potential acquiror of a Singaporean asset from now on, and by their advisors. Expect lawyers to pick up plenty of fees for advising on what can and cannot feature in a pitchbook.

Two, what will happen to Goldman’s relationship with DBS? The bank is one of its most lucrative clients in the region in recent years, not just for its M&A activity but its increasingly sophisticated use of the international capital markets. But Goldman, which did not respond to requests for comment, does not appear to have lost its client yet. Tai tells Asiamoney: “We have been served well by a number of investment bankers, and it will be in our shareholders’ interest to be receptive to the best ideas from the leading investment bankers, including Goldman Sachs.”

Three – and this is the strange part – what on earth were OUB and UOB doing approving an apology like this? An apology which takes a series of criticisms which had only been voiced to a select few investors in Europe and, by way of retraction, demands that these same criticisms, neatly annotated in reader-friendly bullet point form, are printed in the pages of a national newspaper – and therefore immediately repeated on the front pages of every financial newspaper in the world. If anybody had not thought about the integration issues at UOB/OUB before, or the composition of the board, they certainly did so after that appeared. Commentators say that this represents a demand that everybody sees the retraction no matter who saw the original – and that it really did push DBS firmly out of the picture. But the structure of the apology as approved by the libeled parties must surely have done them more harm than the libel itself could ever have done.

 BOX 2: TIP OF THE ICEBERG

 When DBS’s bid for Dao Heng, and Singapore Telecom’s for Cable & Wireless Optus, appeared in the same month earlier this year, it was clear this was going to be an exceptional year for M&A in Singapore. “Singapore is like Switzerland,” says Philip Lee, head of investment banking for JPMorgan in Singapore. “Small country, but a lot of class companies, and for them to grow they need strategic regional investments.” The result, says Lee, is M&A figures over the last 18 months equivalent to the previous nine years put together.

Banks apart – and they can be expected to acquire again in due course, probably regionally – Singapore boasts companies like Singapore Power, PSA, Singapore Telecom, Singapore Airlines, SembCorp, ST Group and the Raffles group, all of whom look like good candidates to acquire and expand. Most of them have already started. The government, through its investment holding arm Temasek, has clearly signaled its intention to reduce its holdings in Singapore’s biggest companies (like DBS, SingTel and Singapore Airlines) once conditions are right, and still other companies are refocusing their businesses – like Keppel Group selling KCH and the M1 mobile phone operator, in the interests of building up in other areas like shipbuilding. “I can see Singapore driving M&A for the next 12 to 24 months,” says Lee.

For bankers with little else to occupy them in the region, this has been a godsend. “At the halfway point of the year, it [Singapore] probably accounts for about three quarters of our Asian M&A business,” says Michael Lien, managing director at Morgan Stanley. “It’s about $22 billion out of $30 billion – and that’s an unusually high proportion.”

As for the type of deals that will be popular, there are a few things we can learn from recent transactions. One, cash is more popular than stock in a volatile market – hardly unique to Singapore but the OCBC deal showed how smoothly an all-cash deal can go. Two, it is a peculiarity of Singapore that although one needs 90% acceptance to allow a bidder to delist its target, there is a separate trigger at 75% that allows the bidder to apply for a waiver to delist – and that could be important. Three, we certainly now know that what seems fair game in hostile takeovers elsewhere in the world will not wash in Singapore.

 BOX 3: WHAT MIGHT HAVE BEEN

 “In my mind there is no question that our bid essentially unleashed the forces,” says OCBC CFO Chris Matten. He’s referring to forces like the government’s clearly stated desire to see consolidation in the industry, the need to gain scale ahead of foreign competition, and the fact that Singapore’s banks are very highly capitalized as a consequence of the country’s historically strict bank capital laws. “It’s like the pressure building up behind the dam. At some point a crack appears and the whole thing goes: whoosh! Well, we were the crack in the dam.”

That catalytic position proved to be more important and influential than it might at first appear. Matten had looked through a dossier on a potential acquisition of Keppel Capital Holdings (KCH) on his first day in his new job in the week of Chinese New Year. (“I started on the Monday and on Tuesday afternoon my entire staff went on holiday,” he recalls, “so I had plenty of time to study it”.) He worked on the project tirelessly through to the general offer on June 12. But he wasn’t the only one with such grand ideas.

Separately, OUB had been taking a good look around. Keppel apart, OUB was the smallest of the major banks – and therefore vulnerable. So it began to scrutinize the one bank in Singapore that was smaller than itself: KCH.

Asiamoney believes OUB had discussions with Keppel, and might well have made an offer for it had OCBC not got in first; furthermore, it would probably have made a counter-bid had DBS not made its own bid for OUB, taking it out of the running as a potential acquiror.

That removed one potential counter-bidder that could have run against OCBC in a battle for Keppel. “If I were a betting man I would assume competing offers would have emerged for KCH had the DBS offer not come into play,” says James von Moltke, head of financial institutions group at JPMorgan, advisors to Keppel. “Clearly once that offer had taken place, it became a market with two sellers and three potential buyers.” The third of those buyers, the only one not yet involved, was UOB, which had no choice but to enter the fray itself – anything else would have left it so marginalized it would run the risk of being acquired itself, or run out of business by its bigger competitors. So it had a straight choice: make a counter-bid for Keppel, or make a counter-bid for OUB. It opted for scale, and styled itself as a white knight for OUB; it seems to have worked.

All of which demonstrates the following: with all of these plans developing among the senior management of the different banks, it was the person who moved first who dictated what would happen next. What if OUB had made a bid for Keppel before OCBC did? What might have happened then? OUB might have avoided being acquired; DBS might have bid for one of the others, possibly either UOB or OCBC; UOB might have counter-bid for Keppel. The whole market could look different. We’ll never know, but it illustrates one thing: the power of first mover advantage.

Asiamoney cover story, May 2002

 The decision of Hynix’s board to reject a deal with Micron, just a day after its creditor committee had approved it, has the international markets doubting that the Korean chip manufacturer can survive. They may be right. But those who believe the decision is a blow to Korean corporate reform miss the intricacies of the deal, and ignore an important point: the right of a board to make an independent decision, even if it turns out to be the wrong one. By Chris Wright.

 There were fireworks, of the literal and the metaphorical variety, all over Seoul on April 30. In several parts of the city, Hynix workers set off firecrackers in celebration. But at the Hilton Hotel, the mood was angrier, as 60 protestors from Daewoo Motor clashed with security officials and occupied a conference hall while two hundred riot police took up positions outside.

Nothing new there, on either count. But in a typically Korean reversal, the more cheerful pyrotechnics were to celebrate the failure of a deal; the angrier scuffles were to protest at the success of another. Hynix’s workers were expressing their delight at their board’s decision to veto a plan by Micron to take over Hynix’s memory businesses. It would have been the largest ever foreign acquisition in Korea, worth over US$3 billion. The protestors at the Hilton, on the other hand, were trying to stop a signing ceremony for what was seen elsewhere in the world as a triumph: General Motors’ US$1.2 billion acquisition of parts of Daewoo Motor. The protestors succeeded, and the high-rolling would-be signatories – GM chairman John F Smith Jr, Daewoo president chairman Lee Jong-dae and Korea Development Bank head Jung Keun-young – had to relocate to the KDB’s head office instead, where the deal was duly signed.

Thus were the topsy-turvey politics of foreign investment into Korea neatly illustrated in a single day. The GM-Daewoo deal, hailed in international circles as a model for Korean corporate reform, took fully four years to conclude and faces many challenges still. The Micron-Hynix deal, which was meant to be the centerpiece of Korea’s restructuring efforts, a landmark remedy to a public and powerful headache, fell apart despite the best efforts of the most senior of Korean financial officials and the willingness of the company’s indebted creditors to lend yet again.

Hynix has put its very survival at stake by rejecting the deal, and the board may soon find itself removed by Hynix’s own creditors. One analyst calls it a “Quixotic gesture,” akin to “the captain of the Titanic refusing to abandon ship”. So why did the board do what it did? And what does it mean for Korea?

 What was on the table?

Micron’s negotiations with Hynix had been underway for five months. The two companies had been acrimonious competitors in the past: when creditor banks set about bailing out Hynix last year, Micron was riled. The Boise, Idaho-based company contacted the state’s senator, Mike Crapo, who lobbied vigorously that support of Hynix contravened South Korea’s obligations under WTO. The dispute even reached the desk of US treasury secretary Paul O’Neill. But on December 3,  Hynix made a formal announcement that the companies were discussing “a possible strategic alliance or other transaction”.

Negotiations were difficult, but well-represented. Goldman Sachs advised Micron, and Salomon Smith Barney continued its long-standing affiliation with Hynix – a link made stronger still by the fact that Citigroup has undisclosed exposure to the company thought to be as much as US$100 million. Those close to negotiations say that Micron sometimes had trouble adapting to the peculiar circumstances, in which creditors were at least as important counterparties as Hynix itself. Untimely resignations didn’t help. First Kim Kyung-Lim, CEO of Hynix’s biggest single creditor, Korea Exchange Bank (KEB), resigned in March. Then the Korean minister of finance and economy, Jin Nyum, stepped down in order to run for election as governor of Kyonggi province. Jin had been an important figurehead pushing for reform in corporate Korea, and his influence had been vital.

Still, neither resignation derailed negotiations for too long – perhaps the reverse. With Kim’s departure, Hanvit CEO Lee Duk-hoon became point man for the creditors in negotiations, and joined Hynix CEO Park Chong-Sup in the final leg of discussions in the US. Hanvit, like all four of Hynix’s major financial creditors (Korea Development Bank (KDB), KEB, Hanvit and Cho Hung) is majority government-owned, but it may be significant that things seemed to move forward when KEB was no longer so significantly involved in discussions. Although the government is the largest single shareholder in KEB, German bank Commerzbank holds 35% and two seats on the bank’s seven-seat board, and it has been speculated that this led to internal friction about how to proceed. Meanwhile on the political side, Jin’s successor, Jeon Yun Churl, immediately started calling for the same corporate reforms as his predecessor.

On April 22, the two companies announced a non-binding memorandum of understanding for the sale of Hynix’s memory businesses to Micron. The terms, expressed simply, were these: Micron would give 108.6 million shares to Hynix for the memory business, which accounts for 75-80% of the company’s total sales, and would invest US$200 million in what was left of Hynix in exchange for a 15% stake. Hynix’s creditors agreed to extend US$1.5 billion of new, long-term loans to the company. The statements put out by both companies that day set a deadline of April 30 for approvals from Hynix, Micron, and Hynix’s creditor committee.

There was outrage among many groups at the announcement: Hynix employees, who feared for their jobs and felt the company could survive independently (an internal survey, disclosed by Hynix itself, found that 93% of employees were against the deal); the small non-financial creditors whose lending to Hynix was unsecured, and who expected to see what little stake they had in the business disappear; and unions across the country, including the powerful 956,000-member umbrella group, the Federation of Korean Trade Unions, which pledged to strike if the deal went through. But ministers, and senior regulatory figures like FSC chairman Lee Keun Young, involved themselves personally in persuading the relevant people to support the deal. On April 29, after four hours of meetings, 77.73% of Hynix’s creditors voted in favour of the sale, just passing the 75% threshold necessary for it to go through. Hynix’s board meeting was set for the following day, and seemed a formality. Only six members of the 10-man board, of which seven were outside directors, needed to vote in favour for the deal to go through, due diligence and regulatory approvals notwithstanding.

But they didn’t. On April 30 Hynix released a short statement rejecting the deal. Micron has since pulled out of negotiations.

So why did it fail?

 Creditor issues

In one respect, it was remarkable that the deal got as far as it did. Creditors to Hynix were already owed over US$6 billion by the company; wasn’t it a bit rich to expect them to extend a further US$1.5 billion? What’s more, sources who have seen the MoU report that the additional US$1.5 billion the creditors were being asked to put into the company would be unsecured, for seven years, with levels of interest capped at 5% and 6% depending on the tranche.

The overall value of the deal, which Korean observers had expected in advance to be around the US$4 billion mark, turned out to be considerably less, since it was calculated assuming a US$35 per share value of Micron – much higher than the share price ever reached while the bid was in play. The most it was ever truly worth, based on the Micron closing price on April 22, was US$3.4 billion; by the time it was rejected on April 30, it was worth US$3.07 billion. Those proceeds would have been split between the creditors, but only after the deduction of various other expenditures, including all debts incurred by a Hynix plant in Eugene, Oregon. True, if Micron shares increased in value – as well they might have done in what would have been the world’s biggest D-RAM manufacturer – then this could well have proved to be a lucrative return for creditors, but that was by no means certain.

In particular, the small, non-financial creditors with unsecured sums caught up in Hynix stood to lose almost everything, and it was these who were particularly targeted by the government in trying to get the necessary 75% creditor approval on April 29. KEB, KDB, Hanvit and Cho Hung, who between them accounted for 65% of the voting representation at the meeting, were clearly always going to vote along government lines, being government-owned. But the various investment trust corporations, insurers, leasing companies and securities institutions required a lot of convincing, and only a third of them were persuaded to vote for the merger. Quite how is unclear. “It’s possible some concessions will be made to provide some sort of sop to the unsecured creditors,” said an analyst in Seoul, speaking before the creditor’s meeting, and correctly predicting the outcome. “The key problem is them: they are getting nothing from this deal. Their recovery rate is zero. It’s possible the authorities may come up with some saving measure that gives them some prospect of loan recovery.”

Sources also tell us that the creditors would have been required to observe a two-year lock-up on their Micron shares, and in some cases could only ever dispose of them through what is described as an “underwriting mechanism” rather than straight into the market. “The final proceeds wouldn’t be received until two to three years after the deal was signed,” says someone who has seen the MoU.

Was any of this fair? It depends how you look at it. “This isn’t really about what is right and fair,” says Jonathan Dutton, an analyst at UBS Warburg in Seoul. “Banks have made a decision to lend money to a capital intensive and volatile business. It should have been clear years ago that the debt levels the company was carrying were driving it towards bankruptcy. You can’t really talk about fairness: creditor banks have to live with the consequences.”

And those close to Micron object strongly to suggestions that this was a deal that screwed Korean creditors and employees just because it could. “The point is that what is on the table is, simply, a future,” says one.

 What the board thought

But, in the end, the creditors proved not to be the problem. The board did, and this stunned the market. “They think it’s all over – it isn’t now,” said one analyst research note sent out the following day.

Why isn’t it over now? Well, the official reasons are there for all to see. Hynix spelt them out in a prepared statement. We’ll quote it in some length.

“We have reached the conclusion that there are too many problems with the creditors’ post-merger restructuring plan for the remaining company. The plan overestimates the value of the Micron stock to be paid for the sale of Hynix’s memory business; unrealistically presumes the size and timing of contingent liabilities; and is too optimistic in its estimate of the cash flow of the remaining company.” It goes on to note that the restructuring plan for what would remain of the company is flawed, “based on the restructuring plan placing too much liability onto the remaining company; restricting the sales of the stock of the remaining company as a collateral security; and overestimating the revenue and cash flow of the remaining company.”

And then, the real killer punch: “We are confident that with the upturn in the semiconductor industry and new developments in our technology… it is possible for Hynix to successfully exist as an independent entity.”

Several points there, but first it’s worth taking a look at the people who made the vote. Hynix championed its own corporate governance when it set up a board containing three of its own people and seven outside directors. The media championed it too: this was a sign of a new Korea, free of the vested interests that had dogged the chaebol. But it seems to have scuppered the deal. The board members were:

•           Chong-sup Park, chairman and CEO of Hynix;

•           Sang-ho Park, COO and president of Hynix;

•           In-baik Jeon, executive vice president and CRO of Hynix

•           James Guzy, president and CEO of Arber Investment Company, and a founder and board member of Intel;

•           Chul-hee Kang, in the engineering department of Korea University;

•           Yong-wook Jun, Professor of business administration at Chungang University;

•           Chang-rok Woo, managing director of Yulchon law firm;

•           Yong-kwon Sohn, president and CEO of Oak Technology, and a senior executive of Intel;

•           Yong-sung Lee, chairman of the Banking Supervision Authority at the Ministry of Finance and the Economy;

•           Eui-Je Woo, former acting president, Korea Exchange Bank.

So who, in that crowd, would have been expected to vote for it? Surely CS Park, among the most proactive of corporate reformers in the country? Certainly Woo from KEB must have been in favour too, given that KEB approved the deal as a creditor the previous day? Lee had seen and approved consolidation in another sector, banking, so would have been expected to rally for this; and Guzy and Sohn, both linked to Intel, might have been expected to support consolidation in technology if they believed it was good for the industry. That’s half the board right there. But the decision was unanimously against it – despite the fact that it was followed by CS Park’s resignation, and despite the presence of a former senior member of the company’s biggest creditor bank on the board.

Oh to have been a fly on the wall of that meeting. The exact discussions will doubtless never be made public, but at least one analyst pondered: “Perhaps the interests of the board members did not ally with those of the creditors.”

Responding to Asiamoney questions, Hynix’s spokesman Chan Jong Park says: “It is true that Mr CS Park initiated these talks with Micron. But at some point, the negotiation proceeded in favour of Micron and our suggestions were not reflected.” Park returns to the issue of whether the leftovers of Hynix could survive, and adds: “I think all of the BOD members couldn’t vote for a deal that would not secure the viability of the remaining Hynix.”

Were they also swayed by the emotions of staff resentment and union pressure? Doubtless it played a part, but if one looks to history, the very vocal nature of Korean employee movements rarely has a long-term effect if the government’s will is strong, as it appears to be with corporate reform. When Kookmin announced its proposed merger with Housing & Commercial Bank, senior executives were barricaded into their offices for days while disgruntled employees vetted their mail and on one occasion threatened to set themselves on fire. The deal still went through. An economist in Seoul once told Asiamoney that a useful economic barometer was the consumption and use of tear gas in any given period: protests in Seoul are very physical and very emotional. But do they derail deals? Probably not.

And so to the reasons the board actually gave. Their concerns about the restructuring plan for what would remain of Hynix are difficult to assess, given that the restructuring plan has never been made public, but enough has made its way out to the media for us to make some educated guesses about what it proposed. With the memory business gone, 75-80% of the company’s sales would have gone with it, leaving a foundry business. As we understand it, the restructuring plan called for creditors to write off W1.78 trillion in debts, followed by a capital write-down in a ratio of 13.5 to one, reducing the capital from W19.8 trillion (dizzyingly high given its assets) to W1.7 trillion. Under an agreement forged last October, W3 trillion of debts held by creditor banks will be swapped into equity in May, and at the end of it all, with the debts from the Eugene, Oregon plant paid off, the remaining Hynix would have had about W3 trillion in remaining debt. Korean creditors would own 69.3% of the company.

Was the board correct to question this? Perhaps so, although it was hardly arguing from a position of strength. “We have our doubts,” says Dutton, asked if he thought the proposed new Hynix could survive (and speaking before the board rejected the deal). “It doesn’t have leading edge process technology, it doesn’t appear to have any track record of strong customer relationships, and its cash flow per wafer – one of the key metrics to look for – is one of the lowest among major players. It would be a new company starting off in life with W3 trillion of debt, paying interest on it, with a 120% debt equity ratio. The theory is that the bulk of its assets would be Micron shares, and that when the time comes the creditor banks can sell them down and retire the debt. But the key question then is what the value of Micron shares is at the time.” Another commentator puts the matter more bluntly. “The bit of Hynix that would be left over is the bit Micron didn’t want. Draw your own conclusions.”

Hynix clearly agreed: CJ Park says the board wanted the remaining company to be left with less than W1 trillion of debt but was overruled by the creditors. “It was obvious that the remaining Hynix cannot survive with interests that were three times of its profit,” he says. And even at one of the creditors that approved the deal, there is a dissenting voice. Manfred Drost is deputy president at KEB. He says: “This is a point that has been neglected in the public discussion: the viability of the remaining company. It’s questionable, even on legal terms, whether you can strike a deal where you buy 80% of the core business and structure it as an asset deal – it is essential to prove the viability of what’s left.”

As for the assertion that Hynix can survive anyway, analysts have their doubts about that too. Many quickly put out sell recommendations, either formally or in private notes to clients. The company will surely lack the internal cashflow to finance upgrades in its manufacturing facilities. Yes, there has been something of a turnaround in the market – the DRAM spot price was US$1.50 when the companies opened negotiations in December, but reached US$4.50 in March before dropping back towards US$3 more recently – but this is a notoriously volatile sector with an oversupply problem. Hynix’s share price jumped on the news of the board’s rejection of the deal, but as Merrill Lynch analyst Sun Chung notes: “We believe that the trend [in the share price] could continue for little longer if, and only if, the creditors are willing to provide the same financing, debt forgiveness and other concessions that they were offering to Micron.”

Much depends on that question: whether Korean creditor banks would be prepared to lend anything else to Hynix. Well, in the circumstances, would you? “I’m not in a position to make a judgement on this deal, but I do know that most of the banks have provisioned about 70% of their existing loans to Hynix,” says David Coe, formerly the senior resident representative for the IMF in Korea, and now responsible for the country in Washington DC. “If I was a banker and I was already provisioned to take a 70% hit on those loans, I wouldn’t be lending more.”

The creditors themselves were non-committal when Asiamoney asked them if they would lend again. “It’s a very complicated problem and very early to say about Hynix,” said an investor relations spokesperson at Hanvit on May 2. “We have a special task force team set up for Hynix but we cannot talk about details because they are very secret.” Asked if the bank would lend to Hynix again, a Cho Hung Bank spokesperson would only say: “At this moment, in this situation, no.” Drost at KEB declined to comment, as did KDB’s investor relations team, and Hynix declined to comment on conversations with its creditors.

 What next?

Although Micron has officially pulled out of negotiations, the deal may not be dead in the water, because Hynix’s board is not as all-powerful as one might think. This is where the debt-equity swap for W3 trillion of debt owed to Hynix’s creditor banks, hammered out last October and due at the end of May, becomes all-important. Why? Because if that debt converts, it will give the creditors majority control of Hynix, potentially even over 75% – which means they could sack the board and appoint a new one with the task of reconsidering the Micron offer, if the Idaho company was prepared to return to the table. A representative of one of the creditor banks, asking not to be named, goes so far as to tell Asiamoney that he “presumes this will happen”.

“We think that the board’s decision may be more of a Quixotic gesture than a substantive act which will scupper the Hynix/Micron merger,” says Dutton. “Compare it to the captain of the Titanic refusing to abandon ship. The creditor banks ultimately control the fate of Hynix.” Even if the creditors did not behave so drastically, they could refuse Hynix fresh loans and push it into receivership, or indeed just threaten to do either of these things in order to get the board to think again.

Court receivership, under which the creditor banks would get whatever a firesale of Hynix assets would provide them with, would have its own political problems in Korea. But the government appears to have worried quite enough about that. Asked for a comment, a Ministry of Finance and Economy spokesperson referred us to Minister Jeon’s remark on May 1 that “the government is taken aback and finds it [the veto] regrettable”. He added: “It is up to the creditors to determine the fate of Hynix. The government will urge creditors to reach a decision at an earliest possible date so as to clear the uncertainties over the Korean market.”

Not everyone is convinced this is the right idea, though. “Great, we’ll push out the board, replace the lot of them,” says someone close to the situation. “Replace them with whom, exactly? We need experts, not retired bank directors and civil servants. It’s not that easy.”

And for Korea? There were plenty of people around the world offering glib “that’s Korea” responses to the news of Hynix’s refusal. But they miss the point. Because the fact is, a board has a right to refuse a deal that it doesn’t think represents its best interests; it has a right, frankly, to be wrong, if that’s how it turns out. “If nothing else,” says one observer, tongue in cheek, “you have to say Hynix’s board certainly demonstrated its independence. To everybody’s surprise.” Whatever else the Hynix situation may represent – and stubbornness may well be a part of it – it is not a government bailout, nor really a step backward in Korean reform.

Although the December election brings with it uncertainty, there is a will at the highest level to see through corporate reform in Korea, and the Daewoo sale to General Motors will doubtless and rightly be promoted by the government as a symbol of Korea’s willingness to move forward. “In terms of the overall progress of corporate restructuring, you have to say this is a bit of a setback, but on the same day it happened the GM deal was signed, and an MoU was signed between Lehman and Woori [Financial Holdings, for a US$1 billion investment],” says Coe. “I think the trend is clearly in the right direction; progress is being made.”

Salomon Smith Barney has spent big – symbolically big – on two established dealmakers in an attempt to push itself in to the top tier of China investment banking after two years in the wilderness. Do Francis Leung and Margaret Ren have what it takes to rebuild Salomon’s bridges? By Chris Wright.

“Listen! This is the sound of me turning the pages of my diary, rrrrrrippping out the appointments that might otherwise keep us apart. I shall have finished my 18 holes of golf by 9.30 am and shall be honoured to meet you thereafter.”

There is only one person on earth who can come out with this sort of boisterous flannel in arranging a time for an interview, and it is Ranjan Marwah, the effervescent headhunter who runs Executive Access in Hong Kong. But on the day Asiamoney calls for a chat he has even more reason than usual to be full of beans. Marwah has just concluded the placement, his own idea, of two of the region’s most celebrated bankers to one of the world’s most powerful banks. Leaving aside the multi-million dollar fee he is rumoured to have received in the process (“we have consistently been the most expensive search firm in town and nothing has changed”), his placement has the potential to change the dynamics of Greater China investment banking.

In July, Francis Leung left BNP Paribas Peregrine to become the managing director and chairman for Salomon Smith Barney in Asia, followed in October by Margaret Ren from Bear Stearns, who becomes head of China investment banking. These are people who occupy that peculiar hinterland of the financial vocabulary which seems more appropriate to the World Wrestling Federation than investment banking: they are ‘big game hunters’, ‘rainmakers’, hunting for ‘elephants’. They are pricey hires, among the priciest we have ever heard of, but at stake is the rehabilitation of Salomon in what is by far the region’s most important market.

The need for rescue

The reason Salomon has needed to spend, and spend big, is well-known. Salomon won’t thank us for revisiting it, but it sets a necessary context to what has happened since.

There was a time when Salomon Smith Barney was a fairly big thing in China. It hadn’t led real landmarks –  a US listing for Qingling Motors through the pre-merger Smith Barney in 1994, a Salomon Brothers’ joint lead role in a Hong Kong dollar issue for Cosco Pacific in 1997, followed by another for Great Wall Technology in July 1999 – but that looked set to change when it was mandated to lead manage the privatization of CNOOC, considered the strongest of China’s three oil majors. This should have been a showcase for the power of Chinese names in the international capital markets. But the 1999 deal, originally mooted to raise up to US$2.5 billion, was pulled on the back of falling markets and weak demand. Although the behaviour of a volatile market was out of the bank’s hands, many felt Salomon had tried to price the deal too highly, and the displeasure at the failure was said to have gone as high as Zhu Rongji. In the aftermath, Merrill Lynch was added to the underwriting team, then CSFB, and when the deal returned to the market earlier this year Salomon had been removed outright. It hasn’t appeared on a China equity deal since, and appeared to have been ostracized from China mandates.

Last year was painful indeed, as the bank looked on while its competitors, particularly Goldman Sachs and Morgan Stanley, took the fees and the prestige of one monstrous equity issue after another from the mainland: Petrochina, Sinopec, Unicom, China Mobile. In Hong Kong, the MTR privatization and, earlier, the Tracker fund sale were completed without Salomon involvement. And this is just the start. Many banks speak of China business occupying more than half of their expected activity in the Asian capital markets in coming years. To miss out on it would be more than depressing; it would be genuinely economically damaging. And people took notice. “What do you think’s going to happen?” a senior figure at a major international bank asked Asiamoney earlier this year. “You can’t tell me [Citigroup CEO] Sandy Weill is just going to sit there and say: fine, let the other US banks have all the China mandates and all the fees that go with them. They must be about to do something.” He was right.

The China team that had, fairly or otherwise, found itself shouldering much of the blame for the CNOOC fiasco moved on earlier this year when Guocang Huan and his team left for HSBC. There had been a difference of opinion on what to do next. “After CNOOC it was very clear that our reputation and our franchise in China had been damaged, and it was equally clear to me that the status quo was not sufficient to help dig our way out of that position,” says William Mills, managing director and CEO for Asia at Salomon. Mills wanted to bring in senior hires while keeping Huan in the group, he says; Huan didn’t like the sound of that and left of his own accord. It might have been for the best in both directions. Huan’s own reputation will be bolstered to an extent if the rumours that HSBC has a role on the Air China privatization prove to be true. And from Salomon’s point of view, Huan’s departure presented the opportunity for a clean break. But where does one go to start rebuilding? Who do you call in order to fight your way back into the arcane world of major China mandates?

Ranjan Marwah thought he knew exactly who to call, and he did: Francis Leung.

Cult of personality

When Leung rejoined Salomon on July 1, he was in fact returning to the Citigroup fold after an absence of 13 years. It probably didn’t much resemble the Citibank he left in 1988, but then, he doesn’t much resemble the person who left in 1988. You could argue that almost as much has happened to Francis Leung in the intervening period as has happened to Citi. He’s certainly made at least as many headlines.

More or less every major touchstone moment of Greater China finance in the last decade has involved Leung. The foundation, rise and collapse of the first and only truly Asian investment bank, Peregrine? Leung was the co-founder with Philip Tose (and the only director to escape censure in the report into its failure). The rise and fall of the red chip market? Leung led a stack of the IPOs, culminating in the astonishing 1,276-times oversubscription of the listing for Beijing Enterprises – the archetypal red chip for which the problems of valuation were complicated by its management of a toll road, department store, hotel, McDonald’s franchise and the tourism rights for the Great Wall of China. He became known as the father of red chips, a moniker he welcomed less when the whole market collapsed. Pacific Century CyberWorks? Leung is said to have taken two hours to raise a billion dollars in funding for the company and was instrumental in its back door listing in 1999, playing his part in the most remarkable corporate finance story of last year. The tech stock boom? Leung helped BNP Paribas Peregrine all but corner the market in new issuance, although many of them crashed dramatically after launch and one, Tom.com, caused near-riots and was criticized in Legco by SFC chairman Andrew Sheng (but does remain above its issue price, almost uniquely among the dot coms). Leung has been called the most significant corporate financier in Asia, and if that sounds bombastic, see who else you can think of who deserves the title, then call us. We’d love to meet them.

Leung is famous first and foremost for his contacts. He knows everyone. Everyone knows him. At Cheung Kong’s AGM this year, Li Ka-Shing told a press conference: “He is a personal friend and a rare talent. Our company will continue to do business with him.” (Li went on to remind Leung that he owed him dim sum in the near future. Shortly after that, Citibank, unusually, was made joint lead alongside Sumitomo on a HK$5 billion loan for Cheung Kong.)

In addition, he is widely liked. His background is not wealthy and he pushed his way to the top through sheer, relentless hard work. Yet, a regular churchgoer, he doesn’t strike you as tough. “Of all senior bankers I’ve worked with, he was totally without ego,” says a former colleague from Peregrine. “He just got on with it and worked hard.” Many from that era recall that they found him easier to deal with than the more arrogant Philip Tose; Leung just got on with his job and made a lot of money, handling as much as 35% of the capital raising for Chinese companies in Hong Kong up to late 1997.

Leung traveled the region, particularly China, pressing the flesh, improving his contacts, serving clients, and in the red-chip boom brought in deals for Peregrine from all over the country: Shanghai Petrochemical, CITIC Pacific, Beijing Enterprises, China Merchants, Guangdong Kelon. “He spoke terrible Mandarin, with a heavy Cantonese accent,” recalls a colleague from the Peregrine days. “But nobody minded. They appreciated the effort.” And though Peregrine was to fail, and the red chip market fall, clients remember him fondly for his devotion to them. “If I have a piece of business, I will give it to them,” says a senior executive at a Hong Kong company. “I think they’ve built a dream team there.”

There is a flip-side to this devotion to clients, of course. Many who have bought deals originated by Leung and his teams have lost a lot of money, first in the red-chip crash and secondly in the tech stock crash, in which BNP Paribas Peregrine was connected with many of the worst-performing new issues anywhere in Asia, among them Techpacific.com, Hongkong.com, iSteelAsia, and weak placements for PCCW and Citic Pacific. Of course, companies like this have plummeted all over the world, and there are examples (the initial PCCW placing, Tom.com) of Leung-led deals that remain above issue price; Leung advocates a buyer-beware attitude and argues that he has never launched a deal for a company that has then folded. The fact that red chips and tech stocks bubbled and burst, he argues, is not really his fault. Nonetheless, he has been associated with more of them than anyone.

One moment of timing that caught the market’s attention was Richard Farrant’s report on the collapse of Peregrine, which was made public earlier this year, and shortly before the announcement of Leung’s appointment. Clearly, discussions were underway beforehand (Marwah says negotiations took about 100 days and that the report came out after Salomon’s offer was made; Leung recalls first being called by Marwah, setting the whole process in motion, late last year), but many have assumed that Citigroup was waiting on the outcome of the report before making the hire. Mills denies this. “Its release was timely from our perspective but we were well down the road with Francis before it was released,” he says. “As you can imagine with a high profile hiring, we were in the process of conducting very thorough due diligence. From that we were very comfortable in terms of pursuing Francis, so we never really thought about it as a precondition.” Actually, the due diligence can’t have been that difficult: Leung himself had seen a draft of the parts of the report that referred to him well before it was ever published, so knew exactly what was coming. In fact the exoneration was explicitly stated, remarkably so for a deputy chairman of a failed bank: “I have no criticisms of Francis Leung’s performance as a director (and deputy chairman) of PIHL [Peregrine Investments Holdings Limited]”, wrote Farrant.

Whatever the significance of the Peregrine report, the deal was struck, with an official start date of July 1 and mind-bogglingly high remuneration. A popular rumour speaks of a guaranteed US$8 million per year over the next two-and-a-half to three years, and an informed source puts it even higher, speaking of a “comfortable eight figures annually”. Salomon and Marwah decline to comment, although Marwah does say this much: “All I am prepared to confirm to you is that he is the best investment banker in Asia Pacific, and his remuneration is absolutely reflective of that.”

Asiamoney cover story, June 2001 (with Saibal Dasgupta)

 India’s groundbreaking, reformist budget has been followed not by momentum and acclaim, but by a stock market collapse, several conspicuous arrests and the banning of brokerages including CSFB. Helped by access to confidential government documents, Chris Wright with Saibal Dasgupta examine whether the country is caught in a permanent pattern of scandal and upheaval, or instead making brave but painful progress towards market reform.

 On February 28, Indian finance minister Yashwant Sinha faced the Lok Sabha (House of the People), the lower house of India’s parliament, and presented a budget that many observers would later call the best for a decade. It was greeted with delight by astonished analysts across the international banking community, who swiftly put out buy recommendations in notes with names like “sunshine on the horizon”. When Asiamoney asked Goldman Sachs strategist Anand Aithal for his suggestions for the Asian finance minister of the year shortly afterwards, he echoed the sentiments of many when he said of Sinha: “If 30% of what he says in this budget is implemented, he will run away with next year’s award.”

But the euphoria lasted less than 48 hours. Within that time the market had unaccountably crashed, and less than three months later India’s markets are back in a familiar mess. The intervening period has seen a sorry procession of scandal and collapse: the stock markets have dropped by a quarter; the president of the Bombay Stock Exchange (BSE) has resigned and had his brokerages banned from trading; his replacement at the BSE has also been removed along with all other broker directors; several brokerages (including Credit Suisse First Boston (CSFB)) have been banned; and the country’s most celebrated investor, Ketan Parekh, has been arrested and incarcerated for allegedly defrauding a bank.

The phrase ‘three steps forward, two steps back’ turns up with monotonous regularity in interviews about India, especially among foreign investors. There are moments of great optimism, when the country’s vast potential seems likely to be realized; then there are crushing collapses that suggest just how much work needs to be done. So what happened this time? And where does it leave India’s markets now?

 The budget

“Sir,” said Sinha on February 28, addressing GMC Balayoyi, the speaker of the Lok Sabha. “I rise to present the budget for the year 2001-2002. I do so in all humility. The challenges we face this year are awesome, made more so by the tragedy and devastation caused by the Gujarat earthquake. I hope I shall get the understanding and support of the whole House in my endeavour to meet those challenges.”

The humility ended there. What followed was revolutionary. Sinha’s budget proposed the liberalization of foreign exchange rules, allowing Indian companies to invest and raise capital abroad; announced bold and wide-ranging tax reforms in support of IT, corporates and the development of the capital markets; raised limits for foreign institutional investors; and, vitally, suggested labour law reforms, expanding companies’ abilities to cut jobs and employ contract labour. His plans to downsize six government ministries started with almost 3,000 job cuts in his own department. A new target of Rs120 billion (US$2.5 billion) was set for the flagging privatization programme, involving the sale of 27 state enterprises over the coming year. It projected GDP growth to rise from 6% to 7% this year with an eventual target of 10%. That figure, the government says, would eliminate poverty in a decade.

“It was a very good budget, I think the best in the last 10 years,” said DSP Merrill Lynch chairman Hemendra Kothari. “It is a bold step towards further liberalization of the economy.” The market echoed his sentiments. The Sensex – the Bombay Stock Exchange’s benchmark index – immediately rose 4.4%. Sinha, a gifted orator and debater, a driven reformer, and even something of a heart-throb (who was once an impressive athelete), must have gone home happy.

 Crash

But if he did, his excitement didn’t last. On Friday March 2, contrary to expectations, the market dropped 4%, by 176 points, mostly within a half-hour period. Sinha was livid to see such a dramatic drop in the index so soon after his budget and, suspecting malpractice, he demanded action.

The appropriate agency to bring it about was the Securities & Exchange Board of India (Sebi), and with a speed in sharp contrast to its sluggish reputation, it launched an investigation almost immediately, scouring the books of brokers who had been active around the time of the crash. On the first trading day after the fall – Monday, March 5 – it introduced a number of measures to contain volatility. Thresholds on volatility limits were changed and, two days later, short selling was effectively banned. It didn’t help: the market continued to fall (see chart), dropping below the 4,000 mark by the end of the week.

By then, there was plenty else to worry about. On March 8, an article appeared in a local newspaper saying that a tape existed of a telephone conversation between BSE president Anand Rathi and his surveillance department on the day of the crash and alleging that Rathi had pressed for, and got, market sensitive information in that phone call. This was particularly significant because Rathi, like several other directors of the notoriously club-like BSE, also owns a number of brokerages. The suggestion was that he had used information from the call for profit. Rathi resigned the same day, protesting his innocence. (See The Accused overleaf.)

And things were to get worse for Rathi. Just four days later, at 10.30pm on March 12, Sebi delivered an order to his house restraining him as director of the exchange and banning his broking businesses – Anand Rathi Securities, Navratan Capital and Securities, Rathi Global Finance and Rathi Capital and Securities – from undertaking fresh business. The order alleged much the same as the newspaper had: that he had obtained information from the surveillance department, in breach of a Sebi circular.