Revolutionary SOEs reform is happening

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<article><section data-type="rtext">Despite the US-China trade tensions and some new skepticism on the direction of China’s reforms, the SOEs, an economic pillar of the state and for years often a drag on its development, are about to change radically. A new massive reorganization is about to start that could revolutionize forever the efficiency of the laggard state sector and boost overall national growth.When “National Guidance on Deepening Reform of State-Owned Enterprises (SOE)” was first released in China by the Chinese Central Government in Aug 2015, there are not many people noticed that this was a milestone document.  Since then, close to 30 documents on implementation instructions, action guidelines or policies of SOE reform have been published by the State Council and related Ministries. 
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 The numbers of administrative guideline documents on Deepening SOE reform, with its new theme of Mixed  Ownership Restructuring (MOR), have been overwhelming, and the signal has become more and more clear – this might be one of the most important initiatives in the Chinese SOE reform history, as described by Mr. Song Zhiping, former Chairman of China National Building Materials Group, as “to open the last door of SOE reform”.Economic reform, centered by three key policy changes in the 1980’s, which include contracting farmers to plant their own land, legalizing citizen to do their own businesses, and opening the door for foreigners to conduct businesses in permitted industries, has created an economic miracle in China.<img data-alt="Source：Global Times " src="//img.huanqiucdn.cn/dp/api/files/imageDir/7a871a687e02a0d70bb77bfe663d1f82u5.jpg?imageView2/2/w/1260" />The recent economic slow-down has led to debates on whether China can continue its economic growth or whether China is heading into stagflation. One thing which seems to be obvious is that China is facing more domestic as well as global challenges today than any time during the past 40 years. Deepening the SOE reform, especially launching the Mixed Ownership Restructuring (MOR) initiative, is a clear signal that the Chinese government adheres to improving its market economy.  MOR initiative, by definition, is to have shareholders from all identities, including state, private and foreign shareholders, to invest in the SOE so that a balanced shareholding structure and balanced board representation is reached. According to Wang Yue, Author of “Mixed Ownership Restructuring”, there are 156,000 of SOEs with total of assets of 130 Trillion Yuan today, which ultimately belong to the state. About 70% of those assets fall into the MOR reform scope.  This magnitude will facilitate major social economic transformation and drive industrial competitive landscape changes. Productivity changes in large number of mega companies in a short period of time will have very positive impact on economic growth and improvement of economic environment.The Chinese economic reform has been advancing cautiously through a long term, gradual trial-and-error process, namely “crossing the river by feeling the stones” for 40 years. The Chinese SOE reform has gone through three stages from Reform 1.0 to 3.0.  SOE Reform 1.0 was from the year 1978 to 1992, defined by “System of Contractual Managerial Responsibility” (SCMR), in which corporate leadership was assigned autonomy of managerial decision-making by the government. This SCMR worked well to stimulate the lifeless and stagnant state owned and planned economy at that time. The Reform 2.0 started in 1993, defined by “Shareholding System Transformation” (SST), in which SOE was restructured into stock limited liability companies, and employees were permitted to acquire stocks from government to become owner of their companies.  Many of the small and medium sized SOEs was privatized during that time which ended in 2003 when State-Owned Assets Supervision and Administration Commission (SASAC) was established at all government levels.  The establishment of SASACs led to Reform 3.0, characterized by consolidating state shareholders of non-financial institutions into one identity as SASAC and strengthening the governance of state-owned assets. Reform 3.0 was critical because many of the SOEs was privatized or sold before 2002 at arguable prices due to information asymmetry, absence of state shareholders and insufficient management insider control. The state-owned enterprises have been strengthened since 2003 under SASAC supervision, and the total assets and net profits have all gone up significantly since.  SASAC was no doubt instrumental to safe-guard state assets during these golden growth period. However, SASAC has not solved the dilemmas of absence or offside of state stakeholder.  The tight control of SASAC on gross payroll, compensation system and rankings of executive team leaves little room for SOEs to incentivize responsibilities undertakings and reward good performance.  The MOR will focalize government responsibility from managing people, businesses and assets to managing capital.  That is the government will exercise its power by vote as equal shareholder and voice its concerns through board representation, instead of through administrative orders and enforcements.  This will empower the board to make quicker decisions based on commercial principles, and as a result, to improve productivities and create better return for state capital.Since 2015, MOR initiative has been moving cautiously and slowly. The US-China trade tension and the slow-down of domestic economic growth might have all contributed to the acceleration of MOR initiative, and we can foresee a wave of MOR transactions is at its tipping pointWhile we welcome the MOR initiative, and believe it is one of the most important reform to safe guard the balance and dynamic of market economy, efficient allocation of resources and fair opportunities for private and foreign investors, it does not automatically guaranty success of any business post MOR transaction. We believe certain conditions are equally important to be met in order to succeed through MOR, (1) an active non-state shareholder with significant stake in the company; (2) a balanced board representation and consummated corporate governance; (3) entrepreneur minded corporate leaders with reasonable investment in the company and proper incentive plan for key employees; (4) clear core business focus, strategic plan and road map for management improvements.  In the past three years, the practice of MOR has been gradually shifting from diversifying shareholder mix to implementing employee stock option plan (ESOP). One of the earliest MOR attempt was the reform of Sinopec gas retail business, who has invited 25 diversified investors to invest ￥120 billion Yuan for 30% stake. The recent announcement of board approval on ESOP in Naura, a domestic listed company headquartered in Beijing, has caused its stock price jump 10% immediately to reach the daily limit of stock price fluctuation set by the security regulator China Securities Regulatory Commission (CSRC).  The reaction from the stock market to MOR measures is a reflection of general belief that MOR could unleash enormous SOE potentials. We can anticipate more fundamental changes to come, especially in the general competitive industries such as consumer goods, food and beverage, pharmaceutical and medical device, TMT, transportation and logistics, clean energy, retail and distribution, and business services, where government will be more willing to give up control.  We will expect more management team and key employees to become shareholders to bring their skin in the game. Temasek Holdings, the Singapore government owned entity, is a role model for Chinese government to mirror their MOR initiative and optimize their corporate governance mechanism. Temasek is guided by an independent board and operate autonomously on commercial principles. The goal of MOR initiative in my view is to create many Chinese “Temasek” under SASAC or Ministry of Finance. Many international investors had enjoyed successful investments in Chinese SOE reform, including the lucrative investments in Chinese state-owned banks such as ICBC, CCB and BOC during the banking reform period of 2003-2008. Those investments include Goldman Sachs’ $2.6bn investment in ICBC, Bank of America’s $2.5bn investment in China Construction Bank, and RBS’s $3bn investment in Bank of China. Each of these international investors produced billions of dollars of profit for those investors. Now, a new, bigger opportunity and opening awaits China and the world.(By Tim Tianwei Zhang,Chief Investment Officer, China Resources Capital.This article represents personal opinion only.)</section></article>

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