Welcome to the LEHMAN, LEE & XU Firm’s “Corporate Governance in China” newsletter, June 7, 2013 edition. 

In this edition of our “Corporate Governance in China” news letter, in Topic 1, we first delve into the world of “undercover” cyber snooping where there is no shortage of finger pointing and accusations being made about who is taking part in these activities. No one is willing to fess up.    Top level meetings are being held to discuss methods of increasing security for internet transactions, and international trade and commerce.  However, after lots and lots and lots of talks have  taken  place, and continuing talks are planned ad infinitum,  truth is, there is so much to be gained from hacking and other forms of intelligence gathering via the internet, that I have to wonder how serious world governments are about putting an end to it. What do you think?

Topic 2 of this newsletter addresses the issues about Corporate Governance and the levels of transparency, or the lack thereof, within today’s rank and file of Chinese Government officials.

Topic 3 looks into further banking law changes that are taking place in the PRC that appear to be welcome changes to the ways China does its banking domestically.

Best Regards,
Lex Smith
Foreign Legal Consultant

The China Corporate Governance News keeps you on top of business, economic and political events in the China.
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In the News

China tapped Google server secrets

Chinese hackers who breached Google’s servers several years ago gained access to a sensitive database with years’ worth of information about U.S. surveillance targets, according to current and former government officials.

The breach appears to have been aimed at unearthing the identities of Chinese intelligence operatives in the United States who may have been under surveillance by American law enforcement agencies.

It’s unclear how much the hackers were able to discover. But former U.S. officials familiar with the breach said the Chinese stood to gain valuable intelligence. The database included information about court orders authorizing surveillance — orders that could have signaled active espionage investigations into Chinese agents who maintained email accounts through Google’s Gmail service.

“Knowing that you were subjects of an investigation allows them to take steps to destroy information, get people out of the country,” said one former official. The official said the Chinese could also have sought to deceive U.S. intelligence officials by conveying false or misleading information.

Although Google disclosed an intrusion by Chinese hackers in 2010, it made no reference to the breach of the database with information on court orders. That breach prompted deep concerns in Washington and led to a heated, months-long dispute between Google and the FBI and Justice Department over whether the FBI could access technical logs and other information about the breach, according to the officials.

Google declined to comment for this article, as did the FBI.

Last month, a senior Microsoft official suggested that Chinese hackers had targeted the company’s servers about the same time Google’s system was compromised. The official said Microsoft concluded that whoever was behind the breach was seeking to identify accounts that had been tagged for surveillance by U.S. national security and law enforcement agencies.

“What we found was the attackers were actually looking for the accounts that we had lawful wiretap orders on,” said David Aucsmith, senior director of Microsoft’s Institute for Advanced Technology in Governments.”If you think about this, this is brilliant counterintelligence,” he said. “You have two choices: If you want to find out if your agents, if you will, have been discovered, you can try to break into the FBI to find out that way. Presumably that’s difficult. Or you can break into the people that the courts have served paper on and see if you can find it that way. That’s essentially what we think they were trolling for, at least in our case.”

The U.S. government has been concerned about Chinese hacking since at least the early 2000s, when network intrusions were discovered at U.S. energy labs and defense contractors.

The Chinese, according to government, academic and industry analysts, have stolen massive volumes of data from companies in sectors including defense, technology, aerospace, and oil and gas. Gen. Keith Alexander, the director of the National Security Agency, has referred to the theft of proprietary data as the “greatest transfer of wealth in history.”

The Chinese emphatically deny they are engaged in hacking into U.S. computer systems and have said that many intrusions into their own networks emanate from servers in the United States.
“The Chinese government prohibits online criminal offenses of all forms, including cyber attack and cyber-espionage, and has done what it can to combat such activities in accordance with Chinese laws,” a Chinese Embassy spokesman, Yuan Gao, said in an email. “We’ve heard all kinds of allegations but have not seen any hard evidence or proof.”

Experts said an elaborate network of interconnected routers and servers can make the Internet tailor-made for the shadowy work of spying and counter spying. It stands to reason, they said, that adversaries would be interested in finding vulnerabilities in the networks of the companies that authorize surveillance on behalf of the government.

“It is an absolute rule of thumb that the best counterintelligence tool isn’t defensive — it’s offensive. It’s penetrating the other service,” said Michael Hayden, a former director of the National Security Agency and the CIA, who said he had no knowledge of the incidents. Hacking into a surveillance database, he said, “is a form of that.”

Google’s crisis began in December 2009, when, several former government officials said, the firm discovered that Chinese hackers had penetrated its corporate networks through “spear phishing” — a technique in which an employee was effectively deceived into clicking a bogus link that downloads a malicious program. The hackers had been rooting around inside Google’s servers for at least a year.

Alarmed by the scope and audacity of the breach, the company went public with the news in January 2010, becoming the first U.S. firm to voluntarily disclose an intrusion that originated in China. In a blog post, Google chief legal officer David Drummond said hackers stole the source code that powers Google’s vaunted search engine and also targeted the email accounts of activists critical of China’s human rights abuses.

As Google was responding to the breach, its technicians made another startling discovery: Its database with years’ worth of information on surveillance orders had been hacked. The database included data on thousands of orders issued by judges around the country to law enforcement agents seeking to monitor suspects’ emails. The most sensitive orders, however, came from a federal court that approves surveillance on foreign targets such as spies, diplomats, suspected terrorists and agents of other governments. Those orders, issued under the Foreign Intelligence Surveillance Act, are classified.

Michael DuBose, former chief of the Justice Department’s Computer Crime and Intellectual Property Section, declined to comment on either the Microsoft or Google case. But, he said, in general such intrusions serve as “a wake-up call for the government that the overall security and effectiveness of lawful interception and undercover operations is dependent in large part on security standards in the private sector. “Those,” he said, “clearly need strengthening.”

Source : The Japan Times News



Corporate governance in China

(MENAFN - Khaleej Times) China's economy has, over the last three decades, staged the strongest growth over any given period in history, as the country moved away from a purely state-owned, centrally-planned economic system to one where foreign capital and private enterprises are allowed. 

Coupled with its immense domestic market and a hunger to catch up and over-take, "China", to international investors, is a byword for tremendous business opportunities. Yet, the word also carries notions of challenges for investors, as they attempt to capture this growth.

From the perspective of Professor TJ Wong from the City University of Hong Kong (CUHK), the root of these challenges can be traced to one word: transparency. Wong, who is also the Dean of CUHK's Faculty of Business Administration as well as the Director of the Center for institutions and Governance at CUHK, was speaking at Singapore Management University recently, as part of the Ho Bee Professorship in Chinese Economy and Business lecture series.

Opaque Transparency
For international investors, the biggest challenge to business in China is the lack of transparency. And according to Wong, this boils down to the country's corporate governance framework.

Corporate governance, by his definition, is "the mechanism of pushing firms to operate efficiently and create value", designed "to prevent potential exploitation of outside investors, particularly shareholders, by corporate insiders, such as the management".

The guiding principles behind corporate governance: firms should not just keep the profits for themselves; they should share them with their investors. The other way to look at it is that the interests of all stakeholders have to be aligned. But beyond these basic principles, specific standards and regulations will vary across countries, industries, or even size of the companies.

Wong likens corporate governance to buying and wearing shoes: there is no "one-size-fits-all" model. However, corporate governance practices are shaped by several basic layers. First, country institutions - that includes the legal system and the government. Second, markets — the dynamics of how labor, products, managers, and financial capital work together. Third, firms - how companies are organized, their ownership and management structures. Last but not least, governance structures and accounting.

Owners and Managers

A major issue faced by international investors and businesses operating in China is the lack of a clear separation between ownership and the company's management.

"In a company, there should be two bodies: the board and the professional managers," said Wong. The picture is made more complicated by government presence in large state-owned enterprises or SOEs — legacies of the country's command economic system. While there is a growing number of privately-owned, non-government companies, SOEs still hold a significant presence in China's economy, especially in vital infrastructure-related and finance industries.

"The key to solving the problem is to allocate different rights to different bodies," said Wong. The owner or shareholder should hold rights - to control firms, to share profits, and to sell the first two rights. But because the shareholder has little know how when it comes to controlling the firm, he or she will assign control rights to the board of directors and managers. All in all, there should be a clear distinction between the rights of the board as well as management.

In China's context, ownership of listed SOEs often remains under the state. Chairpersons, board of directors, CEOs and general managers are also likely to be party members and government officials. This leads to suggestions that their responsibilities extend beyond profit-making as they also have social objectives to fulfill.

Interestingly, many of the CEOs become provincial vice-governors after a 3-5 year run at these listed companies, said Wong. This suggests a lack of separation in the decision rights allocation, as managers become owners. And they all come from the same group — the government.

Govt.-led Relationship-based System

The US relies on a structure of laws, regulation and open competition to ensure that companies fall in line. Companies in China, on the other hand, operate within a government-led, relationship-based structure.

"I'm not trying to say that there is any one system that dominates all. These mechanisms exist for a reason," said Wong. For China, a relationship-based system fosters trust, long-term vision, higher efficiency, and the formation of strategic alliances. However, Chinese firms, especially SOEs, are facing challenges on the global stage - they know they will need to play by international rules if they are to increase their trade and connectivity with the rest of the world, and so, they adapt international practices, including accounting standards.

Governance and accounting indicators in China do not necessarily show the whole picture, according to Wong. For example, research has shown that China's information processes are poor, especially when it comes to releasing bad news to investors. Also, while rigorous accounting rules might be prescribed, the actual implementation might not be as tight — and the external auditors hired to sign off the books indicate as much. "As they are state-owned firms, they do not need to signal that they are good. When they issue shares, the government will support them. They get a lot of support from the government because the market is controlled by the government," he noted.

As such, when evaluating a Chinese company, investors should not just look at the governance and accounting indicators. Rather, they should also assess the firm's ownership type, corporate structure and equally important, the political environment in which it operates.

No Fixed Fix

Wong pointed out that there is no fixed solution for the myriad of issues, to which, Yong Kwek Ping, CEO of private equity firm Inventis Investment Holdings added: nor is there a quick fix.

"This can't be fixed in 3-5 years but we should continue to fight corruption and fix the accounting principles. China needs to link to international society's and market's way of investing. Do it the Western way… or make their system understandable to the West," said Yong, who also suggested that firms could install a suite of good accounting software and incorporate a framework of checks and balances.

Just regulations alone, however, will be insufficient, said John R.V. Palmer, a former deputy managing director of the Monetary Authority of Singapore, the de-facto central bank and regulator of the financial industry; currently a principal consultant at Regulatory Professionals. "Regulations can bring forward guidelines but it does not tell how the owner should behave. Regulators can do a lot but they still cannot solve the problems by themselves," he said.

Just implementing Western rules and standards will not improve corporate governance and accounting quality in China, Wong concurred. "Standards alone do not help. There needs to be more disclosure on key government variables and related party transactions. They are more important than accounting." Other important changes include building the right market infra structure and systems for companies to operate, as well as leveling the playing field between government-owned and privately-owned firms.

With intra-Asian commerce becoming increasingly intertwined, Wong believes that Hong Kong and Singapore — the region's two financial centers with practices aligned with international norms - can play their part in helping China improve its corporate transparency and professionalism of government-controlled firms.

Singapore, for example, can provide a bonding effect of cross-listing, and give implicit indications that certain firms are up to mark. While there is no quick fix and no fixed solution, Wong is quite certain that Singapore and Hong Kong can move the Asian giant towards greater corporate governance and transparency.



Further banking reforms

The banking sector occupies a key position in China's financial system. The capital market in China is relatively underdeveloped and the banking system is the main source of domestic financing. The banking sector influences economic growth, poverty alleviation and the allocation of assets, hence it is critical to identify policies that encourage efficient bank operations.

The remarkable progress that China's banking industry has made in the last several decades has attracted a lot of attention around the world. The government has transformed the banking sector from a centralized and government-owned system to a more commercially driven system. The recapitalization and equitization of the four biggest wholly State-owned banks, namely the Bank of China, China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China, was one of the most recent and significant steps in moving bank restructuring forward. More importantly, the regulatory authorities have put more effort into regulating corporate governance according to international standards.

Many measures have also been taken to increase foreigners' access to the banking sector, such as subsidiaries and ownership of banks. By allowing foreigners to access the domestic market, a greater supply of aggregate bank credit has been provided to domestic borrowers, which has helped firms with financial constraints, although only a certain type of borrower has benefited. Foreign competition has also helped domestic banks to run more efficiently.

However, the domestic private ownership share of banks in China is rather low. There are various reasons for this. One explanation is China's judicial system is less efficient and the protection of private property is weaker than in Western countries. Thus many of China's domestic private firms are more short-term oriented. It is generally agreed that short-termism is associated with greater risk and this affects both corporate governance and asset allocation. Higher risk preference and the low quality of many domestic private firms' corporate governance have made China's banking industry regulators more reluctant to issue approval to open a private bank or a new branch.

China's foreign ownership share is not high either. Although China's financial openness is increasing, so far foreign bank entry still remains at a relatively low level. The percentage of bank assets at foreign-owned banks in China is still below 4 percent. China's economy is still in the process of transition and there is ample evidence that foreign banks are more efficient than domestic banks in transition economies.

Why is the foreign banks' ownership share still low after China joined the World Trade Organization? People in Western countries like to complain about unfair or inappropriate competition in China's banking sector. They argue the capital requirements are a de-facto barrier to entry and so foreign ownership has been effectively limited. Other complaints include overly restrictive requirements for a foreign bank to offer financial services in renminbi and a very slow and cumbersome process for obtaining approval to open a new bank or branch. Some claim that without the preferential treatment offered by the Chinese government, most of the State-owned commercial banks would have no competitive advantage over their foreign counterparts in China's financial markets.

Whether these claims are true or not is hard to test. But no one is able to deny that problems, though hidden, still exist in China's State-owned commercial banks. Although their profitability is increasing, there is a likelihood of a sharp rise in nonperforming loans if there is a big drop in housing prices or a wave of local government debt defaults. Besides, underground banking has been flourishing and hidden exposure has been accumulated, which is also likely to give rise to nonperforming loans in the banking industry.

To facilitate risk management and to mobilize resources, the ownership arrangements of China's banking industry should be broadened to introduce more competition. A higher degree of openness to both domestic and foreign investors is needed. Moreover, given the global trend, China's regulatory system should move toward supervision and away from regulation.


Edward Lehman雷曼法学博士
Managing Director 董事长

LEHMAN, LEE & XU China Lawyers
Founder of LehmanBrown International Accountants

Lehman, Lee & Xu is a top-tier Chinese law firm specializing in corporate, commercial and intellectual property matters. For further information on any issue discussed in this edition of China corporate governance News , or for all other enquiries, please e-mail us at mail@lehmanlaw.com or visit our website at www.lehmanlaw.com.

© Lehman, Lee & Xu 2013.
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