CNOOC just never seems to learn, and they are back to seek a new approval from minority shareholders to lend money to a parent vehicle. We call on investors to vote it down, and send a message to China, Inc. that the practice is unacceptable and we will not allow a repeat of the Japanese keiretsu/main bank system.

Veto CNOOC loans to parent
19 March 2007

Will they never learn? It seems not. CNOOC Ltd (CNOOC, HK:0883, NYSE:CEO) has convened a shareholder meeting for 30-Mar-07 to seek minority shareholders' approval for the continuation of loans (which it calls "deposits") to CNOOC Finance Corp Ltd (CNOOC Finance), an unlisted vehicle majority-owned by CNOOC's state-owned parent, China National Offshore Oil Corporation (CNOOC Parent), for the next 3 years.

Imagine the outcry if Li Ka Shing proposed to set up a finance company and use it to take "deposits" from Cheung Kong and Hutchison Whampoa. It simply wouldn't get shareholders' approval, and nor should CNOOC.

Long-time readers will have a sense of deja vu. Back in 2004, in an Easter Eve announcement, CNOOC sought minority shareholders' approval for the same arrangement. We campaigned against it, and we also accused CNOOC of breaking the Listing Rules for failing to seek prior approval for the same transactions since 2002. CNOOC denied that it had done anything wrong, but a subsequent investigation by the Stock Exchange of Hong Kong Ltd (SEHK) proved us right, and on 6-Oct-05, the Exchange censured CNOOC for failing to seek shareholders' approval for the prior transactions. Richard Williams, Head of the Listing Division of SEHK, said at the time:

"The Exchange views the failure to disclose and obtain prior independent shareholder approval of connected party transactions very seriously. The case is another example of the granting of financial assistance by a listed issuer to a connected party over a lengthy period of time without proper approval. Such conduct prejudices the interests of independent shareholders in that they are not being given information on a timely basis or invited to approve the transactions before they are implemented."

Unfortunately, due to the tight meeting notice period which included Easter 2004, the voter turnout was low, and we failed to mobilise enough shareholders to vote down the proposal, so CNOOC got its 3-year approval which now expires. However, later that year, when listed sister company China Oilfield Services Ltd (COSL, 2883) asked shareholders to approve the same kind of transactions with CNOOC Finance, we campaigned against it and the proposal was voted down by 62.92% of votes.

There they go again...

CNOOC has a history of seeking minority shareholders' approval for proposals against their interests. The last one to catch our eye was a request that minority shareholders tear up a non-compete undertaking which had been given by CNOOC Parent when CNOOC was listed. The undertaking assured that CNOOC Parent would not engage in oil exploration and production, and hence any deals worth doing would be done by the listed company. CNOOC Parent wanted that undertaking amended to exclude deals onshore or outside the PRC, without offering anything in return. We lobbied against that proposal, and in a Saturday New Year's Eve meeting, shareholders voted it down by 59.08% of votes. It was only 9 days later that we found out why CNOOC was in such a hurry to waive the non-compete undertaking for its parent. On the evening of 9-Jan-06, CNOOC announced a deal in Nigeria, and its stock gained 3.7% the next day, adding HK$8bn to the valuation. If the vote had gone the other way, the Nigerian deal might well have gone to the parent.

Meanwhile, on 29-Sep-06, CNOOC Parent listed a third subsidiary on SEHK, fertilizer maker China BlueChemical Ltd (3983). Again, this company obtained a pre-IPO waiver for giving financial support to CNOOC Finance, but this time, among the many connected transactions the listed company has with the rest of the group, it only obtained approval for loans to CNOOC Finance for 1 year after listing (see page 147-148). So before 29-Sep-07, they must either move their money to banks, or seek minority shareholders' approval to continue lending to CNOOC Finance, in which case, we will be ready to oppose them. Sooner or later, they will learn.


Incidentally, CNOOC has resorted to a fairness opinion from ICEA Capital Ltd, a subsidiary of Industrial and Commercial Bank of China (ICBC), which is listed in CNOOC's annual report as one of its Principal Bankers. Have these people no concept of conflict of interest?

If you look back at similar situations, you will find that ICEA also issued a fairness opinion to PetroChina Co Ltd (857) for similar arrangements on 22-Sep-05. At the meeting on 8-Nov-05, the proposal squeaked through with just 56.28% of votes in favour. We should have pushed against that, but we don't have time to fight every battle. ICEA also issued the fairness opinion in a similar situation for China Petroleum & Chemical Corp (Sinopec, 0386) on 21-Apr-06, which passed with 63.43% of votes in favour. Yes, ICBC is listed as first on the list of Principal Bankers of PetroChina, and is a Principal Banker of Sinopec.

We think SEHK's Listing Division should not have allowed a subsidiary of a principal banker to act as an independent financial adviser to a company. If banking isn't a business relationship, then what is it?

Put an end to it, or see a repeat of Japanese history

So CNOOC group is not the only group that has engaged in these practices. Nor is it restricted to the oil sector. In Dec-04 we warned you about Air China (0753), and its pre-IPO waiver. Unfortunately that came up for renewal at an EGM on 28-Dec-06 during the Christmas week, and was approved by 93.17% of votes cast. Institutional shareholders were certainly asleep in the cockpit, and we didn't trigger the alarm, but the high figure in favour was almost certainly aided by strategic shareholder Cathay Pacific Airways Ltd (0293) which, after the Dragonair takeover, now owns 2,125m shares (17.34%) of Air China and would have counted as independent in this vote.

What is at stake here is a worrying trend among the mainland government-controlled groups to set up in-house finance vehicles for the pooling and control of group cash, mixing the assets of listed companies with those of their parents and siblings and ensuring that the purse-strings are controlled by the parent. Minority shareholders of HK-listed companies, particularly institutional shareholders, have an opportunity and responsibility to put an end to this practice and make clear that it is unacceptable. If they fail, then China's conglomerates will continue this practice and evolve to emulate the Japanese keiretsu/main bank system of the 1980s, with companies in the group required to support each other through a centralised finance vehicle, leading to the unsound lending and risk concentration which was a contributory factor to the Japanese asset bubble and its 1990s collapse.

Now we know what you're thinking - the mainland banks aren't that great at credit controls either. True enough, but If anyone is going to do unsound lending, we'd rather the mainland banks did it than have the risk concentrated on one group, and there is at least the hope that companies like CNOOC would deposit money with better-run foreign banks who are now competing for business in China and are less likely to go bust in the next decade.

©, 2007

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