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EU referendum UK house prices China's economic growth Partner sites Business.com Hoover's Online Les Echos FT Deutschland Recoletos Vedomosti CBS MarketWatch Investors Chronicle Comment & analysis / AnalysisPrint article | Email Shanghai tycoons By Richard McGregor, James Kynge and Mure Dickie Published: June 16 2003 20:18 | Last Updated: June 16 2003 20:18 Just off Nanjing Road, Shanghai's premier thoroughfare, stands a vast development site, empty except for a few half-built high-rise flats and one or two remaining old European-style houses whose residents have held out against the bulldozers. Until a few weeks ago, the 43,000- sq-metre development, the first of eight similarly sized plots, was a monument to the success of Zhou Zhengyi, a 43-year-old Shanghai entrepreneur who had turned a small profit from his restaurant business into a multi-million-dollar fortune in barely seven years. With Mr Zhou now in detention as part of a corruption investigation, the property project has come to symbolise something else: the fatal hubris of China's new rich. The scandal surrounding Mr Zhou is not an isolated one. Over the past 18 months four of China's top tycoons and three senior bankers have fallen foul of the law, decimating the upper echelons of a Forbes magazine China "rich list". YANG RONG Displaying remarkable initiative, determination and top-level government connections, Yang Rong emerged out of a middle management position at the central bank in 1992 to organise the first overseas listing of a mainland company, China Brilliance, a carmaker. From that success, he built a diverse and complex financial and manufacturing conglomerate, with offices in Shenyang, Shanghai and Hong Kong, and also an unenviable reputation as a wheeler-dealer on the stock market. The government connections that helped him get started proved to be his undoing when he ran foul of his patrons. But his refusal to bow to the Liaoning provincial government in two disputes, over ownership of a controlling stake of shares in the company and his desire to invest in a rival province, saw him ousted as chairman last year and then charged with unspecified 'economic crimes'. He is now in exile in the US. One tycoon fled to the US. Another tried to make a career in North Korea but failed to elude police in time. A third, a senior banker, was arrested after being summoned from Hong Kong for a bogus "emergency" board meeting in Beijing. And in Shanghai in the past month, Mr Zhou and Qian Yongwei, two 40-something entrepreneurs who have made their fortunes in the city's newly formed private property market, have come under official investigation. The question of what exactly is ailing corporate China has relevance not only for foreign corporations that have made China the world's top destination for direct investment but also for investment bankers and fund managers who have made the multi-billion-dollar foreign listings of Chinese companies a runaway success. The answer heard most often is that Chinese companies suffer poor corporate governance. But that is little more than a euphemism. The forces that drive a disproportionate number of China's emerging business elite to corruption are not explained by management shortcomings alone. Rather, they are the result of a fundamental incompatibility between economic and political systems; a mismatch between the raw, 19th-century capitalism of China's entrepreneurial class and a largely unreconstructed and poorly paid communist bureaucracy that still bears the imprint of its Leninist ancestry. For most of the past decade, private businesses have been kept in legal and political limbo. The assets of private concerns were not protected by law; entrepreneurs were not - until last year - encouraged to join the ruling party; state banks were reluctant to lend to them; and, in many ways, mandarins blocked access to markets and withheld business licences. Shut out from legal avenues to do business, entrepreneurs resorted to less orthodox means. They raised credit from a network of "underground banks", dodged taxes and found ways to send earnings offshore. And, when confronting the bureaucracy was unavoidable, they used their only asset - cash - to buy the influence they required. "The front door was closed, so they had to go through the back door," says Cao Siyuan, author of China's first bankruptcy law and the president of the Siyuan consultancy. "Money and executive power became interchangeable commodities. That is what happens when you deny legal status to private businessmen; they find ways to survive outside the law." ZHOU ZHENGYI The son of a poor factory worker, Zhou Zhengyi began his rapid ascent into China’s rich list in 1995. Using funds from a successful restaurant business, he began buying shares in state enterprises issued to employees just before they were partially privatised in stock market offerings. Mr Zhou maintained his impeccable timing in his next venture, ploughing his profits into land in Shanghai when city leaders were promoting the development of a private property market. Zhou soon gained a dangerously flashy high profile in both Shanghai and Hong Kong, where he acquired a Bentley, an actress girlfriend and a number of listed companies. His ostentatious wealth made him vulnerable to investigations sparked independently on two fronts: through questioning of one of his main bankers and by residents’ protests at their treatment after his acquisition of a massive development site in Shanghai. He has been in detention since late May. These observations are not new and they are no longer of purely academic interest. The detention of Mr Zhou, for example, saw $550m wiped off the market capitalisation of his listed companies in Shanghai and Hong Kong in just two weeks. Mr Zhou perfected the business model favoured by impatient entrepreneurs. Using his strong government ties, he got hold of land that he used as collateral to borrow from banks. That money was spent acquiring listed companies, providing an alluring new currency that, unlike bank debt, did not have to be paid back. Money from the listed companies in the loosely regulated market in China in particular could be, and was, funnelled at exorbitant prices in related-party transactions to other interests controlled by Mr Zhou. Property, however, is the key, and it is here that China's unreformed political system leaves the field most open to corruption. Even as Shanghai has developed a valuable and thriving private property market over the past decade, a model for the entire country, officials have kept the power to sell large tracts of land to themselves. More than two years ago, the government announced a policy mandating open public tenders for land sales - but officials simply ignored it because of the huge profits to be made by maintaining the current system. "The policy has never been implemented, except in a handful of cases," says Sam Crispin, a Shanghai property consultant. The city's open tender system for land still allows the government to ignore the highest bidder without having to give any reason for doing so, said one Shanghai official this week. And with 3,500 officially registered developers in Shanghai chasing land, government officials have leeway to influence the terms of any sale. In some cases in the central Jingan district, the site of Mr Zhou's construction project and the largest in Shanghai, officials have been given equity in the same developments for which they have authorised the sale of land. YANG BIN When North Korean dictator Kim Jong-il named Yang Bin head of a planned free trade zone last October, the Chinese-born Dutch national revelled in his new role as the man who would build a capitalist enclave in the world's last Stalinist state. The appointment was less welcome among leaders in Beijing, however. Within days, police plucked Mr Yang from his European-style villa in a raid that left his business in tatters and his North Korean scheme stalled. It was a dramatic fall for an orphan and naval college graduate who gained Dutch citizenship as a student after claiming political asylum following the crushing of the 1989 pro-democracy movement in Beijing. After building a flower business in Europe, Mr Yang brought his agricultural ideas back to China to much acclaim, with Forbes magazine in 2001 estimating his assets at $900m. But associates say shifting political winds left him vulnerable and now their main hope is that he will be deported to the Netherlands in the next few years. Mr Zhou himself was not the highest bidder for his large project in Jingan but he managed to see off competition from his more experienced and better-capitalised rivals from Hong Kong. Just how he managed to do this will be the subject of the investigation in Shanghai, which is being conducted by the central government. "[Property] is a very deep black hole," says Chen Bogeng, of the Oriental Real Estate Institute. "Although many pieces of land appear to be sold through public bidding, decisions are taken in favour of developers who have bribed officials. "A lot of government land is disposed of by officials for their own benefit as if it is privately owned . . . when state-owned textile companies in Shanghai went bankrupt, the land was sold by the textile bureau to developers, making officials and the businessmen rich." But Mr Zhou, like many of the new entrepreneurs, got too greedy and too careless. His refusal properly to compensate the residents in Jingan emboldened them to stage attention-grabbing protests, including one near the Shanghai leadership compound. Mr Zhou was also snared in an investigation into the Bank of China, which had zeroed in on one of his main lenders, Liu Jinbao, formerly head of the bank in Shanghai and Hong Kong. Although private companies appear to spring most nasty surprises on investors, the abrupt recall of Mr Liu from Hong Hong to Beijing illustrates another example of the incompatibility of Chinese communism with market economics. Because Mr Liu is not just a banker but also a senior Communist official, the probe into his actions was conducted by the Central Discipline Inspection Commission. But this is a party, not a legal body, and is therefore not required to make public statements on its actions. The lack of transparency hit Bank of China's reputation; the CDIC stayed quiet for days and the bank had no option but to deny reports about the investigation into Mr Liu that it later had to admit were true. Investors suffered badly, too, when shares in EuroAsia, the tulip company owned by Yang Bin, formerly China's second richest man, went from being one of the best performers on the Hong Kong stock market to virtually worthless following his arrest last October. LIU JINBAO Formerly the head of the Bank of China in Hong Kong, Liu Jinbao was recalled suddenly to Beijing last month. His job was one of the most highly regarded and visible in the Special Administrative Region, not only because of the bank’s landmark building that dwarfs most other edifices on Hong Kong island. The bank’s Beijing headquarters first denied reports that Mr Liu was under investigation for questionable loans he made while head of the bank’s Shanghai branch from 1993 to 1997. Later, however, it had to confirm the inquiry, which is being conducted by the Central Discipline Inspection Commission, a Communist party organ. Details of the investigation are sketchy but they are believed to centre on whether Mr Liu had any involvement in questionable loans granted to Zhou Zhengyi, the Shanghai property tycoon. Audit reports show that large sums of money loaned by the bank in Shanghai have gone missing. Like Mr Zhou's towers in Shanghai, the sprawling Holland Village estate built by Yang looked like a symbol of the kind of energy and imagination that private business offered the Chinese economy. A towering ornamental gate on the edge of the gritty north-eastern industrial town of Shenyang opens on to a bold, if bizarre, blend of traditional Dutch urban landscape and modern market gardening. A replica of Amsterdam railway station looks down on to hectares of greenhouses, while high-windowed brick-built shop-houses face a canal with little wooden bridges and an old-fashioned windmill. But Holland Village is a reminder of the perils of private enterprise in China. Mr Yang, who made a fortune in flowers in the Netherlands in the early 1990s, was tried last week in a Shenyang court on charges of financial fraud, bribery and illegal use of agricultural land and is now awaiting judgment. The canal he built is dry, the greenhouse plants are withered and the streets are lined with shattered glass from abandoned houses and apartments. Mr Yang's grand scheme faltered after state banks cancelled promised loans and tax men started circling; it collapsed completely after his detention. The case has unveiled classic issues that should give pause to investors in private Chinese companies. The charges against Mr Yang include giving a false account of the assets controlled by his Euro-Asia Agricultural Holdings in order to win a listing in Hong Kong, where reports of soaring profits helped make it the toast of the market. If such examples persuade investors in Chinese companies on stock markets in Hong Kong, New York and Singapore to act with more care, they should encourage caution among people taking advantage of recent rule changes to buy stock in the 1,216 companies listed locally in Shanghai and Shenzhen. But many observers say a loss of political favour was the real reason for Mr Yang's fall and that if he had kept a lower profile his legal transgressions would have gone unremarked. Indeed, corruption appears to have been the norm in Shenyang while Mr Yang was building Holland Village, under a mayor who later died in jail while under a suspended death sentence and a vice-mayor who was executed for graft. The slogan written over the development's gate - which calls for all to sing the Communist hymn "The East is Red" while "building a new Shenyang" hints at the mix of bureaucracy and business that is Chinese capitalism. A close associate of Mr Yang says business in China is close to impossible without some rule-bending. "You cannot be completely clean," he says. "At the very least you have to be good to officials, you have to take them to dinner, buy them drinks, sing karaoke with them, maybe arrange some ladies. Who would dare to refuse?" China's entrepreneurs may inhabit a twilight world of late-night carousing and daytime under-the-table deals. But their vitality not only marks them apart from their sedate cousins in the lumbering state sector, it also makes them indispensable in the country's march to modernity. Slowly, Beijing has come to the realisation that if it is to preserve the robust economic growth that legitimises the survival of its Communist regime, it must bring its private entrepreneurs in from the cold. The dynamism of the private sector leaves it no choice; even though they were starved of official bank credit, private sector concerns boosted sales to Rmb1,148bn ($138bn) in 2001, up from Rmb701bn in 1999. During the same period they created 5.5m jobs. Now, according to a draft revision of the national constitution, Beijing appears poised for the first time to accord private enterprises the same legal protection as the country's 174,000 state companies. Mr Cao believes that such a revision, if it is adopted at a session of the National People's Congress next March, will go some way towards putting the private sector on to a more legal footing. However, the scandals that ensnared Mr Zhou, Mr Yang, Mr Yang and Mr Liu are the harvest of past transgressions. Even if corporate China suddenly becomes more righteous, nobody can tell how many shady deals lurk beneath the turbulent surface of the economy, waiting to be uncovered. 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