Behind the Industrial Bank's Introduction of Foreign Investment
Sound Corporate Governance to Lay Down Solid Foundations
Even by today's standards, the move by the Industrial Bank to introduce three foreign strategic investors simultaneously is pioneering.
On December 17, 2003 the Bank signed strategic investment agreements simultaneously with HSB, IFC and GIC. The move set new records for Chinese commercial banks in several areas, including: most foreign shareholders introduced in a single time as well as the highest proportion of shares and the highest premium multiple for such a move. The Bank's move was perceived as “a sign that the Chinese Government is accelerating the opening up of finance to the outside world” by a renowned global media organization.
The Bank did not stop there. On February 5, 2007, the Industrial Bank made its initial public offering on the A-stock market to become a listed public bank. By the end of this June, the assets of the Bank stood at about RMB 9.17 trillion Yuan, an increase of nearly three times compared with the 2.5 trillion in 2003 before foreign capital was introduced.
“This demonstrates what the investment introduction, issuance of bonds and going public meant to the Industrial Bank.” Tang Bin, the BOD secretary in the Bank, said.
Bringing in Capital First and then Going Public
As one of the first joint-stock commercial banks established after China's reform and opening-up began, capital supplementation used to be a problem that the Industrial Bank had to deal with as it developed. However, Bank's the purpose of inviting foreign investors was not solely the increase of capital. Before the bank eventually did introduce foreign capital, it was faced with a tough decision: introduce capital first or go public first?
In 1996, the Industrial Bank launched its “re-establishment”, setting up its first branches outside of Fujian Province to begin cross-regional operation. The first branch outside of Fujian was located in Shanghai. The Bank also conducted its first increase of capital and shares in that year, which brought the Bank's capital from RMB 500 million Yuan to RMB 1.5 billion Yuan. In 2000, it launched a strategy of developing nationwide, and conducted a second capital and share increase. Several state-owned enterprises, including CEC, Guohua Energy, Baosteel Group and Hunan Electric Power entered the Bank, taking its capital from RMB 1.5 billion Yuan to RMB 3 billion Yuan.
At the time, state-owned shareholders occupied an absolute majority in the Bank's shareholder structure. These state-owned enterprises came from different industries in different regions, and they each had their own interests. Tang Bin, the BOD secretary, was frank, saying that the main thing that shareholders cared about at that time was their annual dividends and when the Bank would be listed.
The Industrial Bank realized that a sound shareholder structure was needed to develop a framework for sound corporate governance characterized by clear rights and liabilities and effective checks-and-balances. Based on this understanding, the Bank decided to introduce investment first.
In the latter half of 2002, the Bank began to talk with financial institutions regarding the issue of investment. At that time it had to overcome the difficulties that “SARS” had imposed on the negations. Finally, the Industrial Bank settled on three foreign institutions to act as its strategic investors, and signed cooperation agreements with them. They were HSB, IFC and GIC.
The reason why they introduced three investors was to ensure that state-owned shareholders retained a controlling position and to construct a relatively centralized but also reasonably dispersed structure of ownership. At the same time, in the selection of institutions, both well-known commercial banks and other kind of financial institution were favored so as to achieve an organic combination in which the various parties could complement each other.
Retail business is a key point for the Bank's development. HSB was noted for its sound internal control and outstanding retailing business. IFC, as an international financial institution under the World Bank, assists developing countries in developing private-owned economies and has played an active role in helping companies establish sound governance structures and risk control mechanisms, promoting environmental protection and EMS loans. Unlike the other two investors, GIC is a typical financial investor.
Eventually, the Bank reached agreements with the three foreign shareholders with a purchase price of RMB 2.7 Yuan per share (1.8 times P/B). The price set a new investment pricing PB record among commercial banks at the time.
Changes after the Investment
It was evident that the Bank did not introduce investment for the sole purpose of supplementing capital. More importantly, the move was aimed at creating a structure for sound corporate governance in the Bank structure. The participation of foreign shareholders brought about a series of changes in the concepts and systems of the Bank, which laid down solid foundations for the Bank's long-term development.
After foreign investors joined the Bank, the ownership structure had changed dramatically. By the end of this June, Fujian Provincial Finance, the largest shareholder, held a 20.40% stake in the Bank. Hang Seng Bank, the IFC and GIC held stakes of 12.78%, 4.00%, 2.73% stake respectively, being the second, third and sixth largest shareholders. Thus a shareholder structure plural in constitution, rational in stakeholder ratio, complementarily in strengths and harmonious in cooperation had come into being.
On the basis of its sound ownership structure, the Industrial Bank went on to comprehensively improve its basic system of corporate governance and operational mechanisms. In addition to the introduction of senior international bankers into the BOD, it also set up independent director and external director systems and constructed rational incentive-and-restraint mechanisms spanning the BOD, the BOS and senior management. As a result, a structure for sound governance characterized by clearly-defined rights and liabilities, effective checks-and-balances and coordinated operation had been formed.
As the standard of corporate governance was improved, the Bank benefited hugely from the concepts brought to the Bank by foreign shareholders in risk control, business transformation and commercial acquisition. For example, when investment was introduced, the foreign shareholders proposed that the Bank, for the sake of long-term development, should have sufficient provisions and strictly carry out risk management under five-tier classification. When acquiring the Foshan City Commercial Bank and other financial institutions, foreign investors and independent directors proposed that acquisitions should not be made for scale expansion alone, but should also take into consideration the demands of strategic transformation and pay attention to input and output, cost accounting and risk control. These concepts, which seemed like shock waves at the time, had positive effects on the Bank's subsequent development.
Moreover, the participation of foreign shareholders contributed a lot to the upgrading of the Bank's concepts in corporate governance. Shifting from the maximization of shareholders' interests seen in the Bank's early days to concern for all interested parties, the Industrial Bank has began to actively highlight the link between the social responsibility of banks and their sustainable development. For the Industrial Bank, the social responsibility it shoulders is not limited to being profitable, paying taxes and making donations to charity. The core of its responsibility is to realize environmental protection, reduce emissions of poisonous gasses and increase social welfare through providing professional services. Thus, a bank is required to follow market principles, make corporate responsibility and sustainable finance core concepts and values, provide outstanding financial products and services to exert its influence and support the sustainable development of communities, the economy and the environment. At the same time, through operation and management guided by social responsibility, a bank is able to open up new markets and fields in which it has the competitive edge, thus achieving the ultimate goal of long-term, sustainable growth. With such a concept, the Industrial Bank took the lead in promoting “sustainable finance” and launching "green credit” among its counterparts.
On May 17, 2006, the Bank signed a cooperation agreement with the IFC, according to which the two would jointly launch the energy efficiency project financing, the first service of its kind in China, providing credit support to Chinese enterprises to improve energy efficiency, develop and promote clean and renewable energies. On February 25, 2008, it signed the phase II cooperation agreement with the IFC in Beijing. Moreover, it announced that a further RMB 10 billion Yuan of loans would be granted within the next three years to support energy conservation and emission reduction in China. On June 28, 2008, the 9th meeting of Industrial Bank's 6th BOD passed a motion regarding application for entry to the "equator principles”, marking that the Industrial Bank had taken another important step in its development strategy of “sustainable finance”.
On February 5, 2007, the Bank was listed on the Shanghai Stock Exchange (stock code: 601166). On July 1, 2008, more than year after being listed, the Industrial Bank was included among sample stocks of the corporate governance index by the Shanghai Stock Exchange and China Securities Index Co., Ltd, which proved once again that the Bank had gained a leading advantage in terms of corporate governance.
“Investment introduction further improved the ownership structure of the Bank, and laid down the foundations for sound corporate governance. Being listed turned the Bank into a real public company.” Tang Bin said. Information disclosure presents the Industrial Bank to the public in a more transparent way. Being monitored by the public is of particular importance to the Bank's future operation and development.
Issuing Bonds: A New Channel to Explore Capital Supplementation
Besides investment introduction and going public, the Industrial Bank also made innovations in capital supplementation.
To ensure that capital growth could meet the demands for business development, the Industrial Bank issued RMB 3 billion Yuan of subordinated bonds (information, market) on the inter-bank market in September 2003, pioneering capital supplementation of domestic commercial banks through the issuing of bonds. After going public was postponed, the Bank issued RMB 4 billion Yuan in hybrid capital bonds in September 2006, becoming the first issuer of hybrid capital bonds in China.
Hybrid capital bonds are long-term bonds with the characteristics of upper tier 2 capital created on the basis of conditions in China, in line with the provisions in the Basle Agreement and in reference to standard international practice in hybrid capital instruments. At the beginning, they were called “high-grade subordinated debts" owing to a literal translation. This puzzled domestic investors, who were not familiar with this kind of tool. They weren't sure whether it was high-grade or subordinate. After repeated brainstorming and deliberation, the Industrial Bank concluded that it had a higher capital attribute compared with other issued bonds, and in terms of the nature of the tool, it belonged among long-term bonds. Therefore, it was a long-term bond with high capital attribute. In light of this, the Industrial Bank proposed the innovative name of “hybrid capital bond”. The name was quickly accepted by the banking industry and was used in later official documents of the supervision and control departments.
In fact, regardless of whether we are talking about subordinated bonds or hybrid capital bonds, there have been many such classic moments at the Industrial Bank. Of course, these financial innovations not only benefited to the Bank itself but also exerted profound influences on China's banking industry and finance market.
First of all, taking the Basle Agreement as an entry point, capital adequacy management was introduced by supervision and control departments. However, the capital composition of domestic commercial banks was monotonous and weak compared to that of the international banking industry, a fact which made it hard to implement such international concepts of supervision and control. The launch of subordinated debts and hybrid bonds not only provided a new means for commercial banks to supplement capital but also fulfilled capital supervision and control in China's banking industry in regard to tools. Additionally, commercial banks can, based on the demands from the market and their own management, take the initiative to conduct financing arrangements and effectively reduce financing costs. In terms of the financial market, the emergence of subordinated debts and hybrid bonds added bond varieties available for investment on China's market, and further enriched the structure of bond market.
At present, issuing debt capital tools, such as subordinated debts and hybrid capital bonds has become one of the main conventional channels for domestic commercial banks to increase supplementary capital. Other banks including the Bank of China, China Construction Bank, China Merchants Bank and the China Minsheng Bank successively issued subordinated bonds or hybrid capital bonds to supplement capital. City commercial banks such as the Nanjing Bank and Hangzhou City Commercial Bank followed suit to.
(Chinese Business News , August 22, 2008)