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Cablegate: Problems Looming for M&a and Venture Capitalists

VZCZCXRO2533
RR RUEHCN RUEHGH
DE RUEHGH #0337/01 1521139
ZNR UUUUU ZZH
R 011139Z JUN 07
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 5903
INFO RUEHBJ/AMEMBASSY BEIJING 1158
RUEHCN/AMCONSUL CHENGDU 0712
RUEHGZ/AMCONSUL GUANGZHOU 0692
RUEHHK/AMCONSUL HONG KONG 0821
RUEHSH/AMCONSUL SHENYANG 0714
RUEHIN/AIT TAIPEI 0584
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/WHITE HOUSE NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 6311

UNCLAS SECTION 01 OF 02 SHANGHAI 000337

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EAP/CM AND EEB
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/ALTBACH/READE
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN/GLICK/LUNG; NEW YORK FRB FOR CLARK/CRYSTAL/MOSELEY
STATE PASS CFTC FOR OIA/GORLICK
CEA FOR BLOCK
USDOC FOR ITA DAS KASOFF, MELCHER AND OCEA/MCQUEEN
TREASURY FOR OASIA - DOHNER/CUSHMAN
TREASURY FOR IMFP - SOBEL/MOGHTADER
NSC FOR KURT TONG

E.O. 12958: N/A
TAGS: EFIN ECON EINV PREL CH
SUBJECT: PROBLEMS LOOMING FOR M&A AND VENTURE CAPITALISTS

REF: A. TARNOWKA-LOEVINGER 5/18 EMAIL

B. SHANGHAI 70
C. SHANGHAI 250

(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels.

1. (SBU) Summary: International private equity (PE) and venture
capitalist (VC) representatives told visiting Embassy Finatt, on
May 16, that Chinese regulations which took effect in September
2006 have effectively shut them out from doing business in
China. Since the "Provisions for Foreign Investors to Merge
with Domestic Enterprises" rule took effect last year, no
Chinese company had been granted permission to form a special
purpose vehicle (SPV) that in preparation for listing on a
non-Chinese stock exchange. As a result, international VC and
PE firms were reluctant to invest in China since they had no
exit strategy. The company representatives asked that this
concern be raised within the context of the Strategic Economic
Dialogue (SED). While this regulation would eventually hurt
NYSE and NASDAQ, enough companies had received permission prior
to this rule's enactment to not impact their current business,
according to the NYSE. End summary.

2. (SBU) Shanghai-based international PE and VC representatives
The Carlyle Group China Chief Representative Luo Yi, ChinaVest
Chairman Robert Theleen, and New Access Capital Managing Partner
Andrew Qian discussed China's mergers and acquisition's (M&A)
environment with visiting Embassy Finatt on May 16. They raised
serious concerns about China's "Provisions for Foreign Investors
to Merge with Domestic Enterprises" rule that took effect
September 8, 2006. (Note: These rules required that any Chinese
company seeking to list overseas via a special purpose vehicle
(SPV) and therefore transfer company assets overseas be approved
by six government agencies. These were the Ministry of
Commerce, State Assets Supervision and Administration
Commission, State Taxation Bureau, State Administration of
Industry and Commerce, State Administration of Foreign Exchange
and China Securities Regulatory Commission (CSRC) (Ref B). End
note.)

3. (SBU) According to Carlyle's Luo, there had been no PRC
approval for any Chinese company to create an SPV since the
rules took effect on September 8, 2006. Forming an SPV was the
best, and often only, route for small- to medium-sized Chinese
companies to list on foreign stock-exchanges as it created a
"clean" company unencumbered by potential contingent
liabilities. They claimed, unless modified, the rule could have
a major negative impact both on U.S. exchanges (NYSE and NASDAQ)
and on the ability of Chinese start-up firms to access the
capital they need to research and develop innovative products.

4. (SBU) Additionally, international VC and PE firms would be
reluctant to invest U.S. dollars in Chinese start-ups if they
were unable to list overseas since they would find it otherwise
difficult to capitalize their gains and exit out of their
investments. Most Chinese start-ups did not receive bank loans
and were unable to meet listing requirements for Chinese
exchanges, which had more stringent profitability requirements
than NASDAQ, said Theleen.

5. (SBU) Qian had also heard rumors of even more restrictive
implementing regulations soon to be issued (including a possible
requirement of USD 1 billion market capitalization to qualify
for an overseas-only listing). This had exacerbated the
international VC and PE companies' concerns, he added.

6. (SBU) Luo, Qian and Theleen provided talking points that
could be used by Treasury in upcoming SED meetings (transmitted
Ref A). They understood it was likely too late to have their
concerns in the May 22-23 SED II meetings in Washington. (Note:
Finatt plans to seek appropriate opportunities to raise these
concerns with relevant Chinese authorities in Beijing, including

SHANGHAI 00000337 002 OF 002


the National Development and Reform Commission, CSRC and MOFCOM.
End note.)

------------------------------------------
The Jurassic Park Rule: Nature Finds a Way
------------------------------------------

7. (SBU) In a separate meeting on May 16, Gaohua (Goldman Sachs)
Securities Company Executive Director Raymond Yin told Finatt
that there had been "a very direct message" to state-owned
enterprises that they should not list overseas, but should list
in China. This was a clear move, he said, to provide more and
better stock offerings into the Shenzhen and Shanghai stock
exchanges in an attempt to provide more supply and contain
upward pressure on stock prices. He said that restrictions on
SPVs were a reflection of this. However, he added, he had also
heard that these restrictions originated with Chinese leaders
unhappy with the "Unocal failure."

8. (SBU) Nevertheless, Yin said that the Jurassic Park movie
tagline, "Nature finds a way," also applies to the market.
"Smart venture capitalists" would always be able to find a way
for their capital to both enter and exit China. This would
lead, he believed, to companies resorting to the unregulated
over-the-counter (OTC) market.

--------------------
NYSE Not Yet Worried
--------------------

9. (SBU) Asia Pacific NYSE Group Executive Director Michael Yang
told Econoff on May 23 that his contacts at the CSRC had
indicated that the September rules were aimed largely at
preventing state-owned enterprises (SOEs) from "being sold too
cheaply to foreigners." Yang said that another genesis of these
regulations was Carlyle's attempted purchase of a controlling
stake in the Xugong Group Construction Machinery Company. This
had worried Chinese leadership who were concerned about foreign
ownership of Chinese companies, he said. Yang also believed
that CSRC's leadership wanted to promote China's stock exchanges
and wanted more good companies to list in China.

10. (SBU) Nevertheless, Yang said companies that had finished
the paperwork necessary to form an SPV prior to September 8,
2006 were able to list overseas. Yang estimated that there were
"many hundreds, up to a thousand" such companies. While not all
of these companies would meet U.S. standards for listing, Yang
said that he knew of between 40 and 50 Chinese companies that
were planning to list on NYSE or NASDAQ this year and an equal
number in 2008. Unless there were changes after 2008, however,
the "Provisions for Foreign Investors to Merge with Domestic
Enterprises rule" would "begin to hurt our business," he said.

----------------------------------
NYSE Ready To Apply for Rep Office
----------------------------------

11. (SBU) Yang said that NYSE would submit its application for a
representative office on July 1, as soon as allowed by CSRC (Ref
B). Yang said that he had heard from CSRC contacts that the
regulations to allow representative offices had been drafted in
such a way to try to exclude stock exchanges from countries
other than the United States from qualifying. He attributed
this to the CSRC wanting to be as protectionist as possible
while still fulfilling its commitment to Secretary Paulson.
Yang reiterated that being allowed to have a legal presence in
China would be a huge symbolic boost for NYSE's business. He
expected that 2007 would be NYSE's best year for listing Chinese
companies, noting that four had listed so far and two more
companies would list in early June.

12. (U) Embassy Finatt cleared on this cable.
JARRETT

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