The 1990s have often been referred to as the decade of the Pacific Rim, and in particular, of China. Obviously for the foreign corporation, the motivation of profits drives the investment process.
However, doing business in China poses many difficulties that companies would not otherwise face at home. At the very least, managers will be in an unfamiliar environment both culturally and linguistically.
The most important issue for investor and government alike is to determine the means to minimise the risks. After all, foreign direct investment, particularly in the large infrastructure projects undertaken by Hopewell, is essentially a partnership between the private and public sector. Any foreign direct investment brings benefits for both parties. The corporate investor gains access to new market and generates profits. The Chinese are the beneficiary of the opportunities for economic growth, for additional employment and for` technology transfers. Because foreign direct investment can only occur when both parties are satisfied with the terms of the capital inflow, public and private entities must understand each other's needs.
I have found that absolutely the most important criterion for deciding whether or not to invest in China is the demand in China for your product. Even though the investor may believe that his own product is the best in the world, he must keep in mind that it is always more trouble for China to accommodate an outside party as opposed to selecting a local player. The investor must ensure that the value he adds to the project is more than sufficient to overcome these reservations. The urgency of demand for the investor's product is a primary motivating factor in working with the foreign investor.
For example, at Hopewell one of our main concentrations is building and operating power plants to meet the severe electricity shortages in China. China's per capita electricity consumption for 1991 is approximately 5 per cent of an average US citizen's and 10 per cent of an average British citizen's. Although we have already built a 700 MW facility in China and are building an additional 2,000 MW, Hopewell plans to build another 8,000 MW in China over the next couple of years. Yet even this demand is a drop in the bucket towards meeting the demands of the Chinese.
By focusing on areas of extreme need, our projects will continue to be supported, regardless of any political changes in government. In much the same way that financial institutions view an IFC syndicated loan as mitigating country risk, I view this sort of demand as an insurance policy against political uncertainty.
Spirit of trust
From this basis, an investor must cultivate a spirit of trust and cooperation with the government in order to ensure the smooth negotiation and operation of the project. In structuring these projects we firmly believe that it is possible to devise a scheme in which all parties involved benefit from the common enterprise. Similarly, our philosophy is such that the gain by one party in the project does not come at the expense of another. On my part, no effort is spared to actually meet, face to face, the relevant authorities at both the central and provincial levels of government and I am always careful to explain the benefits that my plan will bring to each of their constituencies.
During these meetings, I also try to explain Hopewell's position to them, so that a common basis of understanding is found before we proceed. Given that project lifetimes of beyond 30 years guarantees long-term relationships between the investor and the government, I feel that it is mandatory to avert, from the beginning, any future possible sources of opposition. The establishment of this true partnership enhanced by sincere communication is necessary from both sides to ensure a successful venture.
In considering China for foreign direct investment, the investor evaluates his risks against the potential return on committed capital. Given the wide range of risks noted, a way for the government to attract a project is to help the investor boost its return by using its authority to either increase revenues or reduce expenses.
In Hopewell's power station projects, the Chinese provincial authorities sign power purchase agreements, effectively guaranteeing the revenue stream for the project over its concession life. As such, the Chinese have direct control over this profitability aspect of the project.
Similar options exist for the government to assist the foreign investor's return by reducing various liabilities on the project:
* It has the authority to offer the project tax holidays, including relief from its corporate income tax, interest withholding tax or applicable dividend withholding tax.
* Other tax relief can come in the form of tax-free importation of raw materials and exportation of finished goods.
* Waiving any fees or royalties that would be payable by the project.
In its control over the various elements of a project, the government can be prepared to offer the foreign investor a wide range of enticements.
As net return can be used to offset many perceived risks, the ability of a government to consider such incentives will positively influence its ability to attract foreign investment.
Assisting the financing process
One must remember that the corporate investor does not act alone. Since investors arrange funds from financial institutions, this parallel set of lenders committing funds in China often requires the investor to obtain precautions before money is lent. Even though both the investor and China may not deem these precautions as necessary, the investor must keep in mind that the project cannot be comifeted without bank commitments. Since banks only receive fixed returns on their loans, the risks willingly undertaken by these institutions are of a much more limited range.
Because financial institutions can offset the risks they must bear in financing a project with an appropriate lending rate, their primary requirements in financing the foreign direct investment is to maintain the certainty of that risk. In order to raise the necessary funds for an overseas project, concrete assurances are required form the government to ensure this risk certainty.
These assurances will emerge in the context of the terms of the concession agreement and in the context of the host nation's legal framework. Since China will not be viewing the project from the lender's perspective, the investor serves as the lender's representative to advocate the need for certain assurances. Specific measures in which the government can assist the financing process include:
*A letter of comfort from the government or other relevant provincial entity. This will state that the government body will give the project its full support and that the Chinese companies involved in the project will comply with their obligations under the various project agreements.
* Having made that contact, the investor can seek an assurance that the government has given or will give all necessary approvals and consents for the development to take place, including the right to apply its excess cash flows in converting them into foreign currency and then making re-payments to the financier.
* Investors should attempt to extract as many assurances as possible both in relation to the current taxation, royalty and government participation regimes in China, and to the likelihood of material changes being made to them during the term of the project. By including a group of international banks in a financing consortium (including banks from the host nation) it may be possible to reduce the risk of political change. The foreign financier may be able to insist on 'increased costs', 'changes in circumstances' or specific taxation clauses which provide that any increased charges arising from changes in local law should not be borne-by them on the grounds that they could not have been assessed as forming part of the risk they accepted at the outset of the transaction.
* Most of the remaining assurances available to financiers relate to situations in which their interests might be prejudiced by the revocation of the licence or other contract. Where the situation cannot be remedied, the financier will be concerned not only that it has reserved in the loan agreement the right to appoint a receiver over project assets but that it has obtained confirmation from the host government that it will recognise both the financier's receiver and the right to carry out his role effectively. The receiver must be allowed to recover assets of an insolvent joint venturer for the benefit of the financier before revocation of the licence by the government. Without this protection, the right to appoint a receiver becomes practically worthless. *
This article was derived from a speech given by Gordon Wu to the US Chamber of Commerce China Conference in Hong Kong on October 26, 1993.
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