The outbreak of severe acute respiratory syndrome (SARS), a virulent form of pneumonia, paralyzed travel to and from Asia for months in early 2003. China and Hong Kong were at the epicenter of the outbreak, and the initial efforts of China’s Health minister to ignore or conceal the dangers—the government didn’t report its first cases to the World Health Organization until February 2003—helped sow panic around the world. People were not only afraid to visit China, but some also were afraid to meet with anyone Chinese, almost anywhere.
I saw this fear firsthand. My wife, Wendy, had arranged for Rose Niu, who headed the Nature Conservancy program that was working to create national parks in Yunnan Province, to make a presentation in New York City to some of her Chinese friends, a number of whom hailed from prominent families and split their time between New York and Hong Kong or China. Wendy assured everyone that Rose was well and that Yunnan had not reported a single SARS case, but she was forced to cancel the lunch because none of the Chinese was prepared to get in the same room with Rose.
“How can we be sure Yunnan doesn’t have a SARS problem?” one demanded.
Like every organization I knew, Goldman wisely restricted travel and took many other precautions, and I was forced to cancel several planned trips. But I was scheduled to be in Japan for business in early June, and one of my colleagues, Deborah Lehr, suggested that I continue on to China. The crisis appeared to be abating, though very few people were traveling there because of lingering fears. Deborah had worked for the U.S. Trade Representative’s office during the WTO negotiations with China, as well as for the National Security Council, and was advising me on what proved to be a successful effort to get a domestic securities license. She understood China exceptionally well and had great instincts, so whenever she made a suggestion, I paid heed.
We checked with Wang Qishan, who had been installed as acting mayor of Beijing to fix the SARS problem in April. He sent word back that it was safe to travel. Although many at Goldman Sachs advised me not to visit, others, like Fred Hu in our Hong Kong office, urged me to come. Besides, if Wang Qishan said it was okay, that was good enough for me. I flew in from Tokyo on a nearly empty United Airlines flight on the night of June 3. I’ve been told I was the first Western CEO to come to China post-SARS. I was certainly treated like I was. I was put up in sumptuous accommodations in the Diaoyutai State Guesthouse complex, in a suite with a bathtub that might have been a small swimming pool. My visit led the evening TV shows and was splashed across the front pages of the newspapers the next morning. The publicity was a great boost for China, which was seen as open for business again, and for Wang Qishan, who had addressed the crisis head-on.
Glad as I was to help China get back on the right foot, I hadn’t gone just to show the world the country was safe. Goldman had postponed lots of business for months, and I packed in a set of meetings on what could only be a one-day stopover. The morning of June 4, 2003, began over breakfast at the Guesthouse with Jiang Jianqing, then president of ICBC, China’s biggest bank. Although John Thornton and Fred Hu had been working with him for some time, it was the first time I’d met Jiang, who was confident and energetic and determined to transform his gigantic institution. We were interested in doing more with ICBC and the other banks. Indeed, after meeting with Jiang I rushed off to see the new head of Bank of China, Xiao Gang, a charming 44-year-old rising star of Chinese finance. Over lunch we discussed the restructuring strategy and outlook for the bank.
Then it was off to visit Wang Qishan at the mayor’s office in a grand compound that had housed the Japanese mission in the old Legation Quarter just east of Tiananmen Square. Following his stint in Guangdong, Wang Qishan had spent two years in Beijing at an economic reform office before being dispatched to Hainan as Party secretary. He hadn’t been there long before he was called back to Beijing to deal with the SARS debacle. After the virus had emerged in Guangdong Province in November 2002, the Chinese government had hidden its problems and even patients while hundreds died and thousands more were infected in China, as well as in Southeast Asia and Canada. China had finally stopped the cover-up in April, firing the Health minister and Beijing mayor and bringing in Wang Qishan. His straightforward, candid response saved the day: he shut schools, quarantined thousands of people, released accurate case numbers, and designated new SARS-only hospitals—one of which was built in just eight days. By June the crisis was finally under control; it had infected more than 8,000 people worldwide, killing nearly 11 percent of them.
The Chinese government and Wang Qishan had put strict measures in place to control SARS. Body temperature sensors were everywhere—at airports, rail stations, and hotels. Everyone had to have their temperature taken before entering any government offices. The day got hotter, and I worried as we raced from office to office that I’d trigger the sensors and be banned from a meeting. I turned out to be just fine, but not my colleague Richard Gnodde. A tall, broad-shouldered South African who ran our Asia business out of Hong Kong, Richard worked up such a sweat hurrying across the baking grounds at Zhongnanhai that he three times triggered the alarm set up outside the room where we were to meet Executive Vice Premier Huang Ju. Wang Qishan had just detailed the strict quarantine regimen he had put in place for suspected SARS patients, and we had great fun teasing Richard that he’d be locked up for days. Finally, the Chinese brought out an oral thermometer to determine that Richard didn’t have a fever and allowed him through.
I didn’t know it at the time, but this would in some ways become my most important trip to China while at Goldman. For years afterward, Chinese friends referred fondly to my visit, while others I met for the first time often said I was well known to them thanks to the publicity it had generated. To my delight, as they saw Goldman awarded plum assignments, jealous competitors often commented on my lucky timing in going there when I did. In truth, I had long before learned the importance of a gesture to the Chinese, and I was rewarded with a deep and enduring sense of personal satisfaction and pride.
I was happy to have had the chance to finally get back into China and to be received so well. But the flight home was bittersweet. I caught a charter out of Beijing and was joined in Seoul by John Thornton for the return trip. It was John’s last month at the firm. He had decided to leave Goldman after more than 20 years. This did not come as a surprise to me, because John and I had been discussing his career goals for some time.
Typical of John, he had chosen to do something completely out of the box: he was joining Tsinghua University, the first non-Chinese to be named a full professor there since 1949. He would commute between Beijing and the United States, where he would serve as chairman of the board of trustees of the Brookings Institution, the famed Washington, D.C., think tank, as well as, later, chairman of Barrick Gold Corporation. John and I had worked closely for years, and I would miss his advice and my daily exchanges with him. John was an extraordinary strategic thinker, an idea generator of the first order, and a terrific adviser to our clients—a rare combination of visionary and rainmaker. He possessed a loathing of bureaucracy that had made him a natural ally of many of China’s reformers as he helped design and build our China business in the late 1990s, before becoming co-president and co–chief operating officer of Goldman prior to our own IPO in 1999. No one deserves more credit than John for establishing Goldman’s franchise in China.
In the fall of 2004, I had another meeting with ICBC’s Jiang Jianqing that would set the stage for Goldman’s most extraordinary, and contentious, deal in China. It was a crucial time for China’s big banks, which were restructuring in preparation for IPOs. Our involvement with ICBC would underscore a shift in the way Chinese and Western banks worked together. Early on, investment banks like Goldman had advised our Chinese counterparts; now we were looking to become financial partners as well. All of the Western banks sought a leading role in the big bank IPOs, but I can think of no banker who was more eager to win a mandate than Fred Hu. He was the Goldman banker closest to ICBC, and he arranged a lunch for us in early November that year with Jiang Jianqing at a restaurant that overlooked the beautiful Imperial Archives building just off Chang’an Avenue.
A brilliant economist turned exceptional investment banker, Fred understood the economy, the priorities of China’s leaders, and the policy changes needed to achieve them better than just about anyone I knew. He was very well connected and quietly influential to boot. Gifted and driven, Fred typified the rising generation of ambitious, hyperfocused young leaders unleashed by Deng’s reforms. Born in 1963 in a small village in Hunan Province in south central China, Fred was just three years old when the Cultural Revolution began. He endured hardships in the countryside, but his education was largely uninterrupted, despite the decade-long political turmoil. He joined millions in taking a competitive nationwide test for university admission in 1978, and at 15 he went off to the most prestigious, Tsinghua, where he would earn a master’s in engineering science. Most of his classmates were much older and driven to make up for years lost laboring on farms and in factories. Inspired by Deng’s program of change, Fred and his generation of university graduates—like fellow 1978 Tsinghua matriculant Lou Jiwei, who became a key adviser to Zhu Rongji in the 1990s and was named Finance minister in 2013—took up the banner of reform, determined to make a difference in China.
Fred subsequently earned an M.A. and a Ph.D. in economics from Harvard University then worked as a staff economist at the International Monetary Fund. Training central bank governors and finance ministers, he was on the front lines as the Fund pushed for market reforms in countries of the Eastern Bloc and the former Soviet Union. Fred returned to China on several IMF missions and helped to train Chinese officials who visited Washington. He turned down invitations to work for the Chinese government and instead joined Goldman Sachs as the firm’s chief China economist in 1997. We soon saw the potential in Fred’s unique blend of pragmatic knowledge of the economy and proven ability to win the trust of clients, so I made him co-head of China investment banking in 2003. His ability to get things done—he is a prodigious worker and a great networker, whose insightful thinking built strong relationships—was something to behold. Over the years I would increasingly rely on him for strategic advice.
Chinese officials also turned to him regularly for advice. As meetings with senior leaders from Zhu Rongji to Xi Jinping wound down and we were saying our good-byes, Fred could often be seen handing over a memorandum with economic reform proposals or fielding requests for his views on one topic or another. Among our corporate clients, I don’t think anyone appreciated his talents more than the CEOs of China’s state-owned banks.
Jiang brought to lunch several colleagues, including Dr. Pan Gongsheng, his right-hand man. Fred and I were joined by John Rogers, Mike Evans, and Chris Cole, our most senior financial institutions specialist and a superb banker who had become co-head of investment banking at Goldman in 2002. Before Jiang’s party arrived, we had a few moments to strategize. ICBC was China’s biggest bank and had the strongest domestic franchise, but Bank of China and China Construction Bank were slated to go to market first. We had the inside track at Bank of China after doing the IPO of its Hong Kong assets. Since it was highly unlikely that we could win all of these assignments, and getting one might complicate getting another, we debated how hard we should pitch for ICBC. I figured the best course was to trumpet our qualifications and make a strong play to lead the IPO. If Jiang decided he wanted us, we would have a high-class problem that we could sort out later.
We had a lively discussion at lunch, ranging from the health of the economy to whether Bank of China would go public before CCB, how much capital they would raise, what investors they might attract, and how bad each bank’s nonperforming loans were. Jiang candidly acknowledged ICBC’s mixed story: the bank was not making much money, capital levels remained low, and it continued to wrestle with its bad loans. But he also highlighted the strengths of ICBC’s domestic franchise and put a positive spin on the changes he was introducing. ICBC had adopted more stringent loan classification standards, strengthened credit policies and procedures, installed a new credit management system, and invested heavily in IT infrastructure. It had separated what it called the Old Book, loans made before January 1, 1999, from the New Book, loans made afterward. The ratio of nonperforming loans among the old corporate loans had reached nearly 57 percent by the end of 2003; the NPLs in the new corporate loans came in under 2 percent. That was progress, but ICBC had a long way to go by any stretch.
I described Goldman Sachs’ experience in advising banks and our capital markets prowess, emphasizing what we had learned guiding the biggest Chinese companies, like PetroChina, through major restructurings that led ultimately into the public market. I reminded him that Mike Evans had personally led these marquee underwritings and would oversee future Chinese deals. I added that Mike had just been named chairman of our Asian business and would be moving to Hong Kong to take an even more hands-on role. Chris Cole, I said, had advised many of the world’s best-known banks and insurance companies, and both Chris and Mike had worked closely with me on Goldman’s IPO. I noted that after the IPO of Bank of China (Hong Kong), Fred Hu and his team had successfully advised Bank of Communications on implementing a comprehensive restructuring program that gave it a stronger balance sheet and secured HSBC Holdings as a strategic investor—the first-ever foreign strategic partner for a Chinese bank. Bank of Communications was almost ready for an IPO in Hong Kong.
Jiang and I were sitting side by side at the big round banquet table, and when the interpreter had translated my remarks, Jiang shifted in his seat to face me more directly.
“Hank,” he said. “Would Goldman Sachs be interested in becoming one of our strategic investors before we do our IPO?”
His proposition caught me off guard. I’d expected to pitch for the underwriting and had not focused on this option. The idea itself wasn’t new: we’d been discussing and debating investing, pre-IPO, in Chinese banks, including ICBC, for more than a year. Fred had been an early advocate and in his persistent way converted Chris, Mike, and others to his thinking.
I was the biggest skeptic. The financial rationale was tempting: investing in banks, especially in emerging markets, is essentially a leveraged play on their home countries’ economies, and the booming Chinese economy was set to grow faster. But I was preoccupied with the potential pitfalls. While Chinese banks were cleaning up their bad loans with government assistance, even the best teetered on the edge of capital impairment and insolvency. Committing a big chunk of Goldman’s capital carried financial and reputational risks that made me nervous.
Jiang’s direct approach made me a bit uncomfortable, as well. I’m sure Fred had discussed investing with him, but I would have expected our staffs to have hashed out the details before he floated the idea publicly. But that, I would learn, was Jiang’s style. He was bold and brash, cut from a different cloth from most of the CEOs of Chinese state-owned enterprises I’d met. They tended to be careful and scripted; they avoided making a request like this unless they knew the answer beforehand, for fear of being turned down and losing face. Jiang was forceful, direct, and spontaneous.
I would come to admire these characteristics, but I didn’t know him well then. A tall man with jet-black hair, strong features, and an athlete’s gait, Jiang moved quickly, with power and purpose, no wasted motions. He smiled easily and openly. He struck me as perhaps a bit too self-confident. He’d been at the bank for years, and I wondered if he wasn’t underestimating the problems he faced and overestimating his ability to deal with them. I feared, as Donald Rumsfeld might have put it, that he didn’t know what he didn’t know, and I sure as heck didn’t know what he didn’t know, either. That made me uneasy.
“We’d like to work with you on the IPO,” I responded. “But as for investing—”
I hesitated for a moment, searching for a diplomatic way to say no—that Goldman, while grateful to be asked, wouldn’t want to invest. I didn’t want to offend him and lose the chance at underwriting the IPO. I was about to finish my thought when I heard someone clearing his throat. It was Mike Evans.
“Hank, perhaps we should consider doing both?” he said in a low voice. Knowing my opposition to the investing idea and my propensity for saying what’s on my mind, he didn’t hesitate to interrupt me before I closed the door on that opportunity.
I quickly surveyed my colleagues’ faces: John, Mike, Fred, and Chris were all nodding in agreement. Despite my concerns, I made a snap decision to give my team the benefit of the doubt and keep the investing option open. We could always find a graceful way out later if we had to.
I turned back to Jiang and said, “We’d also like to work with you in exploring a possible investment in ICBC. Thank you.”
I made sure to add that this would obviously be a major undertaking and that we had a lot to learn, as well as our own internal processes to go through. I reiterated that we were eager to help by lead-managing the IPO, and that we could also help him find other strategic investors.
“Fred and the entire Goldman Sachs team will be here to help you every step of the way,” I assured him.
When I finished, Jiang nodded and thanked me. I could see he was pleased. I know how to read clients, and I knew that Jiang—Mr. Self-Confidence himself—would want a direct answer, and I gave him as direct a one as possible. He was sophisticated enough to know that I couldn’t be more definitive until I knew more than I did then.
I followed up shortly after with a letter saying that we would begin careful internal evaluations and that we took the opportunity to invest “seriously.” Fred has since told me that he did his best, in the Chinese version we sent to chairman Jiang, to emphasize our seriousness.
If I was skeptical of investing in ICBC, it was for good reason. Chinese banks continued to suffer from the corrosive legacy of so-called policy lending directed by the government, particularly to prop up loss-making, unviable state-owned enterprises. In the late 1990s Premier Zhu Rongji had tried to redirect policy lending into new, specialized institutions while strengthening the internal controls and risk management skills of state-owned banks to transform them into more commercially oriented banking institutions. He injected $32.5 billion to recapitalize the four biggest state-owned banks, but as bold as that effort was at the time, the amount soon proved to be far from adequate. The magnitude of bad loans turned out to be a gross underestimate because of the antiquated accounting and loan classification system the banks used. Four years after that recapitalization, the government estimated that another 1 trillion yuan ($121 billion) was needed to bring the banks up to the 8 percent international standard minimum capital ratio. That was half of China’s annual fiscal revenues, or nearly 10 percent of GDP.
ICBC was a perfect example of the problem. Beginning in 1999 it had transferred roughly $50 billion in bad loans to Huarong Asset Management Company, the entity created to work out and recover bad debts. But five years later ICBC still had $85 billion to $95 billion in bad loans on its books, or about one-fifth of its total loans.
Zhou Xiaochuan had taken the lead in finding a way to avert a looming banking crisis and accelerate reform down the path he had drafted for Zhu Rongji. His influence had only grown with his appointment to head the central bank, after a stint as the nation’s securities overseer. Zhou was also a member of a newly minted policymaking group that cut across government agencies to lead financial sector reform. Set up in 2003 by new premier Wen Jiabao, the group was headed by Executive Vice Premier Huang Ju, with day-to-day operations run by Zhou. At the same time, the government established the China Banking Regulatory Commission, with Liu Mingkang as its first chair, to take over the regulatory and supervisory role of the banking industry from the PBOC, which would focus on monetary issues. The new agency would function like the present-day Office of the Comptroller of the Currency in the United States.
Zhou Xiaochuan’s original bank reform plan envisioned that banks would list after restructuring and attracting foreign strategic investors that would shore up the banks, share advanced technology and business practices, and strengthen corporate governance. Zhou had concluded that selling stakes to foreign investors was the best way to attract stable capital to bolster the banks’ fragile balance sheets. Later he would be criticized in some quarters for having given away Chinese assets too cheaply, but looking back, I believe that this was an absolutely crucial and wise decision his country made. Had China not taken this approach, it’s entirely possible that its banks might have failed to strengthen their capital bases and suffered the fate of Europe’s overleveraged, undercapitalized institutions, many of which foundered when the financial crisis hit in 2008.
But before the banks could begin the IPO process, they were going to have to clean up their balance sheets once again. Zhou Xiaochuan decided to use some of the country’s foreign exchange reserves, which were growing rapidly thanks to booming exports and soaring capital inflows, to boost the banks’ capital bases and dispose of tens of billions in additional bad loans. In contrast to the restructurings of industrial companies like China National Petroleum, the Chinese wisely decided to include all of the banks’ operations in their IPOs. Rather than listing a subsidiary, like PetroChina, that would remain under the control of an opaque Party-led parent company board, the entire bank would be publicly listed.
The central bank created a new vehicle, Central Huijin Investment Company Limited, to hold the government’s shares of the systemically important banks so that they could be recapitalized to ensure stability of the financial system. At the end of 2003, the central bank injected $22.5 billion apiece into Bank of China and China Construction Bank. This increased their capital levels to 8 percent and wiped out the Ministry of Finance’s stake in each of the banks, which found themselves under the control of a new stakeholder, the stricter but more reform-oriented central bank.
Despite this mop-up work, many sophisticated investors questioned the quality of the bank loans and, ultimately, the solvency of the industry. We were as acquainted with this skepticism as anyone. Bank of Communications had by far the cleanest books of the big banks, but working on its planned IPO, expected in mid-2005, we found that most foreign banks were reluctant to invest in the Shanghai bank because of concerns over nonperforming loans and an expected capital shortage. After our team came up with capital replenishment solutions, HSBC agreed to buy up to 19.99 percent.
Jiang Jianqing later told me he had approached more than 40 potential strategic investors, a global who’s who of leading financial institutions, but the only ones that were interested were Allianz and Fortis in Europe and, later—after our negotiations leaked—JPMorgan Chase & Company and Citigroup in the U.S. Even these were reluctant to commit to anything on the order of the multi-billion-dollar sum he was looking for.
I had given my word to Jiang—and my colleagues—that Goldman would take a very serious look at the investment, and I directed Fred, Chris, and Mike to organize a thorough examination of the bank. Convince me, I challenged them. I soon began to see the results of their work, and the numbers just about blew my mind. I had been focused on asset quality, and all those sour loans. But the other side of the balance sheet was a revelation. ICBC had more than $600 billion in deposits, and new deposits were flooding in at a rate that worked out to nearly $225 million every business day. In one year that would bring in enough money to rank among the top 15 of all U.S. banks.
The economics were incredible. The Chinese government set the rates for what banks could charge companies on loans as well as what they could offer customers in interest on deposits, and it kept the spread between the two rates artificially wide, ensuring a hefty return to lenders. With all that cash pouring in, ICBC was minting money. A profit-making machine like that would easily erase the losses on a lot of bad loans.
“This has got to be the world’s biggest mattress,” I said one day to Chris Cole.
The arguments of Chris, Fred, and Mike in favor of investing were beginning to persuade me. China’s vitality and growth potential were inextricably linked to its banking sector, and few institutions stood as a better proxy for the booming economy than ICBC, with its 150 million retail customers, 2.5 million corporate customers, and 17 percent share of the country’s banking assets. It was hard to imagine any company that would benefit more from China’s growth on such a massive scale. Moreover, we knew the government was committed to the bank’s success. It wanted healthier, better managed, and profitable banks. After all, following the IPO, the government would remain the controlling shareholder. It was a perfect alignment of interests.
I grew to like and trust Jiang Jianqing. I realized that his confidence came from hard work and application. Jiang had been born in Shanghai; his father had been a chemist in a hospital and his mother a teacher. After graduating from junior high school, he was sent down to the countryside in remote, poverty-stricken Jiangxi Province, where he grew rice and taught at a rural elementary school before he went off to work in a coal mine in Henan Province. When the Cultural Revolution ended, he returned to Shanghai, attended Shanghai University of Finance and Economics, and joined the Shanghai branch of the People’s Bank of China as a clerk. The years of hardship had made him, like so many of his peers, stronger and more determined.
Jiang had an uncanny facility and familiarity with accounting. “Numbers in banking books are like tones in music. They always have a logic,” he once told me. “When I read a financial report, I read it like I’m reading a sheet of music. I enjoy that feeling.”
Jiang worked his way up the ranks, earning a master’s in engineering and a Ph.D. in management from Shanghai Jiaotong University in his few spare hours. He became ICBC president in 2000 (he would become chairman in October 2005) and proved himself to be a dynamic leader willing to spearhead needed reforms by unleashing a wave of changes on the culture, people, and processes of the organization where he’d spent nearly all of his career.
Ultimately, apart from ICBC’s amazing domestic franchise, what persuaded me to invest was Jiang—his skill and enthusiasm for banking, for digging in and doing the work, for motivating his employees and transforming his institution. We had to make sure the numbers made sense, but it was absolutely crucial to be sure the institution had a strong leader. Boy, did it. He was a true believer. Sometimes, I thought he was too optimistic. As it would turn out, he wasn’t nearly optimistic enough!
I ran the idea of investing in ICBC past every wise head I could find in the firm. We subjected it to a formal vetting process that involved a series of rigorous checks and cross-checks from one internal committee to another all the way up to the board of directors. Yet in the end, I understood that making this investment would be about more than number crunching and due diligence. As I explained to senior executives and board members, it wasn’t just a financial investment in the conventional sense. We would ultimately be making a bet on China itself, knowing that the Chinese government needed ICBC and its sister banks to succeed. Their IPOs would be as much about the validation and global legitimacy of China’s banking system as they were about raising money. The importance of the banks was difficult to overstate. With no real capital markets to speak of, the big banks were the four financial pillars that held up the entire Chinese economy. The government could not let them fail; our money would be safe as could be. And, of course, this was a two-way street: the Chinese were looking for the Goldman Sachs investment to validate ICBC.
We began to negotiate specific terms with ICBC, aiming to shrink any margin of error. Our agreement gave us the right to scour ICBC’s portfolio and sign off on decisions about loan valuations. These “marks” ultimately determined the valuation of the bank, because any losses would come out of capital. The scrutiny gave Chinese regulators confidence that there was a process in place to ensure the bank would be adequately recapitalized. We also began coordinating with American Express Company and Germany’s Allianz, which would join us as investors in ICBC.
We thought a lot about both sides of the potential partnership: What would ICBC get from having Goldman Sachs as a partner, and what would we gain from partnering with them? Being a strategic investor would mean sharing technology and know-how. Drawing on a key strength of the Goldman franchise, we established a strategic cooperation team and helped install much better risk management systems, information technology, and management controls, helping ICBC improve in such areas as reporting, transparency, and governance. Senior Goldman executives like former New York Fed chief Jerry Corrigan flew to Beijing to lead seminars and training sessions on the culture and practice of good credit risk management for ICBC’s board of directors and executives.
Meantime, the Chinese leadership and Jiang Jianqing pushed ahead on a sweeping restructuring. ICBC would ultimately slash its branches and other outlets from about 42,000 in 1997 to 18,000, while trimming employees from some 390,000 at the end of 2003 to 355,000. (It had had nearly 570,000 in the mid-1990s.) During the spring of 2005, ICBC began to overhaul its balance sheet. In April it received a capital injection of $15 billion from the country’s foreign exchange reserves, while the Ministry of Finance retained a $15 billion ownership stake.
ICBC also dumped two huge batches of bad loans. In May the bank shifted about $30 billion in NPLs directly to the Ministry of Finance in return for an interest-bearing bond. One month later it sold $55 billion to the four asset management companies at auction. Including the NPLs hived off in 1999 and 2000, China’s biggest bank had disposed of $135 billion in bad loans in less than six years, an extraordinary number that underscored just how shaky ICBC and the banking industry had been and how determined the government was to clean up the mess. By June we had reached a handshake agreement with ICBC, and we were eager to organize formal due diligence and engage outside auditors to comb through the bank’s books.
A number of events were combining to change the way the market looked at Chinese banks. For one, a feeding frenzy among Western banks to own a piece of the Chinese financial sector had begun. In June China Construction Bank announced that Bank of America Corporation had agreed to invest $3 billion in return for a stake of approximately 9 percent, with an option to purchase up to 19.9 percent. If that didn’t catch the eye of skeptical investors, the following week’s IPO of Bank of Communications certainly did. Its shares, which we underwrote with HSBC, jumped 13 percent the first day, driven by massive demand for the $1.9 billion offering. HSBC, which had gone out on a limb to buy its 19.9 percent stake the previous summer, now looked brilliant, and the dynamic for investing in Chinese banks suddenly changed. In short order, Temasek Holdings, the investment arm of the Singapore government, agreed to invest $1 billion in CCB. A group led by Royal Bank of Scotland announced the purchase of a $3.1 billion, 10 percent stake in Bank of China, which was advised by Goldman. Temasek agreed to take an additional 10 percent stake, while UBS bought a 1.6 percent stake. Pariahs barely a year before, the Chinese banks had become the belles of the global investment ball.
By July, along with Allianz and Amex, we had reached a handshake agreement on the key details of an investment in ICBC. Because of the success of the BoCom IPO, our group would pay a slightly higher valuation and purchase 8.45 percent of what was perceived to be the shakiest of the banks that were being readied at that point for public listings but that we believed was the strongest thanks to its domestic franchise and deposit base. (Agricultural Bank of China was in much worse shape than the others and would not debut on the market until 2010.) At $3.8 billion, the deal represented the single biggest foreign direct investment since Deng Xiaoping opened China to foreign capital.
Despite the agreement and Jiang’s strong backing, we knew we had a way to go before getting final approval, since we needed sign-offs from the central bank, financial regulators, government ministries, and, ultimately, the State Council. We were optimistic but knew approval was by no means assured.
By an unlucky coincidence, word of our agreement with ICBC came out on August 30, 2005, the same day that Bank of China publicly announced that we had been selected as a lead manager, or bookrunner, for its IPO. It was a classic embarrassment of riches: we had already managed the high-profile IPOs of Bank of China (Hong Kong) and Bank of Communications. Now we had won two more huge plums. Moreover, it was widely assumed we had the inside track to lead the ICBC underwriting as well. And, indeed, we did: the memorandum of understanding for the investment stipulated that we would be the bookrunner on the IPO.
This was exactly what Jiang wanted—for us to manage the IPO as well as do the investment. But he was concerned that Goldman would be stretched too thin to manage both his IPO and that of Bank of China at more or less the same time, and he wanted to rush ahead and beat Bank of China to market. Jiang came to the States in September 2005 for the World Bank/IMF meetings in Washington, D.C. First, he stopped off in New York, where he gave a terrific presentation on the bank’s prospects to the management committee, after which we hosted a lunch introducing him to New York financial luminaries. To his delight we had invited David Rockefeller, knowing that his fascination with the Rockefeller family’s history had led him to visit the clan’s estate in Pocantico Hills outside of New York City.
I saw Jiang several times at the World Bank/IMF meetings, and he emphasized how much he wanted Goldman to lead the underwriting, while pressing me to abandon our work with Bank of China. He was relentless. We spoke at Goldman’s D.C. office and on the sidelines of a dinner we hosted where Goldman Sachs International chairman Peter Sutherland, who had been the first director-general of the WTO, interviewed former president Bill Clinton on world events. At the dinner Jiang insisted we meet again the next morning before he flew home. Each time the message was the same: give up the Bank of China mandate. I did my best to convince him that Goldman would have no problems handling both transactions.
I was being optimistic, as it turned out. The ICBC and Bank of China announcements had stunned the investment banking world, and the blowback was sharp and intense. Our rivals were up in arms, sniping in the press and behind closed doors that Goldman was getting too much business and that our assignments were riddled with conflicts of interest. We argued that our unmatched reach and experience in the Chinese financial sector should be seen as a unique strength that could be leveraged to serve our clients. And since they were state-owned sister banks, it was in the Chinese government’s best interest to coordinate the offerings so as not to have them come to the market at the same time in a direct head-to-head competition for investors. That’s what I told Jiang and Bank of China chairman Xiao Gang.
But the drumbeat of criticism grew louder. A number of our competitors employed princelings, and they were only too happy to use their influence against us. How much this affected officials’ thinking I can only guess, and there were clear differences among the financial sector’s leaders about our activities. Zhou Xiaochuan supported our roles in ICBC, because as part of the effort to improve governance he supported Jiang’s right to make decisions for himself, just as a CEO and his board would do in Western markets. But clear pockets of resistance had emerged. The Ministry of Finance did not believe that it made sense for investment banks to be strategic investors in China’s commercial banks. The China Banking Regulatory Commission’s new chief, Liu Mingkang, wanted to see China’s financial sector opened up, but, like the Ministry of Finance, he preferred that a commercial bank invest in ICBC.
Complicating matters, some terms of the deal leaked, unleashing a wave of popular criticism that China was selling state assets on the cheap. The invective wasn’t directed at Goldman alone: the ICBC investment had been priced at 1.18 times book value, while the China Construction Bank and Bank of China deals had been, respectively, 1.15 and 1.14 times book. We knew the pricing reflected how hard it had been to persuade foreign strategic investors to risk so much of their capital, but these deals were now being compared to the incredible success of BoCom: its shares were up 32 percent since listing and were trading at the equivalent of twice book.
Matters soon came to a head. On November 3, 2005, a year after Jiang Jianqing had asked us to invest in ICBC, I had lunch with Zhou Xiaochuan in the dining room on the ninth floor of the central bank headquarters on Chang’an Avenue. Normally, lunch with Zhou was a pleasant, intellectually stimulating affair that touched on topics ranging from economic conditions in both of our countries to reform in China and the development of the nation’s fledgling capital markets or to progress being made at the Tsinghua School of Economics and Management. Not that day.
Zhou was as poised and urbane as ever, but apart from running the central bank, he also served as director of the State Council’s leading group for state bank reform, an interagency coordinating body with decision-making power. He reported directly to Executive Vice Premier Huang Ju and played a key role in designing and implementing the restructuring plan for each of the four biggest state-owned banks. In that capacity he had a sobering message for us, straight from the top. The leadership had decided that one investment bank managing two big deals like these at the same time wouldn’t create a fair competitive environment. Goldman would have to choose which assignment to drop. It was clear Zhou hadn’t invited us in to debate the issue or to hear our side so much as to impart the news, as pleasantly but as firmly as he might.
Perhaps to emphasize the urgency, Zhou left the dining room so that Mike Evans, Chris Cole, Fred Hu, and I could decide right then and there. After a brief but intense conversation among us, I told Zhou Xiaochuan that we would underwrite Bank of China, invest in ICBC, and waive the condition that we serve as a joint bookrunner on the IPO for ICBC. We felt we could do more for ICBC as a strategic investor than as a lead underwriter, and a landmark investment in the bank would be far more significant in the medium and long term for both ICBC and Goldman Sachs’ role in China than our doing just the IPO. We were also concerned that it could hurt Bank of China if we had to decline the IPO we had already been entrusted with. I confirmed our decision in a note a few days later.
In the end, we did win the right to invest in ICBC. In January I flew to Beijing for the ICBC strategic investment signing ceremony. Our investment of $2.6 billion was the biggest investment we had ever made.
ICBC held its formal beauty pageant for the lucky bank that would take Goldman Sachs’ place as lead underwriter. It awarded Merrill Lynch, Credit Suisse, Deutsche Bank, ICEA Capital, and CICC the mandate for the deal, which was expected to come to market later in the year. The press, which loved to chronicle battles among rival investment banks, went to town with what they chose to portray as a stunning humiliation for Goldman. And it’s true we didn’t receive the mandate for what would, in October 2006, become the world’s biggest IPO. Instead, Goldman made an investment that would yield billions in profits over the years. Moreover, we had found a real partner in Jiang and ICBC, and we were able to make a significant contribution to restructuring ICBC and to bank reform in China.
The Goldman team, under Fred Hu’s lead, brought Bank of China public in Hong Kong in June 2006. The bank raised $11.2 billion—making it the biggest such offering since 2000. The bank raised a further $2.5 billion through a Shanghai offering a month later. It was the first mainland company to list in both places and became the most valuable company in China’s A-share market. ICBC went public in October 2006, the first bank to list simultaneously in Hong Kong and Shanghai, raising $21.9 billion.
These transactions were the high-water mark of financial reform in China. After years of restructuring, many of the biggest SOEs had stabilized. They dominated domestic markets and had become influential vested interests blocking further advances. Turf fighting had increased among the ministries, and more conservative factions resisted changes, which required their relinquishing power. Antireform, protectionist rhetoric became more pronounced.
Success can lead to complacency, and the push for reform stalled with its most senior advocates now on the sidelines. Zhu Rongji had stepped down from the premiership in 2003, and Jiang Zemin, the former leader, gave up his last official post as head of the Central Military Commission in late 2004. Their successors, Hu Jintao, as general secretary of the Party, and Wen Jiabao, as premier, shifted their attention from reform to social stability and harmony. Executive Vice Premier Huang Ju, a Jiang Zemin ally and the member of the Communist Party Standing Committee who oversaw finance and the economy, had the backed the reformers, but he developed a terminal illness in 2005 and died in 2007. Notably, control of Central Huijin, the institution that held the government’s stakes in the Big Four banks, was moved from under the central bank to the Ministry of Finance, which was less favorable to reform then.
Meanwhile, the state-owned banks continued to capitalize on their domestic franchises on their way to becoming enormous, lushly profitable machines. By 2012 ICBC ranked as the biggest bank in the world by market capitalization, followed in second place by China Construction Bank. Agricultural Bank of China ranked fifth, with Bank of China seventh. When the global financial crisis erupted in 2008, China’s banks, five years removed from the brink of collapse, would emerge as a force to stabilize the Chinese economy and to help prevent the world’s markets from going into free fall. But this came at a further price to reform efforts, which had aimed to get the banks to act in a more commercial manner. In 2009 the Chinese government would push the banks to extend an enormous 9.6 trillion yuan ($1.4 trillion) in stimulus lending. This was a sharp U-turn back to the policy lending approach of the past and one that has undoubtedly led to an increase in bad loans as the banks financed many projects that were uneconomical or inefficient.
Government-bestowed subsidies, regulatory protections, or other advantages all too frequently become sacrosanct entitlements, and changing that mind-set is difficult to sustain without a strong push from the top. But China’s leaders seemed to have become more interested in preserving stability than in continuing to press for change, as if the rapid economic growth they had inherited from the groundbreaking reform efforts of their predecessors would continue on its own momentum. In my view, China needed to approach its economy very much as a work in progress. It was still near the beginning of a difficult evolution that had to be completed for the country to realize its full potential. China risked stumbling—and undermining stability—more by going slow on reform than by going too fast.