CEO Asia Update Luncheon

“The China Story”

Guest Speaker Vincent H C Cheng, GBS, OBE, JP Chairman The Hongkong and Shanghai Banking Corporation Limited

Tuesday, 2 May 2006
The Windsor, Melbourne

Good afternoon everyone. It is indeed a pleasure to be in Melbourne. This is clearly one of the world’s very best cities, no matter what the folks over at Mercer might say.

I actually arrived here earlier than originally scheduled just so I could watch the Hawks take on the Bombers on Sunday afternoon. You may be surprised to hear this, particularly given the Hawks have been wearing the HSBC logo for a couple of years. But truth be told, Sunday’s match was my very first time at the ‘G’.

Perhaps you will be less surprised to hear that in order to cheer on the Hawks, I was willing to cut short a visit to New Zealand. Now before anyone gets the wrong idea, I should stress the fact that I have absolutely nothing against your Kiwi cousins. In fact, when I was much younger, I spent a few years studying economics ‘over the ditch’ as I believe you say here. However, I was not about to pass up an opportunity to watch a good game of footy. Which I suppose by local definition is any game of footy!

I actually have a little souvenir from Sunday’s match that I want to show you later on. But first, I should probably do what I promised to do when I accepted the invitation to speak today. Namely, to talk about China.

It was really not too difficult to decide on my topic for this luncheon speech. In fact, a month or so ago, one of my assistants rang down to ask if there was any particular topic that this audience might be interested in. The answer was: anything - as long as it is about China.

Now, all of you have probably heard various China stories - with emphasis on the plural. Stories of foreign businessmen making culturally incorrect gestures when giving gifts to their business partners in China. Incorrect gestures such as handing out green hats, which in China are symbolic of an unfaithful wife. Or giving someone a clock, which in Mandarin sounds the same as “seeing someone off to his end.”

You have also probably heard stories of foreign companies and the people who lead them going to China and apparently leaving their common business sense at home. Foreign companies entering joint ventures with Chinese domestic entities that have absolutely no connection to their particular line of business but seem to offer a short cut to the right approvals. Foreign companies getting involved in messy and protracted legal tussles with local partners. Foreign companies being forced to leave their Chinese factories idle for extended periods due to disputes with local partners. Foreign companies pumping millions of dollars into projects in the country only to later sell their stakes for nominal amounts. In one case, selling their entire investment - plant, equipment, everything - for the equivalent of just one Australian 20 cent piece. A rather sobering exchange for what was a multi-million dollar investment.

There are, of course, also stories of foreign companies doing well when doing business in and with China. BHP Billiton and Rio Tinto are two obvious Australian examples. If I recall correctly, when BHP announced its recent record profits, it cited increased sales to China as well as to India as the reason for the rise. Foreign companies from elsewhere also seem to be doing quite well. For instance, American-affiliated companies in China earned an estimated US$3.2 billion last year. This is up from zero in 1990.

Indeed it seems everyone is talking about China. About the astonishing progress the country has made since deciding to liberalise its economy. About China becoming the workshop of the world. About the wide range of goods - from the most basic to the most sophisticated - being manufactured in China. About China’s increasingly affluent consumer market. About exactly when China will become the world’s largest economy, albeit in absolute terms and not GDP per capita. About China’s expanding thirst for oil and the impact this is having on global energy supply. About China’s demand for commodities and natural resources in general.

Of course, any discussion on this last point usually results in Australia’s name coming up. How this country is not only benefiting directly from China’s need for your natural resources. But also benefiting indirectly as Chinese demand is also pushing up the prices everyone else has to pay. All of which has prompted some glowing comments about Australia’s economic outlook. Comments suggesting Australia is ideally located on China and India’s doorstep. Comments suggesting that this country has already become the “Saudi Arabia of commodities.”

As for the outlook for China, it is safe to expect that for most multinationals the great call of China will continue. Simply put, there are a number of reasons why foreign firms are likely to remain bullish on China. For some, it will be the continuing opening of the market in line with WTO commitments. As well as the supportive policies of the government. For others, it will be the abundant supply of cheap labour. Or perhaps the improving infrastructure, which is making it easier to reach larger numbers of Chinese consumers. For most, however, it will simply be the country’s continued rapid growth. Growth rates which offer opportunities that cannot be matched in few, if any, other market - emerging or otherwise. Just to confirm this trend, China’s GDP went up by 10.2 per cent in the first quarter of 2006.

Certainly, inflows of foreign direct investment show little signs of slowing down. The total for the first quarter of 2006 was some US$14.3 billion according to the Ministry of Commerce. An amount which puts China on track to nearly equal the US$60 billion in FDI it has attracted in both of the last two years.

It is also safe to assume that household incomes in cities and rural areas will continue to grow. After quadrupling in the past decade, income growth will be fuelled by further economic reform for the foreseeable future. Given China’s sheer size it is not surprising that corporates around the world are not only seeing China as a place to sell to, but also a place to sell in.

The evolution of China into a major consumer market is an inevitable and welcome consequence of the country’s position as the world’s main manufacturer. History suggests that the typical transition from a developing to developed economy starts with growth based initially on trade and in particular exports - which China has experienced. This in turn tends to attract capital - again which China has done. Eventually the workers who are creating the goods and services themselves become a market - and once again this is happening in China. The country is following the same workers-become-consumers transformation that several other economies in Asia went through during the last 50 years. Economies like Japan, Hong Kong, Malaysia, and Singapore for example.

Already in China, there are numerous foreign companies positioning themselves in anticipation of the Mainland becoming one of the biggest markets for their respective organisations. Of course, any and all corporates doing or interested in doing business in China might want to keep in mind certain realities - again with emphasis on the plural.

First, China may have a very attractive, rapidly growing and increasing affluent pool of consumers. However, it is important to remember that China is not one big, single market. It is a collection of markets made up of some 650 cities, spread across more than 30 different provinces, autonomous regions, centrally administrated municipalities, and special administrative regions. What sells well in one city - in Shanghai for example - may not in another city like Beijing. What works in coastal China will not necessarily work in inland China due to the great regional diversity in terms of living standards, tastes and culture.

Another reality is that in China a good local partner can help you with everything from labour issues to establishing valuable relationships with the appropriate administrative entities. However, the corresponding reality is that finding the right joint venture partner is not easy. Careful selection is critical. Just ask the company that walked away with the 20 cents!

Another reality companies need to remember is that although China’s legal environment is improving, offering better protection to domestic and foreign investors, certain laws continue to favour indigenous enterprises. Likewise, enforcement of judgements has room for improvement. I recall hearing about one survey focusing on the success rates of arbitration cases. It found that only one-third of foreign investors who were successful in arbitration cases actually received 75 to 100 per cent of their awards. In other words, two-thirds of foreign investors did not get what they deserved.

Also, while China continues to attract foreign investment partly because of its business-friendly policies, differences in the interpretation of policies between central and local governments often arise. China has been trying hard to trim down bureaucratic red tape in recent years, with one-stop service counters for foreign investors. But the functions and responsibilities of some government bodies are still not well-defined or coordinated. Approval procedures remain complex.

Given my role at HSBC, one of the questions I am asked frequently is what is the key to success in China. The short answer is there are no shortcuts. Companies have to work hard, even if they have been there more than 140 years like HSBC.

For the record, HSBC’s strategy in China is based on both organic growth and opportunistic investments. We are the largest foreign bank in mainland China with some 40 offices. And it is a position we intend to maintain. In the last 4 and a half years alone, we have made some U$5 billion worth of strategic investments in select Mainland entities. This total includes the funds we spent to maintain our 19.9 per cent stake in China’s fifth largest bank - Bank of Communications - after its highly successful IPO. On the organic side, we are continuing to expand our own operations when and where possible. Increasing our local staff, adding more branches in more cities. We also, by the way, have several thousand staff working in our Group services centres in China.

But rather than lurching any further into a verbal commercial about our China operations, let me close by sharing one last China story. A personal one.

Prior to becoming Chairman of HSBC Asia Pacific, I spent 7 years as Vice-Chairman and CEO of Hang Seng Bank - a principal member of the HSBC Group. During this period, one of the things I spent a considerable amount of time on was building Hang Seng’s China-related business. Including the acquisition of a 15.98 per cent stake in a Chinese domestic bank called Industrial Bank.

Last year, when my new appointment was announced there was a fair bit of attention to the fact that I was going to be the first ever Chinese chairman of HSBC Asia’s operations. There were even some articles in some publications which suggested that my appointment was due to HSBC now placing more emphasis on the China market. The underlying implication being that I got the job because I am Chinese.

Putting aside the fact that HSBC is a meritocracy. Putting aside the fact that ethnicity has never been a consideration in any job at HSBC. Putting aside the fact that to suggest otherwise is rather insulting. Putting aside such facts, it is obvious that my Chinese language abilities may help HSBC’s business in China a little bit. For example, we now don’t have to hire as many interpreters as we did before!

Equally obvious, however, is the fact that if nationality was a major consideration, then HSBC would have needed to find someone who was of Chinese-Indian- Malaysian-Singaporean-Korean- Japanese-Vietnamese-Filipino-Thai- Indonesian-Sri Lankan- Bangladeshi- Kiwi-Aussie descent.

After all, this is an Asia-Pacific job.

The point I want to make is that yes, China is a big and increasing influential part of Asia. And yes, it is an increasingly important market for HSBC and others. However, it is important to remember that China is also only one of many markets in the region with enormous potential.

Indeed, I believe that any business which ignores the rest of Asia and focuses solely on China is destined to miss out on an even bigger story. Namely, Asia’s re-emergence on the world economic stage. A re-emergence that is being powered by a rapidly growing China. But also by a recovering Japan, an eager to catch up India and a number of other dynamic economies such as Vietnam, where we have recently made an investment into the Technology and Commerce Bank.

That said, I am fully aware that I am probably talking to the converted in terms of Asia’s overall potential. Clearly, as an audience, you are very much aware the many opportunities throughout the entire region. After all, if you were not aware, my speech today would not have been to the Asia Society - it would have been to the China Society!