Protecting China's Red Princes

When it comes to protecting the well-connected from their own incompetence, greed and worse, few institutions rival the Communist Party of China. Minor corrupt officials are routinely executed, big fish very seldom.

So it should perhaps come as no surprise that following the rescue of Hong Kong-listed Citic Pacific by its Beijing former parent and now guardian, it has left unchanged the top management that oversaw the loss of US$2 billion – yes, US$2 billion – in currency speculation little connected with any of its core businesses.

In the process Beijing has showed just how little it cares about corporate governance, let alone the public interest when its favorites are concerned. It has also cast doubt on the willingness of Hong Kong authorities to take corporate governance seriously when not only a Beijing favorite is involved but also one of their own pet business stooges.

Citic Pacific is a Beijing creation that was in effect handed on a plate to Larry Yung who just happened to be the son of Rong Yiren, a "patriotic" capitalist who became a vice-president of China and at Deng Xiaoping’s request set up Citic – China International Trust and Investment Corporation as a conduit for foreign capital. Citic Pacific was subsequently spun off as a Hong Kong-listed subsidiary .In a deal reminiscent of Russia under Boris Yeltsin, back in the 1990s Larry Yung was able to obtain a large chunk of shares of Citic Pacific at a knock-down price, and the Beijing parent’s stake eventually fell to 29 percent.

Using the Citic name and Beijing connections, Yung built a sprawling but ill-focused conglomerate. It hit no critical problems during the Asian financial crisis of 1997-1998 but it was widely believed in the market at that time that persons connected to Citic lost large sums by being on the wrong side of futures and warrants contracts, but resulting debts were written off by a state-owned mainland bank.

This time Citic Pacifc itself has become the loser from making massive derivatives bets on the Australian dollar, a currency that has fallen nearly 30 percent in the past few months. It touched a peak of US98¢ and is now around 65¢. The mainland former parent has had to step in with a US$1.5 billion standby facility and a convertible loan which would on conversion take its stake to 57 percent. No pretence here at being a private Hong Kong company!

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For sure, Beijing will be exercising plenty of oversight from now on but Yung, as chairman, and family members remain in situ. Yung’s attempts to blame “unauthorized speculation” for the losses have been received with some scepticism by a market which believes that Yung family members were directly involved. His daughter is an executive in Citic’s finance department.

The way in which the Chinese state has handed billions to Yung over the years is remarkable. But Yung’s gravy train may have been slowing even before this disaster. Back in 2005 Yung was granted options of 100 million Citic Pacific shares by the Hong Kong arm of the Beijing parent. They were issued at a price that was already below the then-traded price of the shares. They could have been exercised already this year at a HK$700 million profit. But Yung did not exercise the options and has ceased to have an interest in them. Perhaps this indicates Beijing had finally tired of Yung’s greed and told him to hand back the options– but still is not prepared to sack him or his top executives for incompetence.

From a governance point of view, as bad as the loss itself was failure to report it to shareholders for several weeks after it was known. Indeed it even issued a report well after it had known of the problem saying it was not aware of any material adverse change in its financial or trading position. This has prompted investigation by the Hong Kong authorities. But do not hold your breath for appropriate action. Citic Pacific Chief Executive Henry Fang is a member of Hong Kong’s policymaking Executive Council, a government appointed director of member of HK Exchanges, which runs the HK Stock exchange, a member of the panel on Takeovers and Mergers, government appointed Chairman of the Mandatory Provident Fund Authority and Treasurer of the University of Hong Kong. He has temporarily stepped aside from these roles – but seems likely to escape largely unscathed from the dramatic failure of his management.

Fan is indeed typical of an elite class of who hold down myriad jobs simultaneously in the private sector and government and quasi-government bodies. Members of this small coterie of backscratchers often have scant real business experience but are mutually self-supporting and can be relied upon to bend with the prevailing political winds. They in turn can expect to be protected. Accountability is not a word appreciated by the upper echelons of Hong Kong’s bureaucracy which would prefer the kind of system which rewards and protects the likes of Larry Yung.