China is regulating state-owned enterprises that are investing outside of their core business realms, concerned that poor investment decisions
could lead to loss of state-owned assets, but some doubt
the effect of the new regulation
SUPERVISED INVESTMENT: SOEs’ investment outside core businesses will soon be restricted, which may help avoid scandals like this one in 2004, when Singapore-based China Aviation Oil suffered heavy losses from oil derivative trading conducted by its former CEO Chen Jiulin (left)
Starting this year, state-owned enterprises (SOEs) directly affiliated with the Central Government should concentrate on their core businesses and allocate no more than 10 percent of their total investment in areas outside key activities. The State-Owned Assets Supervision and Administration Commis-sion (SASAC), which supervises 165 central SOEs on behalf of the Central Government, put the 10 percent cap on investment outside core businesses in the Interim Measures for the Supervision and Administration of the Investments by Central Enterprises promulgated on August 14.
According to the SASAC, this regulation is to prevent the loss of state-owned assets in case of investment failures.
Loss caused by blind investment in sideline businesses is not a rare case among SOEs. The most severe one was in 2004 when Chen Jiulin, former CEO of the China Aviation Oil (Singapore) Corp. Ltd., tried to extend the company’s business to petroleum derivative trading, causing a heavy loss of $554 million.
SOEs have already begun choosing the stock market for investment. Many of them deal with short-term investment in treasury bonds or stocks, the latter of which brings certain risks to state-owned assets.
SASAC’s statistics show, in 2004, total investment of central SOEs was about 1 trillion yuan, 5 percent of which, or 50 billion yuan, was invested outside their core businesses.
“Some central SOEs have excessive core businesses,” said Li Rongrong, Chairman of the SASAC. “A few invest a large proportion in sideline businesses. Blindly diversifying investment is a big problem facing them. There are also many loopholes and hidden troubles in investment management. We should further strengthen supervision.”
Insuring the value of state-owned assets
“To an SOE with an asset of about several hundred billion yuan, a loss of several hundred million yuan won’t destroy the enterprise. But if there appear several such SOEs, our country will suffer great losses. We’re still in a developing period; we can’t bear it,” continued Li.
So far, there are altogether 165 central SOEs, with total assets of 10.6 trillion yuan, most of which belong to key sectors or areas concerning national security and the economy. Some even belong to pillar industries. If the phenomenon of blindly making decisions and investments remains unchanged, it will not only cause a loss of state-owned assets, but also affect the effective implementation of macro-control policies, according to the SASAC.
In 2003, the SASAC proposed controlling SOEs’ investment in non-core businesses. But the worry that the practice would limit their own diversification-oriented development aroused disputes between SOEs and decision-makers.
After the China Aviation Oil incident, the SASAC successively defined and made public the core businesses of 96 central SOEs. The remaining 70 were classified into two groups: One is of a large scale, but without clear core businesses; and the other is of a smaller scale and in a transitional period. To prevent them from blindly expanding, their core businesses will be defined and made public in due course, and their investment activities will be standardized under government guidance.
The SASAC stressed that central SOEs’ investment should center on their core businesses in order to enhance their competitiveness.
According to the new regulation, SASAC’s supervision and administration of central SOEs’ investment will mainly accord with four indexes: investment direction, component of capital to be invested, investment scale and proportion of the investment in an enterprise’s total annual investment.
Regarding problem areas central SOEs have invested in, the SASAC will require those involved to redress and make relevant risk-preventing measures. The SASAC will veto investment to be made by central SOEs if the following situations appear:
-- l The investment is not in accordance with the national development plan and industry policies;
-- The investment goes against investment decision-making procedures and relevant management system;
-- Investment outside core businesses is not in accord with the requirements for industrial adjustment and reform, and affects the development of core businesses;
-- Liabilities of these SOEs go beyond their financial affordability.
Chairman Li denied some people’s worry that the SASAC’s supervision will affect the decision making of central SOEs, saying, “Instead of replacing and helping central SOEs to make investment decisions, SASAC’s supervision aims to get hold of their investment information, find out common problems or problems that may occur, provide necessary warning and suggestions, guide enterprises to prevent investment risks, and insure or increase the value of state-owned assets.”
According to Li, SASAC will supervise the whole process of investment activities, including examining annual investment plans and plans for newly added projects and other major items; finding out common problems or problems that may occur based on analysis of investment statistics, and providing necessary guidance during the investment process; and assessing investment projects to sum up experience and improve management.
Will it take effect?
Most of the 96 central SOEs whose core businesses have been made public by the SASAC have more than one core business.
“From this point of view, SASAC’s supervision will not affect their diversification-oriented development,” said Shi Jianhuai, professor at China Center for Economic Research of Peking University. The only worry is that SASAC’s policy will not really hold back blind investments.
“Past investment activities show that most investments in non-core businesses are prompt, with investment plans not submitted to the SASAC in advance,” Shi said. “These investments were exposed only because they failed.” Every central SOE has branches. Many of them even have overseas-listed companies. If central SOEs let their branch companies invest in non-core businesses, SASAC will have no way to exercise prompt supervision over them, said Shi.
Liu Fuxiang, professor with the University of International Business and Economics, said the SASAC regulation can control SOEs’ blind investment to some extent.
He explained that central SOEs’ sideline investment falls into two categories. The first features random investment. Some enterprises (mainly listed companies) tend to invest their large amounts of disposable capital in any projects awaiting funds on impulse to make profits. The second category focuses on conscious investment to look for new profit sources.
“Some enterprise leaders have a clear idea about whether their enterprises need to invest in non-core businesses and develop diversely, but some others don’t have the vision. SASAC’s new regulation will curb investment on impulse,” said Liu.
Yu Hui, researcher with the Institute of Industrial Economics under the China Academy of Social Sciences, said the new regulation can solve many problems. At least central SOEs will be restrained in making unnecessary investment, he said. But what about enterprises that make more profits in non-core businesses than in their core businesses?
According to SASAC’s data, in 2004, among the listed SOEs, there were 86 whose profits from investment in the stock market outnumbered their core business profits. If this kind of investment is restricted, profits of these enterprises will drop substantially.
Yu argued that instead of restricting their investment, measures should be taken to make enterprise decision-makers responsible for failure.
“The present situation is that when an SOE fails in investment, no one in it takes the responsibility, needless to say legal responsibility, even if the loss is heavy,” Yu said. “We’ve never heard that any SOE boss is sued because of losses.”
Many SOE leaders are now concerned of the issue of how to define the investment failure of decision makers, such as losses caused by market changes, and how to confirm responsibilities and dispose of failure. But these are not mentioned in the new regulation.
In the long run, tightening up supervision and administration over central SOEs’ investment activities facilitates the sound development of SOEs and the rational arrangement of the economic structure.
However, while Chairman Li Rongrong stressed once again that the SASAC would not intervene in enterprises’ decision making, many central SOEs still worry that SASAC’s regulation will fetter their decision making.
“Business opportunities flee fast,” said a vice president of a central SOE, who wished to remain anonymous. “With one more procedure added to our investment decision, our development may be hindered.”
“The SASAC will supervise the entire investment process and impose necessary guidance. It’s impossible that it won’t affect our work,” he added.