China Capital Outflows to Tighten in 2017
After a record amount of capital outflows from China in 2016, Beijing is looking to reverse course this year.
Chinese authorities’ efforts to restrict capital outflows appear to be working. Foreign exchange reserves rose for four consecutive months through May, as inflows finally exceeded outflows. Outbound direct investment dropped almost 46 percent during the first six months of 2017 compared to the same period last year, according to official data.
Beijing is using a multipronged approach to stem the money flow. Regulators have restricted fundraising activities of insurance companies, a main source of recent foreign acquisitions. The China Banking Regulatory Commission (CBRC) in late June asked banks to check their exposure to several conglomerates with activities abroad, including the Dalian Wanda Group. And most recently, regulators are applying stricter standards before approving foreign investments and using state-controlled media to root out offenders.
China is especially targeting so-called “asset transfers,” or purchases of foreign assets with little to no potential economic returns. Such purchases, regulators believe, are purely used to shift or launder funds abroad.
“China will continue to encourage only genuine and rule-abiding outbound investments by financially competent companies,” said Wang Chunying, a spokesperson at the State Administration of Foreign Exchange (SAFE), according to Caixin, a mainland business magazine. SAFE is China’s foreign-exchange regulator.
Reading between the lines, it’s clear that regulators believe some recent high-profile foreign acquisitions were backed by dubious financing, and the quality of such assets raises questions.
Beijing has also utilized the state-controlled media to step up criticism of the recent string of high-profile overseas acquisitions by Chinese companies, where academic and business experts publicly question the motivation behind such deals.
During a July 18 segment shown on state-owned China Central Television (CCTV), the host asked why a little-known Chinese appliance retailer would buy the Italian soccer club Internazionale, also known as Inter Milan, given that the company had been losing money for the last five years.
“Some companies are already highly indebted at home, yet they spend lavishly with bank loans abroad. … I think many overseas acquisition deals have a low chance of generating cash flow, and I cannot exclude the possibility of money laundering,” said Yin Zhongli, a researcher with the Chinese Academy of Social Sciences, during the CCTV segment, according to the South China Morning Post. The Chinese Academy of Social Sciences is a think tank affiliated with the State Council, China’s cabinet.
Publicly traded shares of Suning, the appliance retailer that bought Inter Milan, immediately fell intraday following the CCTV segment. Yin Zhongli, the academic researcher, later clarified that he did not intend to call out Suning in particular, but was commenting in general about Chinese firms buying assets abroad.
SAFE spokeswoman Wang said the regulator would focus its attention on cross-border deals in real estate, hotels, entertainment, cinemas, and sports clubs.
The industries cited by SAFE are not coincidental—such companies were main targets of China’s dealmakers during the recent acquisition frenzy.
China’s banking regulator recently asked banks to look into their exposures to several Chinese conglomerates, including Anbang Insurance Group Co., Dalian Wanda Group Co., HNA Group Co., Fosun International Ltd., and Rossoneri Sport Investment Lux, which acquired Italy’s AC Milan soccer team in April.
Foreign real estate and hotels are frequent targets of insurer Anbang and conglomerate HNA, while Hollywood movie studios and cinemas have received heavy investment from commercial developer Wanda.
Ownership of foreign sports clubs has also drawn Chinese regulatory scrutiny. Rossoneri’s original proposal to buy AC Milan almost fell apart after it was postponed several times, due to Beijing’s refusal to sign off on certain funds leaving China. The deal finally concluded in April after billionaire investor Paul Singer’s hedge fund Elliott Management stepped in to provide partial financing. Besides the two Italian clubs, Chinese companies also have ownership stakes in English club Aston Villa, Spanish club Atletico Madrid, and French club OGC Nice.
Anbang Chairman Wu Xiaohui was detained by Chinese authorities in June. Anbang had been one of the most active foreign dealmakers over the last three years. It owns the Waldorf Astoria hotel in Midtown Manhattan—currently closed for renovation—and Chicago-based Strategic Hotels & Resorts. In 2016, Anbang famously launched a failed bid to acquire Starwood Hotels & Resorts Worldwide.
Wu is believed to be a close ally of an influential political faction, led by former Party leader Jiang Zemin, that is in opposition to the Xi leadership. Jiang was head of the Chinese Communist Party (CCP) for more than a dozen years (1989–2002) and continued holding sway over the Chinese regime through a network of cronies for another 10 years (2002–2012). Since entering office in 2012, Xi has waged a battle to uproot the influence of Jiang and his faction.
Sources close to Zhongnanhai, the central headquarters of the CCP, told The Epoch Times in June that Wu is one of the key “white gloves,” or money launderers, for the Jiang political faction and the family of Zeng Qinghong, the former Chinese vice premier and longtime Jiang confidant.
HNA and US Banks
Another active foreign acquirer, HNA may be finding itself shunned by leading Wall Street banks and advisers.
Last week, Bank of America Corp. told its bankers to stop working with HNA Group and its affiliated entities on future transactions, due to concerns about the group’s debt levels and opaque ownership structure, according to a Bloomberg report. The report also stated that other banks, including Morgan Stanley and Citigroup Inc., gave similar directives to their staff.
A source at a major Wall Street bank confirmed the Bloomberg report.
Currently, HNA is closing on the purchase of a majority stake into hedge fund SkyBridge Capital LLC. SkyBridge’s founder and co-managing partner is Anthony Scaramucci, President Donald Trump’s new communications director.
Approvals are required from banks’ compliance departments before bankers can conduct business with potential clients, a process known as KYC (know your client), which scrutinizes a potential client’s credit-worthiness, track record, and ownership. Citigroup and Morgan Stanley struggled to obtain sufficient clarity on HNA’s sources of funding and its ownership structure, according to the report.
Similar to other Chinese conglomerates, HNA has a Hong Kong publicly listed arm, HNA Holding Group Co. Ltd., which is owned by a parent company with obscure ownership identities.
HNA’s ultimate structure is a complex web of investment trusts, provincial and local government agencies, and small-business ventures.
Thirteen individuals ultimately control 76 percent of the company through intermediary companies. Chen Feng, the public face of the company, controls 15 percent of HNA and has connections with former presidential candidate Jeb Bush and American investor George Soros. HNA’s biggest owner, Guan Jun (with a 29 percent stake), doesn’t work for the company and is a relative unknown. Listed addresses for Guan through various public filings and records include a side street beauty salon in western Beijing, a shabby Beijing office building, and a nondescript apartment building in southwest Beijing, according to the Financial Times.
HNA is also highly indebted. At the end of 2014, HNA had a combined debt of 196.9 billion yuan ($29.5 billion) on its balance sheet, compared to only 73.2 billion yuan ($10.9 billion) of equity, according to prospectuses filed with the Irish securities regulators in connection with a 2015 $1 billion bond offering of one of its subsidiaries.
While actions of individual U.S. banks may have little to do with Chinese politics or regulatory desires, the path forward for Chinese companies looking to acquire foreign assets is becoming more and more difficult.