Beijing flexes financial clout with move on Wall St bank

PUBLISHED : Friday, 21 December, 2007, 12:00am
UPDATED : Friday, 21 December, 2007, 12:00am

Morgan Stanley saviour gets in while world markets reel

A popular joke among mainland businessmen in recent weeks has it that although China exports toxic toys to the United States, the US exports something far more damaging: toxic financial waste.

With yesterday's announcement that China Investment Corp will pay US$5 billion for an eventual stake of 9.9 per cent in Morgan Stanley, a venerable Wall Street bank that recently announced US$9.4 billion in write-downs related to subprime mortgages in the US, China has moved from toxic trading partner to financial saviour.

And in the process it is picking up prime assets at reduced prices and flexing its financial muscle on the world stage.

Following hard on the heels of UBS's sale of a 9 per cent stake to the Government of Singapore Investment Corp for US$9.75 billion and Abu Dhabi Investment Fund's US$7.5 billion rescue of Citigroup, the deal reinforces the opportunity presented by the subprime fallout for sovereign funds to invest their foreign reserves in the biggest names in global banking.

Under the agreement, CIC will buy US$5 billion of equity units carrying annual interest of 9 per cent, convertible into common stock on maturity in August 2010. In keeping with its protestations that it is merely a portfolio investor, CIC will remain a silent investor.

'CIC's purchase of Morgan Stanley's convertible equity units is a long term, passive financial investment,' the company said in a statement designed to cool fears that it was making a strategic investment on behalf of the central government.

Analysts agreed that CIC, which was set up in September with US$200 billion to secure a higher rate of return on the country's ballooning foreign reserves, was taking the opportunity presented by the turmoil in global credit markets to buy while prices were low.

'This is a good investment for CIC because Morgan Stanley is a major franchise. It's a much better deal than the US$3 billion they spent on 10 per cent in Blackstone which did not have much of a history,' said one China-based analyst.

CIC has received heavy criticism at home for a paper loss of millions of US dollars on its investment in the American private equity group. 'CIC has learned from its experience with Blackstone,' said another analyst.

For Beijing, coming to the rescue of one of the world's most powerful banks was not only a financially astute piece of business but also allowed it to flex its financial muscle on the world stage.

According to sources, Morgan Stanley first approached the fledgling state investment agency early this summer, just as bankers were becoming aware of the potential impact of the subprime mortgage crisis. At that time, managers viewed a partnership with CIC as a useful means of fostering deeper relations with Beijing as well as a deep-pocketed investor.

'The investment banks are very interested in tying up with CIC. China is the big new market for investment banking and they believe that an investment by CIC will create good relations with the Chinese government,' said a banking analyst.

However, as Morgan Stanley's write-downs grew, CIC rapidly became an obvious source for a massive cash injection to balance the books. The bank's desperation for capital allowed CIC to rewrite the original terms of the contract.

'[Chief executive] John Mack postponed the earnings announcement and he had to find a way to escape. This allowed CIC to get a very good bargain - securing a sound investment at high interest,' said one person familiar with the deal.

'The deal was very much driven by the subprime crisis. Without this injection of cash, the share price would have collapsed and everyone would have been baying for John Mack's head.'

Yesterday's agreement was hammered out during the last month before the quarterly earnings announcement, when Morgan Stanley announced an additional US$5.7 billion in subprime write-downs, with losses per share almost US$1.50 lower than expected.

'If you're looking for a pool of cash to provide liquidity without adding any value, CIC is an easy play,' said Fraser Howie, co-author of Privatising China.

For CIC, buying a significant stake in one of the world's top investment banks appears less a piece of strategic thinking than a glorious act of opportunism - a chance too good to pass up.

However, the publicity generated by the deal contrasts with the softly-softly approach nurtured by CIC's management and raises questions about who brokered the agreement.

CIC chairman Lou Jiwei has consistently downplayed the fund's potential global impact, telling a forum last month that CIC would concentrate on domestic investments and expected to wait a year before making any major investments overseas.

In October, the Group of Seven industrialised nations called for new rules to improve transparency in deals by sovereign funds and foreign analysts had advised CIC to concentrate on making small acquisitions to avoid retaliation from politicians about the growing financial clout of such funds.

CIC's investment in Morgan Stanley suggests a decision taken over the heads of CIC's nominal management by the nation's political masters. 'Of course, Morgan Stanley had to go to the highest leadership,' said the person familiar with the deal.

Although reigniting nationalist fears in Congress is clearly not Beijing's intention, yesterday's agreement nevertheless suggests that CIC is not entirely the apolitical investment vehicle it had claimed to be.

'A US$5 billion investment in a foreign brokerage company, how could that not be political? In China, the bigger the business the more political it is,' Mr Howie said.