On July 25 2002, Bank of China Hong Kong successfully completed its US$2.67 billion IPO - the first international equity offering by an affiliate of a PRC bank.
Historically the state bank specializing in foreign exchange transactions, Bank of China has always had an international orientation, with an extensive network of subsidiaries, branches and agencies around the world and the most direct knowledge, among Chinese state-owned banks, of evolving international banking practices.
Financial reform in China has called for a revolution in the operations and management of PRC banks. For state-owned commercial banks, the central objective of these reforms has been to complete their transformation from policy banks to fully commercialized, return-driven banks.
In part moved by China's accession to WTO and competition with foreign banks in China, the reforms have looked to international standards and practices in matters such as corporate governance, risk management and management of the asset base including non-performing loans. Its international outlook and experience has allowed the Bank of China to play a leadership role in these reforms.
Since 2001, the People's Bank of China, the regulator of commercial banks in China, has issued guidelines for corporate governance, requirements for information disclosure and a system of asset classifications with corresponding requirements for provisioning and write-offs. These regulatory requirements drew in part on the reforms that began to be implemented at Bank of China since 2000.
Bank of China has reformed its board of directors, reducing its membership from 68 to 12, with a view to having the board provide strategic vision for the Bank and decide on matters of key importance to the Bank as a whole. Other components of the Bank's corporate governance improvement programme include streamlining its decision-making structure, making risk management and profitability key considerations in business decisions, instituting a system of management incentives and accountability, implementing prudent accounting practices and transparency, and bolstering internal audit and compliance functions.
Bank of China was the first among state-owned banks in China to adopt the five-grade loan classification system subsequently required by the PBOC. Since 2000, Bank of China has been disclosing its non-performing loan ratios according to this classification system in order to provide a better understanding of its asset quality statistics.
Over the past two years, it has expanded the types of assets it monitors for asset quality. It took aggressive provisions and write-offs in 2001 (RMB 22.89 billion) and the first half of 2002 (RMB 11.88 billion), in contrast to an average of RMB 5 billion annually between 1995 and 2000. It has seen a decline in its non-performing asset ratio.
Bank of China has been consolidating its domestic operations, streamlining its branch network and centralizing IT. It is upgrading its retail banking business as well as its clearing and payment systems with advice of international consultants. Overall, it is instituting centralized, enhanced management throughout its domestic network, and increasing its urban and international business focus. This year it became the first PRC bank to enter the top 50 in the European syndicated loan market.
The IPO for the Bank of China's Hong Kong operations this year was a showcase for many of the reforms being implemented at the Bank of China at large, as well as a model and reference for the continuing reform at the parent bank.
The Bank of China Hong Kong was created last October through the merging of 13 commercial banking operations in Hong Kong. Prior to the merger, these had been branches or subsidiaries of Bank of China. The bulk of these operations were in Hong Kong and had operated here for decades with relative independence from one another, although various aspects of their management and operations had been coordinated through the Bank of China's Hong Kong and Macau Regional Office. The merger in advance of the IPO was to consolidate and streamline the Hong Kong commercial banking operations under the Bank of China umbrella.
The merger presented an opportunity to redesign and restructure the organization and management of Bank of China Hong Kong's banking operations. BOCHK engaged an international consultant to design management structures, charters and procedures for the newly merged bank based on international best practices.
Similarly, extensive studies were done to create a comprehensive risk management system and IT infrastructure. The restructuring created an integrated bank organized into lines of four strategic business units, retail banking, corporate banking, strategic planning and back office operations. This enhanced customer focus and operational efficiency.
Functional duplication among the predecessor operations was eliminated. The branch network was rationalized and streamlined. Key functions, such as risk management, non-performing loan resolution, finance and accounting, internal audit and compliance, business planning and information technology, were centralized and standards are uniformly applied throughout the new bank.
In contrast to uneven corporate governance practices of the predecessors, the new bank is overseen by a board of directors that includes four distinguished and experienced independent directors. An audit committee, a risk management committee and a remuneration committee operate at the board level.
This is consistent with international best practices, but is also an indication of the importance the new bank attaches to these functions and an acknowledgement of the important role of independent directors in these matters.
Apart from these board committees, the new bank is managed through several other executive committees, such as an asset and liability management committee and a credit committee. All committees operate under their respective charters. Senior executives are evaluated by reference to their goals and responsibilities which are also clearly set out.
In preparation for the IPO, the new bank undertook a comprehensive examination of its asset base. In addition to some exceptional measures to reduce its non-performing loan ratio, such as selling problem assets to the parent bank, the new bank implemented measures to help reduce and prevent asset problems in the future.
These measures are based on an in-depth analysis of the causes of these problems including the systemic and behavioral failures that allowed them to occur. Based on these diagnostic procedures, the bank devised a rigorous risk management system to promote a risk-sensitive culture throughout the bank, to establish limits and guidelines to manage risk, and to focus on the credit origination process and subsequent monitoring as a key method for controlling credit risk.
The bank is implementing corresponding IT infrastructure to enhance the effectiveness of various risk management procedures. Moreover, to deal with non-performing loans once they arise, the bank has set up a special team dedicated to managing, restructuring or otherwise recovering on these troubled assets.
The result of the merger and restructuring, namely Bank of China Hong Kong with all its reform initiatives and promise, was shown to the world in its IPO which closed at the end of July 2002 and raised approximately US$2.5 billion. The offering included a public offering and listing on the Hong Kong Stock Exchange, a public offering without a listing in Japan, and a global private offering to institutional or professional investors around the world.
The offering overcame the challenges of a depressed and volatile market to become the biggest Hong Kong IPO ever. The retail offering was 26 times over-subscribed - the highest retail over-subscription rate of any Hong Kong IPO in recent memory - reflecting the bank's deep roots in Hong Kong and the loyalty of its banking customer base built up over the past 85 years.
As one of the two largest corporate lenders in Hong Kong and one of three currency note issuing banks in Hong Kong, the Bank of China Hong Kong also received strong institutional support for its offering from Hong Kong-based corporates, such as Hutchison Whampoa, New World and the Kerry Group. As a further reflection of the bank's stature and importance in Hong Kong, Standard Chartered Bank became its strategic investor in the offering. Outside Hong Kong, the offering generated a stunning US$2.9 billion in demand among investors in Japan, where it was the first China offering to include a public offering without listing component.
Of a long list of firsts, perhaps the most significant is that this was the first international IPO out of the Chinese banking sector. It was both a step in the banking sector's reforms and an instrument to further such reforms. The enthusiastic market reception that greeted Bank of China Hong Kong can be seen as an endorsement of the reform efforts and measures that produced this new bank, although not to be neglected is the special place that this bank inhabits in the business community and in the hearts and minds of Hong Kong.
With all these changes and initiatives, the Bank of China Hong Kong is a special part of the Bank of China. Bank of China is its controlling shareholder, is committed to working with the Hong Kong subsidiary to implement its China strategy, and was a key moving force in the merger, restructuring and IPO.
At the same time, the parent bank must respect the corporate governance structures now operating at Bank of China Hong Kong. Its relationships with the subsidiary must also give due deference to the regulatory frameworks to which Bank of China Hong Kong is subject.
However, this new arms-length relationship with its Hong Kong subsidiary is yet another sign of the progress of reforms at Bank of China. Bank of China has created a model and testing ground within its group for applying international best practices. This has not only put Bank of China Hong Kong on a launching pad to become a leading bank in the region. It is also providing valuable experience for Bank of China at large in its drive to become a world-class financial institution.
Data and certain other information in this article were provided by the Bank of China.
Shearman & Sterling was counsel to Bank of China and Bank of China Hong Kong for the IPO. For more information about this article, please contact the author at [email protected]
