China’s stake in the Middle Eastern turmoil is staggering as it seeks to restore a 21^st-century version of the Silk Road. 

Two decades ago, the US was dependent on the Middle East. Now there is much less US dependence, hence America's changing role. Now it is China that needs the Middle East, and the planned Chinese role in the troubled region goes way beyond simply oil.

 The US fought the Iraq war and led the drive for sanctions against Iran. But it is the Chinese who plan to capitalise on the fall-out from the American strategies. China won the peace -- at least until now.

China is investing billions in both Iraq and Iran not only to secure China’s need for more oil but also to make China the major player in Middle Eastern trade. Fortunately most of the Chinese investment in Iraq is in the south, which has so far has escaped the fighting.

The biggest single Chinese investment is in the remarkable Rumaila oil field in southern Iraq. Rumaila is a 50-mile-long deposit of sweet crude with estimated reserves of 16 billion barrels.

The Chinese believe it will be the second largest oil deposit in the world. Saudi Arabia’s Ghawar field is the largest. China National Petroleum Corporation has a 37 per cent stake in the field and BP has 38 per cent. Iraq interests hold the remainder. 

The BP and CNPC investment requires a rapid increase in production. CNPC is looking for output from Rumaila to be lifted from 1.06 million barrels a day to 2.85 million in seven years. Such a rapid increase in production of a field as large as Rumaila is without precedent, but it’s just the start of the Chinese plan to develop Iraq into a rival of Saudi Arabia and, with Iran, to become the second largest oil producer in the world.   

CNPC is actually operating four projects in the southern part of Iraq and is the single biggest foreign investor in Iraq, which is already China’s fifth-largest overseas oil supplier. China has now surpassed the US as the world’s largest oil importer as a result of the big rise in US oil production and virtually stagnant Chinese oil output. 

China’s proposed support of Iran is no less ambitious. Earlier this year, the President of Iran, Hassan Rouhani, met with Chinese President Xi Jinping. They discussed a remarkable project to construct a rail link from the Chabahar port in southeastern Iran to Pakistan, Afghanistan, Kyrgyzstan and China.

The Chinese will also be key financiers of the proposed Khoda-Afarin Dam in Iran, which aims to control the floods of Aras River and irrigate 62,000 hectares of agricultural lands. China is also looking to invest in the steel industry in Iran.

For China’s grand Silk Road plan to work, the area needs stability. That now looks unlikely.

Can you be Maoist and ultra-capitalist at the same time? Yes, you can. The embodiment of this ultimate contradiction is Ren Zhengfei, the legendary founder of the Chinese telecommunication giant, Huawei.

He is one of China’s most respected and powerful businessmen, an admirer of the Whiz Kids of Ford -- who pioneered a data-driven decision-making process -- and is a personal friend of American business tycoons such as Hank Greenberg of AIG and John Chambers of Cisco.

At the same time, he openly professes his loyalty and support to the ruling Chinese Communist Party, believes the Chinese system will be superior to American and European models in the long run, and his strategy is most deeply influenced by Mao (Is Mao China's greatest business strategist?, June 11).

Ren offered his first ever interview to Chinese media this week, outlining his vision for the company, future of the technology, and geopolitics. China Spectator has delved into some of these questions a day already (see Huawei’s love-hate relationship with the US, June 18).

Here are the rest of his answers:

Ren on China and the Chinese Communist Party

One of the greatest controversies surrounding Ren and his company is its alleged link to the Chinese state and ruling party. It is the Achilles heel of Huawei’s global ambition, especially in key markets like the US.

When Ren was asked about his faith, he didn’t shy away from the controversy and said he believed in China.

“It was not clear to me before which block -- the US, China and Europe -- will be [the] dominant force in the future. But I think I know the answer now, it will be China. The country only faces short-to-medium difficulties as it transforms its economic structure, and it will grow stronger and stronger in the future,” he told a gathering of Chinese journalists.

Huawei’s corporate culture and foreign employees

Huawei is a global company with more than two thirds of revenue and coming from outside China, and it employees over 40,000 foreign employees out of its 160,000 strong workforce. Ren was asked how he integrates foreign employees into the company’s corporate culture.

He laid down some ground rules: “Rule number one: we are a Chinese company and we must support the Chinese Communist Party and love our country. Rule number two: Huawei’s employees must obey laws and regulations of countries where Huawei operates and an elected compliance committee will monitor employees’ behaviour when they are abroad.”

Ren openly admits it is difficult to integrate foreign managerial talents into Huawei, which still has a deeply Chinese -- some would even say militaristic -- corporate culture. “We have 40,000 foreign employees and most scientists will adapt well because they don’t care about inter-personal relationships. But it is most difficult for managers who find it hard to get established,” Ren said.

He cited the example of Colin Giles, a former Nokia senior executive who only lasted less than a year at Huawei as executive vice president of its Consumer Business Group. “I personally approved Colin Giles’ resignation and it was very painful for me. He could not survive here and the conditions were not right and we couldn’t keep him,” he said.

Ren emphasised the company must adapt and change itself to be more welcoming of foreign talent. “If we can’t keep the best foreign talent, how can we become the world’s best company?” he asked.

Ren on the future of technology

When we talk about Huawei, it is often talked about in the context of its alleged security threat. However, we often overlook the fact it is one of the most innovative technology companies in the telecommunication sector, with 10 per cent of revenue dedicated to research and development.

Chinese tech journalists asked him about the future of technology. Ren thinks the biggest technological disruption will be the graphene revolution, replacing the dominance of silicon. “Graphene is the absolute frontier of technological innovation,” he said.

He also commented on Nokia's demise. “Nokia’s mistake was to stay in the industrial age, when the emphasis was on cost and quality. The Nokia handset is the only device in the world that you can own for 20 years. However, it overlooks the internet age innovation unleashed by Apple,” he said.

Ren remains a deeply paradoxical figure who has to navigate China’s first true multinational company in dangerous domestic, as well as foreign, markets. In China, Huawei has to profess its loyalty to the party in order to survive and prosper, and on the other hand, its vast global operation dictates that it must remain at the arm’s length from the Chinese state.

The 71-year-old imperial chief has an impossibly difficult acrobatic role to play, a common plight for many of China’s most successful private entrepreneurs. 

The brother of a top aide to former leader Hu Jintao has been put under investigation on suspicion of corruption the Communist Party’s Central Commission for Discipline Inspection said on its website on Thursday.

Ling Zhengce, a top official in China’s Shanxi province, is reported to be the brother of Ling Jihua, a former presidential aide who has been accused of covering up a Ferrari crash that killed his son.

Ling Jihua was considered a top candidate for the party’s Politburo before the crash in March 2012 according to the South China Morning Post. According to the paper, accusations that he tried to cover up details of the crash led to his eventual demotion in September that year.

The vice governor of coal-rich Shanxi province, Du Shanxue, is also under investigation according to a separate statement on the anti-graft agency website.

According to the statements, both Ling and Du are under investigation for suspected “serious discipline and law violations” a euphemism often used to refer to corruption.

Ling and Du are the latest provincial officials to be caught up in President Xi Jinping’s nationwide crackdown on corruption. The New York Times reported earlier this week that Xi’s own family members have been offloading assets in an attempt to strengthen his position as the anti-graft campaign continues.

The campaign is growing into one of the biggest of its kind in China’s history with approximately 435 arrests of mid-to-senior level officials since   the 6 December 2012.

The arrest of prominent human rights lawyer Pu Zhiqiang last month as well as three anti-corruption activists this week has highlighted the limits to the anti-corruption campaign.

Will there be a more important driver of Australian growth over the next decade than Chinese investment? The near-term prognosis for investment is reasonably good but iron-ore producers must be getting nervous as prices decline and demand shows tentative signs of slowing and Chinese authorities look to curb excess capacity.

Investment has been a major driver of China’s economic success story. Real gross fixed capital formation has increased by an average annual rate of 11 per cent since 2000, although this has declined a little in the past couple of years.

Investment accounts for almost half of total Chinese GDP; by comparison, investment in Australia accounts for almost a quarter of economic activity. In fact much of our recent investment has been in response to rising demand for iron ore, which has been necessary to facilitate Chinese infrastructure investment.

As a result, the outlook for Chinese investment is of central concern to not only Australian miners but also the broader Australian economy. Resource export growth will be a key determinant in whether our economy returns to trend growth and whether we can successfully transition away from a growth model that relied disproportionately on mining investment.

It should then be no surprise that the Reserve Bank of Australia published a recent piece on the outlook for Chinese investment in their quarterly bulletin. It presents a fairly bullish picture of investment, noting that “there is still some way to go before China achieves convergence with the provision of infrastructure seen in advanced economies”, including some other developing Asian economies.

The rural-city migration in China will continue to push the demand for greater and improved infrastructure. The government’s urbanisation plan targets an urbanisation rate of 60 per cent by 2020, which is an increase of 6 percentage points on its current level.

According to Chinese Vice Foreign Minister Wang Bao’an, a further 100 million people will migrate from agricultural and rural areas toward the cities by 2020, resulting in investment worth around 74 per cent of Chinese GDP divided over the next six years.

Those estimates only include the investment necessary to facilitate further infrastructure -- just one component of total investment. But it helps to highlight one risk to the investment outlook in China: the pace of urbanisation is beginning to slow.

For investment to contribute to growth, activity must increase year-after-year. If the pace of urbanisation slows, then this will weigh on the contribution investment makes to growth, even if by developed standards investment growth remains quite high.

Further weighing on demand is China’s anaemic population growth, which may begin declining over the next 10 to 15 years, as well as excess capacity through over-investment.

As Peter Cai noted last week, the Chinese economy is showing signs that it is determined to rein in excess capacity (Curbing China’s excess capacity, June 10). In May, the Ministry of Industry and Information Technology, which oversees the steel industry, said the country would need to cut an extra 1.7m tonnes of steel and 8.5m tonnes of cement in 2014.

In an ideal world, curbing excess capacity would be offset by greater household spending and higher productivity as a result of earlier investment. Unfortunately, this would be to the near-term detriment of Australian growth, since we produce very little that the household sector consumes.

Another concern for infrastructure investment is project selection and evaluation. According to the RBA, about 85 per cent of infrastructure investment in China is undertaken by the government -- a much higher share than is typical in other countries.

With the lack of price signals available, this gives rise to poor project selection and inadequate evaluation of alternatives. This is currently an issue in Australia and given the sheer level of investment in China, the likely costs must be far greater (The great infrastructure drain must be plugged, March 17).

There is also growing concern regarding the financing of infrastructure in China. This mostly relates to local governments, which sometimes lack the capacity to finance investment through revenue or via debt issuances. Chinese authorities are looking at a range of reforms to address this issue, which are discussed in detail in the RBA’s article.

For the Australian resource sector, the risk relates not just to Chinese demand but also to commodity prices. Obviously the two are related in a sense; high commodity prices and our elevated terms-of-trade were a direct result of high Chinese demand. But with greater supply coming online recently -- mostly from Australia -- iron ore prices have declined by over 30 per cent, presenting an existential risk for some domestic iron ore producers.

This is already weighing on margins across Australia’s resource sector and as The Australianreported yesterday, it has already claimed its first victim: the Cairn Hill iron ore project in South Australia. Fortescue remains at risk, with high levels of debt and a relatively high break-even of $72 per tonne (Fortescue gets another wake-up call, June 17).

Urbanisation will continue to drive demand for infrastructure investment in China but we shouldn't ignore the effects of population growth and the declining rate of urbanisation. Both will weigh on growth in the medium-term.

Of more immediate concern, however, is the excess capacity resulting from past investment. This points to softer demand for iron ore and coking coal and may result in commodity prices falling even further. This presents a near-term risk for the Australian economy, not just in the broadest sense but with regards to individual iron ore producers.

Hong Kong citizens cast their ballots in an unofficial referendum on democratic reform on Sunday, as booths opened across the territory in a poll that has enraged Beijing and drawn nearly 650,000 votes since it opened online.

Tensions are growing in the former British colony over the future of its electoral system, with increasingly vocal calls from residents to be able to choose who can run for the post of chief executive.

Hong Kong's leader is currently appointed by a 1,200-strong pro-Beijing committee. China has promised direct elections for the next chief executive in 2017, but has ruled out allowing voters to choose which candidates can stand.

Beijing and Hong Kong officials have dismissed the poll as illegal, but participation since voting began online on Friday has beaten all expectations despite a major cyber attack that the organisers have blamed on Beijing.

On Sunday, thousands of voters, some toting umbrellas in the pouring rain, turned out to physically cast their ballots at the 15 polling booths set up around the city.

"I am just acting in accordance with my conscience and this is for our next generation too. As I am not familiar with computers, I came to the voting booth," a 68-year-old retired teacher told AFP at a station set up at a teachers' union.

Another voter, 18-year-old Lau I-lung, said: "I am happy I can use a vote to determine the future system of elections. I think it can make a difference."

"People were lining up to vote. It shows that Hong Kong people have a strong desire for genuine democracy," said Benny Tai, one of the founders of the Occupy Central movement which organised the ballot.

The more than 603,000 who had voted both online and at the polling booths as of Sunday afternoon represent a sizeable chunk of the 3.47 million people who registered to vote at elections in 2012.

The poll allows residents to choose between three options on how the 2017 chief executive ballot should be carried out -- each of which would allow voters to choose candidates for the top job.

The "PopVote" website, built by the University of Hong Kong and Hong Kong Polytechnic University, suffered a large-scale attack last week that Tai and the pro-democracy press said could only have been carried out by Beijing.

Although the unofficial referendum has no legal standing, activists hope that a high turnout will bolster the case for reform.

"If the government decided to ignore people's call, indeed there may be a possibility of more radical action. I hope the government does not push Hong Kong people to that point," Tai told reporters.

Rimsky Yuen, the city's secretary for justice, on Sunday echoed the official stance that the vote "cannot be regarded as legally-binding, let alone be regarded as a so-called 'referendum'".

"For that reason, it can only be regarded as no more than an expression of opinion by the general public," Yuen said.

Occupy Central, a pro-democracy movement launched by local activists, has threatened to paralyse the city's financial district with thousands of protesters at the end of the year if officials don't produce an acceptable proposal.

The group is planning a massive sit-in mimicking the Occupy protests in cities such as New York and London in 2011, to force electoral guarantees from the authorities.

China's State Council, the equivalent of its cabinet, said on Friday that any referendum on how Hong Kong elects its leader has no constitutional basis and would be "illegal and invalid", state news agency Xinhua reported.

Hong Kong officials have also dismissed the vote -- which runs until June 29 -- and said it has no legal bearing.

Outside one polling station, a dozen pro-Beijing activists rallied against the referendum, shouting through loudspeakers at those going into the venue.

"The referendum is a hoax," protesters shouted.

A U.S. government group has released a report warning that investors face "major risks" if they buy shares in Chinese companies like e-commerce giant Alibaba Group Holding Ltd.

The report, released this week by a group that advises the U.S. Congress on U.S.-China economic issues, took aim at the legal structure underpinning Alibaba as well as a host of other Chinese Internet firms, calling it "a complex and highly risky scheme of legal arrangements." It warned that the structure was vulnerable to abuse by Chinese investors and could lead to losses by shareholders in the U.S.

"U.S. shareholders face major risks from the complexity and purpose" of the structure, said the report, released on June 18 by the U.S.-China Economic and Security Review Commission. The group has in the past issued critical reports about China.

The report comes amid a surge in Chinese Internet companies tapping the U.S. markets for capital. Alibaba has applied to U.S. securities regulators for approval for what might be the largest initial public offering in history, which could come as soon as this summer. An Alibaba spokeswoman declined to comment.

Other Chinese firms structured similarly include Baidu Inc., a longtime U.S.-traded search company sometimes called the Google of China, and Alibaba rival JD.com Inc., which listed in the U.S. last month. A Baidu spokesman said it thoroughly disclosed its structure in its filings. He referred to a Moody's Investors Service report from last month that said the search giant could successfully manage its VIE risk.

JD.com didn't immediately respond to requests for comment.

The U.S. government group's report focuses on a structure called a variable-interest entity, or VIE. Chinese companies seeking to sell shares on U.S. markets use the structure to circumvent Chinese government restrictions on foreign ownership of businesses in sensitive industries, including Internet-related businesses.

The VIE structure solves the problem of foreigners investing in prohibited industries by splitting companies into two entities. One, based in China, controls licenses and other assets required to do business in China. Foreign investors can buy shares in the foreign-listed parent of the second entity, which is based offshore.

Under a typical VIE structure, the Chinese entity pays fees and royalties to the foreign entity based on a series of contracts, thus ensuring the economic benefits of the Chinese operations flow to shareholders in the foreign entity.

The structure has drawn criticism from some corporate governance experts. They argue that it gives foreign investors little control over key assets of the company, which generally remain under the control of the Chinese entity and its owners. In a 2011 dispute that propelled the problems of VIEs into the spotlight, the individuals who controlled Alibaba's Chinese entity split off the assets of an important payments unit and put them under the control of Alibaba founder Jack Ma--over the objections of Yahoo Inc., a major shareholder in the foreign entity.

Experts say Alibaba and others have moved to address some of those concerns by shrinking the share of revenue that comes from the Chinese part of the VIE structure. In the fiscal year ended March 31, Alibaba said 11.8% of its revenue came from its VIEs.

"They've gotten the religion," said Paul Gillis, a visiting professor of accounting at Peking University's Guanghua School of Management and a vocal critic of the structure, referring to both Alibaba and JD.com. "Experts and regulators have been harping on the dangers of VIEs for the last several years. It's clear that both Alibaba and JD.com have structured VIEs to minimize that risk."

Still, in its IPO filing in the U.S., Alibaba warned that contracts between the Chinese and foreign-based entities "may not be as effective as direct ownership in providing us with control over our variable-interest entities." The Chinese entities that own important licenses and assets are controlled by Mr. Ma and not by Alibaba itself, the filing said.

Citing Alibaba's filings and other writings on the matter, the U.S. commission's report said many U.S. legal experts believe the VIE structure is illegal under Chinese law, though it added that Chinese officials haven't moved to stop them. It also argues that the contracts between the U.S. side and Chinese side of the structure are enforceable only if upheld by Chinese courts.

"For U.S. investors, a major risk is that the Chinese shareholder of the VIE will steal the entity, ignoring the legal arrangements on which the system is based," it said.

Beijing has neither endorsed the use of VIEs to circumvent ownership rules nor come out against them. China's courts haven't explicitly ruled against VIEs.

The Alibaba-Yahoo spat isn't the only time the VIE structure has led to disputes. In 2011, the founder of an online computer-games company successfully dissolved the relationship between its Chinese entity and the U.S.-listed company, after a Shanghai arbitration panel found in his favor, according to lawyers involved in the dispute. A person familiar with the matter has said the U.S.-listed company was GigaMedia Ltd.

Thirteen people were killed and three policemen were injured on Saturday morning in an attack on a police station in China's far western Xinjiang region, the local government said.

The assailants, called mobsters in the government report, drove an unspecified number of vehicles into a police building in Xinjiang's Kashgar area and set off an explosion, according to the official Tianshan website.

Xinjiang, which is home to the restive Muslim Uighur ethnic minority, has reported a series of violent attacks so far this year.

Saturday's incident came after a Chinese court earlier this week sentenced three people to death for their role in a deadly car crash off Beijing's Tiananmen Square in October, which authorities alleged was part of a series of terrorist attacks mounted by Uighur separatists from Xinjiang.  

China’s anti-monopoly regulator has rejected a proposed global container-shipping alliance, which involves a three-way tie-up between Denmark’s A.P. Moeller-Maersk, Mediterranean Shipping Co and CMA CGM SA.

It is the second time in recent months that Beijing has decided to flex its muscle and project its jurisdiction globally in mergers and acquisitions transactions. Global mining giant Glencore was forced to offload its high-quality copper asset Las Bambas in a bid to overcome Beijing’s reservations about its merger with Xstrata.

The proposed global shipping alliance, to be known as P3, called for three shipping companies to pool together 250 ships in order to address the problem of over-capacity and low charter rates in the industry since the start of GFC.

The three shipping companies would continue to retain their own separate pricing, sales and marketing teams to avoid the potential accusation of price collusion. The arrangement works a bit similar to the code-sharing arrangements between airlines, and the tie-up would allow shipping companies to cut billions in costs every year.

American and European anti-trust regulators both cleared the transaction and it was widely expected that the Chinese regulator would do the same until its ‘surprise’ rejection last week. The Chinese Ministry of Commerce, the anti-monopoly regulator, treated the operational joint venture as an effective merger between the three companies, which differed significantly from the analysis of its international peers.

Many legal experts believe that the Chinese regulator has not convincingly nor fully explained its decision to the parties and international observers.

“In light of MOFCOM’s failure to address the effort to adopt a structure which would preserve competition among the would be alliance partners, its decision already has been interpreted in some quarters as driven by an effort to protect domestic shipping companies from what would have been three more efficient rivals,” according to Davies & Polk, a Wall Street law firm.

A more important lesson that comes out of this decision is Beijing’s willingness and confidence to assert its jurisdiction globally in cases where it involves Chinese interests. Though it is only the second time that Beijing has blocked a deal since the country enacted its anti-monopoly laws in 2008, it is an indication of Beijing’s newfound confidence as well as power.

It was only back in April that Beijing effectively forced Glencore to divest its lucrative copper asset to a Chinese led-consortium before it would give its blessing to a proposed marriage between Glencore and Xstrata.

It is notable that neither Glencore nor Xstrata own or operate any assets in China. Nevertheless, Beijing finds that the combined market power of Glencore and Xstrata in exporting copper concentrate to China would have anti-competitive effect.

Beijing explains that the combined Glencore and Xstrata entity would be the world’s largest supplier of copper, with 9.3 per cent of market share globally and 12.1 per cent in the country. It is a large concern for Beijing as the country is heavily dependent on copper imports and China sources 68.5 per cent of its copper from abroad.

However, many lawyers have questioned Beijing’s willingness to find market power at relatively low levels. For example, the European Commission deems that players with less than 25 per cent of market share as not having an anti-competitive effect.

“The Las Bambas divesture demonstrates MOFCOM’s growing confidence as regulator and willingness to pursue an extraterritorial structural remedy where the case requires in it MOFCOM’s view, and notwithstanding that such a remedy might appear controversial to some,” according to Mayer & Brown, a international law firm.

For years, bankers and lawyers have to live with and take into account the extra-jurisdictional power of American and European regulators when it comes to global transactions. Americans have consistently used the country’s status as the global financial centre to impose its jurisdictions and laws on international banks. Now people have to take notice of a new and powerful kid on the block, China, which has shown a willingness to flex its muscle.

Despite the trend for MOFCOM to introduce more transparency and detailed explanations for its decision-making processes, its recent decisions seem to have differed considerably from its international sister agencies.

China is particularly sensitive about the fact that it is the world’s largest market for many commodities, including copper and iron ore. Any significant mergers between global mining players can expect close scrutiny from China.    

China's imports of copper and iron ore may drop due to an alleged financing scandal, as banks withhold credit and customs officials tighten checks on incoming shipments, metals traders say. 

Western banks are looking into allegations that a Chinese trading company illegally pledged metals as collateral to more than one lender.

The operator of Qingdao Port, the eastern Chinese port where the metals are stored, has confirmed that Chinese authorities are investigating allegations of fraud relating to stockpiles of metals. 

China's government hasn't commented publicly. 

Traders have used metals as collateral to bring in some $110 billion into China since 2010, Goldman Sachs estimates. That trade is a legal way to circumvent China's capital controls and has helped keep metal import volumes high even as China's economic growth has slowed. 

Now, traders say there are a number of disruptions to this trade related to the ongoing probe and China's efforts to tamp down big capital inflows that have fueled rapid credit growth. 

Customs officials are taking longer to clear metal imports since the allegations of fraud emerged, traders say. 

"Customs are taking anywhere from 15 to 20 days to up to a month to clear shipments of copper cathodes. Earlier, it used to take seven to 10 days," said a Qingdao-based metals trader, who didn't want to be named. 

Authorities were worried about the pace of growth of metals-backed financing even before the current allegations. In April, regulators raised concerns with local governments about the practice, which speculators have used to bet on higher Chinese interest rates.

That sent shivers through the market, traders said. In May, iron-ore imports fell 7 per cent from the previous month, while copper imports tumbled 16 per cent.

Imports in the months ahead could be even weaker, traders say. Many banks are starting to withhold letters of credit that are used in commodities financing, they add. 

"Things are getting worse and worse. Imports have shrunk in May. It could fall even further in June and July," said an executive with a Hong Kong-based commodities trading company.

"Already, people are finding it very difficult to open letters of credit for import of copper and other metals in banks in China." 

An estimated third or more of Chinese metal imports are believed to be used as collateral for loans from China's "shadow banks," a vast network of loosely regulated lenders. These stocks are rolled in and out of bonded zones instead of being used to feed actual demand. 

China is the world's largest importer of many commodities, and these imports represent one of the most closely watched indicators of economic activity in the world's second-largest economy. 

Copper stocks in bonded zones nationwide stand at around 800,000 metric tons, said Li Chunlan, a Beijing-based analyst with the metals consultancy CRU Group. At current prices, that's worth about $5.4 billion. 

Premiums on spot copper prices for immediate delivery from Shanghai warehouses have shrunk to $70 a ton, down by more than half from around $185 in December, a signal that more people want to sell rather than hold the stocks, said the Hong Kong-based executive. 

Three-month copper prices on the London Metals Exchange are down nearly 10 per cent since the start of 2014. After news of the probe broke two weeks ago, prices fell sharply but have remained mostly flat in recent days. 

Some traders say imports could fall more sharply from August. That's because purchases are made in advance and problems with financing now would take a couple of months to show up in lower physical shipments. 

Helen Lau, senior analyst with UOB Kay Hian, said prices could fall further if traders are forced to sell collateral to repay loans, dumping metals onto the market. 

"The market concern about copper prices is real. I am not saying copper prices will keep falling, but there is a downside risk. Prices will fluctuate. There will be no upside in copper prices in the near term," she said. 

Others say real demand for metals like copper and iron ore for industrial purposes will limit further declines in imports. 

The official probe so far appears confined to Qingdao, and another nearby port, neither of which is a major player in commodities financing compared to larger hubs like Shanghai. The probe is unlikely to discourage many traders who still want to import metal for use as collateral in legitimate financing plans, CRU Group's Ms Li said.

Activity in China's manufacturing sector has expanded for the first time in six months in June, according to a preliminary survey.

The HSBC China flash purchasing managers' index printed at 50.8 in June, up from 49.4 in May.

The reading came in well above forecasts. A survey of analysts by Bloomberg tipped a slight rise in the survey to 49.7.

The flash index is published ahead of final PMI data and is usually based on 85 per cent to 90 per cent of total survey responses each month.

HSBC chief economist China Hongbin Qu said the improvement in the PMI  was broad-based with both domestic orders and external demand sub-indices in expansionary territory.

"This month's improvement is consistent with data suggesting that the authorities' mini-stimulus are filtering through to the real economy," he said.

"Over the next few months, infrastructure investments and related sectors will continue to support the recovery.

"We expect policy makers to continue their current path of accommodative policy stance until the recovery is sustained."

In 2040, the world’s second largest population after India will be Chinese pensioners, numbering 400 million people, about the same size as the populations of the US, Britain and Australia combined. 

The proportion of people aged 60 or above will increase from one seventh of China's population to about one quarter within the next two decades. This will significantly increase the dependency ratio of the country as the proportion of working age people declines.

In 2012, China’s labour force declined for the first time in the country’s history, and the number of working age people shrank by 3.45 million people.  It is estimated that the number of working age people will decline by as many as eight million people a year from 2023 onwards as the country becomes increasingly grey.  (Is a labour shortage looming in China?, February 21.)

While the Chinese population is becoming older, the country’s women are not giving birth to enough babies to rejuvenate the population. China has one of the lowest birth rates in the world. In 2011, the birth rate was only 1.04 and it was just 1.18 the year before, according to data from the National Bureau of Statistics.

The birth rate in China is less than half of the world’s average and significantly below the fertility replacement rate of 2.2, which the country needs to maintain its current level of population. Models tells us if the current trend persists, China’s population could shrink by as much as one third between 2030 and 2070.

One of the main, if not principal, culprits for China’s dangerous demographic decline is the country’s notorious one-child policy. The country’s fertility rate been declining since the 1970s, when the policy was first introduced.

The one-child policy has left the country with the so-called '4,2,1' population structure, four grandparents, two parents and one child since the 1990s, leading to fewer workers and a lower fertility rate.

Having realised China’s dire demographic situation, Beijing decided to significantly scale back the one-child policy in November last year. Is it too late to reverse the damaging trend, and do people actually want to have more than one child?

Under the new policy, there are between 15 million and 20 million young people in China who are eligible to have a second child and of those people, between 50 and 60 per cent want to have a second child, according to a survey conducted by China’s Family Planning Commission.

Leading Chinese demographers, such as Cai Fang from the Chinese Academy of Social Sciences, predict the policy change will lead to a significant improvement in the country’s terribly low fertility rate. Cai believes the birth rate will bounce back to 2.4 if the change in one-child policy is implemented immediately. Even a gradual implementation would lead to a much healthier figure of 1.8, according to his interview with Caixin.

However, the reality on the ground is much less optimistic than what scholars are predicting. For example, Zhejiang province has a population of 54 million people, with a birth rate of 1.02, and it is one of the first local governments to scale back the draconian one-child policy.

If Cai’s prediction is right, there should be 360,000 new babies born in the province this year. However, only 27,549 eligible couples applied for approvals to have a second child by March 31, according to Caixin. In Jiangxi, a province of 45 million people, only 3,477 eligible couples applied to have another baby, according to Jiangxi Daily. 

In Sichuan, the country’s most populous province, with more than 80 million inhabitants, 28,464 couples applied and only 5,530 of the applications were approved. In Chongqing, a mega-city in the southwest, only 6,780 couples applied, and 4,431 received approval.

In Beijing, Shanghai and Tianjin, three of the largest, most affluent cities in China, with the lowest fertility rates, only 2,300, 1,730 and 3,985 couples lodged their applications with the family planning authorities, according to a detailed investigative report by Caixin.

The lukewarm response to the change in policy shows that the government has significantly overestimated peoples' willingness to bear more children. The early data is particularly concerning given that people are expecting more couples to apply for permission to have more children in the first few months after the change in policy.

Preliminary results show that the change in the one-child policy will not result in a significant improvement in China’s dire demographic challenge. It looks like Beijing’s change of heart is too little, too late. China’s highly effective family planning policy is starting to look more and more like a case of winning the battle, but perhaps losing the war.

The Communist Party's flagship newspaper on Monday warned foreign investment banks, speculators and domestic property developers from taking "overly pessimistic views" about the housing market.

A commentary in the overseas edition of the People's Daily warned there were individuals with "ulterior motives" who wanted to disrupt the market and force the government to loosen curbs put in place to keep prices in check.

"The property market is undergoing a normal correction and we have to be vigilant against those with ulterior motives who are talking down the market [in an effort] to disrupt it, mislead policy and meet the demands of private interests," the paper said.

The purpose of these pessimistic comments is "to pressure the government into loosening home purchase restrictions, ease credit and launch other moves to rescue the market so that developers can continue to benefit from high property prices...," the commentary said.

The domestic edition of the newspaper didn't use the same commentary though it published a separate article by Yu Liang, president of big developer Vanke Property, repeating his view that the housing market is no longer in its golden age though it is now entering a "silver age."

"While the property market has left behind its golden age it is not a Titanic about to collide with an iceberg," Mr Yu said referring to recent comments by Soho China's Chairman Pan Shiyi describing the dangers ahead of the market.

The overseas edition of the paper also criticized those who hoard apartments--adding that many of those who have been negative publicly are actually trying to buy up property at the market bottom.

"It is a trick they have been using for years and it's no longer surprising," the paper said.

It specifically named reports from Societe Generale, Morgan Stanley, Nomura Securities and UBS as talking down the property market though it didn't specifically say they had ulterior motives.

The property market is an important driver of economic growth and its recent weakness has had a knock-on effect on construction, steel and furniture.

Policy makers have tried to curb speculation and keep already-high prices from climbing while trying to ensure first-time home buyers have adequate financing.

A flurry of Chinese companies, including a drug maker and a real-estate developer, launched Hong Kong initial public offerings seeking to raise as much as roughly US$1.2 billion and capitalize on recent gains in the city's stock market.

Luye Pharma Group Ltd., partly owned by a group of private-equity firms, is seeking to raise up to US$764 million in the biggest of the Hong Kong IPOs launched in recent weeks. Hong Kong's benchmark Hang Seng Index is up 5% since the start of May.

Tian Ge Interactive Holdings Ltd., operator of a social-media video platform, and Guorui Properties Ltd., a Beijing property firm, also began raising funds for IPOs on Monday. Tian Ge, which is backed by Sina Corp., is raising up to US$208 million; Guorui Properties aims to raise as much as US$242 million.

Luye Pharma, whose shareholders include CDH Capital, Citic Private Equity and New Horizon Capital, delisted from the Singapore stock exchange in 2012. The deal will be CDH's first Hong Kong offering since the IPO of WH Group, the Chinese pork producer that bought Smithfield Foods Inc. in 2013, was withdrawn in April due to a lack of demand from investors.

CDH was the biggest shareholder in WH Group.

Conditions in Hong Kong's IPO marked have improved since then, partly due to lower pricing. Of 11 IPOs in Hong Kong since the start of May, only two have fallen below their offering prices. Train maker China CNR Corp. is down 1.9% from its float price, and port operator Qingdao Port International Co. has declined by 5.9%.

In contrast, many of the big IPOs that made their debuts in Hong Kong before May are struggling. HK Electric Investments, a trust holding billionaire Li Ka-shing's electricity business, is down 3.5% from its IPO price, while China Everbright Bank, which raised $3.2 billion at the end of last year, is trading down 11% from the level at which it was listed. HK Electric's US$3.11 billion IPO in January remains the world's biggest so far this year.

"Investment sentiment towards IPOs has improved in recent months as most of new firms are listed at reasonable valuations," said Conita Hung, a director at Hong Kong-based Amicus Asset Management Ltd.

The less aggressive pricing is working. Colour Life Services Group, a Chinese property-management company, raised US$122 million on Monday after pricing its Hong Kong IPO at 3.78 Hong Kong dollars (49 U.S. cents) a share, near the middle of the range that had been indicated to potential investors. The firm is scheduled to list in the city on June 30.

Luye is selling 999.6 million shares, of which 33.2% are from existing shareholders, at between HK$5.38 and HK$5.92 a share, according to a term sheet seen by The Wall Street Journal. The price represents 24.2 times to 26.6 times the company's forecast earnings for 2014.

CDH, Citic Private Equity, New Horizon, Government of Singapore Investment Corp. and Luye Investment, which is controlled by Chairman Liu Dian Bo, will sell part of their stakes in the offering, according to the term sheet.

The drug maker, which started taking orders from institutional investors Monday, has lined up six so-called cornerstone investors to buy US$280 million of shares, or 37% of the maximum offering size. They include Hong Kong-based asset-management firm Value Partners Group Ltd., which has agreed to acquire US$100 million of the IPO. Cornerstone investors receive large allocations of IPO stock, but commit to holding the stakes for six months after a company has listed to build confidence among other investors.

Tian Ge, whose live video content ranges from music to talk shows, has also managed to secure a total of US$80 million in cornerstone purchases, or 38% of its maximum fundraising size, from 10 investors. The buyers include New York-listed Chinese Internet firm Qihoo 360 Technology Co., fund manager Atlantis Investment Management Ltd., and Hong Kong health-care network Town Health International Medical Group Ltd. Online media company Sina owns around 33% of Tian Ge, according to the listing candidate's preliminary prospectus.

Guorui Properties joins a couple of bigger property developers from China seeking Hong Kong listings. China Vanke Co., the country's largest property developer by revenue, said Monday it plans to list by introduction on Wednesday, meaning it won't issue any new shares or raise funds.

A flurry of Chinese companies, including a drug maker and a real-estate developer, launched Hong Kong initial public offerings seeking to raise as much as roughly US$1.2 billion and capitalize on recent gains in the city's stock market.

Luye Pharma Group Ltd., partly owned by a group of private-equity firms, is seeking to raise up to US$764 million in the biggest of the Hong Kong IPOs launched in recent weeks. Hong Kong's benchmark Hang Seng Index is up 5% since the start of May.

Tian Ge Interactive Holdings Ltd., operator of a social-media video platform, and Guorui Properties Ltd., a Beijing property firm, also began raising funds for IPOs on Monday. Tian Ge, which is backed by Sina Corp., is raising up to US$208 million; Guorui Properties aims to raise as much as US$242 million.

Luye Pharma, whose shareholders include CDH Capital, Citic Private Equity and New Horizon Capital, delisted from the Singapore stock exchange in 2012. The deal will be CDH's first Hong Kong offering since the IPO of WH Group, the Chinese pork producer that bought Smithfield Foods Inc. in 2013, was withdrawn in April due to a lack of demand from investors.

CDH was the biggest shareholder in WH Group.

Conditions in Hong Kong's IPO marked have improved since then, partly due to lower pricing. Of 11 IPOs in Hong Kong since the start of May, only two have fallen below their offering prices. Train maker China CNR Corp. is down 1.9% from its float price, and port operator Qingdao Port International Co. has declined by 5.9%.

In contrast, many of the big IPOs that made their debuts in Hong Kong before May are struggling. HK Electric Investments, a trust holding billionaire Li Ka-shing's electricity business, is down 3.5% from its IPO price, while China Everbright Bank, which raised $3.2 billion at the end of last year, is trading down 11% from the level at which it was listed. HK Electric's US$3.11 billion IPO in January remains the world's biggest so far this year.

"Investment sentiment towards IPOs has improved in recent months as most of new firms are listed at reasonable valuations," said Conita Hung, a director at Hong Kong-based Amicus Asset Management Ltd.

The less aggressive pricing is working. Colour Life Services Group, a Chinese property-management company, raised US$122 million on Monday after pricing its Hong Kong IPO at 3.78 Hong Kong dollars (49 U.S. cents) a share, near the middle of the range that had been indicated to potential investors. The firm is scheduled to list in the city on June 30.

Luye is selling 999.6 million shares, of which 33.2% are from existing shareholders, at between HK$5.38 and HK$5.92 a share, according to a term sheet seen by The Wall Street Journal. The price represents 24.2 times to 26.6 times the company's forecast earnings for 2014.

CDH, Citic Private Equity, New Horizon, Government of Singapore Investment Corp. and Luye Investment, which is controlled by Chairman Liu Dian Bo, will sell part of their stakes in the offering, according to the term sheet.

The drug maker, which started taking orders from institutional investors Monday, has lined up six so-called cornerstone investors to buy US$280 million of shares, or 37% of the maximum offering size. They include Hong Kong-based asset-management firm Value Partners Group Ltd., which has agreed to acquire US$100 million of the IPO. Cornerstone investors receive large allocations of IPO stock, but commit to holding the stakes for six months after a company has listed to build confidence among other investors.

Tian Ge, whose live video content ranges from music to talk shows, has also managed to secure a total of US$80 million in cornerstone purchases, or 38% of its maximum fundraising size, from 10 investors. The buyers include New York-listed Chinese Internet firm Qihoo 360 Technology Co., fund manager Atlantis Investment Management Ltd., and Hong Kong health-care network Town Health International Medical Group Ltd. Online media company Sina owns around 33% of Tian Ge, according to the listing candidate's preliminary prospectus.

Guorui Properties joins a couple of bigger property developers from China seeking Hong Kong listings. China Vanke Co., the country's largest property developer by revenue, said Monday it plans to list by introduction on Wednesday, meaning it won't issue any new shares or raise funds.

Lowy Interpreter

So China's economy will soon overtake the US in PPP terms.

Some commentators believe market-rate calculation is more meaningful than PPP, and forecast that on this basis China still is decades away from catching America. For here is a remarkable fact: the equity market capitalisation of the US is US$23 trillion compared to China's US$3 trillion. In other words, the market value of shares in listed American companies is roughly eight times that of China.

There are several possible explanations for this astonishing differential.

Perhaps the US stockmarket is overvalued while China's is undervalued. Not all Chinese companies are listed on an exchange, including some of the best ones (notably Huawei and Alibaba, although the latter soon will be). American companies are more seasoned and experienced. They are run solely for profit, while Chinese ones serve broader stakeholder objectives. And while China's PPP output may rival America's, it does so with different inputs: more labour and less capital. So China's capital stock should accordingly be valued less.

All are valid points. But there is a deeper explanation that reveals a stark contrast between American and Chinese capitalism: capital structure.

Capital essentially comes in two flavours: debt and equity. Debt is a real obligation, while equity is a residual, a leftover to reward shareholders. 

China's mix of capital is heavy on debt and light on equity; its corporations are among the world's most leveraged. The debt load they carry weighs down their equity. Why Chinese companies have taken on so much debt is easy to understand: financial repression (keeping interest rates low) has made debt cheap, especially for state-backed borrowers. Lenders assumed that such companies could never go bust. Chinese industry splurged on investment and now faces over-capacity, which has depressed profits and slowed the accumulation of equity. Now facing liberalised interest rates, weaker companies are in a gearing spiral.

Chinese banks are worried. They play a hugely important role in financing China, which doesn't yet have a well developed market for debt.

They also play an outsized role because of their own leverage: a dollar of bank equity can mobilise $10 of credit in the economy. Both banks and their customers have stretched their equity. But now that parts of China's economy are struggling, confidence in the banks' balance sheets has faded too. Some estimates suggest that total bank losses could go as high as US$3 trillion. Maybe we'll never know the true extent of damage, but Chinese banks are concerned enough about their eroding capital that they are raising more money. The deficiency of bank capital is like a hole in the heart of China's economy.

What China's banks really need is true equity, the residual capital that absorbs the ups-and-downs of the business cycle.

But because of waning investor confidence, bank stocks are now valued by the market below their book value. Under Chinese law, state property can't be sold at less than cost. So banks are unable to raise new equity at current prices. Regulators reluctantly allowed a new wheeze to circumvent this restriction. At least two large banks, ABC and BOC, are marketing 'preferred stock', which is a hybrid form of capital that lies between true debt and true equity. A whopping US$100bn worth of preferred stock reportedly is on its way. Preferred stock counts as bank capital under international rules, but it's seen as a controversial accounting fudge, discredited after the GFC experience.

The key technical question is 'loss absorption', which is exactly what it sounds like: do the holders of this weird hybrid capital (also known cynically as 'junk' capital) take the pain if the bad debts start rolling in?

Indeed, risk of loss is the root problem. Both Chinese industry and banks lack real equity. The economy is highly credit intensive, yet banks must continue underwriting loans to keep it running. But investors have lost confidence in the true state of the banks, which are in turn forced to issue junk capital. Investors are unwilling to buy it except at a high price, perhaps 7-8 per cent per annum for the best banks, which means 10 per cent or more for the weaker ones. No investor really expects a state-owned bank to go bust (if they did they'd demand a lot more than 7 per cent) but they are nonetheless scared of corporate losses piling up at the banks.

Under China's bold new economic reforms, it still isn't clear whether and how major financial losses will be permitted. Beijing needs somehow to untangle this knot and begin the recapitalisation of the banks and the entire economy: more equity, less debt.

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.

Trade Minister Andrew Robb is confident the free trade agreement with China will be completed this year.

Mr Robb and Treasurer Joe Hockey are in Beijing this week for the inaugural Australia-China Strategic Economic Dialogue.

Part of that visit included discussions with the chairman of the National Development and Reform Commission (NDRC), Xu Shaoshi, a body that plays a central role in setting China's strategic economic direction and manages investment within and outside China.

Mr Robb said the chairman has indicated the NDRC will be active in concluding the FTA.

"The conclusion was it was do-able this year, it could be completed and both governments are determined to bring it to completion later this year," Mr Robb told reporters.

Earlier this year, Prime Minister Tony Abbott signed FTAs with South Korea and Japan, which allow for liberalised two-way trade with Australia.

Mr Hockey said the meeting had been very productive where discussions included the economic growth target that was agreed in Sydney earlier this year under Australia's G20 2014 presidency.

There was also an aim for closer financial relations, including Australia's desire to have a clearing bank for renminbi trading.

"There are tremendous opportunities to deepen the relationship at a number of levels, in particular expanding services exports from Australia to China," Mr Hockey said.

Under a suggestion made by Chairman Xu, there was an agreement to create an investment co-operation framework which is expected to be completed by the time of the G20 summit in November.

"It will give us a significant road map going forward on significant investment issues," Mr Robb said.

BEIJING -- Australia and China will create an investment cooperation framework to identify key areas and projects to improve the countries’ investment relationship, Treasurer Joe Hockey and Trade Minister Andrew Robb announced in Beijing on Tuesday.

The framework will identify individual projects and areas where the two countries will give each other particular consideration, Mr Robb said.

The investment cooperation framework is separate to the discussions about a free-trade agreement with China, which Trade Minister Andrew Robb is confident will be completed this year.

Mr Hockey and Mr Robb made the comments following a Beijing meeting on the first annual strategic economic dialogue between China and Australia, with the powerful National Development and Reform Commission’s chairman, Xu Shaoshi.

And demand for new projects in Northern Australia was a particular area that “created a lot of interest” in discussions with Mr Xu, Mr Hockey said.

Mr Robb said he identified multiple industries outside of resources and mining including agriculture and services such as health, medical research, tourism and ageing as well as infrastructure as areas China could invest in.

Meanwhile, Chairman Xu suggested the NDRC would be active in helping to conclude that free trade agreement before the year’s close.

"The conclusion was it was do-able this year, it could be completed and both governments are determined to bring it to completion later this year," Mr Robb told reporters.  

"There is a negotiation, so anything can happen. But we're both confident and we went through in some detail what ground had to be covered, including agriculture," Mr Robb said.

The investment cooperation framework would be concluded by the time President Xi Jinping visits Australia for the G20 summit in Brisbane in November, he added.

That framework will be based on the strategic economic dialogue, which will be held this year.

Mr Hockey has extended an invitation to Mr Xu to attend that meeting.

The Abbott government has pledged a free trade agreement with China will be reached by the end of the year that would follow the completion of deals with South Korea and Japan.

Mr Hockey met with People's Bank of China Governor Zhou Xiaochuan on Monday to discuss closer financial relations including the establishment of a clearing bank in Australia.

Chinese e-commerce giant Alibaba’s upcoming IPO on the New York Stock exchange is widely expected to be the largest ever in US history. But just how much risk are investors willing to take on to get a piece of the action?

Just last week a US Congressional Commission report warned that shareholders face “major risks” from investing in Chinese internet companies like Alibaba that use a variable interest entity structure to get around China’s foreign ownership laws.

Foreign ownership is prohibited in key areas of the Chinese economy including in finance, media, education and the internet. In essence foreign companies are not legally eligible to run an internet business in China such as Alibaba. So they have to enter into a set of contractual agreements -- the VIE -- with Chinese nationals who hold the licences to reap economic benefits from its investment and exercise indirect control.

Here, for example is the VIE structure of Weibo, China’s leading micro-blogging website.

When foreign investors buy shares of Weibo on the NASDAQ, they are buying into Weibo Corporation in the Cayman Islands. That company is then linked to a string of other companies through a byzantine series of contracts that attempt to mimic the conventional control normally obtained through ownership.

The result is an extremely precarious situation in which Chinese regulators are told the business is Chinese-owned and foreign investors are told they own it. As the US-China Economic and Security Review Commission report states: “Neither claim is technically true, and the arrangement is highly risky and potentially illegal in China.”

Because of the shaky ground the structure is built upon, "the contracts are only binding and enforceable if Chinese courts are willing to uphold them", the report says. The major risk for US investors is “that the Chinese shareholder... will steal the entity, ignoring the legal arrangements on which the system is based" it said.

The report highlighted that Alibaba’s filings with the Securities and Exchange Commision ahead of its IPO indicate that it will use VIEs as well as a dual share preferential stock structure that consolidates control of the company with its founders in China. 

"Alibaba's controversial history, with its first major foreign investor Yahoo, sheds light on the risks US investors face in buying into Chinese internet companies under the VIE structure," it said.

In 2011, Alibaba CEO Jack Ma secretively spun off Alipay from Alibaba Group, placing it under his own control in what has been the most high-profile case of the VIE structure being used against the interests of its foreign investors.

Legal developments in China in the past couple of years have prompted regulatory bodies in the US and Hong Kong to demand more assurances from Chinese companies that they have a solid legal grounding for the use of the structure.

The first major warning came in October 2012, when China’s Supreme People’s Court invalidated similar contracts between Chinachem Financial Services, a Hong Kong company, and China Small and Medium Enterprise Investment, a mainland Chinese firm. The Supreme Court ruled that the agreements between the two companies were invalid and aimed to circumvent Chinese laws and regulations. The arrangement, the ruling stated constituted “concealing illegal intentions with a lawful form.”

Despite there being a number of other decisions that seem to indicate VIEs have completely fallen out of favour in China, the recent spate of Chinese companies listing on overseas bourses suggests Chinese regulators have tacitly approved it, says Paul Gillis, a visiting professor of accounting at Peking University’s Guanghua School of Management.

“I’m expecting to see reform some time in the next year or two which will regularise these structures and basically make them unnecessary,” says Gillis.

Closing the regulatory loophole would not only benefit foreign investors but Chinese investors too, he says.

“If China allowed direct investment into the internet sector, those same Chinese companies could get listings on China’s stock exchanges and sell their shares to Chinese people.”

It’s unlikely that investors’ appetite for the upcoming Alibaba deal will be dampened by concerns over the company’s structure. Gillis, who is no fan of the structure, says it has done as much as they can to minimise the amount of business that they conduct within the VIE.

“What we have seen in the past is that the highest risk VIE structures are those where the entire business is operated in the VIE because in those situations, it’s much easier for the owner of the VIE to simply take the business and disregard the contract.”

In a letter to employees at the time of the Alibaba IPO filing, Ma said that “a public listing has never been our goal” but was merely “a gas station along the road to the future” and that after going public, the company would continue to adhere to the principle of “customer first, employee second, shareholder third.” 

Until real reforms are made, investors will need to decide just how much they trust Jack Ma to look out for their interests.

Haworth’s Beijing showroom, in the landmark Parkview Green building.

Making and selling furniture in China is a tough business, there are over 15,000 registered furniture manufacturers in the world’s factory. And if you want to have a textbook definition of what perfect competition looks like, furniture manufacturing in China is a good example of that.

However, there is a Western company that is making headway in this crowded space and growing its business in a tough environment. Haworth is an American office furniture supplier with operations across the globe, including China and Australia.

China Spectator spoke to Frank Rexach, vice president of the company’s Asia Pacific, Middle East, Africa and Latin America operations, to find out what it’s like to carry coal to Newcastle and make money.

Rexach, who has been running the company’s regional operations from Shanghai, says rule number one is to pursue a “premium” strategy. “If you want to go in and be the lowest cost manufacturer, you will get killed,” he said. “There is no question about it.” 

Anybody who is in the middle is going to get eaten from below and we don’t want to be there. We want to be at the top end and that is where you are going to make a difference.” 

The company supplies big multinationals in China such as HSBC, Australia and New Zealand Banking Group, Standard Chartered and Microsoft and Chinese "red chip" companies such as ICBC, the world’s largest commercial bank by market capitalisation and Sinopec, a large state-owned oil company. At the moment, about two thirds of its revenue comes from Western companies, and the rest is from Chinese clients.

Rexach says the future growth potential will come from big Chinese companies like Alibaba and Tencent, two of the largest internet companies in the world. “We are really trying to penetrate these companies,” he told China Spectator.

His optimism is based on two large emerging trends: the globalisation of Chinese companies and the increasing brand awareness in the world’s second largest economy.  Many of China’s leading firms are going abroad, from mining companies looking for raw materials to tech giants who want to flex their muscles beyond home market.

“I think these companies will end up acquiring a lot of global brands,” he said. “My kids are using WeChat and can’t believe people still use Facebook.” Wechat is one of China’s most popular instant messaging apps, with more than 355 million active users and has recently formed a partnership with Google to expand into the US.

Globalisation of Chinese companies means they also demand more cosmopolitan office space, work environments, and hopefully Haworth's custom-made furniture.

The Chinese office environment is out of sync with China’s increasingly international and upwardly mobile workforce. “They want to have the same cool space that is here in Australia,” he said. “People want to have the freedom to work everywhere, because they are using mobile devices and so you can’t handicap them with this whole cubicle world.”

The broader trend is that the Chinese are becoming increasingly aware of global brands; in fact, they are responsible for about one quarter of global consumption of luxury goods. “People who are buying the real Burberry, Louis Vuitton are Chinese, and we are the one who are buying all the fakes,” he said with laughter.

The key to Haworth’s success in China is about its focus on marketing, quality design and a premium brand image. The company designed and supplied furniture to the players’ lounge at Shanghai Master Tournament, using it as a show room for potential Chinese clients.

Rexach said when the company first went into China, management made a conscious decision not to be a manufacturing-driven company. “We want to be a marketing driven company and we want to add value where our competitors can’t,” he said.

“There is this awareness of brand and there is this appreciation of design,” he said, “they are beginning to see the importance of environment, quality, leather and everything. We are just getting to this wave we are going to catch,” he said.

With rising wages, land prices and other costs of production, many foreign companies in China are talking about the need to relocate to other cheaper places like Southeast Asia, but it not easy to replicate China’s well-developed logistics and infrastructure network.

“Wages are still a small part of the overall product cost,” he said,” the market itself is so big in China and the lead time in our industry is short and we need to manufacture in China.”