If it had come off as scheduled, China Telecom's planned US$3.68 billion initial public offering would have been Asia's deal of the year, ready to be showcased ahead of the opening of the Communist Party Congress. Instead, it flopped embarrassingly on its first IPO attempt. Timing was not on the side of the fixed-line giant, which was hit by negative developments at a critical moment. In what underwriters described as 'unfortunate coincidences'', two areas of greatest concern to investors market risk and regulatory risk came to the fore to dampen investor enthusiasm in China Telecom. When China Telecom began an international roadshow in mid-October, the company and bankers were optimistic, with market sentiment gradually improving and with the price of shares in the two listed mainland mobile telecom firms China Mobile and China Unicom. Among the bankers involved, China International Capital, Merrill Lynch and Morgan Stanley are the sponsors and lead underwriters of China Telecom's IPO. Goldman Sachs, although a member of the underwriting syndicate, played only a limited role in the share sale. The first 'unfortunate coincidence'' came when Goldman Sachs downgraded China Mobile and China Unicom on the day China Telecom launched its first public offering in Hong Kong. Goldman put a sell recommendation on China Mobile and China Unicom and reckoned the pair, which are comparable to China Telecom, would have to fall in price about 20-25 per cent to offer a more attractive entry point for investors. The US banker cited concern about over-capacity and market competition risks in China's telecoms industry as reasons for its downgrade decision. Goldman's downgrade came at a time when China Mobile and China Unicom were on recent highs. The news triggered heavy sales in China Mobile and China Unicom shares that week, dragging the price down 10 per cent within days. Bad news struck not once but twice. Two days before China Telecom was to set its offer price, its director of international services division wrote to SAR operators to raise the interconnection charge for (IDD) calls to China 8.5-fold, confirming investor worries about regulatory risks in the mainland telecom sector. But do not say China Telecom had not given prior warning. On page 26 of the listing prospectus, under 'Risk Factor'', it noted: 'We cannot assure you that future regulatory changes, such as those concerning tariff setting, interconnection and competition, will not have a material adverse effect on our business and operations.'' Earlier, on October 24, China Telecom chairman and chief executive Zhou Deqiang said the company had applied to the Ministry of Information Industry (MII) to raise the interconnection charges. But the scale of the increase, approved by the Beijing authority on October 23 and coming into effect a week later, came as shock and met with some strong opposition from the Hong Kong community. From November 1, China Telecom charged 0.17 US cents per minute, a 772 per cent rise from the 0.022 US cents charge to carriers, adding HK$1.5 billion and more in calling costs from Hong Kong to China. Fund mangers responded by offering to take China Telecom at a price 'substantially'' below the low-end of the HK$1.48-HK$1.71 price range to cover the higher regulatory risk premium. China Telecom, however, was forced to call off the IPO when barely 20 per cent of its shares for sale were taken up. The company then had to decide whether to halt the whole listing plan already delayed two years due to a decision to break up the monopoly of the fixed-line operator or severely cut the size of the offer, which would have been the world's third-largest this year. In an attempt to turn the situation around, China Telecom on November 3 offered volume discounts and other compensation to Hong Kong carriers, who were summoned to an urgent meeting in Shenzhen. The face-saving move was aimed to ease the burden of Hong Kong operators and the ultimate users. Then last Saturday, Mr Zhou declared that 'the mainland's phone operators met Hong Kong's four biggest phone operators to discuss the rise in fees and both sides reached a consensus''. The sudden changes in stance on such an important issue prompted analysts to say the policy changes in China Telecom were 'too obvious'' an example of what is known as China regulatory risks; that is, the mainland desires to play in the international game but not to follow international rules. They said the IDD crisis was reminiscent of the introduction of a caller-party-pays (CPP) system two years ago, and showed that little had been learnt from past experience. In November 2000, the MII scrapped plans to implement this system after the share prices of China Mobile and China Unicom stumbled by as much as 30 per cent, wiping out more than HK$300 billion in market capitalisation in just two months. The decision to delay the proposed charging system, which had been studied for months and was to have been an important factor in lowering overall calling costs, followed market worries that mobile operators would lose revenue if the system was brought into force. It would end a system whereby the recipient of a call is also charged. The issue was especially sensitive to China Unicom, which had been listed only five months earlier in China's largest privatisation programme by far, before the CPP proposal was leaked to the media. Amid the row over charges, it is often overlooked that there are inconsistencies in tariff setting, as shown in the case of IDD charges. In December 2000, MII cut IDD charges to Hong Kong by as much as 56 per cent, to 80 fen (about 74 HK cents) per six seconds from the previous 18.4 yuan per minute. At the time, Information Minister Wu Jichuan said the previous charge was too high compared with the international standard and that it would damage the telecom industry's competitiveness in China. In under two years, the MII appeared to think it had given in too much, and it drastically increased tariffs more than seven-fold. The rate increase was aimed at offsetting declining IDD contributions to China Telecom they contributed about 21 per cent of the fixed-line giant's revenue of 68.54 billion yuan in 2001. What will happen next after this rate increase. There is still concern about the regulatory regime, especially if Mr Wu retires later this year as expected. What will happen to the competition landscape after another mobile and fixed-line licence is granted remains to be seen. Potential investors in any case are advised to read the following paragraph in the 15-page section on risk factors: 'Future changes to the regulations and policies governing the telecommunications industry in China may have a material adverse effect on our business and operations.''