林日升 Evans Y. Lam/First Vice President
                 - Investments Salomon Smith Barney
    
    
    July 20, 2002, US President Bush signed the Accounting Industry Reform Act, a legislative recipe to end so called "book-cocking" accounting tricks that have alarmed investors. President Bush declared Today, I sign the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt. What is the significance?
    
    Here is the disturbing fact: After 911, the Dow Jones industrial average lost 7% of its value before finding a bottom. Since news of the corporate scandals began to snowball in mid May, the Dow went down 20% before experiencing some rebounds. In other words, corporate wrong doers have done 3 times as much damage to the US stock markets and investors as Osama bin Laden. Investors suffered a total collapse of confidence in corporate America due to perceived and actual conflicts of interest committed by corporate insiders. We have seen auditors who become the servants of managers rather than of shareholders, investment analysts serve their own interest rather than offer unbiased advice to investors; bankers who might compromise their fiduciary duties to transact with questionable characters. There have been similar problems in China which have shaken the confidence of the public in the Chinese financial system and investment market.
    
    The 1990's witnessed a new era in the US business: the rapid application of the Stock Option Plan. Companies try to empower each and every employee to become a shareholder of the company through the stock option plan, which can turn an employee into an owner of a business and enhance shareholder value. The ultimate goal of this is the ballooning of the company' s stock price. It is no question that the employees' incentive as owner, coupled with the massive advancement and application of new technology, resulted in the tremendous increase in productivity of 3.5% per year, twice the historical average. On the other hand, the single tunnel vision of greater profitability at times pushes managers to the edge of their limits. Integrity and judgement are compromised. In order to win the lucrative consulting business, auditors begin to lose sight of their most important function - the accountability of the financial statement, which is the most important protection for shareholders and stock investors. As people' s greed to advance through fraudulent behaviors, the system loses its ability to detect them. As soon as self-regulation fails and corruption uncovers, the market reacts with instability. Trillions of dollars of investor money vanishes along with the punishing fall of the stock price. If the problem is not addressed, it will hamper the stability of any financial system. The stock market will fail in its mission as the place of capital raising - a major pillar of economic development.
    
    The new legislation aims at curtailing fraud and corruption in corporate America. It sets up an independent private-sector oversight board to watch over the accounting industry and restricts the ability of accounting firms to perform consulting work for companies they are auditing. A chief executive officer or chief financial officer who certifies false financial reports could get 20 years in prison and be fined US$5 million. Shredding of documents could result in a 20-year sentence. In addition, the law calls for the immediate disclosure of stock sales by company executives and prohibits companies from giving personal loans to top officials.
    
    In President Bush's own words, the Act says to corporate executives: No boardroom in America is above and beyond the law. To accountants: The high standard of your profession will be enforced without exception. The auditors will be audited, the accountants will be held to account. To the American workers: We will not tolerate reckless practices that artificially drive up stock prices and eventually destroy the companies, pensions and your jobs.
    
    Who should American investors rely on for protecting their interests? While the laws and regulations are loud and clear, let's not forget in the end, it rests primarily with the markets and the ability of the markets to self-govern. Government regulation provides a framework in which self-regulatory organizations like New York Stock Exchange can function and enhance corporate credibility. The market itself is a disciplining force. But it is up to the corporations themselves, and the structure that is put into place with independent board of directors and management that is responsive to shareholders' interest. The US financial system' s great strength rests in the investor' s trust of the markets - not only in the dynamic of the economic systems but its integrity as well. We in the US have learned a great lesson over the past six months. Will the other countries take notes?
    
    While China has very comprehensive laws prohibiting accounting fraud, Chinese investors often lack the confidence in the accuracy of the accounting reports. Investors need to be assured of the people with whom they do business are operating in an honest, transparent, and disciplined fashion. Listed companies should strive for complete and fair disclosure that will address publicly and openly all issues that arise, including conflicts of interest. I am recommending a system of independent directors who ask tough questions of management. An independent audit committee will be elected to monitor the works of the auditors, who would be responsible for the accurate reporting of the financial conditions according to General Accepted Accounting Principles (GAAP), and ultimately will be penalized for their failure to perform.
    
    The lack of confidence in the investment market partially explains the high savings rate in the Chinese banking system. As of June 30, 2002, private savings reached RMB 8.2 trillion (about US$ 1 billion), compared to RMB 1 trillion ten years ago. The amount of increase is far greater than the economic growth, despite the very low savings interest rate of less than 1%. Over the past 5 years, bank deposits from private clients have grown at 17% a year compounded, twice the national GDP rate. It is estimated that on top of bank savings, another RMB 4 trillion is estimated sitting in bank safe deposit boxes which is earning nothing. The huge deposits have created tremendous pressure for the banks to lend. Bank lending standards might be compromised as a result.
    
    With the rapid economic development in China, investment capital is profoundly needed. How do we encourage Chinese savers to become investors? How do we channel the private savings to the investment market?
    
    1.The public needs to gain confidence in a stock market that is open, fair and transparent, and that the financial information provided by the listed companies accurately reflects the strengths and risks. For example, investors would prefer listed companies with simpler corporate structure rather than conglomerates with diverse business interests. They can better understand the merits the operations with a single line of business, which has become a global trend recently.
    
    2.The public needs attractive investment vehicles. Other than savings, the national bond yields about 2.6% and 2.7% for a 7-year and 10-year, respectively. While the low yield reflects the non-inflationary or to some extent deflationary environment China is in, it does not compensate the interest risk in light of the strong economic growth China enjoys. Collateral saving products similar to mortgage backed securities are encouraged for conservative investors. Banks can package various segments of their lending portfolio (asset-backed securities) and market it to depositors. It creates higher rate investment vehicles for depositors and yet lays out the default risks for banks.
    
    3.Stringent regulation of the securities firms. As reported by the Chinese Securities & Exchange Commission, there were 118 firms with RMB 90 billion of net equity. Their low Liquidity assets nevertheless reached RMB 46 billion, or half of the net equity. While there are various speculations on the areas of problem loans, the major ones are losses from IPO price stabilization guarantees, soured real estate investment in earlier years and poor management.
    
    4.Prudent acceleration of the mutual fund market. In the United States, mutual funds are the most popular choice of investments with total assets over US$5 trillion. At present, there are only seven open ended mutual funds in China with minimal assets, distributed by two security firms only.
    
    5.Encourage QFII (Qualified Foreign Investment Institute) to invest in the Chinese capital market to improve its depth and flow. China has been attracting over US$40 billion foreign direct investment every year. Foreign institutional investors are also eager to invest in attractive listed companies through the capital market. While the Chinese government should set up rules and regulations to discourage and prohibit short-term speculation from QFII, their presence and expertise in stock selection would create stability of the stock market. Retail investors would also benefit from the detail analysis they perform on their investments.
    
    Finally, the integration of banks / insurance companies / securities firms and trust companies through the establishment of financial holding companies. I recognize this is one of the most controversial subjects in the Chinese finance reform. The separation is deemed necessary for better regulatory control. With the entry to WTO, Chinese banks and securities firms will have to compete with foreign banks, especially from the American and European ones. They are powerful financial institutes with solid assets, equities and resources, armed with every conceivable investment and banking product.
    
    The integration would also accelerate the banking reform. The four major state-owned banks are facing high non-performing loans (27% of assets). Unless there is a separation of the State and banks, these banks cannot be construed as commercial banks and operate according to sound banking principles. These include solid credit analysis, control on director loan, and inter-company loans and such. The first step is to open up shareholder ownership to allow private investors and QFII to invest. With non-performing loans gradually work out by the four asset management companies, these banks would be ready for new capital injection from the public through IPO's.
    
    The roads to reform are always challenging. Over the past ten years, China has achieved an economic miracle unprecedented in human history. The opening of the stock market in the early 1990' s was a major milestone. The entry to WTO would mean more economic growth and opportunities for China. The capital market will be an indispensable pillar to facilitate and finance this prosperity. Let us all work on the ultimate goal towards a sound, fair, and transparent financial system in China.
    
    Evans Lam July 31, 2002
    
    The opinion expressed above is strictly from the writer. It does not represent the position of Salomon Smith Barney nor of its parent Citigroup.