Article

China

Will the successful Initial Public Offerings (IPOs) for Chinese banks translate into a success in reforming China's banking system? I believe they will, but it could take many years to overcome the obstacles in China to make banking reforms work. In any case, events are moving in the right direction.

The first IPO in October 2005 was for China Construction Bank, the fourth largest bank in the country. It was followed by the one for the Bank of China, China's second largest bank, in May 2006. This, in turn, was followed in October 2006 by the largest IPO yet, the USD 10 billion float for the Industrial & Commercial Bank of China (ICBC), China's largest bank. Other IPOs were for China Merchants Bank and Bank of Communications.

Investors viewed Chinese bank IPOs as good ways to profit from the nation's roaring economic growth. Their success also reflected investors' confidence that the banking system will be reformed to meet the challenges of the fast-growing economy, which is leaping ahead by 10 per cent a year. If ICBC grows in tandem with the Chinese economy, investors will consider it to have been a good investment.

However, these largest publicly traded Chinese banks and other smaller local banks have a long way to go to match the level of services and products offered by global banks. Just go to ICBC to try to withdraw some money and you will understand better why it is hard to be overly optimistic about ICBC's performance in the equity market. Moreover, there has been a history of bad loans and bad management at the bank, so much so that it received a USD 15 billion injection from the government to clean up its balance sheet last year. In fact, all of these publicly traded Chinese banks received multibillion- dollar government bailouts after writing off massive amounts of bad debt.

The history of bad loans and bad management at these banks is further evidence that the Chinese banking system needs further reform in order to compete domestically and internationally. At first, Chinese banks revamped their operations with the help of foreign strategic investors. Yet all three listed banks are still controlled by the state. More than 72.5 per cent of ICBC is held in equal shares by the Ministry of Finance and the state's asset management arm, Central SAFE Investments Ltd. The national pension fund holds a 5.4 per cent stake and foreign strategic investors a combined 7.4 per cent. This makes it difficult for investors to have any influence on reform.

On the bright side, these initial public offerings may be the first step towards the reform that the Chinese banking system badly needs, especially to raise their standards of international banking practice, to reduce bad loans and to improve operational management. One day, if not in the immediate future, these banks may well become first-rate international financial enterprises.

Simon Jian
Executive Vice President Chief Operating Officer
Edward Trading
email: simonjian@edwardtrading.com

Spain

Over the last few months, several financial entities in Spain - mine among them - have received requests from foreign banks to issue demand guarantees subject to the ICC's Uniform Rules for Demand Guarantees (URDG). There is nothing unusual about this, but there is one noteworthy new factor - namely that the instructing banks offer a counter-guarantee in the form of a standby letter of credit subject to International Standby Practices (ISP98).

After some research on the reasons for this, I found that beneficiaries to whom the guarantees were destined required the URDG as governing rules, while banks issuing the counter-guarantees preferred ISP98 for different reasons.

Whatever the reasons, we are now in a situation where the pieces of the puzzle do not fit perfectly. While guarantees and counter-guarantees are independent of each other according to article 2 of URDG, both undertakings are, in fact, economically related, in theory at least, though they are governed by different rules. Some legal departments object to accepting the practice of working with two sets of rules, while commercial departments strive to find a compromise in order not to miss out on any business, even if the rules do not always fit with each other.

In this situation, international operations departments end up with the task of trying to persuade the counter-guarantor to have its counter-guarantee governed by URDG as well, in order to homogenize the whole operation. If that is not possible, it is then up to each entity to accept (or not) the different rules, and thus to carry out the operation (or not).

While there are some differences, ISP98 and URDG have a great deal in common. At the end of the day, both standby letters of credit and demand guarantees are independent guarantees. In fact, both are linked to a unique international text: the United Nations Convention on Independent Guarantees and Standby Letters of Credit, the common territory of both sets of rules.

Both ISP98 and the URDG also enjoy the support of the International Chamber of Commerce, since the ICC Commission on Banking Technique and Practice was involved in drawing up both sets of rules.

Both sets of rules have long histories: ISP98 were approved by the ICC in April 1998 and the URDG go back even further, to 1991. The URDG are now so old that at the last meeting of the ICC Banking Commission, it was agreed to give a new mandate to the Task Force on Guarantees to start working on what might lead to a revision of the URDG. Whether to move full speed on the revision will be decided at the next Banking Commission meeting in Singapore.

If we are looking to a possible revision of the URDG, and having in mind that ISP98 have been in force for nearly a decade, perhaps it is time to start considering bringing the two sets of rules closer together, or even to merge them into one single set, in order to avoid problems like those I mentioned earlier.

Since both concern independent guarantees and both are linked to the same UNCITRAL convention, ICC, which has as its mission to facilitate trade and to make life simpler for traders, should give serious consideration to such a merger.

We have an excellent opportunity, although it would not be an easy task. Very little worth doing is easy. Why not try?

Xavier Fornt
International Advisor
Caixa Catalunya
email: xavier.fornt@caixacatalunya.es